Delta Associates Trend Lines 2010

TRENDL INES®

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Identifying Opportunities During the RecoveryTrends in Washington Commercial Real Estate

You may neither copy nor disseminate this report. If quoted, proper attribution is required.To order your copy of TrendLines, contact the Publications Administrator at 703.836.5700.

A Collaborative Publication of Delta Associates,Partners in Excellence with Transwestern

© 2010. All Rights Reserved.

We are pleased to provide you this thirteenth annual edition of TrendLines®: Trends in Washington Commercial Real Estate. This is a collaborative publication of Transwestern and its research affi liate, Delta Associates. Our purposes are to distill the trends of 2009 and to shed light on pivotal forces and issues that we believe will affect the region’s economy and commercial real estate in 2010 and beyond.

2009 was a challenging year. Capital was in short supply as many loans came due. Owners cut rental rates to maintain occupancy and as a consequence values declined in all commercial product types. Only Class A apartment assets did not see a decline in occupancy during the year. And yet condominiums performed as we projected last year: an improvement in performance over 2008.

Despite the hardships, the Washington real estate market survived 2009 better than any other major metro market. The Federal government ramped up hiring, and is scheduled to continue that trend in 2010. Investors domestic and foreign have come to Washington and bid down cap rates at the end of the year. And many owners have used the downturn to position assets with improvements to compete better and operate more effi ciently.

We believe 2010 is a unique opportunity to:

Buy assets at below replacement cost with low-cost debt or with readily available equity.

Reposition existing under-performing assets, whether yours or others, to draft-up in the coming recovery.

Position now for development in the next cycle – for delivery in 2010 through 2013, depending on the product type.

The diffi culties of 2009 give this annual publication, TrendLines, even greater importance. It can shed light on the path forward during a

challenging time in our industry. What are the signposts to look for in the period ahead, indicators that can shape our approach to the future? We address this topic in Section One of this report. With regard to overall market performance, our expectations for 2010 include:

National and Regional Economy: A stabilizing job market, with consistent growth beginning in 2010.

Offi ce Market: Rising vacancy through mid-2011, followed by a need for spec development by 2013 as demand returns. Many tenant-driven opportunities before then thanks to BRAC, GSA, and corporate moves.

Retail and Flex/Industrial Markets: Stabilization in 2010; spec development warranted by 2012.

Rental Apartment Market: Rising vacancy and declining rents through 2010, but improvement in 2011 as supply and demand return to balance. Rent spikes in some submarkets by 2013 as product shortages emerge.

Condominium Market: Price increases in some submarkets this year, with some conversions due to product shortages.

Capital Markets: Gradually rising volumes as credit and product begin to reappear. Values likely will decline further in 2010 as property performance remains a challenge in many areas.

Overall: More opportunities in our industry in 2010 than we found in 2009. The volatility will continue to require patience, cash, vision and an appetite for risk.

Thank you for your interest in our research and other services, including brokerage, property management, investment sales, and development. We look forward to helping you interpret everything you see in the market, and to being your service partner in the period ahead. Best wishes for a successful 2010.

Foreword

To our friends, clients and colleagues:

February 2010

Th omas NordlingerPresident, Mid-Atlantic Region

Gregory H. Leisch, CREChief Executive

To Our Clients and Business Associates:

As a leader in our business community for more than 30 years, Beers + Cutler is once again proud to support TrendLines. But this year, you may notice something a bit different about our presence at TrendLines.

Since we convened last February, Beers + Cutler has merged with Baker Tilly. While the name has changed, our level of commitment and dedication to our clients’ business needs remains the same. The team of talented professionals that has built trusted partnerships with our clients over the years will continue to work with them in the future.

All of us are excited about this new opportunity and new chapter in the history of our fi rm. Jim Beers and John Cutler started something very special back in 1976 when they came together to create their own fi rm. Over the years, we have all taken pride in ensuring the Beers + Cutler name stood for the highest levels of service and quality in the delivery of tax, assurance and consulting services. As the marketplace evolves, we believe becoming part of a national fi rm with a greater breadth and depth of resources will serve our real estate clients well and position us for continued success.

While our region has fared better than many areas around the country, the past 18 months have been like no other period in recent memory, and there is no doubt that the turbulent economy has signifi cantly impacted the local real estate market. However, the Washington region continues to be well-positioned to thrive long term.

As the unpredictable market continues, we will be right here with you, advising on ways to navigate through this diffi cult environment and gain a competitive edge. Serving as business and tax advisors to the real estate industry since the mid-1970’s, we draw upon our experiences with many of the region’s top companies to assist in creating tax-effi cient ownership structures and developing planning alternatives. We also identify opportunities by being experts in the industries we serve and in the areas of Federal and state tax laws that impact our clients.

We look forward to continuing our work with the entrepreneurs who are the foundation of the Metro Washington real estate industry, as well as investors – foreign and domestic – who recognize our area as one of the most desirable markets in the United States.

To learn more about how we can help you manage your business in today’s changing marketplace, please contact us.

Very truly yours,

Kelly P. [email protected]

Dear TrendLines Participant:

PNC is once again proud to sponsor the 2010 TrendLines® report, the premier resource for our region’s commercial real estate professionals.

In today’s rapidly evolving real estate environment, having access to timely market knowledge is critical to running your business. For years, the TrendLines report has been such a source, delivering a valuable overview of the Washington, D.C. real estate market.

Equally critical is having confi dence in your lender, an institution that has experienced varied economic cycles and has always been available to its customers. PNC is one of those lenders.

PNC has been part of the Washington, D.C. real estate community for decades, delivering one of the industry’s broadest platforms of products and services – including construction, interim, and permanent fi nancing, along with access to the capital markets, treasury management services and the comprehensive capabilities of PNC Real Estate, from multifamily debt and equity expertise to best-in-class third party loan servicing, asset management and technology solutions for the commercial real estate industry provided by Midland Loan Services, Inc.

With our acquisition of National City Corporation, PNC is now one of the nation’s top fi ve banks by deposits and branches. Our strength lies not only in our size, but in the innovative way in which we deliver products and solutions to help you achieve your goals.

To learn how we can bring ideas, advice and solutions to you, call us or visit www.pnc.com/realestate.

Sincerely,

Michael N. Harreld William R. Lynch IIIPresident Senior Vice PresidentPNC Bank – Greater Washington Area PNC Real Estate Finance202.835.5513 [email protected] [email protected]

Acknowledgments: The editor, Gregory H. Leisch, CRE, wishes to acknowledge

and thank this project’s research team at Delta Associates: Alexander (Sandy)

Paul, President of the Transwestern Support Group and National Research

Director; and Elizabeth Norton, Mid-Atlantic Research Director. The creative

design team at Transwestern and the administrative staff at Delta have our

gratitude. Most of all, our appreciation is hereby expressed to the dozens of

industry leaders who spent their valuable time responding to questions about

the future of our industry here in the Washington area.

Representations: Although the information contained herein is based on sources

that Delta Associates (DA) and Transwestern (TW) believe to be reliable, DA and

TW make no representation or warranty that such information is accurate or

complete. All prices, yields, analyses, computations, and opinions expressed

are subject to change without notice. Under no circumstances should any such

information be considered representations or warranties of DA or TW of any

kind. Any such information may be based on assumptions that may or may not

be accurate, and any such assumption may differ from actual results. This report

should not be considered investment advice.

TrendLines®: Trends in Washington Commercial Real Estate was designed in-houseby Ji Chang, Lauren Dean, and Brent Weigelt for Transwestern and Delta Associates.

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IdentifyingOpportunities During

the Recovery

Table of Contents

Section One Identifying Opportunities During the Recovery 9

Section Two Th e National Economy 25

Section Th ree Th e Washington Area Economy 39

Section Four Th e Washington Area Offi ce Market 51

Section Five Th e Washington/Baltimore Flex/Industrial Market 63

Section Six Th e Washington Area Apartment Market 71

Section Seven Th e Washington Area Condominium Market 83

Section Eight Th e Washington Area Retail Market 91

Section Nine Capital Markets and Investment Trends 103

Section Ten TrendSetter Award Recipients 111

Identifying Opportunities During the Recovery 7

9

Identifying Opportunities

During the Recovery

10 Section One

The purpose of TrendLines® is to distill the trends of 2009 and shed light on pivotal issues that shape our commercial real estate opportunities in the Washington marketplace in 2010 and beyond. With many describing 2009 as annus horribilis, perhaps just surviving the year was enough. But we view events of 2009 as having set up 2010 as a year with remarkable opportunities.

While it is always instructive to review the year past – and we do in this TrendLines – we prefer to use this opportunity to look ahead. Specifi cally, how can we in the real estate industry identify profi table opportunities during the recovery, and position ourselves now for intermediate and long-term success?

The 44th president was sworn into offi ce at the beginning of 2009 on the slogan “Yes We Can,” replacing a leadership with one of the worst approval ratings in history.

The American Recovery and Reinvestment Act (ARRA), a $787 billion economic stimulus plan, was signed into law in February – making a promise to create or save 3.5 million jobs over the next two years.

To aid the ailing automobile industry, in July the government enacted a car allowance rebate, “Cash for Clunkers,” which provided $3 billion in incentives for vehicle trade-ins.

The hope of the early part of the year was consumed by some diffi cult realities:

Only $257 billion of the $787 billion in stimulus money had been allocated by year-end, according to Recovery.gov.

In this chapter, we identify three opportunities and four signposts to watch, so as to know if we are on track. The balance of this report drills down to each property type to get more specifi c about trends and opportunities for each.

First, let’s take a macro view of trends of the past year and decade as a background to our overall identifi cation of opportunities and signposts.

2009: Began as a Year of Hope; Concluded with “Let’s Hope This Year Just Ends”

The nation entered 2009 with a fi nancial hangover from the year prior. However, a handful of positive indicators gave hope to the nation that 2009 would be a year of positive change:

Identifying Opportunities

During the Recovery


American Recovery and Reinvestment ActOverview of Funding

Source: Recovery.gov, Delta Associates; January 2010.

Bernie Madoff stole $65 billion from investors in an elaborate Ponzi scheme.

Bankruptcy fi lings increased to 1.4 million in 2009, a 32% rise from 2008.

Unemployment continued to rise, from 7.4% at December 2008 to 10.0% at December 2009.

Foreclosures increased 21% in 2009, to 2.8 million properties receiving at least one foreclosure fi ling, according to RealyTrac.

Total retail sales declined 6.2% in 2009.

Washington Fared Better But Did Not Escape

The Washington metro area experienced its share of economic pain in 2009, as evidenced by modest job losses. However, these losses were the fewest of any major metro area in the nation.

And our real estate industry has seen an increase in distressed commercial real estate assets, but ranks well below Manhattan and South Florida in dollar volume per capita. Yet the industry feels the sting of the bankruptcy of General Growth Properties and Opus East.

In fact, a handful of companies, most with a large employee base located here already, relocated headquarters to the area in the past 15 months. Those companies include: Hilton, Volkswagen, Computer Sciences Corporation, SAIC, and most recently Northrop Grumman.

Payroll Job LossesLarge Metro Areas | 12 Months Ending November 2009

Source: Bureau of Labor Statistics, Delta Associates; January 2010.

12 Section One

2000-2009: The Lost Decade Nationally, But Not in Washington

Some observers have summed up the past 10 years as the lost decade nationally. By most economic measures, compared to the previous four decades, the aughts (2000-2009) ranked the worst:

Job growth was fl at – the worst showing of any decade since the 1930s.

Real GDP grew just 18% – half that of the next-worst decade.

The Dow declined 8% and household net worth declined 4% – the worst showing of any comparative decade, all of which were positive.

Comparably, the Washington metro area fl ourished. The region’s job base grew by 16%, compared to only 0.2% growth nationally during the past ten years.

And the Washington metro area grew more jobs during the decade, as a percentage of its base, than any other major metro area. The Washington metro area was followed in growth by Houston and Phoenix.

The local stock market index, comprised of over 200 companies located in the Washington metro area, experienced growth during the past decade. According to the Bloomberg DC Area Index, stocks gained roughly 19% during this time period, compared to an 8% decline in the Dow Jones.

Much has been written about the housing bubble and the resulting decline in prices – both nationally and locally. With declines reported quarterly, one cannot get a sense of the bigger picture.

National Economic Indicators of the Past Five Decades

*Adjusted for infl ationSource: Washington Post, Delta Associates; January 2010.

Job Growth

GDP*Household Net Worth* Dow Jones

1960s + 31% + 53% + 44% + 18%

1970s + 27% + 38% + 28% + 4%

1980s + 20% + 35% + 42% + 234%

1990s + 20% + 39% + 58% + 309%

2000s + 0% + 18% - 4% - 8%

Distressed Commercial Real Estate Value Per CapitaNovember 2009

Note: Excludes Manhattan at $3,742 per capita.

Includes properties in default or foreclosure, and lender REO. Value based on loan amount.

Source: Real Capital Analytics, graphic by Delta Associates; January 2010.

But looking at value change from 2000 to today, the Washington metro area experienced the largest gains in housing value during the past ten years, compared to other large metro areas. The New York and Philadelphia markets round out the top three in housing gains, behind Washington.

So, by many economic measures, Washington outperformed the nation and every other major metro area during the past decade, thanks to the presence of the Federal government, which spends money during good national economic times and bad. We also experienced a fl ourishing private sector that in some measure draws its lifeblood from the Federal establishment via outsourcing – Federal contracting. There was no lost decade here.


Payroll Job ChangeJanuary 2000 to November 2009

Dow Jones Industrial Average


Note: Through December 2009.Source: Dow Jones, Delta Associates; January 2010.

That is a brief review of what went wrong – and, to a lesser extent, what went right – during the past decade. What is ahead during the recovery, and how can smart investors capitalize? To understand opportunities in a recovery, fi rst, what is a “recovery”?

What Is “Recovery”?

We often hear talk of economic “recovery,” but we rarely hear the word defi ned. What do those making predictions mean when they say “the economy will recover by [a frequently shifting, speculative date of one’s choice]”? Let’s examine a few possible defi nitions of “recovery.” After all, if we are giving advice on opportunities in recovery, we should have a notion of the time period involved. And do we mean “recovery” or “recovered”? After all, a recovery is a time period with a beginning and an end.

Does “economic recovery” mean job growth has resumed?

As the beginning of recovery, job growth is traditionally late in the game. Job growth follows other signals – like positive GDP growth, another sign that recovery has begun. But if job growth is a sign that we are in recovery, this is a fairly easy prediction to make. We are confi dent that job growth will resume nationally and in the Washington metro in 2010 – although it may in fact have resumed nationally in late 2009, as the Bureau of Labor Statistics recorded a net gain of 4,000 jobs based on preliminary statistics for November. However, BLS is infamous for re-benchmarking prior period statistics, so December is still in doubt when the numbers are fi nalized.

Creating jobs certainly is an important element of recovery, but most analysts would not accept some net job growth as a defi nition of recovery. It is merely a start. Keep in mind that we can be in recovery but not recovered – just as the recession was a drawn-out process, so too will be the recovery period.

14 Section One

House Price Index Change2000 to 2009

U.S. Economic Trends and Forecast1981 – 2014

Purchase Only Indexes.Source: FHFA, Delta Associates; January 2010.

Source: Bureau of Labor Statistics, Bureau of Economic Analysis, Delta Associates; January 2010.

Does “economic recovery” mean a return tothe long-term average growth rate for GDP (gross domestic product)?

The long-term average annual growth rate for U.S. GDP is between 2.5% and 3.0%. GDP growth is likely to be choppy for the next few quarters, as the effects of the Federal government’s various stimulus programs taper. We expect GDP growth to reach the long-term growth rate on a consistent basis by 2011. However, unlike previous recovery periods such as 1983 or 1992, there is not likely to be a burst of growth in the near future. We are looking at gradual improvement as consumer spending, which comprises over two-thirds of the economy, slowly increases. So, 2011 is an important year for the commercial real estate industry, as GDP growth drives the creation of jobs and pushes down unemployment. Eventually these factors create demand for commercial real estate.

Does “economic recovery” mean a meaningful decline in the unemployment rate? And if so, what is “meaningful”?

Economists typically describe a 5% unemploy-ment rate as the “frictional unemployment rate” for the U.S., or the rate at which full employment is occurring. This is because even in a robust economy, some workers will be unemployed for a brief period of time as they search for a more desirable job. However, this means that a 5% unemployment rate is essentially a best-case scenario in most economic cycles. What is a reasonable rate of unemployment?

Of course, to someone who is looking for work, there may be no such thing as a reasonable level of unemployment. However, in the aggregate, and in particular when coming off a severe recession, most observers probably would see a 6-7% unemployment rate as signifi cant progress.

But for commercial real estate, employment growth is a crucial element of recovery, because jobs fi ll offi ce space and apartments, and they create consumer confi dence to get shoppers back into retail space. So 2010 is a pivotal point in our industry.


When Will We See Opportunities?

Following the logic above, we believe that the most meaningful opportunities of a cycle are found at the confl uence of:

The bottom of the real estate cycle

and

The beginning of the economic recovery

That would be 2010, in our opinion.

What About Recovery for Washington Commercial Real Estate?

Our take is that the local industry’s recovery began in 2009 for some product types and that all product types will be in recovery in 2010 to one degree or another. 2009 did not feel much like recovery, but by July or August there were early signs of it:

It starts with the sobering realization that there is no place for construction starts for spec product – and there were virtually none in 2009.

Equity began to re-enter the market, and investment sales perked up in the second half of the year. In fact, by year-end our broker clients were reporting a shortage of listings.

Cap rates seemed to have peaked during the summer months, at least for all but offi ce buildings.

The rate of distressed assets hitting the market slowed.

Even the offi ce market, which struggled with dis-absorption throughout the year, pulled into the positive by year-end. The Washington metro area was the only major metro area to fi nish in the positive in 2009.

It would be a meaningful decline from a current level of 10% – a level that is likely to rise further before beginning its cyclical decline by mid-2010. We see a 300-400 basis-point decline in unemployment, which would translate into 4-5 million new jobs nationally, as “meaningful” progress. It is the kind of progress that would refl ect a major boost in confi dence by hiring managers that a robust part of the cycle has returned. It is likely to be late 2012 or early 2013 before we achieve this kind of decline in the unemployment rate.

If that bar seems too high, and we defi ne “meaningful” simply as a consistent decline in employment, even at a slow pace, then we put recovery at 2011, as shown in the graph on the previous page. We expect the unemployment rate to peak in the fi rst half of 2010, and gain traction next year as consumer confi dence rises, pumping more money into the economy and leading to job growth. In 2010, any improvement in unemployment is likely to be modest, since as conditions improve, many of those who gave up searching for work will return to the labor market, increasing competition for available jobs. But by 2011, the hiring trend will be obvious. Slow, but clear. So 2011 will be an important milepost in the commercial real estate industry, as unemployment declines enough to:

Induce added apartment occupancy by encouraging un-doubling

Add to retail spending via an increase in consumer confi dence

Increase offi ce absorption due to job growth

Does “economic recovery” mean all of the jobs lost during the recession have been regained?

This defi nition of recovery sets a very high bar, particularly given the number of jobs lost during the recent downturn: 7.2 million. Considering

that most observers expect the next few years to be a “slow-growth” period, it is likely to take until 2013 or beyond before all of those persons are put back to work. During the four-year period from 2004-07, the U.S. created 7.9 million jobs – and this was considered a rather robust part of the economic cycle.

Of course, it is not all of the actual jobs that were lost that will come back – in many cases, the positions lost in 2008 and 2009 will never return, such as many manufacturing jobs. Instead, other positions will be created to replace them, often requiring new or different skills, and making the rehiring of laid off workers less likely. Those seeking work not only need to fi nd employment opportunities, they need a skills match with the positions for which they are applying.

But 2013 will be a key year for the commercial real estate industry, as the re-hiring of the 7.2 million workers will herald more normalized times for:

The offi ce market, as supply/demand conditions will approach equilibrium

Retail and industrial/distribution markets, which will get a boost from consumers who go back to their old ways of spending

Personal wealth accumulation, which will be on track to encourage consumers to buy homes/condominiums and travel more freely

To which defi nition of “recovery” do we subscribe?

We are not sure it matters: By all of these defi nitions it appears that between 2010 and 2013 the national economy will move through recovery at which time we can declare it recovered by 2013.

16 Section One

When Will Washington Area Markets Transition?

Source: Delta Associates; January 2010.

The condominium and apartment markets showed signs of life with improved 2009 absorption over 2008. And product short-age is likely to emerge in select submarkets by 2010 and 2012, respectively.

At year-end 2009, the housing market saw a 2.2% increase in home prices on a trailing 12-month basis, the fi rst increase since the 4th quarter of 2007. Washington was one of the few major metro areas in the nation to see housing price increases in 2009.

Emerging Trends and AFIRE again put the Washington metro at the head of lists of areas for which their respondents target investment.

The recovery period ends (and the robust part of the cycle begins) when we reach landlord market conditions, defi ned as long-term average rent growth. We believe landlord conditions will arrive from 2010-14 – a wide range that can be narrowed as follows based on product type:

Here is our thesis:

Commercial property values have declined 30% to 45% from the cyclical high of 2007, depending on the metric.

And values are somewhere near their cyclical low point. If you try to time the bottom perfectly, you will miss it.

Values are well below replacement cost.

Values will rise in the period ahead. Not sure if it is 2012 or 2014 that robust increases will be seen in Washington, but both cap rates and property performance will cooperate.

Interest rates are lower today than they will be for the next fi ve years or more.

Real estate is an infl ation hedge and infl ation will be higher in the intermediate future than it has been in the recent past.

There is an unprecedented amount of equity on the sidelines looking to buy.Use it.

#2: Invest in repositioning existing under-performing assets, whether yours or others to be acquired.

Here is our thesis:

If they are your assets, values are too low to sell – you should be a holder/buyer at these prices.

Stress and distress are putting some deals on the market for acquisition/improvement. Buy location and make improvements that fi t.

And as market fundamentals improve over the next three years for all property types, you would be well served to make investments that draft up in asset class.

Contractors need work. And competition makes renovation work cheap compared to 2007.

2010 for condominiums

2012 for apartments, industrial and retail

2013 for offi ce product (in many submarkets)

As far as the specifi cs on why we believe these dates for the return of “landlord conditions,” see the property-specifi c chapters that follow.

Now that we have defi ned “recovery,” what are the opportunities we see in the period ahead? And what are the signposts we should be looking for to know if we are on course?

Identifying Opportunities in Washington During The Recovery

#1: Selectively accumulate assets at below replacement cost while prices and interest rates are low.


Cyclical Fluctuation in ValueU.S. Commercial Real Estate – 1988 Through 2014

Recommended Development Activities in the Washington Area

Source: NCREIF, Delta Associates; January 2010.


#3: Position now for development into the next cycle.

For condominiums and apartments, that translates to:

Convert apartments to condominiums in select submarkets as early as 2010.

Build boutique-size condominium deals in select submarkets as early as 2010 – if you can fi nd a lender.

Start construction on apartments in select submarkets in 2010-11 for delivery in 2012. More broadly throughout the metro for delivery in 2013.

For the balance of commercial real estate, that translates to:

Begin construction of retail, offi ce and industrial in 2012 in select submarkets. Sooner if tenant-driven. And there are signifi cant tenant-driven opportunities thanks to BRAC and the appetite of GSA.

If you do not own entitled land, given the high barriers to entry in the Washington metro area, you are already late to the party.

Four Signposts to Keep Us on Track

We believe that four signposts stand out as especially important indicators of how to modulate your plans vis-à-vis these opportunities:

1. Job growth

2. GDP growth

3. Real estate values

4. Mortgage interest rates

These are the ones we are watching most closely in 2010 and beyond.

18 Section One

#1: Job growth: Jobs are essential to the commercial real estate market.

Approximately 7.2 million jobs have been eliminated since the start of the recession in December 2007 – a 5.2% decline. This calculates to an average loss of 302,000 jobs per month. When job losses began, offi ce absorption stopped nationally and slowed to a trickle in the Washington metro area.

For the past fi ve months job losses have moderated below the monthly average of 302,000, a positive indicator that the worst of the recession is over and we are on the road to recovery.

Another positive indication of job recovery is the rise in temporary help. According to the American Staffi ng Association index, employers have been increasing the demand for temporary help since July 2009. Companies fi rst test their confi dence in the economy by hiring temporary labor – indicating a demand for help, but also an unsteadiness of the duration of demand. Once confi dence is gained, we expect temporary staffi ng to level off and companies to slowly start to fi ll full-time positions. We expect this to occur by mid-year 2010.

One of the single best barometers of recovery is initial unemployment claims, which peaked in April 2009 – indicating the recession likely has been over for months. In each of the past fi ve recessions, dating back to 1975, the recession’s end has coincided with the peak in the four-week moving average in initial unemployment claims.

This observation, made by Robert J. Gordon (a member of the Business Cycle Dating Committee of the National Bureau of Economic Research, the agency that determines when recessions began and ended), is startling in its simplicity.

U.S. Payroll Job Change


American Staffi ng Association Index

Source: American Staffi ng Association, Delta Associates; January 2010.

In each case, the recession ended within a month of the peak in initial claims. The peak in claims during the 2007-2009 recession was in early April 2009. It is unlikely that another peak will occur during the current cycle, as layoffs have been decelerating.

Look for job growth: Meaningful offi ce and industrial absorption is sure to follow.


Consumer spending is 70% of the GDP. The University of Michigan’s monthly index of consumer sentiment is a valuable measure, as it provides a look into the consumer mindset – indicating if consumers are confi dent enough to part with their money. The index rose to 72.5 in December 2009 – rising unevenly since the low of 56.3 in February 2009.

The index remains below the long-term average of 88.2 and low enough to hamper robust spending. However, we believe spending will rise slowly in 2010, as the nation has a pent-up demand for goods, which will help keep GDP growth in positive territory.

Look for GDP growth above 2.5%: Mean-ingful retail and housing market progress will follow.

U.S. Initial Unemployment ClaimsFour-Week Moving Average | December 2007 to December 2009

Note: Data is seasonally adjusted.Source: Bureau of Labor Statistics, Federal Reserve Bank of St. Louis, Delta Associates; January 2010.

Duration of Recession

Peak in Initial Unemployment Claims

End of Recession

16 Months February 1975 March 1975

6 Months June 1980 July 1980

16 Months October 1982 November 1982

8 Months March 1991 March 1991


Source: Smart Money via MSN.com, NBER, BLS, St. Louis Fed, Delta Associates; January 2010.

#2: GDP growth: It refl ects greater economic activity, creating jobs and a sense of consumer confi dence that drives the retail and housing markets.

After four straight quarters of decline, the GDP increased 2.2% (at an annualized rate) during the 3rd quarter of 2009.

We believe the GDP experienced the last of its cyclical decline during the 2nd quarter of 2009. The GDP likely rose during the 4th quarter to a similar level as experienced during the 3rd quarter, once the numbers are fi nalized, as the Federal stimulus and capital injections work their way further into the economy.

Duration of Recent Recessions

20 Section One

#3: Real estate values: When rising, higher values drive capital into the market. Rising values are a barometer of the health of the real estate market, bubbles aside.

While investment sales struggled in 2009, commercial real estate investment remains a solid long-term play. Over the past fi ve-year and ten-year periods, real estate outperformed stocks and bonds, with annual total returns of 6.16% and 7.84%, respectively. Only during the past 12 months, concurrent with the recent bull market on Wall Street, did stocks outperform real estate. This is why the institutions have not re-allocated out of real estate in this cycle like they did in 1990, and why our recovery should be faster than during previous cycles.

What is driving values today? Nationally, offi ce vacancy rose 180 basis points during 2009. In the Washington region, vacancy rose 240 basis points last year. Similar trends have occurred in other product types. These trends are causing property performance to deteriorate, affecting both income returns and the perceived value of capital assets in the marketplace.

In addition, rents have been declining both nationally and locally, across the various product types. Apartment rents have held up well, with just a 2% decline locally over the past year, compared to a 6.9% decline for offi ce space. Nevertheless, values have been hurt by a weaker income stream and a lack of available credit, which has reduced the number of bidders for available properties.

As shown in the accompanying graph, the current cycle saw core values decline approximately 30% during this cycle – in a two-year period. While we expect values to decline

GDP Percent Change2007 – 2009

Consumer Sentiment

Source: Bureau of Economic Analysis, Delta Associates; January 2010.

*Through December 2009.Source: University of Michigan, St. Louis Fed, Delta Associates; January 2010.


Investment AlternativesCommercial Real Estate vs. Stocks vs. Bonds | 12 Months Ending September 2009

Commercial Property ValuesUnited States | 1999 Through 2009

Note: December 2000 = 100.Source: MIT, Morgan Stanley, Delta Associates; January 2010.

further in early 2010, we may hit bottom by the end of the year. A total decline of 40% would approximate the decline from the early 1990s – but that decline occurred over a six-year period. This time around, the market was faster down, and should be faster to recover. Values should begin rebounding by 2011, meaning that now is the time to beat competitors into the market.

The MIT Transactions-Based Index for commercial property values indicates that values are back to 2004 levels as shown in the accompanying graph.

We believe values will begin to stabilize by late 2010, given the improvement in overall economic conditions. But importantly, those who wait until it is apparent that values are stabilizing will be entering the market too late to achieve maximum value. Based on a combination of factors, we believe now is the ideal time to buy commercial real estate product in the Washington area:

NOI will be at its low point in late 2010 or early 2011.

The cost of fi nancing is not likely to get any lower – for more on mortgage rates, see the following section.

The availability of fi nancing should improve during 2010 as lenders become more convinced of an economic recovery.

Cap rates are already leveling off locally, based on our proprietary Market Maker Survey (see Section Nine of this report).

Look for commercial real estate values to hit bottom in 2010, if they have not already. All of these indicators suggest that now is the time to enter the market in order to beat competitors to prime assets and achieve the best combination of low pricing and low interest rates.


22 Section One

#4: Mortgage interest rates: When low, they can facilitate a recovery.

A critical ingredient for enlivening the commercial real estate market moving forward is the availability of credit at terms that are attractive to borrowers. What is likely to happen in the credit markets in 2010 and beyond?

We believe that the availability of credit will increase in 2010, but that interest rates will increase 100 to 300 basis points in the next 12 to 36 months. What impact will this have on the commercial real estate recovery?

Long-term mortgage rates are likely to rise due to government defi cit spending, as the Federal government will have to offer higher interest rates to creditors to continue attracting capital. At the same time, the buyers of debt, such as China, are easing back on their purchases of American treasuries, which will drive the government to increase interest rates in order to make U.S. treasuries more attractive. Mortgage rates for commercial properties will follow suit.

The likely increase in mortgage rates is a signpost that investors should be watching closely. While availability of debt will remain a problem during 2010, those who have access to credit should be prepared to act quickly this year before rates become less attractive.

U.S. Treasury Supply1993 – 2011

Note: 2009-11 is estimated.Source: U.S. Treasury, Morgan Stanley, Delta Associates; January 2010.

Look for mortgage interest rates to increase. With it, cap rates that began to settle down at the end of 2009 will likely not decline much in 2010-11 even if good product is in short supply as some brokers threaten. And cash will remain king for at least another year. In addition, it is possible that development lending will remain lean into the early part of the development cycle, creating spikes in rents in 2012-15.

* * * * *

We hope the information in this report assists you in making informed decisions to meet your particular business objectives in 2009 and beyond. Best wishes for success in the period ahead.


25

2The

National Economy

26 Section Two

Downturn Has Ended; Slow Recovery Underway

Last year in the TrendLines report we said that the recession would end in mid-2009. Given the downward-spiral of the economy at the time, many readers found this a wildly optimistic view. The good news is: That prognostication appears on target. The bad news is: Other than the fear factor, it appears to have made little difference in the quality of the economic climate.

So this is recovery!

The national economy experienced a turbulent year, as 4.2 million jobs were eliminated during the 12 months ending December 2009 and unemployment climbed to 10.0%. Despite the distress experienced during 2009, we believe the recession ended about mid-year, although offi cial word has not come as of this writing. Although we expect further decline in the labor market, as unemployment lags, we believe a handful of indicators show the recession has ended:

Job losses have moderated with a loss of only 85,000 jobs during December 2009 – compared to the peak of job cuts at 741,000 during January 2009.

Temporary help – an indicator of recovery – has been steadily rising since July 2009.

GDP increased 2.2% during the 3rd quarter of 2009 – rising for the fi rst time in four quarters.

The leading economic indicators index has increased 7.2% since its low in March 2009.

Claims for unemployment insurance peaked in April 2009 and are declining.

Although the national recession has ended, warning signs suggest a slow growth recovery:

Increased worker productivity which in turn is leading to reduced job growth. Reduced consumer sentiment that is depressing consumer spending. A high personal savings rate that is also contributing to dampened consumer activity.

The

National Economy

Implications for commercial real estate?

Offi ce and industrial space, fi lled by employees, will be slow to materialize. We believe it will be until 2011-2012 before a meaningful reduction is seen in the unemployment rate. It will be after 2012 before we rehire the 7.2 million workers who lost their jobs in this recession.

The retail sector will take a few years to recover, as consumer confi dence is low, indicating fear in parting with disposable income.

Apartments, on the other hand, are in demand, as demographics support household formations and we witness a structural shift from homeownership to rental.

Components of a Recovery

Worker productivity (output per hour) jumped8.1% during the 12 months ending September 2009, as companies experienced a rise in profi ts stemming from reduced employee costs. This is the highest increase experienced since the 9.7% rise during the 12 months ending 3rd quarter of 2003 and compares to the long-term

The National Economy 27

average of 2.0%. Productivity typically spikes at the end of a recession due to companies signifi cantly reducing costs – by eliminating workers and reducing or capping salaries and overhead costs.

The spike in productivity during the 3rd quarter, coupled with reduced costs, should encourage companies to ease layoffs and start hiring temporary staff until they regain confi dence to hire full-time staff. A rise in temporary employment indicates companies need workers in order to keep up with demand, but do not want to hire full-time staff until they are certain economic recovery has real traction.

Temporary help has been steadily rising since July 2009, according to the American Staffi ng Association index. We believe temporary employment will continue to rise through 2010, as companies test their confi dence in the economy. After confi dence has been gained, we expect temporary staffi ng to level off and companies to slowly start to fi ll full-time positions.

Rising productivity and the hiring of temporary workers are both good signs for the economy. However, consumer spending drives job growth, as it accounts for two-thirds of the GDP. Although showing signs of modest gains, spending remains limited.

The University of Michigan’s monthly index of consumer sentiment is a valuable measure, as it provides a look into the consumer mindset – indicating if consumers are confi dent enough to part with their money. The index rose to 72.5 in December 2009 – rising unevenly since the low of 56.3 in February 2009. Although the index is on the rise, it has been wavering as consumers remain unsure about the economy. In addition, the index remains below the long-term average of 88.2 and low enough to hamper robust spending.

The lack of consumer spending is refl ected in the personal savings rate, which has jumped to 4.5% at September 2009 from 1.7% in 2007. A rise in 1.0% of savings equals $100 billion lost in discretionary spending.

We believe it will take time for consumers to regain confi dence in the economy – not until material job gains are felt and consumer wealth is regained. Until that time, consumers will likely refrain from spending on non-essential items. Given the unemployment rate likely will not decline until mid-2010, we

believe consumers will not regain spending confi dence until mid-2010 – and even then spending will be sporadic until 2011. Not until 2012 or later will spending be robust – as consumers regain the $14 trillion in wealth that evaporated during the housing and stock market corrections of 2006-08.

U.S. ProductivityEmployee Output per Hour

Source: Bureau of Labor Statistics; January 2010.

American Staffi ng Association Index

Source: ASA; January 2010.

28 Section Two

Economic Outlook

GDP: negative 2.5% in 2009 once the numbers are fi nalized; positive 2.5% in 2010.

Payroll jobs: modest job gains in 2010.

The housing market: Stabilization in early 2010, leading to traction by late 2010. Some local markets, like Washington, sooner.

Long-term interest rates: up 100 to 300 basis points in the next 12 to 36 months.

Infl ation: Not a meaningful factor in the short-run.

Federal Intervention in the Economy

The American Recovery and Reinvestment Act (ARRA), more commonly known as the 2009 Stimulus Program, was signed into law on February 17, 2009, at a cost to taxpayers of $787 billion. Under this program, President Obama plans to save or create 3.5 million jobs nationally. Of the $787 billion, the largest share, $288 billion, is devoted to tax relief, with another $144 billion set aside to aid government budget crunches at the state and local levels.

Only $257 billion of the $787 billion stimulus money has been allocated so far, according to Recovery.gov. This funding has reportedly created or saved over 640,000 jobs. These positive signs should continue through 2011 as more of the stimulus money fi lters through the economy.

There has been some discussion of infl ation worries. We believe this is an intermediate to long-term problem and not a short-term issue due to the lack of pricing pressure in the economy until 2011 or 2012. The Fed has promised to do what it takes to get the economy back on track while balancing the issue of infl ation. We believe the Fed will start to increase short-term rates modestly during 2010 to head off infl ation. And long-term rates we believe will rise as much as 100 to 300 basis point in the next 12 to 36 months – further dampening economic activity and pricing pressure.

Now, for a look at the components that make up our economy:

Consumer Sentiment

Personal Savings Rate

*Through December 2009.Source: University of Michigan, Federal Reserve Bank of St. Louis; January 2010.

*Third quarter 2009 at annualized rate.Note: shaded bars represent recessions.Source: Bureau of Economic Analysis; January 2010.

Recovery will be slow-paced, with the worst performance behind us. We expect to see more bankruptcies and foreclosures, as we are not fully out of the woods. High worker productivity, coupled with low consumer confi dence and restrained spending means few new jobs in the near-term.


U.S. Economic Trends and Forecast1981 – 2014

American Recovery and Reinvestment ActOverview of Funding

Source: Recovery.gov; January 2010.

Federal Funds Rate

*Unchanged since December 16, 2008.Source: Federal Reserve Board; January 2010.

GDP Percent Change2007 – 2009

Note: Annualized.Source: Bureau of Economic Analysis; January 2010.

Source: Bureau of Labor Statistics, Bureau of Economic Analysis, Delta Associates; January 2010.

Gross Domestic Product (GDP)

After four straight quarters of decline, the GDP increased 2.2% (annualized rate) during the 3rd quarter of 2009, compared to declining a revised 0.7% during the 2nd quarter.

We expect GDP to rise by a similar level during the 4th quarter, once the numbers are fi nalized, as Federal stimulus and capital injections work their way further into the economy. However, for the year, we expect the GDP to decline 2.7%. The GDP should rebound with 2.5% growth in 2010, 90% of the long-term average.

30 Section Two

U.S. Payroll Job ChangeLeading Economic Indicators Index

U.S. Payroll Job Change12 Months Ending December 2009


Note: Index has been re-benchmarked, with 2004 as the base year.Source: The Conference Board; January 2010.


A decline in demand for goods.

Gains in productivity due to automation.

Continued off-shoring of manufacturing due to lower production costs overseas.

Index of Leading Economic Indicators

The index of leading economic indicators has increased for the eighth consecutive month – rising to 104.9 in November 2009. The index is above the 99.2 experienced one year ago and has risen 7.2% since its low in March 2009 – both positive signs for the economy.

This index suggests recovery is unfolding and economic conditions should continue to improve through 2010. However, we expect growth to be slow through 2010.

Payroll Jobs

Approximately 7.2 million jobs have been eliminated since the start of the recession in December 2007 – a 5.2% decline.

On a month-to-month basis, the peak in job losses was experienced during January 2009. Since January, the nation continued to shed jobs, but at a reduced rate. Most notably, the nation shed only 85,000 jobs in December, after a slight gain of 4,000 in November. This compares to the monthly average of 302,000 jobs lost since the start of the recession.

Not all sectors are cutting jobs, as the Health/Education sector added 376,000 new jobs during the 12 months ending December 2009. The manufacturing sector experienced the most job cuts during this period – 1.3 million jobs – due to:


An indicator of market health, the Purchasing Managers’ Index (PMI) was at 55.9 in December 2009, compared to 32.9 one year earlier. The PMI has risen above 50 (an indication of expansion) for the past fi ve months, the fi rst time since January 2008. We expect the demand for goods and services will remain slow during 2010, as consumers gradually regain confi dence.

Business inventories grew at an above-average pace during 2004 through 2008. However, with the recession hampering consumer spending, businesses have been working to reduce stockpiles. During the 12 months ending the 3rd quarter 2009, companies slashed inventories by 13.4%. With reduced inventories, the supply/demand ratio will gradually balance.

Unemployment Rate

The U.S. unemployment rate is 10.0% at December 2009, up from 7.4% one year ago. The under-employed rate is 17.3%. This rate includes employees working part-time and overqualifi ed workers taking a lower-skilled position.

Purchasing Managers’ Index

U.S. Total Business Inventories U.S. Unemployment Rate

Source: Institute for Supply Management; January 2010.

Note: Seasonally adjusted.Source: U.S. Census; January 2010.

Note: Through December 2009; seasonally adjusted; shaded bars represent recessions.Source: Bureau of Labor Statistics; January 2010.

We anticipate the unemployment rate will continue to edge up during the 1st quarter – before declining slowly during the balance of 2010. Of note, although economic recovery is underway, unemployment is a lagging indicator.

Unemployment Claims

Initial unemployment claims peaked in April 2009 – indicating the

recession is over by the single best barometer. In each of the past fi ve recessions, dating back to 1975, the recession’s end has coincided with the peak in the four-week moving average in initial unemployment claims. This observation, made by Robert J. Gordon (a member of the Business Cycle Dating Committee of the National Bureau of Economic Research, the agency that determines when recessions began and ended), is startling in its simplicity.

32 Section Two

U.S. Initial Unemployment ClaimsFour-Week Moving Average | December 2007 to December 2009

U.S. Infl ation

Note: Data is seasonally adjusted.Source: Bureau of Labor Statistics, Federal Reserve Bank of St. Louis, Delta Associates; January 2010.

*12-months percentage change through October 2009.Source: Bureau of Labor Statistics; January 2010.

In each case, the recession ended within a month of the peak in initial claims. The peak in claims during the 2007-2009 recession was in early April 2009. Although it is possible another peak could occur, the pattern of previous recessions suggests that the April peak will not be reached again during the 2007-2009 contraction, as layoffs have been decelerating.

Infl ation

Consumer prices declined 0.2% during the 12 months ending October 2009. Prices reached a recent low in April 2009 and have been steadily rising since – at a 1.7% rate.

We believe that infl ation will be controlled at 0.5% to 1.0% during 2009, when the numbers are fi nalized, as companies work to get rid of high inventories and consumer spending remains lackluster. As consumer confi dence returns, the Fed will watch for infl ationary effects on commodity prices. In the intermediate and long term we expect infl ation to be an issue but not in the short-term.

Energy Prices

Oil prices are starting to rise again, after sinking to a cyclical low of $39 per barrel in February 2009. Since this bottom, prices have increased 90% to $75 a barrel in December 2009 and even higher at this writing.

As prices dropped, OPEC cut oil production by three million barrels a day in order to regain supply/demand balance. This reduction set supply below the current demand levels and prompted prices to rise. The cartel’s preferred price range is $60 to $80 per barrel.

Duration of Recession Peak in Initial Unemployment Claims End of Recession

16 Months February 1975 March 1975

6 Months June 1980 July 1980


8 Months March 1991 March 1991


Source: Smart Money via MSN.com, NBER, BLS, St. Louis Fed, Delta Associates; January 2010.

Duration of Recent Recessions


Oil Prices

Dow Jones Industrial Average

Note: 12 month averages of WTI NYMEX prices.Source: GASearch; January 2010.

Note: Through December 2009.Source: Dow Jones; January 2010.

Gas prices have increased to $2.61 per gallon at this writing, a 62% rise during the past year. Although gas prices have increased, the price of gas remains lower than the recent peak of over $4.00 a gallon during the summer of 2008. We expect oil prices to average $70 to $80 per barrel in 2010.

Stock Market

The stock market is not the economy. But many believe it is a leading indicator – a predictor of economic conditions in 12 months or so. The Dow Jones peaked in late 2007 and bottomed out in March 2009, with the Dow at 6,547.

Since hitting bottom, the Dow has increased approximately 59%, as investors are starting to regain confi dence and stocks were at bargain rates, allowing buyers to reap the rewards of the next economic expansion. To sustain this bull market, profi ts need to follow.

Mortgage Rates

The 30-year fi xed mortgage rate is currently under 5% – a boon to home buyers. A low interest rate, coupled with the fi rst-time home buyer tax credit – now expanded to move-up buyers, has sparked a jump in mortgage applications. However, tight underwriting requirements have kept some buyers out of the market.

New Housing Construction and Sales

New homes sold at an annualized rate of 430,000 units during October 2009, up 5% from one year earlier. Notably, new home sales have increased 31% from the low of 329,000 units sold at an annualized rate during January 2009.

Sales prices on new homes declined to an average of $261,000 per unit in October 2009, down 4.7% from one year earlier. However, prices have risen 6.4% from the cyclical low of $245,200 during January 2009.

34 Section Two

U.S. New Home Sales vs. Sales Price

*Annualized sales rate at October 2009.Source: U.S. Census; January 2010.

Mortgage Rates30-Year Fixed Rate

*At December 2009.Source: Freddie Mac; January 2010.

Annual Change in Existing Home Sale Prices

*12 month ending September 2009.Source: National Association of Realtors; January 2010.

U.S. Existing Home Sales vs. Sales Price

*Annualized sales rate at October 2009.Source: National Association of Realtors; January 2010.

Existing Home Sales

Now we are talking progress! Existing homes sold at an annualized rate of 6.1 million units during October 2009, up 24% from one year ago. The current inventory is at a 7.0 months supply, down from 10.2 months one year ago.

Sales prices on existing homes declined to an average of $218,100 per unit, down 5.0% from one year ago. However, prices have risen 5.5% from the cyclical low of $206,700 during January 2009.

According to the National Association of Realtors (NAR), price changes during the 12 months ending September 2009 ranged from a low of -34.5% (Las Vegas) to a high of +0.2% (Houston).

We believe housing sales will continue to rise through 2010, given low interest rates and the home buyer tax credit – now extended through Spring 2010. With the inventory declining, prices should start to stabilize during the fi rst part of next year and gain traction soon after. Many local markets, like Washington, are already seeing the early stages of a housing market recovery.


Federal Budget Defi cit

The Federal budget defi cit climbed to $459 billion during 2008, as spending exceeded revenues. The defi cit was boosted by the $168 billion Economic Stimulus Act of 2008.

The Congressional Budget Offi ce (CBO) anticipates, with the most recent projections, the U.S. budget defi cit for 2009 will total $1.59 trillion. The defi cit will balloon this year, as the government foots the bill for TARP, the auto bailout, and the American Recovery and Reinvestment Act, among other programs.

U.S. Trade Defi cit

When annualized, the trade defi cit through September 2009 retracted to $361 billion, compared to $677 billion in 2008. Annualized exports declined 17% from 2008, compared to imports which declined 26%.

We expect exports to decline notably during 2009, once the numbers are fi nalized, as our global partners experience a steeper and longer recession compared to the U.S. Imports should decline as well, as American consumers demanded fewer goods.

Federal Budget Defi cit

*Projected by CBO as of August 2009.Source: OMB, CBO; January 2010.

U.S. Trade Defi cit

*Through September 2009 annualized.Source: U.S. Census Bureau, Bureau of Economic Analysis; January 2010.

36 Section Two

U.S. Payroll Job Growth

Job Change %Change

2009* -4,164,000 -3.1%

2008 -558,000 -0.4%

2007 1,527,000 1.1%

2006 2,397,000 1.8%

2005 2,276,000 1.7%

2004 1,423,000 1.1%

2003 -344,000 -0.3%

2002 -1,489,000 -1.1%

2001 36,000 0.0%

*Change for 12 months ending in December 2009; others are comparisons of annual averages. Note that BLS has rebenchmarked fi gures since their initial publication; the fi gures presented above are the most recent estimates.

Economic Outlook

We believe the national economy reached the bottom during the middle of 2009 – concluding this economic downturn. Although recovery is underway, we are not out of the woods yet, as we predict unemployment, a lagging indicator, will continue to edge up into 2010. In addition, we expect more bankruptcies and foreclosures, as the fi nancial markets remain unsettled.

The stimulus spending is starting to have an impact. Greater gains will be felt during 2010, as more stimulus money is disbursed. We believe the 4th quarter GDP will grow at the same level achieved during the 3rd quarter. However, for the year, we expect the GDP to decline 2.5%. The GDP should rebound with 2.5% growth in 2010, about 90% of the long-term average.

High worker productivity, coupled with low consumer confi dence and restrained spending, means few new jobs will be created in the recovery period that will last through 2012.

Until job growth resumes, consumer spending cannot return to robust levels, thereby creating a protracted and anemic recovery.

National Payroll Job Growth Summary

The U.S. economy shed 4.2 million payroll jobs over the 12 months ending December 2009. This represents a decline of 3.1%. The pace of job change has been rapid, as 7.2 million jobs have been cut since the start of the recession. However, job losses have moderated, as the recession has ended and a slow recovery is underway.


12-Month Payroll Employment Change Through November 2009

Job Change

Metro Area # %

Jacksonville (2,500) -5.2%

Austin (4,300) -0.5%

San Antonio (6,200) -0.7%

New Orleans (7,000) -1.3%

Columbus (OH) (10,000) -1.1%

Memphis (13,500) -2.1%

Washington, DC (15,300) -0.5%

Oklahoma City (15,400) -2.6%

Raleigh-Durham (20,300) -2.7%

Kansas City (22,200) -2.2%

Baltimore (25,800) -2.0%

Nashville (26,100) -3.4%

Pittsburgh (26,600) -2.3%

Salt Lake City (29,400) -4.6%

Indianapolis (33,300) -3.6%

Cincinnati (33,600) -3.2%

Charlotte (37,500) -4.4%

St. Louis (38,100) -2.8%

San Diego (43,300) -3.3%

Sacramento (43,900) -5.0%

Orlando (44,000) -4.1%

Cleveland (45,500) -4.3%

Dallas/Ft. Worth (50,700) -1.7%

Denver-Boulder (51,300) -3.7%

Tampa-St. Pete (51,900) -4.3%

Portland (OR) (52,200) -5.0%

Job Change

Metro Area # %

Minneapolis-St. Paul (52,700) -3.0%

Boston (Metropolitan NECTA) (53,100) -2.1%

Las Vegas (60,400) -6.7%

South Florida

West Palm Beach/Boca Raton (15,900) -2.9%

Miami/Miami Beach/Kendall (24,400) -2.3%

Fort Lauderdale (24,800) -3.3%

Subtotal South Florida (65,100) -2.8%

Seattle (68,500) -3.9%

Philadelphia (80,900) -2.9%

Houston (88,900) -3.4%

Phoenix (110,200) -6.0%

Atlanta (117,100) -4.9%

San Francisco Bay Area

Oakland/Fremont/Hayward (34,900) -3.4%

San Jose/Sunnyvale/Santa Clara (42,700) -4.7%

San Francisco/San Mateo/Redwood City (48,200) -3.4%

Subtotal Bay Area (125,800) -4.3%

Detroit (Detroit/Warren/Livonia) (128,600) -6.8%

New York (186,100) -2.2%

Chicago (186,600) -4.1%

LA Basin

Orange Co. (Santa Ana/Anaheim/Irvine) (53,000) -3.6%

Riverside/San Bernardino/Ontario (55,200) -4.6%

Los Angeles/Long Beach/Glendale (141,900) -3.5%

Subtotal LA Basin (250,100) -3.7%


39

TheWashington Area Economy

3

40 Section Three

The

Washington Area Economy

Payroll Job GrowthWashington Area | 1981 Through November 2009

*12 months ending in November 2009.Source: BLS, Delta Associates; January 2010.

Although conditions remain sluggish, the worst condi-tions appear to be behind us, and a slow recovery is underway, as suggested by the following indicators, among others:

Retail sales, for nondurable goods, bottomed outduring the 1st quarter. Although still sluggish,sales increased during the 2nd and 3rd quarters.

The metro area unemployment rate peaked in June 2009 at 6.5% and has declined to 6.1% in November 2009 (the most recent statistic available at this writing).

Consumer confi dence in the South Atlantic bottomed out in the 1st quarter of 2009 at 20.8 and has risen to 23.9 during the 3rd quarter. This pattern is paralleled by the Greater Washington Board of Trade’s Consumer Confi dence Index that shows the regional index bottomed out in December 2008.

The Washington Metro area Index of Lead-ing Economic Indicators bottomed out in the 1st quarter of 2009 and is up since.

We believe GRP may have declined as much as 0.5% during 2009, once the numbers are fi nalized. Thisdecline is less severe compared to the projectednational decline of 2.5%. The decline locally is due largely to retail and construction – the two hardest hit industries in the metro area, which are taking longer to recover.

Slow Regional Recovery Underway Since 1st Half 2009, as Federal Initiatives Stimulate the National Economy; Area Holding Up Better than the Nation

Two years ago in TrendLines we declared the region to be resilient, yet we observed that the local economy had peaked for this cycle in 2004. Last year we described the Washington metro area as recession-resistant, as the nation tumbled into recession. This year we observe that in 2009 the region suffered its fi rst recession since 1990, losing jobs. Yet, we believe the Washington metro area economy experienced a shallow and short-lived recession in 2009 and was in recovery by the Spring of the year.

The Washington Area Economy 41

Although sluggish conditions remain as a slow recovery is underway, Washington maintains one of the strongest economic bases in the nation.

Payroll Employment: 3.0 million at November 2009.

Job Growth: negative 15,300 during the 12 months ending November 2009.

Unemployment Rate: 6.1% at November 2009, up from 4.3% one year ago.

Coincident Index: 104.0 at September 2009 – up from the bottom at 103.8 in February 2009.

Leading Index: 107.0 at September 2009, the same level as one year ago.

Infl ation: prices decreased 0.8% during the 12 months ending September 2009.

Housing Prices: increased 2.2% during 2009.

Source: BLS, GMU-CRA, MRIS; January 2010.

Jobs

With 3.0 million payroll jobs, the Washington metro area ranks the fourth largest job base among metro areas, behind New York, the LA Basin and Chicago.

Payroll employment declined 15,300 in the Washington metro area over the 12 months ending November 2009. This represents a decline of 0.5%, compared to the national decline of 3.5% during this period.

Payroll Job ChangeWashington Metro Area | 12 Months Ending November 2009


Despite a net job loss of 15,300 payroll positions in the metro area, four of the twelve sectors grew jobs over the past 12 months. The region continues to grow high-end jobs even as it sheds low-end jobs. The top three sectors leading job growth are Government, Education/Health, and Professional/Business Services – with a total of 27,000 new jobs added to the economy in these three sectors.

The Government sector gained 17,300 jobs during the last 12 months, with 76% of these jobs created in the Federal government.

The Education and Health sector gained 5,200 jobs in the previous 12 months, with most of these positions in the health fi eld.

The Professional and Business Services sector gained 4,500 jobs during the last 12 months.

The greatest number of jobs lost during the past 12 months occurred during the month of January 2009 with 59,900 jobs cut during the month. We believe this was a deep loss because (1) the National Bureau of Economic Research (NBER) declared in December 2008 the country was in a recession, spooking employers who then eliminated workers, and (2) the retail sector eliminated holiday staff.

However, the Washington metro area has grown jobs since January 31, 2009 – adding 50,700 new jobs. The Government and Professional/Business Services added 32,600 and 12,400 new jobs, respectively, since January 2009.

While January is typically a poor month for job growth because of seasonal layoffs, we believe the monthly trend in 2009 is a legitimate source of optimism for the year ahead.

Despite job losses that have occurred over the past year, the metro area is holding up well compared to other large metro areas, which have experienced notable declines. For example, over the past year, the LA Basin and Chicago metros shed over 437,000 jobs combined – 3.7% and 4.1% of their workforce, respectively.

42 Section Three

Payroll Job Change12 Months Ending November 2009


Trends in Employment by Major SectorWashington Metro Area | In 000’s of Payroll Jobs

November 2009 12-Month Change 15-Year Annual Average

Government 688.1 17.3 4.0

Edu./Health 351.3 5.2 8.3

Prof./Bus. Svs. 692.6 4.5 20.3

Leisure/Hosp. 259.5 0.5 5.4

Transport/Util. 62.6 -0.4 0.0

Other 183.7 -1.5 4.5

Whole. Trade 67.3 -2.3 0.6

Manufacturing 57.3 -2.6 -0.4

Financial 146.7 -5.3 1.7

Information 84.3 -5.9 0.6

Retail Trade 258.6 -9.1 2.6

Constr./Mining 154.0 -15.7 4.5

Total 3006.0 -15.3 52.1

Source: BLS, Delta Associates; January 2010.

Unemployment RatesLarge Metro Areas | November 2008 vs. November 2009


Unemployment Rate

The Washington area unemployment rate was 6.1% at November 2009, up from 4.3% one year ago. This compares to the national rate of 10.0% in November and December 2009.

The Washington metro area has the lowest unemployment rate among large metro areas. Although the region’s unemployment rate has risen 180 basis points over the past year, the rise is less severe compared to other metro areas such as San Francisco Bay and Los Angeles, which experienced a rise of 370 and 330 basis points during the past 12 months.


Index of Coincident Economic IndicatorsWashington MSA

Source: GMU Center for Regional Analysis, Delta Associates; January 2010.

Index of Leading Economic IndicatorsWashington MSA

Source: GMU Center for Regional Analysis, Delta Associates; January 2010.

Coincident and Leading Indices

The Washington Metro Area Coincident Index, which represents the current state of the area economy, was 104.0 in September 2009, below the 20-year average of 107.9. However, the index remains above the low of 103.8 experienced in February.

The following factors contributed to the rise in the Coincident Index since February – as the local economy slowly recovers from the recession:

Retail sales, for nondurable goods, bottomed out during the 1st quarter – although still sluggish, sales increased on average 6.5% during the 2nd quarter, and 0.6% during the 3rd quarter.

Although consumer confi dence in the South Atlantic region ticked down to 23.9 during the 3rd quarter, from 24.4 during the 2nd quarter, it is above the low of 20.8 experienced during the 1st quarter.

The Leading Index, which forecasts Washing-ton area economic performance over the next 18 months, is 107.0 at September 2009. This isabove the cyclical low of the 1st quarter, but matches the level achieved one year ago. How-ever, it is above the 20-year average of 102.6.

Consumer Price Index

Overall infl ation in the Washington/Baltimore region was -0.8% during the 12 months ending September 2009, compared to the annual average of 4.5% in 2008. However, prices have increased 2.4% since January 2009.

Money and demand for goods are stronger here compared to the nation, as prices decreased 1.3% nationwide during the 12 months ending September 2009, but have risen 2.3% since January 2009.

44 Section Three

Consumer Price Index (CPI)Washington/Baltimore Region

Housing Market IndicatorsWashington Metro Area | At Year-End 2009

Source: U.S. Commerce Department, Delta Associates; January 2010.

Change vs. Last Quarter Change vs. Q4 2008

Q4 Avg. Sales Price $376,188 2.7% 2.2%

Q4 Sales (units) 14,549 12.3% 18.9%

Q4 Days on Market 72 9 32

Sales Pace* 5.3 Months 0.1 Months 2.0 Months

Although prices continue to rise for food, shelter, and medical care, prices dropped notably for gas over the past year. However, in recent months, the price of gas has risen again, as supply has been cut to better match demand.

We expect prices rose just slightly in the Washington/Baltimore region during 2009, when the numbers are fi nalized, as recession-conscious consumers continued to tighten belts. And we expect infl ation to remain tame in 2010 as well.

Housing Prices

The average price of a Washington-area home is $376,188 in the 4th quarter of 2009. The metro-wide price of homes sold in the 4th quarter of 2009 was down 2.7% from the 3rd quarter of 2009, but it was 2.2% higher than in the 4th quarter of 2008. This is the fi rst time metro-wide prices have risen on a trailing 12-month basis since the 4th quarter of 2007.

The Washington metro area median home price was 2.9 times the median household income during the 3rd quarter of 2009 – just above the nation at 2.8. So, even with high housing prices, housing in the region is no less affordable due to higher incomes.

Washington metro home prices increased an average of 9.5% per year from 2000 to 2006, outpacing the average annual income growth of 2.5% during the same period. Prices started to decline in 2007 due to the Credit Crunch and fell further at the onset of the national recession, as the credit markets froze and job losses increased foreclosures.

Housing became more affordable as the metro area nearly matched that of the national average for affordability among major metros. The New York metro area is the least affordable with a ratio of 6.6.

The Washington housing market has entered the recovery phase of the cycle in 2009. We expect that a combination of continued Federal impact on the Washington housing market and a recovering labor market will continue to bring gains to the Washington housing market in 2010, particularly in the Core (the District, Arlington and Alexandria). The pace of the recovery may be uneven, but in early 2010, we expect that renewed demand will yield yearly price gains, particularly in the Core, where inventory is more limited and demand is strongest, but extending to the Outer suburbs by late 2010/early 2011.

*Sales pace is ratio of total for-sale inventory to current month’s sales.Source: MRIS, Delta Associates; January 2010.


Ratio of Median Home Price to Median Household IncomeWashington Metro Area

*Third quarter 2009Source: NAHB/Wells Fargo Opportunity Index, Delta Associates; January 2010.

Gross Regional Product (GRP)Select Metro Area | 2008

Source: Dr. Stephen Fuller, Delta Associates; January 2010.

Region’s Core Industries

The Washington area’s gross regional product (GRP) was $401.3 billion in 2008, an increase of 4.7% from revised 2007 fi gures. Data for 2009 is not yet available.

The Washington metro area ranked 9th in population, yet was the nation’s 4th largest economy among major metros during 2008. Only New York, Los Angeles and Chicago outsized the Washington metro area economy.

The Washington metro area ranks number one in terms of Federal spending per capita. During 2008, the Federal spending per capita in the Washington metro totaled $25,860, well ahead of the $9,042 spent per capita nationwide. For procurement spending, the Washington metro obtained $12,756 procurement dollars per capita in 2008, compared to $1,620 nationwide.

Approximately one-third of the Washington metro GRP is generated by the Federal government – the region’s most important core industry. A core industry is one that imports capital and exports a good or service. Total Federal spending in the Washington metro area was up in 2008 to $134.8 billion, a 7.8% increase from 2007.

The performance of the Washington area’s core industries bolsters the area during economic downturns.

Federal Spending – Per CapitaSelect Metro Areas | 2008

Source: Consolidated Funds Report, Dr. Stephen Fuller, Delta Associates; January 2010.

46 Section Three

Core Economic Sectors - In Current Year DollarsWashington Metro Area

Note: Figures are estimates. Procurement fi gures do not include US Postal Service and FAA purchases. Source: Dr. Stephen Fuller, Delta Associates; January 2010.

2008

GRP in Billions $ %GRP

Total Federal $s $134.8 33.6%

Portion Procurement $66.5 16.6%

Technology $60.0 14.9%

Building Industry $23.1 5.8%

Int’l Business $18.8 4.7%

Hospitality $7.8 1.9%

Other $156.8 39.1%

Total GRP $401.3 100.0%National Recession Washington Metro Area GRP Change

12/07 - 6/09 0.0%

3/01 - 11/01 2.5%

7/90 - 3/91 0.2%

7/81 - 11/82 3.1%

1/80 - 7/80 2.3%

We expect GRP in the metro area edged down 0.5% during 2009, once the numbers are fi nalized. This compares favorably to our projection of the national gross domestic product change of negative 2.5% in 2009.

During past national recessionary periods, the Washington metro economy has grown. During the last four periods of national GDP contraction, ranging six to sixteen months, the Washington metro area GRP grew 0.2% to 3.1%. We believe this recession will be different, as retail spending and construction – the two hardest hit industries in the metro area – are taking longer to recover than originally anticipated. With this, we expect GRP to have declined slightly for this recession.

The most important element of Federal spending in the metro area economy is procurement — the Federal government’s purchase of goods and services from the private sector. Spending increased notably during 2008 by 10% to $66.5 billion – above the 15-year annual average of 7.5%. The rise in spending was due, in part, to an increase in funds fl owing from the Department of Homeland Security. Procurement funding increased 37% in this agency, compared to the average increase of 20% per annum.

Substate Area 2009

Northern Virginia -1.0%

Suburban Maryland -0.5%

District 1.0%

Total Metro Area -0.5%

GRP ChangeWashington Metro Area

Source: Dr. Stephen Fuller; January 2010.

Source: BEA, Dr. Stephen Fuller; January 2010.

Federal Procurement SpendingWashington Metro Area

*Estimate.Source: Dr. Stephen Fuller, Delta Associates; January 2010.


Procurement spending is projected to rise 13.2% in 2009, once the numbers are fi nalized, to $75.3 billion in current year dollars, accounting for 53% of all Federal funds fl owing into the area economy. This level of procurement spending supports about 550,000 private sector jobs.

Procurement funding will build upon already-established government initiatives to increase the concentration of Federal government contractors in the Washington area. While there has been some speculation about the Obama Administration tightening the rules on government contracting, it is our judgment that it is unlikely to reduce the amount spent, even if it reduces the rate of growth in spending.

Regional ConsumerConfi dence Index

Consumer confi dence is on the rise in the metro area, according to the Washington Region Confi dence Index by the Greater Washington Board of Trade.

The index increased four points to 60 at November 2009, from 56 at April 2009. The District experienced the greatest rise, to 67, from 59 in April 2009.

Consumers are also more confi dent in job security, as 25% believe their company will expand jobs in the near-term, up from 22% in December 2008. Those believing their companies would eliminate jobs declined to 15% in November 2009, from 24% in December 2008.

Consumer Confi dence IndexGreater Washington Area

Source: Greater Washington Board of Trade, Delta Associates; January 2010.



48 Section Three

Households Age 25-34 with Income $100K+Top 10 Counties

County Total HH Age 25-34 $100K+ % Age 25-34 $100K+

Loudoun County, VA 104,327 10,494 10.06%

Arlington County, VA 92,693 8,172 8.82%

San Francisco County, CA 332,596 26,026 7.83%

New York County, NY 768,292 58,448 7.61%

Douglas County, CO 102,379 7,403 7.23%

Forsyth County, GA 59,296 4,128 6.96%

Alexandria City, VA 65,453 4,372 6.68%

Delaware County, OH 62,451 4,151 6.65%

Scott County, MN 45,157 2,975 6.59%

Broomfi eld County, CO 20,834 1,360 6.53%

Source: The Nielsen Company; January 2010.

Local Recovery Efforts

Only 10.8% of jobs expected to be saved or created locally through the American Recovery and Reinvestment Act have been so far. The Federal government estimated that a total of 65,000 jobs would be saved or created in the metro area through stimulus dollars. However, to date just over 7,000 jobs have been saved or created. This is not surprising, as not all the funds have been spent and the funding is through 2011. We expect job creation through the stimulus act to pick up pace during 2010.

Washington Area Economic Outlook

We expect the Washington metro area economy to slowly recover during 2010; it will pick up steam thereafter. We believe the local economy hit bottom during the 1st half of 2009 and recovery is now underway. However, we expect the speed of recovery to be slow, as consumers and companies remain cautious. We expect consumer confi dence will edge up moderately during 2010. Consumer confi dence is currently very low and will remain challenged until healthy job growth is reported.

Young and Affl uent in the Metro Area to Help with Recovery

A larger share of young and affl uent households resides in the Washington metro area, compared to other U.S. counties, according to the Nielsen Company. Loudoun County ranks fi rst with 10% of its population young (between the age of 25 to 34) and affl uent (making $100,000 or more). This compares to only 2.2% of young and affl uent households nationally.

We expect the younger consumer to help pull the regional economy through the recovery. Given consumer spending is two-thirds of the GRP, retail sales is a heavyweight in economic health.

According to the Greater Washington Board of Trade, younger generations are more confi dent about the economy compared to older generations, as the younger consumer has time to recoup money lost during the recession. This is no doubt a boon to the area, as the Washington metro has a larger share of young and affl uent residents living here. We expect those closer to retirement to remain more cautious about spending in the next two years.

With consumers stashing cash during the recession, a rebound in spending is anticipated during 2010 – riding upon the economic recovery and pent-up demand for goods.

Retail spending is projected to rise 5.5% in the Washington metro area during 2010, according to Woods & Poole. This is above the 25-year annual average of 3.5%. The 2010 sales total is expected to mirror what spending totaled back in 2004. This will help boost the GRP in the metro area.




Total Jobs Created or Saved Through the American Recovery and Reinvestment ActWashington Metro Area

*Delta Associates’ estimate based on state-wide job creation and regional population share.Source: Recovery.gov, Delta Associates; January 2010.

We believe GRP may have declined 0.5% during 2009, once the numbers are fi nalized. This decline is less severe compared to the national decline of 2.5%. The decline locally is due to retail spending and construction – the two hardest hit industries in the metro area, which are taking longer to recover. Conditions should stabilize in 2010 with a GRP rise of 2.7%. This compares to the national GDP rise of a projected 2.5%.

Given these factors, in consultation with Dr. Stephen Fuller of George Mason University, we estimate that 24,500 payroll jobs were eliminated in the metro area in 2009, once the numbers are fi nalized. We expect the Suburban Maryland and Northern Virginia substate areas eliminated 17,800 and 11,200 positions, respectively. The District likely added 4,500 new jobs as the government staffed up in 2009.

Job growth will resume in 2010, with 24,900 new jobs and gain steam in 2011 with 34,900 new jobs. It is not until 2012 or 2013 that we are likely to return to job growth numbers that parallel historic levels – 52,000 annual average. This level of performance is likely to be among the strongest in the nation among metro areas. And it provides plenty of job and population growth to support a recovering and eventually robust housing and commercial real estate market in the period ahead. Just where are these opportunities? Read on . . .

Payroll Job GrowthWashington Metro Area | 2000 Through 2012

Note: Data restated since 2000 consistent with redefi nition of metro area in March 2005.Source: Dr. Stephen Fuller, Delta Associates; January 2010.

51

The Washington Area

Offi ce Market

4

52 Section Four

The Washington Area

Offi ce Market

Market Fundamentals Deteriorate Further, Yet Sturdy Compared to the Nation; Prospects of “Normalized” Market Conditions by 2013

In the 2006 TrendLines report, when we predicted vacancy rates would rise and rents would decline by 2008, we had no idea that these fundamentals would also be compounded in 2009 by a decline in absorption due to a severely weakened economy. Even though the Washington metro area offi ce market fi nished the year with modest positive absorption, taken together these factors have conspired to raise the regional vacancy rate in 2009 to the highest rate seen since the early 1990s.

The regional offi ce market struggled through the lowest absorption year in 40 years, as government, health care, and contractors boosted absorption with notable lease deals. Although overall vacancyincreased 240 basis points during the past year, it remains lower than most large metro areas due to the stabilizing infl uence of the Federal government. Given rising vacancy, average net effective rents declined 6.9% in 2009. Construction levels have declined notably, but remain elevated at this point in the cycle – particularly in the District.

Despite weak conditions, the metro area remains one of the top performing markets in the nation.

Supply/demand fundamentals are expected to return to equilibrium by 2013 for the metro area around which time the regional rental rate will be increasing at the long-term average of 3.8%. Select submarkets with stronger fundamentals will experience this sooner.

Largest U.S. Offi ce Markets2009

Note: Excludes New York at 1 billion SF.Source: CoStar, Delta Associates; January 2010.

The Washington Area Offi ce Market 53

National Context

The Washington metro area is the 3rd largest offi ce market in the nation, behind New York and Los Angeles/Orange County.

Offi ce Vacancy RatesSelected Metro Areas | Year-End 2009

Net Absorption of Offi ce SpaceSelected Metro Areas | 2009

Source (For Both): CoStar, Delta Associates; January 2010.

Washington metro has the fourth-lowest overall vacancy rate among large metro areas in the United States. The New York metro area holds the lowest overall vacancy rate in the nation, at 10.7% – at least for now.

While lower Manhattan has been hit hard by fi nancial fi rms putting space back on the market, the New York metro vacancy rate has been bolstered by the suburbs.

The Washington metro area ranked fi rst among the nation’s large metro areas in net absorption during 2009, with positive 630,000 SF. The Federal government, the engine that never stops, helped buoy the metro area during the downturn, while other large metros suffered negative absorption.

2009 Offi ce Market Highlights

Net absorption: 630,000 SF, compared to 3.4 million SF in 2008.

Sublease space: Increased by 1.2 million SF. Sublease space represents 1.4% of the standing inventory compared to 3.4% at the peak of 2002.

Overall vacancy rate: 13.0%, up from 10.6% one year ago. Fourth lowest rate in the nation.

Direct vacancy rate: 11.6%, up from 9.3% one year ago.

Pipeline (U/C and U/R): 5.7 million SF, down from 15.4 million SF one year ago.

Pipeline pre-lease rate: 48%, compared to 26% a year ago.

Average Effective Rents: Down 6.9%, compared to an increase of 0.1% in 2008.

Investment sales: $2.0 billion compared to $3.7 billion in 2008. Average sale price: $276/SF.

54 Section Four

Net Absorption of Offi ce SpaceWashington Metro Area | 1980 Through 2009

Net Absorption of Offi ce SpaceWashington Metro Area | 2009


Net Absorption: 630,000 SF

Net absorption of offi ce space in the Washington metro area totaled 630,000 SF, compared to 3.4 million SF in 2008 and the long-term average of 7.5 million SF.

Northern Virginia and the District experienced positive net absorption during 2009, as government, health care, and government contractors signed notable deals in these sub-state areas. Suburban Maryland experienced negative net absorption, as demand could not keep pace with tenants vacating large blocks of space. For instance:

Lockheed Martin vacated 180,000 SF at 6560 Rock Spring Drive in the North Bethesda submarket.

Verizon vacated 123,000 SF at 3901 Calverton Boulevard in the Beltsville/ Calverton/College Park submarket.

Sublease space increased 1.2 million SF during 2009, compared to rising 407,000 SF in 2008. Sublease space currently represents 1.4% of standing inventory. This compares to a level of 3.4% during the peak of the 2001-02 downturn. While sublease space is impacting lease rates and market conditions in select submarkets, it is not as market wide concern nor is it expected to become such in this cycle.

Net absorption of Class A space totaled 2.8 million SF in the Washington metro area during 2009, compared to 4.3 million SF during 2008.

Net Absorption of Offi ce Space And Change in Sublease Space2008 vs. 2009 (000s of SF)

Direct Space Net Absorption

Sublease Space Absorbed or (Returned)

Market 2008 2009 2008 2009

NOVA 2,333 360 (386) (348)

Sub MD 524 (649) (21) (113)

District 546 919 0 (706)

Total 3,403 630 (407) (1,167)



Gross Leasing Volume Down; FavorsGovernment & Business Services

We estimate gross leasing activity totaled 24.5 million SF during 2009, below the 10-year average of 31.2 million SF. Large renewals continue to dominate the market, as tenants remain skeptical about expanding during the recession. We expect renewals to dominate through 2010 as well.

The most notable non-renewal deal of the year was during the 2nd quarter, with the Raytheon Company’s lease of 600,000 SF in AOL’s former space at 22110-22270 Pacifi c Boulevard in Loudoun County.


Gross Leasing ActivityWashington Metro Area | 2000 Through 2009

Offi ce Leasing Activity by SectorWashington Metro Area | 2005 – 2009

*Legal, Financial, Business Services.Source: CoStar, Delta Associates; January 2010.

*Estimate.Source: CoStar, Delta Associates; January 2010. Vacancy Rate: Up to 13.0%

The Washington area’s overall vacancy rate is 13.0% at year-end 2009, up from 10.5% one year ago. This is the highest rate seen since the early 1990s.

The Washington metro area direct vacancy rate increased to 11.6% at December 2009, from 9.3% one year ago.

The Washington area overall Class A vacancy rate is 14.5% at year-end 2009, up from 11.9% one year ago. The Washington area direct Class A vacancy rate is 12.6% at December 2009.

Vacancy Rates and Vacant Space (All Classes)Washington Metro Area | December 2008 vs. December 2009

Vacancy Rate December 2008 December 2009

Direct 9.3% 11.6%

Sublet 1.2% 1.4%

Vacant Space (Millions of SF)Direct 36.0 45.7

Sublet 4.6 5.8

Source: CoStar, Delta Associates; January 2010.

Despite the national recession, gross leasing activity in the Washington metro area increased 12.3% in 2008 compared to 2007, due in part to numerous renewal deals by the Government as tenants wait to relocate to bases under the Base Realignment and Closure (BRAC) decision. However, the tech/telecom sector experienced a notable rise in leasing due in part to procurement spending, which increased 10.0% during the year.

Although we expect procurement to rise 13.2% during 2009, compared to 2008, once the numbers are fi nalized, leasing has tallied below 2008 levels given the worst of the recession was felt during the past year. Given this, tenants will re-arrange space in the near-term, sometimes doubling-up employees in offi ce space, until they are comfortable enough with their economic future to lease expansion space. The share of gross leasing activity has increased in the past year by government and legal/fi nance/business services. This is consistent with the growth in jobs in these categories.

56 Section Four

Leasing on Recent Deliveries and Projects U/C or U/RWashington Metro Area | 2007 – 2012

Note: Recent deliveries are based on % leased upon delivery.Source: CoStar, Delta Associates; January 2010.

Construction and Pre-Leasing Elevated; Starts Halted

There is 5.7 million SF of offi ce space under construction or renovation in the Washington metro area at December 2009, down from 15.3 one year ago.

48% of the space under construction is pre-leased at December 2009, up from 26% a year ago.

Offi ce Space Under ConstructionWashington Metro Area | Millions of Square Feet

December December December

Substate Area 2007 2008 2009

NOVA 8.0 3.4 0.4

Sub MD 3.3 2.3 0.6

District 9.3 9.6 4.8

Total 20.6 15.3 5.7


Pre-lease rates on recent deliveries in the Washington metro area have eased over the last few years. However, projects delivering during 2010 and 2011/2012 have picked up tenants, as pre-leasing is currently 49% and 45%, respectively. These pre-lease rates are on par with the 10-year average pre-lease rate of 55%.

Notably, the GSA pre-leased 288,000 SF at One Constitution Square in the NoMa submarket during the 4th quarter, as it plans to take this space short-term as its headquarters building undergoes a green renovation – compliments of the stimulus package.

Construction starts of offi ce space in the Washington metro area have slowed down to a trickle – totaled 2.1 million SF during 2009, compared to 7.8 million SF in 2008.

Given the credit crisis, developers are fi nding it diffi cult to either start construction or continue construction that has broken ground. Only all-cash projects or projects with notable pre-leasing in place appear to be breaking ground at this time.

One project of note likely will start construction early in 2010. Armed with the recent deal with the Defense Advanced Research

Projects Agency (DARPA) to fully lease the new offi ce project, the Shooshan Companies intends to develop a 353,000 SF offi ce building at 675 N. Randolph Street in the RCB Corridor of Arlington, Virginia.

Approximately 11.7 million SF of offi ce space, including renovations, delivered in the Washington metro area during 2009 at 23% leased. During 2008, 10.7 million SF delivered at 36% leased upon delivery.

Construction StartsWashington Metro Area | 2002 Through 2009



Offi ce Space Demand and DeliveriesWashington Metro Area | 24 Months Ending December 2011


Projected Supply vs. Demand: Vacancy to Decline by December 2011

We project the overall vacancy rate will decrease over the next two years, from 13.0% today to approximately 12.6% by December 2011.

We project vacancy to rise in the District due to elevated pipeline. Vacancy in Suburban Maryland and Northern Virginia should experience a slight decline, as the level of construction has declined notably.

We expect overall vacancy outside the Beltway to tick down to 14.6% at December 2011, from 15.9% today due to the notable reduction in pipeline projects. However, we project the overall vacancy rate inside the Beltway to edge up to 11.1% over the next 24 months, from 10.8% today, due to the high construction levels in the District.

Offi ce Space DeliveriesWashington Metro Area | 1980 Through 2009

Note: Delivery totals include renovations.Source: CoStar, Delta Associates; January 2010.

Offi ce Space Demand and DeliveriesWashington Metro Area | 24 Months Ending December 2011


Rents: Declined in 2009; Cyclical Increases Expected by 2012

The average effective offi ce rent declined 6.9% during 2009, compared to ticking up 0.1% during 2008. Rents declined at a faster pace outside the Beltway, by 7.8% during the year,

as vacancy remains high. Rents declined 6.0% inside the Beltway during the same period.

Concessions to tenants increased during 2009, as competition to sign tenants intensifi ed. The average TI cost for space increased to approximately $45.00/SF, for all classes of space. The average free rent offering rose to 4.0 months at December 2009.

We project rents will decline 5.0% to 7.0% during 2010, as vacancy remains elevated. However, better buildings in better submarkets will outperform these averages.

By 2012 we expect rents to begin their cyclical increase.

58 Section Four

Investment Sales: Cap Rates Up; Prices Down; Volume Uptick in Second Half of 2009

Investment sales were limited during 2009, as tight credit, a large bid/ask gap, and moderating property performance kept investors on the sidelines. Sales volume totaled $2.0 billion during 2009, compared to $3.7 billion during 2008.

Investment sales increased in the Washington metro area during the 2nd half of the year as investors tip-toed back into the market. A total of 23 transactions closed during the last six months of the year, compared to 16 sales completed during the 1st half.

The volume during the 2nd half totaled $1.2 billion, compared to $801 million during the 1st half. Given distressed assets coming to the market, investors looking for deals with long-term stability prospects have targeted the Washington metro market.

Sales prices averaged $276/SF in the Washington area during 2009, compared to $431/SF in 2008. The decline in average sales price was due to few transactions during the past 12 months, plus investors’ concern about future near-term market performance.

Loan defaults remain a concern in the Washington metro area. However, distressed assets remain relatively low in the metro area compared to the nation. The Washington metro area makes up only 1.6% of the nation’s distressed assets. This compares to New York at 8.3% and South Florida at 5.3%. So far, only $1.1 billion of offi ce assets has come under distress in the

NCREIF Return Index1

Offi ce Properties

Metro Area 12-Month Total Return at 3rd Quarter 20091

Houston -16.16%

Washington -18.76%

Wash. CBD -18.51%

Wash. Suburbs -19.06%

Atlanta -19.19%

Dallas -20.74%

Chicago -20.93%

Denver -22.99%

National Average -24.52%

Los Angeles -25.08%

Phoenix -25.55%

San Francisco -26.10%

New York -32.87%

Boston -34.27%

1 NCREIF compiles return based on its members’ $87.7 billion offi ce portfolios. The index includes both current income and capital appreciation returns.Source: Delta Associates, based on data in NCREIF’s 3rd Quarter 2009 Real Estate Performance Report.

Cap Rates for Core Offi ce AssetsWashington Metro Area | 2002 Through October 2009

*Trailing 12 monthsSource: Real Capital Analytics, graphic by Delta Associates; January 2010.

Washington metro area. We expect this total to remain relatively low.

The average cap rate for core offi ce assets in the Washington metro area, on a 12-month trailing basis, is 8.1%, up from 6.5% one year ago, according to Real Capital Analytics. We expect this trend to continue in the near-term but we believe most of the rise in cap rates is behind us for this cycle.

Investment Returns: Among Best in Nation

The yield on Washington area offi ce assets for the 12 month period ending September 2009 was second in the U.S., behind only Houston. Total returns are, of course, negative due to asset value declines which offset current returns/cash fl ow. Total returns realized in the Washington offi ce market were negative 18.76% for the 12 months ending September 2009. The Washington area return compares favorably to the national return of negative 24.52% and all other major metros except Houston.

We expect the metro area to remain a desirable destination for investors’ cash in the long-run. Although transactions started to rise during the 2nd half of the year, we believe total sales will be limited through 2010, although higher than in 2009.


Offi ce Market Outlook: Identifying Opportunities During the Recovery

The Washington metro area market should remain one of the best performing offi ce markets in the nation. We believe the recession bottomed out locally during the fi rst half of 2009 and a recovery is underway. Recovery will be slow during 2010, as the Federal government’s oversight activities begin to ramp up hiring and offi ce leasing. However, meaningful growth will not be felt until 2011. And “normalized” offi ce market conditions will not be felt until 2013.

We expect vacancy to rise inside the Beltway, peaking at 12.5% in 2010, as a greater amount of spec product is set to deliver at that time. After peaking in 2010, vacancy should start to decline, not falling below the rent equilibrium zone (a zone where rents tend to neither rise nor fall) until 2014.

Overall Offi ce VacancyInside the Beltway


We believe vacancy outside the Beltway to have peaked at year-end 2009 at 15.9%, as most projects have already delivered. We expect vacancy to decline slowly during 2010 and 2011. However, we do not expect vacancy to reach the rent equilibrium zone until 2015 or so, as we believe demand will be softer outside the Beltway compared to inside the Beltway.

We project rents will decline by 5.0% to 7.0% in 2010 – with concession offerings limiting effective rents. We expect available space to remain elevated in 2010, keeping rents down. By 2012 rents should gain traction, and return to the long-term average increase of 3.8% by 2013.

Overall Offi ce VacancyOutside the Beltway


Offi ce Rent Growth per YearWashington Metro Area


60 Section Four

We project sublease vacancy will rise during the 1st half of 2010, but it should not rise to the levels experienced during the last downturn. Submarkets with large shares of leasing by the fi nancial sector should feel the pinch of rising sublease space impacting rents. These submarkets include Bethesda/Chevy Chase and Tysons Corner.

The District could attract a few suburban tenants, as the emerging submarkets of NoMa, Southwest, and Capitol Riverfront deliver spec construction at lowered rents. Tenants looking to trade up could choose these submarkets.

We anticipate limited investment sales into 2010 – with the exception of all-cash transactions, as lending remains modest. With stressed and distressed assets arriving to the market, sales volume should increase in the near-term as potential buyers take advantage of reduced prices.

Overall, the long-term outlook for the metro area remains positive, driven by the continued activity of the Federal government. We expect the Washington metro offi ce market to remain among the best performers in the nation.

As a result, the successful investor/developer will:

1. Selectively accumulate assets at below replacement cost while prices and interest rates are low.

2. Invest in repositioning older, under-performing assets at superior locations for delivery in 2013 or sooner if tenancy is not a risk until 2013 or beyond.

3. Develop and deliver new projects before 2013 only on a tenant-driven (pre-leased) basis or sooner in the few submarkets where supply/demand fundamentals warrant.

4. Position now for development throughout the metro area in 2013 and beyond as more “normalized” conditions return to the market.


63

The Washington/Baltimore

Flex/Industrial Market

64 Section Five

The Washington/Baltimore

Flex/Industrial Market

Regional Market Contracted in 2009; Stabilization Expected In 2010

The Washington/Baltimore fl ex/industrial market contracted during 2009 with 2.3 million SF of negative absorption.

Market conditions held up better in the Baltimore metro area than in the Washington metro, as a handful of large bulk warehouse lease deals kept absorption only modestly negative during the year.

The Washington metro experienced a larger share of tenants vacating space – with fewer large lease deals to offset the loss.

Rents declined over the past 12 months as property owners competed for tenants.

The amount of space in the construction pipeline is down, which will help stabilize the market during 2010. However, a handful of spec construction projects started in the Baltimore metro area in 2009, as the area prepares for BRAC-related tenants.

Overall, fl ex/industrial conditions are weak in the Washington/Baltimore region, but should regain solid footing in 2010 due to the relative strength of the Baltimore market.

National Context

The Washington/Baltimore fl ex/industrial market, at 356 million SF, is a mid-scale market where the primary function is regional distribution and accommodation of R&D and low-cost offi ce uses. With the exception of

Largest U.S. Flex/Industrial Markets 20092009


some older product in the Baltimore area, there is little manufacturing in this region.

The Washington/Baltimore region’s overall vacancy rate, at 11.4%, is just above the national average of 10.0%.

Net Absorption Down

Flex/industrial net absorption totaled negative 2.3 million SF in the Washington/Baltimore region during 2009, compared to 4.4 million SF during 2008. This compares to the 10-year average of 4.0 million SF per annum.

The Washington/Baltimore Flex/Industrial Market 65

2009 Market Highlights

Net absorption: Negative 2.3 million SF, compared to positive 4.4 million SF in 2008.

Sublease space: Increased by 217,000 SF. Available sublease space represents 0.9% of standing inventory.

Overall vacancy rate: 11.4%, up from 10.1% one year ago.

Under construction: 1.1 million SF, down from 3.5 million SF one year ago.

41% of the space under construction is pre-leased, up from 30% a year ago.

Rents: Down 4.3%, compared to rising 0.3% in 2008.

Investment sales: $136.9 million. Average sales price: $58/SF.

Net absorption during 2009 fell into the negative, as demand could not keep pace with tenants vacating space. Although there were some gains in leasing of bulk warehouse space, it was offset by tenants vacating fl ex/warehouse and fl ex/R&D space.

Leasing of bulk warehouse space was fairly healthy, as:

Sun Products Corporation leased 503,000 SF at 1900 Clark Road in Harford County.

IDX Corporation leased 434,000 SF at 8901 Snowden River Parkway in the Columbia submarket.

Hhgregg leased 393,000 SF at 14301 Mattawoman Drive in Prince George’s County.

Parcorini Metals leased 135,000 SF at 7700 Rolling Mill Road in the

Baltimore County East submarket.

However, numerous tenants vacated fl ex/warehouse and fl ex/R&D space.

For instance:

IDX Corporation vacated 196,000 SF at 1710 Midway Road in the BWI submarket.

HBO vacated 121,000 SF at 8855 McGaw Road in the Columbia sub-market.

Edge Technologies vacated 45,000 SF of fl ex/warehouse space at 8003-8039 Laurel Lakes Court in Prince George’s County.

Northrop Grumman vacated 98,000 SF of fl ex/R&D space at 9310-9370

Gaither Road in Montgomery County.

Flex/Industrial Net Absorption Washington/Baltimore Region | 1997 Through 2009


Flex/Industrial Vacancy Rate Select Metro Areas | Year-End 2009


66 Section Five

Sublease space increased 217,000 SF during 2009, compared to increasing 753,000 SF during 2008. Sublease space represents 0.9% of the standing inventory.

Net absorption of newer space (built after 1987) totaled negative 1.1 million SF during 2009, compared to 5.2 million during 2008. For newer space, the Washington metro area absorbed negative 836,000 SF and the Baltimore metro area absorbed negative 240,000 SF.

Gross Leasing Activity Down

We estimate gross leasing activity in the Washington/Baltimore region totaled 17.1 million SF during 2009, below the 10-year average of 20.9 million SF.

Gross Leasing Activity Washington/Baltimore Region | 2000 - 2009

Buildings with Contiguous Blocks of Available SpaceWashington/Baltimore Region | December 2009

Type of Flex/Industrial Inventory & AbsorptionWashington/Baltimore Region | 2009

Inventory at 12/2009(millions of SF)

Net Absorption2009

Type of Space SF % SF

Bulk Warehouse 110.5 31% (88,000)

Flex/Warehouse 212.3 60% (1,259,000)

Flex/R&D 33.6 9% (947,000)

Total Flex/Industrial 356.4 100% (2,294,000)


Location of Flex/Industrial Inventory & AbsorptionWashington/Baltimore Region | 2009

Inventory at 12/2009

(millions of SF) Direct Space Including Sublet

Metro SF % SF % SF %

Wash. 177.7 50% (1,904) NA (1,964) NA

Balt. 178.7 50% (390) NA (547) NA

Total 356.4 100% (2,294) NA (2,511) NA


*Estimate.Source: CoStar, Delta Associates; January 2010.

Note: Includes buildings under construction or renovation.Source: CoStar, Delta Associates; January 2010.

The most notable lease deal in the region during 2009 was Sun Products Corporation’s lease of 503,000 SF at 1900 Clark Road in the Harford County submarket of the Baltimore metro area. The most notable deal in the Washington metro area was Hhgregg’s lease of

Net Absorption (000s of SF)


Flex/Industrial Vacancy RateWashington/Baltimore Region | 1998 Through 2009

393,000 SF of bulk warehouse space at 14301 Mattawoman Drive in Prince George’s County.

There are 1,114 buildings with contiguous blocks of available space over 10,000 SF in the Washington/Baltimore region. This compares to 963 buildings one year ago. The largest block of space is 1.1 million SF at 2800 Eastern Boulevard in the Baltimore metro area.

Vacancy Rate Up

The region’s overall fl ex/industrial vacancy rate increased to 11.4% at year-end 2009, from 10.1% one year ago. The Baltimore area’s overall vacancy rate is 190 basis points lower than the Washington area’s rate.

The region’s direct fl ex/industrial vacancy rate was 10.5% at December 2009, up from 9.3% one year ago.

The region’s overall vacancy rate for newer product (built since 1987) increased to 13.1% at year-end, from 10.7% one year ago. The region’s direct vacancy rate for newer product is 11.9%, up from 9.5% a year ago.

Construction Activity Way Down

The amount of fl ex/industrial space under construction in the region is 1.1 million SF at year-end 2009, down from 3.5 million SF one year ago.

Space under construction is 41% pre-leased at December 2009, up from 30% one year ago. The Washington area’s pre-lease rate is 55%, compared to the Baltimore area’s at 2%.

Only a handful of projects started construction during 2009. Ground-breakings totaled 696,000 SF during the past year, compared to 4.0 million SF in 2008. Notably, 260,000 SF started in the Baltimore metro area during the 2nd half of the year, as the area prepares for an infl ux of BRAC-related tenants by September 2011.

Pre-lease rates at delivery are starting to rise in the Washington/Baltimore region, after declining through 2009. With 1.1 million SF due to deliver during 2010, developers have been more judicious on breaking ground on spec projects, which has allowed pre-lease rates to rise.

1.8 million SF of fl ex/industrial space delivered in the region during 2009, compared to 7.3 million SF in 2008.

25% of the space delivered during the past year was leased upon delivery, compared to 24% during 2008.

Direct Flex/Industrial Vacancy RatesWashington/Baltimore Region | All Space

MarketYear-End

1996Year-End

2000Year-End

2009

Wash/Balt Region 12.3% 7.3% 10.5%

Wash/Balt Subs. 10.4% 6.1% 10.6%

Balt/Wash Corr. 10.8% 7.5% 10.9%

Wash. Metro Area 10.5% 6.2% 11.3%

Balt. Metro Area 14.5% 8.4% 9.6%


Flex/Industrial Space Under Construction and Pre-LeasedYear-End 2008 and Year-End 2009 | (Millions of SF)

At 12/2008 At 12/2009

Metro AreaSF

U/C% Pre-leased

SFU/C

% Pre-leased

Washington 2.2 28% 0.8 55%

Baltimore 1.3 33% 0.3 2%

Regional Total 3.5 30% 1.1 41%



68 Section Five

Supply v. Demand: Vacancy to Decline; Rents to Rise in 2011

The regional fl ex/industrial vacancy rate likely will tick down to 11.0% by year-end 2010, from 11.4% today. The overall vacancy rate will edge down 40 basis points, as we project demand to outpace new supply by approximately 1.0 million SF.

Although demand is likely to remain below average during 2010, given the construction pipeline has been cut substantially over the past year, demand is likely to exceed new supply modestly.

We expect more progress in 2011, with the vacancy rate declining towards the equilibrium zone (10.3% to 10.5%), heralding the resumption of region-wide rent growth.

Rents Tick Down for the First Time Since 2003

Flex/industrial rents in the Washington/Baltimore region declined 4.3% during 2009, after rising 0.3% during 2008.

Rent growth for each product type experienced decline during 2009. Rents declined most notably for fl ex/R&D space, as overall vacancy increased the most, at 260 basis points over the past year, for this product type. The Washington metro area experienced stronger rent declines of 4.9% during 2009, as overall vacancy climbed 190 basis points since year-end 2008. Rent decline in the Baltimore metro area was lower at 3.5%, as overall vacancy ticked up 70 basis points.

We expect fl ex/industrial rents to edge down during 2010, as the region slowly recovers from the national recession. We anticipate rents will tick down by 2.0% to 3.0% in 2010, as the economy gradually recovers. However, during 2011 we expect rents to gain slight traction as the region-wide vacancy rate continues to decline.

Flex/Industrial SpaceDeliveries and Pre-Leasing | Washington/Baltimore Region | 2009

MarketMillions of SF

Delivered % Pre-leased

Washington 1.5 20%

Baltimore 0.3 46%

Regional Total 1.8 25%


Leasing on Recent Deliveries and Projects U/C or U/RWashington/Baltimore Region | 2006 Through 2010

Note: Recent deliveries are based on % leased upon delivery.Source: CoStar, Delta Associates; January 2010.


Investment Sales

Flex/industrial investment sales volume totaled $137 million in the Washington/Baltimore region during 2009, compared to $564 million in 2008.

Sales prices averaged $58/SF for the 15 transactions that closed during the year. This compares to $102/SF for 45 transactions in 2008.

We expect limited investment sales activity, though possibly some distressed sales, during 2010. With low prices, few deals on the market, and tight credit markets, we expect a low volume of transactions again in 2010. Regardless, investors will remain interested in the Washington/Baltimore fl ex/industrial market, given its long-term, stable nature.

The Flex/Industrial Market Outlook:Identifying Opportunities During the Recovery

Flex/industrial market conditions in the Washington/Baltimore area should stabilize during 2010 Demand should remain steady in the Baltimore metro area, as tenants start to lease space due to BRAC relocation.

Conditions in the Washington metro area should remain sluggish, as tenants are hesitant to lease space until improving business conditions are felt.

Rent traction should return region-wide by 2011.

Given this background, the successful investor/developer will:

1. Selectively accumulate assets in 2010 at below replacement cost while prices and interest rates are low.

2. Invest in repositioning existing under-performing assets.

3. Position now for development of new projects in 2011 in select locations in the Baltimore market and 2012 in select submarkets in the Washington metro.

Projected Year-End 2010 Vacancy RatesWashington/Baltimore Region | Flex/Industrial Market | (Millions of SF)

Wash.Metro

Balt.Metro

Regional Total

Inventory

Inventory at 12/09 177.1 178.7 356.4

Pipeline Th ru 12/101 1.1 0.5 1.5

Inventory at 12/10 178.7 179.2 357.9

Supply2 vs. Demand

Vacant Space at 12/09 21.9 18.6 40.5

New Supply Th ru 12/10 1.1 0.5 1.5

Avail. Space at 12/10 22.9 19.1 42.0

Demand Th ru 12/10 1.7 0.8 2.5

Vacant Space at 12/10 21.2 18.3 39.5

Vacancy Rate2

Vacancy at 12/09 12.3% 10.4% 11.4%

Vacancy at 12/10 11.9% 10.2% 11.0%

1 Pipeline equals buildings under construction and those planned that may deliver by year-end 2010.2 Includes sublet space.Source: CoStar, Delta Associates; January 2010.

Rent Decline by Product TypeWashington/Baltimore Region | 2009

Submarket% Change

December 2008 to December 2009

Bulk Warehouse -4.1%

Flex/Warehouse -4.3%

Flex/R&D -4.8%


71

The Washington AreaApartment Market

6

72 Section Six

The Washington Area

Apartment Market

Class A Absorption Continues Record Pace While Vacancy Edges Down; Pipeline Continues to Shrink with Product Shortage Now on the Horizon

The Class A apartment market did not get the memo about conditions in the commercial real estate market. While net effective rents did edge lower by 2.0% over the year due to elevated concessions, all other indicators showed improvement and set the stage for the coming recovery.

The Washington metro area continues to be one of the best apartment markets in the nation due to:

1. A job market, that while losing lower wage earners, is still adding higher wage earners – those who occupy Class A apartments.

2. A transient work force that has produced a large pool of renters by choice.

3. A demographic trend that is turning would-be purchasers into renters.

However, we are in the midst of a more competitive apartment market due to deliveries outpacing demand for the past 18 months. While several quarters of weaker performance are ahead for the Washington metro, the groundwork is being laid for stronger market conditions in 2011 and 2012, and an emerging product shortage by 2012 in select submarkets and widespread shortages in 2013.

The pipeline of supply continues to decline from its peak in the fourth quarter of 2007.

Annualized Class A absorption exceeds 7,900 – the highest of any metro market in the nation.

National Context

Though 9th in population, with an inventory of approximately 518,600 units, the Washington metro area is the third largest apartment market in the U.S., behind New York and Los Angeles.

The Washington metro wide vacancy rate is 4.3% at year-end 2009. The national rate is nearly double this rate at 7.6%.

The metro-wide absorption of Class A and Class B units in 2009 was 6,061 – the highest of any metro area in the nation. And this compares to a national total of negative 41,118 units. The Washington metro total of Class A unit absorption set another record – 7,955 units absorbed in 2009.

Net effective rental rates for all classes of apartments in the Washington metro area declined 2.0% during 2009. On the other hand, rents declined 3.7% nationally. Class A rents in the Washington metro area declined 1.7% in 2009.

The Washington Area Apartment Market 73

2009 Washington Metro ApartmentMarket Highlights:

The region’s stabilized vacancy rate for Class A apartments is 3.6% – down from 4.4% a year ago. For all investment grade apartments (Class A and B) it is 4.3%, the same as a year ago. With the national rate at 7.6%, this is one of the lowest vacancy rates of any metro area in the nation.

Rents edged down over the past twelve months for Class A units – 1.7% – compared to growth of 0.1% during the preceding year. For all investment grade product – Class A and Class B units – rents declined 2.0% since December 2008.

Annual net absorption was strong, at 7,955 units for Class A product – maintaining a nation-leading pace. With Class B dis-absorption, 6,061 Class A and B apartments combined were absorbed in 2009.

Average monthly absorption at new projects slipped to 14 units per project per month from 15 last year, as the cumulative effects of product delivered in 2009 impacted lease-up pace. However, several projects are stabilizing: over the last year projects in lease-up have declined from 51 to 37.

Concessions at Class A projects continued to edge higher. At year-end 2009, concessions were 7.2% of face rent, compared to 5.7% of face rent at year-end 2008. This upward trend began in the fi rst quarter of 2007, as the market became more competitive.

Pipeline: After rising from a historically low 18,000 units in 2005, the pipeline ballooned to 36,951 units in December 2007, largely driven by the reversion of condominium projects. In the fi rst quarter of 2008, the pipeline began its cyclical decline, and has continued downward to a new historical low of 16,606 as of year-end 2009. We believe this downward trend will continue over the next year due to the diffi culty of obtaining development credit. It is now below equilibrium and will result in product shortages by 2012.

Annual Net Absorption Class A & B ApartmentsMajor Apartment Markets

Wash = 12 months ending 12/09. All other markets are 12 months ending 6/09.1/The largest 171 apartment markets in the U.S.Source: REIS and Delta Associates; January 2010.

Apartment Vacancy RatesMajor Apartment Marktes | 2009

1/The largest 171 apartment markets in the U.S.*Mid-year 2009 data except Washington, Baltimore, and Philadelphia are as of year-end 2009.Source: REIS, Delta Associates; January 2010.

74 Section Six

Rents

Net effective rents for Class A and Class B apartments combined decreased over the year by 2.0%. This decrease was driven by rent declines in both the Class A and Class B markets.

High-rise Class A product, almost exclu-sively inside the Beltway, decreased 2.1% while Class A gardens, largely outside the Beltway, declined 1.6%. This is an inverse pattern compared to prior years.

There are currently 14 low-rise projects containing over 4,200 units in lease-up. Several projects reached stabilization at year-end 2009, reducing the number of mid- to high-rise projects in lease-up to 23 – containing over 6,100 units.

Vacancy

Washington metro area vacancy rate for all classes of apartments was fl at, remaining at 4.3% at year-end 2009. The vacancy rate for Class A apartments declined – moving down to 3.6%, from 4.4% a year ago. This rate remains elevated for the Washington metro area but it continues to be among the lowest in the nation.

The stabilized vacancy rate remains elevated – fl at since year-end 2008 at 4.3%. However, only in the fi rst quarter of 2009 did rents for Class A product begin to decline – for the fi rst time since 2003.

Concessions

Concessions rose for all Class A projects, from 5.7% at year-end 2008 to 7.2% at year-end 2009. Concessions for all Class A properties (that is, those fi lling up as well as those replacing turnover) are the highest they have been since 2003. See the accompanying table for details at the substate level.

Effective Rental Rate and Vacancy RateAll Types and Classes of Apartments | Washington Metro Area


Concessions for All Class A Properties Washington Metro Area

Year-End 2006 Year-End 2007 Year-End 2008 Year-End 2009

No. VA 2.7% 5.8% 5.3% 6.8%

Sub. MD 2.1% 3.4% 6.0% 7.3%

District 2.7% 3.3% 6.3% 8.7%

Metro-Wide 2.4% 4.8% 5.7% 7.2%

Concessions for Class A Properties Currently Filling Washington Metro Area

Year-End 2006 Year-End 2007 Year-End 2008 Year-End 2009

No. VA 6.0% 9.5% 12.8% 14.9%

Sub. MD 6.0% 8.4% 12.0% 15.0%

District 5.4% 7.9% 7.8% 17.8%

Metro-Wide 5.9% 9.0% 11.5% 15.7%

Source (For Both): Delta Associates; January 2010.


Concessions for projects currently fi lling up, and not yet stabilized, are the highest we have ever recorded. See the accompanying table for details at the substate level.

Concession rates are up due to the large number of projects in lease up, currently 37. However, this number is a decline from a peak of 54 projects in lease-up in the fi rst quarter of 2009. Approximately 54% of the 10,322 units in projects leasing up have been absorbed, compared to 49% of 14,640 units in lease-up at year-end 2008.

Pipeline

The pipeline is shrinking: During 2007, the pipeline grew signifi cantly in response to the robust performance of the apartment market, available development fi nancing, andreprogrammed condominium projects. The metro-wide pipeline peaked in the fourth quarter of 2007, with declines registered across the region throughout 2008 and 2009.

The District’s 36-month pipeline of

projects has declined to 3,683 units as of December 2009 – a 48% decrease from its peak. This fi gure includes only those units that are under construction as well as those we believe are probable to move forward as planned and deliver within 36 months. Vacancy, at 3.6%, is up from 3.0% one year ago. The rent story in the District is a tale of two cities. In total, effective rents have declined by 1.3%. However, when projects in the Capitol Riverfront submarket are removed from District totals, effective rents in the remainder of the city have increased by 2.1%. Projected deliveries for the next 12 months stand at 822 units – a 30% decline from deliveries during the preceding 12 months. Given recent demand patterns and limited future supply over the next

A Word About Our Defi nition of Vacancy Rate

We sometimes hear from apartment developers and managers that their portfolio vacancy rate is 200 to 400 basis points higher than the numbers we report, which places them under unfair investor scrutiny. As a result, we thought it appropriate to describe here our term “vacancy.”

When we conduct our quarterly surveys, we obtain information on “units available to lease” – that is, physical vacancy. Obtaining the information this way, of course, may produce several important differences from “vacancy” as reported in your fi nancial statements. Simply stated, the difference can be characterized as:

Delta’s Defi nition: Available units to lease

Operating Statement Vacancy: Economic vacancy

Our defi nition (available units) may therefore be understated compared to yours (economically vacant) by our exclusion of units occupied by non-paying tenants (which we cannot know), and of units not available for lease, such as employee units and model apartments. We estimate that this adds about 100 to 150 basis points to your defi nition of vacancy, as compared to ours. Our vacancy rate may also be understated, compared to yours, by our exclusion of what at present are economically vacant, on-notice units for which a lease to occupy in the future has been signed (hence, they are not currently available to lease). We estimate that this potentially adds another 150 to 200 basis points to your defi nition of vacancy, as compared to ours.

24 months, the District should begin to see an easing of downward rent pressure before other substate areas. months, the District should begin to see an easing of downward rent pressure before other substate areas.

Northern Virginia’s 36-month pipeline declined to 7,830 units at year-end 2009 – a 54% decrease from the peak at year-end 2007. Projected deliveries for 2010 are down 27% over the 2009 totals. We expect supply to exceed anticipated demand through 2010, with stabilized vacancy likely edging up in 2010 and into early 2011.

Rent trends over the past twelve months:

■ Down 3.2% for all investment grade apartments.

■ Down 2.1% for Class A garden apartments.

■ Up 1.7% for Class A high-rise apartments.

76 Section Six

Suburban Maryland’s pipeline grew to over 12,700 units by the peak at year-end 2007 but has declined by 60% to 5,093 at year-end 2009. Approximately 1,245 units are expected to deliver in this substate area over the next twelve months, down 28% from the preceding year. Current stabilized vacancy stands at 3.8%, the highest in the metro area, driven upward due to a higher concentration of job losses in this area. Recent deliveries and project-ed additional supply will maintain pressure on occupancy and rental rates throughout 2010. However, with just two new project starts in 2009 conditions should begin to improve in 2011 as the local economyfi rms up.

Suburban Maryland net effective rent growth over the past twelve months:

■ Down 0.5% for all investment grade apartments.

■ Down 1.0% for Class A garden apartments.

■ Down 4.6% for Class A high-rise apartments.


Market Rate Apartment Development PipelineWashington Metro Area | 1999 Through 2009

Absorption

The Washington area’s Class A apartment absorption has been extremely strong over the past year – 7,955 units. Absorption has been consistently strong at between 4,300 and 6,500 units per annum over the past twelve years. What then is driving this strong Class A absorption pace even amid an economic downturn that includes overall job losses?

The lingering for-sale housing downturn is readjusting the renter vs. owner ratio back toward historical norms – perhaps even overshooting the norm during this recession.

The Washington economy continues to add well-paying jobs, even as losses at the lower end of the pay scale occur. These well-paid wage earners rent Class A apartments. These jobs are concentrated inside the Beltway, helping to fi ll the large number of Class A high-rise projects delivering there.

The large number of projects in lease-up places no structural limit on absorption that a more limited supply has in years past.

High concessions are buying absorption at newly leasing Class A properties – over half are offering specials equal to or exceeding two months of free rent. In select submarkets, newly leasing projects are very competitive with Class B rents, causing move-ups to Class A units from Class B units. The resulting rent compression is causing elevated vacancy in Class B projects.


Annual Net Apartment AbsorptionClass A and B Units | Washington Metro Area

Absorption Pace Per Project Per MonthFor Projects in Initial Lease-Up | Washington Metro Area



These factors have led to the absorption of 7,955 Class A units in the past twelve months. Concurrently, jobs losses in economic sectors which consist of Class B renters, coupled with move-ups to Class A properties due to rent compression, have resulted in the dis-absorption of over 1,800 Class B units during 2009. So while Class A absorption remains near record highs, total unit absorption totaled 6,061 units over the past twelve months – closer to the historical norm of 4,700 units per annum.

Resumption of overall job growth in 2010 should positively impact the apartment market in general and continued job growth in the Class A renter demographic should positively impact Class A apartment absorption in 2010.

Per-project monthly absorption has been impacted by deliveries over the past 18 months, gradually declining to the current pace of 14 units per month. The number of projects in active lease-up has been declining, and is currently 37 projects.

When Will the Market be on theUpswing Again?

Metro-wide rent trends are likely to be negative through mid-2010 as projects currently under construction continue to deliver. As deliveries slow in late 2010, rent growth will gradually return to the market. Stabilized vacancy rates will likely peak in the 2010 before edging

downward, with particular speed in the fi rst half of 2012. To take advantage of the market “sweet spot,” position now for delivery in early 2012, or even deliver in 2011 in select submarkets.

78 Section Six

Supply compared to demand? The tightening credit markets have impacted development throughout the region, bringing construction starts to a near standstill for most of 2009. The “materialization rate” for units that were to have begun construction over the preceding year is just 6%, with only 1,073 units starting construction in 2009.

The diffi cult task of securing development fi nancing will continue to hamper new projects during 2010 in our view. While frustrating in the near term, this tightening of the development spigot will improve supply/demand balance and the health of the Washington apartment market over the intermediate term. In our judgment, a product shortage will emerge by late 2011 in select submarkets and metro-wide by 2012.

Apartment unit deliveries will continue their cyclical decline from 6,417 in 2009 to an estimated 4,635 units in 2010 – a 28% decrease.

However, with numerous projects already under construction and delivering over the next nine months, we anticipate that supply will outpace demand in the short run.

Close monitoring of the overall health of the Washington economy will be increasingly important during this period as job growth is key to producing these results. Continued growth of high-income jobs will be necessary to sustain and fi ll the large number of projects delivering over the next nine months.


Annual Class A Apartment Unit DeliveriesWashington Metro Area | 2008 Through 2010

Class A Apartment Unit StartsWashington Metro Area | 2008 Through 2009


Projected DeliveriesProjects Currently Under ConstructionWashington Metro Area | 2010 Through 2011



Summary of Washington Apartment Indicators

NoVa SubMD District Metro-Wide

Net Absorption Class A & B:

2009 2,541 1,611 1,909 6,061

2008 3,404 2,384 505 6,293

2007 1,001 380 606 1,987

Deliveries:

2009 3,510 1,737 1,170 6,417

2010 2,568 1,245 822 4,635

2011 513 677 738 1,928

2012 2,182 1,232 1,232 4,646

Starts

4Q 2009 46 0 289 335

2009 477 307 289 1,073

36-month Pipeline: 1/

At 12/31/09 7,830 5,093 3,683 16,606

At 12/31/08 11,884 9,411 5,902 27,197

At 12/31/07 17,120 12,706 7,126 36,952

1/ Includes vacant units in projects leasing up, units under construction, and units expected to begin con-struction and deliver in the next 36 months.

Rent Projections

We expect stabilized vacancy rates in Northern Virginia, Suburban Maryland, and the District to be below 1.5% at year-end 2012.

We believe that supply will come into equilibrium with demand at the metro level in late 2011 or early 2012. Given the projected delivery schedule of projects currently under construction, we expect the region-wide vacancy rate for stabilized Class A apartment properties to edge up to the mid-4% range in 2010 before declining to 1.1% by year-end 2012. The 36-month projection now extends beyond the peak vacancy of this cycle when the pipeline’s low materialization rate and the subsequent improvement of supply/demand balance begins to impact the market.

Demand and Supply Projections, Class A Apartment MarketWashington Metro Area | December 2009 Through December 2012

1Probable supply after projected attrition.2Includes unleased units at projects in lease-up.Source: Delta Associates; January 2010.

Class A Apartment Vacancy RateWashington Metro Area | 2002 Through 2012


80 Section Six

Class A rents will continue to give up some ground in 2010 at the metro level. As deliveries slow to a crawl in the later part of 2010, rents will gain traction in 2011, though well below the long term average of 3.6% per annum. Rents will slightly exceed the long-term average in 2012 in select submarkets with a spike in rents in 2013, and better projects in stronger submarkets will vastly outperform these market averages.

Annual Class A Apartment Rent GrowthWashington Metro Area | 2000 Through 2013


Washington Investment Sales: Total Volume Off Despite Late Year Uptick; Cap Rates Appear to Have Peaked 2009 was signifi cantly off the pace of prior record-setting sales years. In 2007, we identifi ed $1.95 billion in multifamily Class A building sales volume. That total declined to $885 million in sales volume on twelve transactions 2008. In 2009, we noted just $504.8 million of multifamily Class A building sales (four garden properties, and four mid/high-rise properties). Most of this volume came at the end of the year.

The average per-unit prices for 2009 closed sales were 34% to 41% lower than at the peak of the market in 2007. We believe this confi rms that cap rates are up by a similar amount trough-to-peak. Cap rates on 2009 sales were too spotty to draw a conclusion about rates. However, based on our year-end 2009 Market Maker Survey, cap rates for apartments appear to have peaked in the spring/early summer of 2009 at 7.44% (all classes and types of apartments) and declined at year-end 2009 to 7.15%. By type, at year-end 2009:

Class A high-rise: 6.61%

Class A suburban garden: 7.09%

Class B suburban garden: 7.75%

Overall: 7.15%

We believe that cap rates will hold in this pattern for a while. Price increases may now have to be earned the old-fashioned way, by performance enhancement. We believe the apartment segment is a winner in the turmoil that follows this credit crunch, with home ownership rates edging down from their cyclical high of 70%. If homeownership rates continue to decrease, it is a refl ection of strong demand for apartment units in conjunction with limited availability of credit. In turn, demand for this asset class among investors should remain strong.

We have observed a meaningful increase in pre-sale activity among our clients. We believe this foretells heightened sales activity in the next twelve months. Little wonder: prices are meaningfully below replacement cost – a time to accumulate assets.


Apartment Market Outlook: Identifying Opportunities During the Recovery

In this phase of the real estate cycle, the successful investor/developer will:



3. Develop new projects before 2012 only with superior design features at premier sites within submarkets that will outperform the overall market.

4. Position now for development in 2012 as the metro area develops a supply shortage.

Superior design features: As the mixed-use moniker becomes more prevalent at projects across the region, what was once seen as a niche is increasingly common. Merely adding fi rst fl oor retail to an otherwise common project will yield diminishing differentiation in this market. We feel creative approaches to place-making, partnered with bold design, and designing for niches is essential – niches such as student housing, seniors housing, mid-market housing in some locations and up-market housing at others.

Superior locations: Not just transit access, but those submarkets with superior supply/demand fundamentals are keys to success in the period ahead. And by our analysis there are many submarkets with good supply/demand fundamentals that warrant attention and development before the metro “sweet spot” of 2012.

Timing: Except for a half-dozen submarkets that will be ready sooner, most successful developments will deliver in 2012 and beyond. With entitlements especially diffi cult in the region, it is not too soon to be positioning for the next round of development – in 2012 in most areas and even before then in select submarkets.

83

The Washington AreaCondominium Market

84 Section Seven

The Washington Area

Condominium Market

Sales Volume Up; Pipeline Down, With New Product Shortages Expected in 2010 in Select Submarkets

Given the free-fall of 2008, many in the TrendLines audience snickered last year when we stated that prices would gain traction in 2009 in select submarkets and that sales volume would improve in 2009 over 2008. And we said this with the headwind of job losses in the metro area. Nevertheless:

Prices increased 0.9% in Arlington and Alexandria.

Metro-wide volume increased 34%, to 2,350 units in 2009.

Let’s hope our tarot cards are working two years in a row:

Price traction will likely spread to a few more submarkets in 2010, including the District.

Volume should increase in 2010 over that of 2009 – perhaps to 2,400 to 2,700 units.

Select submarkets are anticipated to experience product shortages in 2010, triggering condominium conversions in the next six to 18 months, and new product construction as

soon as prices rise to support new development and a lender can be found.

National Context

The Washington metro area is the fi fth largest condominium market in the nation, with approximately 220,300 units. Only the nation’s three largest cities (New York, Los Angeles, and Chicago), plus the popular second-home location of Miami, have a larger inventory of condominiums than the Washington area.

2009 Condominium Market Overview

Sales volume: Over the past few quarters, condominium sales volume in the Washington metro area has accelerated. For 2009 it totaled 2,350 units – a level not seen since 2007. Several factors have played a role in the increase in sales activity:

Interest rates remained near historic lows at year-end and were below 6% throughout 2009. Near the end of the year, FHA rules were relaxed to allow the new condominium pre-sale requirement to drop from 70% to 30%.

Since January 31, the metro area has been growing jobs, mostly in sectors that support condominium ownership.

The fi rst-time home buyer credit helped bring more buyers to the market. The tax credit was extended until April 2010 and expanded to include the move-up market, which should fuel more demand in the fi rst half of 2010.

Contract kick-outs are returning to more normalized levels, since building deliveries dropped off in 2009. A typical kick-out rate is 15%-20%, whereas when the market was severely oversupplied, cancellation rates were sometimes higher than 50%.

The Washington Area Condominium Market 85

Net New1 Unit Sales By Jurisdiction 2009

Submarket # of Units Sold2

Loudoun/Prince William 707

District of Columbia 524

Arlington/Alexandria 439

Montgomery 273

Fairfax/Falls Church 202

Anne Arundel/Howard 185

Prince George’s 20

Metro Total 2,350 1 Includes conversions; 2Net number of binding contracts executedSource: Delta Associates, January 2010.

New Condominium Activity by Sales FirmWashington Metro Area | 2009


Prices continue to decline metro-wide, but in some submarkets, the declines are moderating. Buyers sense that the market may be recovering and are taking advantage of lower prices before they start to increase.

Prices: Net effective sales prices (after concessions) are down, but the declines are moderating in the District and Northern Virginia.

Effective new condominium prices were down 5.8% metro-wide from 2008. But, Arlington/Alexandria was up 0.9% and the District was down just 3.7%.

Re-sale prices declined by 2.8% during the past 12 months. Prices are up in all Northern Virginia jurisdictions, while Suburban Maryland suffers from double-digit price declines.

Concessions: Metro-wide, concessions are down, averaging 3.6% of the purchase price at year-end 2009 (down 60 basis points from one year ago).

Pipeline: At year-end 2009 there were 6,071 unsold new condominium units actively marketing in the metro area, a decline of about 40% from a year ago. This represents 2.6 years’ worth of inventory on the market at current rates of sales velocity. Arlington/Alexandria and the District are below the metro average and are approaching levels considered “product shortage.”

Sales pace: Projects that have sold out in the past two years have averaged about three sales per month.

Sales Volume Elevated in the District and Northern Virginia

In 2009, there were a total of 2,350 sales, which is an increase of 34% from 2008. A disproportionate share of this increase came in the District and Northern Virginia. Lower sales fi gures in Suburban Maryland are perhaps explained by a lack of job growth in that substate area compared to the District or Northern Virginia. The most sales during 2009 occurred in Loudoun/Prince William (attributable to fi rst-time buyers) and the District (thanks to government job growth).

Two fi rms accounted for 44% of all new unit sales in 2009 – McWilliams|Ballard and The Mayhood Company.

86 Section Seven

Highest Prices in the District; Price Decline is Moderating in Northern Virginia

The average effective price per square foot for “same-store” new condominium sales declined by 5.8% from a year ago. Price declines were most severe in Prince George’s County, where prices dropped by 18.2%.

Concessions as a Percent of Average Sales Priceby Substate AreaYear-End 2008 and Year-End 2009

% of Sales Price

Substate Area YE 2008 YE 2009

Suburban MD 4.9% 3.5%

Northern VA 2.4% 3.0%

Th e District 5.3% 4.8%

Wash. Metro Avg. 4.2% 3.6%

Source: Delta Associates, January 2010.

However, prices increased in Arlington and Alexandria – 0.9% – as the inventory of available product dwindles. The region’s highest effective prices per square foot are found in the District and Arlington/Alexandria, whereas the lowest are found in Loudoun/Prince William and Anne Arundel/Howard.

Concessions Down

Concession rates declined everywhere from a year ago except in Northern Virginia. The lowest concession rate in the metro area is in Arlington/Alexandria at 2.3%. Conversely, the highest concession rate in the metro area is in the District at 4.8%.

Effective New Condominium Sales Price ChangeWashington Metro Area | 12-Month Change

New Condominium Prices Per SF*Washington Metro Area | Year-End 2009


New Condominium Price Change2009

Price Change

Jurisdiction Group Asking Eff ective

Suburban MD -7.7% -6.9%

Northern VA -5.3% -6.2%

Th e District -3.6% -3.7%

Metro Average -5.5% -5.8%

Note: “Same store” sales.Source: Delta Associates, January 2010.

*Refl ects prices of condominium projects currently selling, so averages should not be compared from quarter to quarter since locations of projects change each quarter.Source: Delta Associates; January 2010.


36-Month Condominium Market PipelineWashington Metro Area | 2008 Through 2009

Years of Condominium SupplyWashington Metro Area | 2008 Through 2010


36-Month Pipeline Stabilizes; Years of Supply Dwindles; Pace on the Rise

The number of unsold condominium units in projects currently marketing now stands at 6,071 units, the lowest since 2004. In addition, there are 5,176 units planned with sales scheduled to begin within the next 36 months. After more than three straight years of decline, the entire 36-month pipeline has edged upwards for the fi rst time since the fi rst quarter of 2006. The metro-wide inventory-to-sales ratio is at 2.6 years as of year-end 2009, compared to 5.9 years at year-end 2008. Currently, Arlington County/City of Alexandria and the District have the lowest inventory-to-sales ratios in the metro area. Prices declined the least during 2009 in the District; during the same time period, there was a slight increase in prices in Arlington/Alexandria.

Current Inventory-To-Sales Ratio Year-End 2009

Jurisdiction Group Inv./Sales Ratio

Arlington/Alexandria 1.4 years

District of Columbia 1.8 years

Central DC 1.8 years

Loudoun/Prince William 2.3 years

Wash. Metro Average 2.6 years

Anne Arundel/Howard 3.0 years

Fairfax/Falls Church 3.8 years

Montgomery 4.2 years

Prince George’s 22.0 years

Source: Delta Associates, January 2010.


88 Section Seven

By the end of 2010, we project that the inventory-to-sales ratio will be close to what it is currently, after dipping lower for a couple of quarters, and by that time, price traction should be taking hold in most of the metro area. It appears that price traction may have already started in the Arlington/Alexandria area. This is the only submarket where prices increased over the past year.

The trend of removing condominium units from the pipeline has slowed dramatically, as market conditions are fi rming.

Projects that sold out during the past two years have averaged three units of sales per month. Actively marketing projects are averaging about the same.

Condominium Market Outlook: Identifying Opportunities During the Recovery

The Washington metro area currently has an inventory of 6,071 new condominium units to sell – perhaps a 2.6-year inventory at current rates of net sales velocity. While prices declined 5.8% for new units in 2009, we believe prices will trend higher in select submarkets in 2010.

Even as there is an increase in mortgage interest rates and the end of the home buyer tax credit occurs in April 2010, there are other circumstances in play that will allow a net sales pace of 2,400 to 2,700 units per annum over the next two years.

Positive job growth projections in 2010 compared to job losses in 2009.

A better economic picture in general will boost consumer confi dence.

A slowdown in the rate at which demographics shift from homeownership to rental.

With this, select jurisdictions will fi nd equilibrium arriving quickly – it appears that equilibrium has arrived in Arlington/Alexandria and will reach the District soon. As a result, it is entirely possible that within the next 6 to 18 months, we may see a trend of apartment projects converting to condominiums in select submarkets due to a tightened condominium pipeline and increased demand. Given enough time for prices to rise, new development may commence in 2011, at least in select submarkets. This, of course, presumes one can fi nd a lender willing to lend on a condominium deal.


91

The Washington AreaRetail Market

8

92 Section Eight

The Washington Area

Retail Market

Low Consumer Confi dence and Increased Saving Rate Hampered Th e Retail Market in 2009; Poised For Recovery

The Washington metro area retail market contracted during 2009, as consumers tightened wallets due to uncertain economic conditions.

The vacancy in all shopping center formats increased 120 basis points to 5.7%, as regional and lifestyle centers suffered from tenants vacating space.

The stalwart grocery-anchored category, with chronically low vacancy, moderated in 2009, but vacancy remained healthier compared to other types of centers:

■ Vacancy increased to 5.3% at year-end 2009, from 3.7% last year.

■ Rents decreased 5.8% in 2009, compared to rising 1.7% in 2008.

Despite these indicators, with consumers stashing cash during the recession, a rebound in spending is anticipated during 2010 – riding upon the economic recovery and pent-up

demand for goods.

National Context

The Washington metro area has the second-lowest shopping center vacancy among large metro areas at year-end 2009. Overall vacancy for all types of shopping centers was 5.7% in the metro area, up from 4.5% one year ago. This compares favorably to the national average of 9.5% at December 2009.

Shopping Center Vacancy - All TypesSelect Metro Areas | Year-End 2009

Note: Includes grocery and non-grocery anchored shopping centers.Source: CoStar, Delta Associates; January 2010.

The Washington Area Retail Market 93

Average Household Income

2000 2008 2013

Jurisdiction (Actual) (Est.) (Proj.)

Washington Metro Area $80,600 $102,800 $118,400

U.S. $56,600 $67,900 $75,800

Source: Claritas Inc; January 2010.

Although vacancy has risen in the metro area due to the economic slowdown, shopping center retail maintains a relatively low vacancy rate. A low vacancy rate is maintained by steady population growth, high incomes, and the fact that the metro area has lost the fewest jobs of all major metro areas.

Personal income in the Washington metro area grew by 27.5% from 2000 to 2008, compared to 19.9% nationally. By 2013, the Washington metro area’s average household income is projected to rise 15.2%, compared to a rise of 11.6% nationally.

Retail Inventory

The Washington metro area has over 118 million SF of retail space, inclusive of all types of retail, in over 1,000 shopping centers. Northern Virginia is home to over half of the total metro retail inventory.

The metro area has 25.0 SF of retail space per capita, compared to the national average of 23.4. Although Northern Virginia and Suburban Maryland are above the national average, the District remains underserved at just 8.5 SF of

retail space per capita.

Grocery-Anchored Shopping Center Market Conditions

Given the demand for groceries at all points of the economic cycle, grocery-anchored shopping centers maintain the greatest stability compared to other retail property types. As a result, the bulk of investor interest and therefore our analysis in this section is focused on grocery-anchored shopping centers.

Of the total retail inventory in the Washington metro area, 55.9 million SF is located in 319 grocery-anchored shopping centers, which is almost half of the total retail inventory in the metro area.


Retail Space per CapitaWashington Metro Area | 2009

We survey these centers each year to tabulate vacancy and rent data. The charts following summarize trends from 1999-2009.

The metro-wide vacancy rate for grocery-anchored shopping centers increased over the past year to 5.3% at year-end 2009, from 3.7% one year ago. The Suburban Maryland vacancy rate at year-end 2009 was 5.4%, a rise of 160 basis points over the past year. The Northern Virginia vacancy rate was 5.3%, a rise of 170 basis points since year-end 2008.

The inner and outer ring submarkets experienced the steepest rise in vacancy during the year, at 180 and 190 basis points, respectively. The core submarkets experienced only a slight rise in vacancy – at 10 basis points.

Rental rates at grocery-anchored centers decreased 5.8% in 2009, after rising by 1.7% in 2008. Metro-wide average in-line tenant rents were $31.77/SF at year-end 2009. Suburban Maryland rents were $32.25/SF, a 4.8% decline from one year ago. Northern Virginia rents were $31.29/SF, down 6.6% from year-end 2008.

94 Section Eight

The core submarkets experienced the least decline in asking rates during 2009, as there continues to be demand within the core and this area has limited availability.

The inner and outer rings experienced steeper rent declines at 5.4% and 7.4%, respectively, as these submarkets have less demand and a greater amount of available inventory.

New development: There are nine notable grocery-anchored shopping centers, totaling 3.0 million SF, under construction or renovation in the metro area at year-end 2009. Two of the nine projects are creating or renovating shopping centers around existing grocery stores.

There are additional stores in the planning stages that are not included in the adjacent table, some of which may deliver as late as 2013.

Construction momentum has halted on shopping center development in the metro area. Developing new projects has become a challenge with tenant hesitancy, lackluster customer demand, and frozen credit markets.

We expect few projects to move forward in the near-term, with the exception of projects with notable pre-leasing and fi nancing in place. However, given the long-term demand for goods in the metro area, we believe developers will look to deliver new product by mid-2012, as the market transitions back to landlord conditions.

Grocery-Anchored Shopping CentersWashington Metro Area | 2009 | Millions of Square Feet

Note: Estimate.Source: CoStar, Delta Associates; January 2010.

Vacancy Rates for Grocery-Anchored Shopping Centers Washington Metro Area | 2009 vs. 2008

Jurisdiction 2009 2008

Core 4.5% 4.4%

Inner Ring 5.0% 3.2%

Outer Ring 6.9% 5.0%

Washington Metro Area 5.3% 3.7%

Core = DC, Arlington, AlexandriaInner Ring = Fairfax, Montgomery, Prince George’sOuter Ring = Loudoun, Prince WilliamSource: Delta Associates; January 2010.

Grocery-Anchored Shopping Center Vacancy RatesWashington Metro Area | 1999 Through 2009



Grocery-Anchored Shopping Center Asking RentsWashington Metro Area | 1999 Through 2009


Grocery Market Review

The per store average sales volume for all grocers in the Washington metro area was $24.4 million during 2009, a 4.3% increase from $23.4 million one year ago. Wegmans surpassed all other food retailers, with $62.2 million per store. However, this is a 24% decline from $81.4 million during 2008 for Wegmans.

Walmart scored top sales growth, as food sales increased by 11.2% in 2009, after a 1.4% rise in 2008. Giant Food experienced a healthy 4.2% rise during 2009.

During 2008, traditional grocers outpaced organic/ specialty stores

in average per store sales volume growth by 60 basis points, as these companies reinvented themselves in order to compete with the organic/specialty market.

Given current economic conditions, consumers have shifted spending towards super center/club stores in order to save money, however. During 2009, super center/club stores outpaced organic/specialty and traditional stores in average per store sales growth by 130 and 150 basis points, respectively.

Walmart, although not a strong player in the Washington metro area, operates just over 3,500 stores nationwide, with 75% of these stores as supercenters, which includes a full-service grocery store. The company expanded supercenters by 7% nationwide during 2009, compared to shuttering 8% of the traditional format stores. Given supercenters experience better returns, the company has expanded this format by 34% since 2005, compared to shuttering the same amount of the traditional format stores. During 2010, the company plans to add 125-140 super-center stores.

Notable Grocery-Anchored Shopping Centers Under Construction or Under RenovationWashington Metro Area | Year-End 2009

Shopping Center RBA Anchor

Dulles Landing 700,000 Super Wal-Mart

Woodmore Towne Center 685,000 Wegmans

Potomac Town Center 550,000 Wegmans1

Village at Leesburg 464,000 Wegmans1

North Bethesda Market 230,000 Whole Foods2

Moorefi eld Village 150,000 Harris Teeter

Urbana Village Center 94,000 TBA

Goose Creek Village 73,000 Harris Teeter3

Adams Square Shopping Center 60,000 Giant1

Total 3,006,000

1/ Building/renovating, using existing grocery store as an anchor.2/ Relocating from existing store at Congressional Plaza.3/ Phase 1 only.Source: CoStar, Washington Business Journal; Delta Associates, January 2010.

Asking Rents Under RenovationGrocery-Anchored Shopping Centers | Washington Metro Area

Jurisdiction 2009 Yr % Chang

Core $37.05 -2.5%

Inner Ring $32.90 -5.4%

Outer Ring $27.02 -7.4%

Washington Metro $31.77 -5.8%

Core = DC, Arlington, AlexandriaInner Ring = Fairfax, Montgomery, Prince George’sOuter Ring = Loudoun, Prince WilliamSource: Delta Associates, January 2010.

96 Section Eight

Since December 2007, consumers have harbored a total of $346 billion from retailers (based on a 1.4% savings rate). During this time, consumers refrained from purchasing non-essential goods, particularly big-ticket items, postponing pur-chases until the economy improves.

The motor vehicle industry suffered the largest sales decline in the Washington metro area at 14.9% during 2008. The projected decline for this industry during 2009 is 15.9%. Electronics, building supplies, home furnishings and clothing also experienced notable declines during this period, as consumers postponed spending on these goods.

Notably, food/beverage and health/personal care products have remained stable, as consumers continue to demand these items even during an economic slowdown.

With consumers stashing cash during the recession, a rebound in spending is anticipated during 2010 – riding upon the economic recovery and pent-up demand for goods. Retail spending is projected to rise 5.5% in the Washington metro area during 2010, according to Woods & Poole. This is above the 25-year annual average of 3.5%. The 2010 sales total is expected to mirror what spending totaled back in 2004.

The industries that suffered the greatest decline during the recession should experience notable gains during 2010. The motor vehicle industry should experience a rebound of 12.5% in the metro area, according to Woods & Poole. Build-ing supplies and home furnishings closely follow,as consumers have pent-up demand for goodsthey postponed purchasing during the downturn.

Although a 5.5% rise in Washington metro area retail sales in projected during 2010, we believe this spending will occur later in 2010, as retail sales during the fi rst six months of the year should remain sluggish. This is refl ected in the

Average per Store Sales Volume Growth – By TypeWashington Metro Area

Type 2009 Growth 2008 Growth 2007 Growth

Supercenter/Club 3.5% 1.0% 1.6%

Organic/Specialty 2.2% 4.0% 0.6%

Traditional 2.0% 4.6% 1.9%

Note (All): Includes only grocery stores with $2 million or more in sales; data through June 2009 annualized.Source (This Page): Food World, Delta Associates; January 2010.

Average per Store Grocery Sales Volume Top Five | Washington Metro Area | 2009

Store Sales (in millions)

Wegmans $62.2

Costco $47.4

Shoppers $33.1

Sam’s Club $31.4

Whole Foods $27.6

Target operates over 1,600 stores nationwide, with 14% of these stores as SuperTarget, which includes a full-service grocery store. In order to compete with Walmart, Target has expanded food options in 100 stores this year. This expanded food option is labeled “PFresh,” which offers about 60% of the items at SuperTarget. During 2010, Target plans to add expanded PFresh food sections to 350 stores.

Overall, grocery-anchored shopping centers weather economic downturns better than centers without a grocery anchor. However, centers with a supercenter/club anchor tend to perform better during slowdowns, as con-sumers tend to shift preference to bargain goods during lean times to save money.

We expect supercenter/club stores to grab a larger share of shoppers from traditional and organic/specialty stores during 2010, as consumers remain price sensitive.

Retail Sales: Anticipated Rebound

Retail sales declined 3.5% in the Washington metro area during 2008. This compares to the national decline of 3.7%. Woods & Poole, an economic forecasting fi rm, projects a 7.0% decline in the metro area during 2009 once the numbers are fi nalized. This compares to a projected national decline of 7.6%.

With the threat of job loss looming during the recession, the national savings rate climbed. The rate currently resides at 3.3% at September 2009, above the 1.4% rate at the start of the recession in December 2007.

Average per Store Grocery Sales GrowthTop Five | Washington Metro Area | 2009

Store Sales Increase

Walmart 11.2%

Giant Food 4.2%

Safeway 2.2%

Shoppers 1.1%

Harris Teeter 0.6%


most recent Washington Region Confi dence Index by the Greater Washington Board of Trade.

The consumer confi dence index in the Washingtonregion increased four points to 60 at November 2009, from 56 at April 2009. The District experienced the greatest rise, to 67, from 59 in April 2009.

Despite a rise in confi dence, few respondents plan to purchase higher-priced items during the next six months according to the survey:

29% plan to spend more than $5,000 on home improvement, up from 25% in April.

30% plan to purchase a major item, on par with April results.

10% plan to purchase/lease a vehicle, on par with April results.

With unemployment not expected to decline meaningfully in 2010, as it is a lagging indicator, consumers will remain conservative until they are certain about their job status. Given this, we expect a large portion of consumers to concentrate spending at discounted/wholesale retailers in 2010 to maximize value.

During 2010, we expect shopping centers anchored by a grocer or drug chain to be successful. We also expect centers located in healthy micro-markets, such as Pentagon City and Potomac Yards, to remain stable. Shopping centers with notable vacancies will have a hard time attracting new tenants, unless the center is located in a top performing submarket. If these centers fail to attract tenants over the next year or two, redevelopment into a different use could occur.

Look for the younger consumer to help pull up retail sales over the next couple of years. According to the Greater Washington Board of Trade, younger generations are more confi dent about the economy compared to older generations. This is expected, as the younger consumer has time to recoup money lost during the recession. We expect those closer to retirement to remain timid about

spending in the next two years.

Change in Total Retail SalesWashington Metro Area | 2001 Through 2012

Note: 2009 through 2012 are projectionsSource: Woods & Poole, Delta Associates; January 2010.

Retail SalesWashington Metro Area | 2010 Projections

IndustryPercent Increase2010 vs. 2009

Motor Vehicle 12.5%

Building Supplies 10.3%

Home Furnishing 9.1%

Gas Stations 6.5%

Electronics 4.1%

Clothing 3.5%

Health/Personal Care 3.5%

Food/Beverage 2.1%

Total Retail 5.5%

Source: Woods & Poole, Delta Associates; January 2010.

98 Section Eight

Investment Sales

Investment sales of grocery-anchored shopping centers in the Washington metro area suburbs totaled $79 million during 2009, compared to $85 million on fi ve notable transactions during 2008.

Spectrum Partners and Potomac Capital Advisors purchased Westgate Shopping Center in Manassas for $25 million in July 2009. More recently, Kimco Realty purchased Pentagon Center in Arlington for $54 million in November 2009.

Grocery-anchored shopping centers are typically a favorite with investors during soft economic periods, since everybody still patronizes grocers during lean times. However, as the economy contracted, the retail sector suffered as consumers tightened their spending on both essential and non-essential items. In addition, borrowing is diffi cult, even with record-low interest rates, simply because risk is being re-priced.

While cap rates may have fi nished their cyclical increase, we believe values will edge down during 2010 as asset performance remains challenged due to rising vacancies and declining rents. Buyers with cash can be successful in purchasing assets with low price tags. The investment worthiness of this product type has increased, according to our annual Market Maker Survey. Each year we survey those who shape the real estate industry, including

Consumer Confi dence IndexGreater Washington Area | By Substate

Consumer Confi dence IndexGreater Washington Area | By Age Group

Sources: Greater Washington Board of Trade, Delta Associates; January 2010.

Grocery-Anchored Shopping Center PurchasesWashington Suburbs | 2000 Through 2009

*Includes large portfolio sale by CalPERS.Note: Excludes sales of regional malls and power centers; excludes properties under contract.Source: Real Capital Analytics, CoStar, graphic by Delta Associates; January 2010.

Sources: Greater Washington Board of Trade, Delta Associates; January 2010.


Investment Worthiness IndexGrocery Anchored Shopping Centers | Washington Metro Area

*A score below 5.0 is considered to have more interested sellers than interested buyers.Source: Delta Associates’ Market Maker Survey; January 2010.

developers and fi nancial experts, here in the Washington region. In 2009, our respondents scored grocery-anchored shopping centers in the metro area at 6.2 for investment worthiness, up from 4.3 in 2008. This product type increased two spots to fi fth place for investment worthiness out of ten alternatives.

Our Market Maker survey respondents noted that cap rates for grocery-anchored shopping centers have risen to 8.5% at October 2009, from 7.5% one year ago. However, when surveyed at June 2009 respondents noted an 8.6% rate, indicating a modest decline over the past four months. Have cap rates peaked for this cycle?

Return Rates for Retail Properties

Total returns (cash fl ow plus appreciation) realized in the Washington retail market were negative 12.72% for 12 months ending September 2009. Returns have declined for all major metro areas. The Washington area return compares favorably to the national return of negative 15.78%.

Although Washington area retail property performance has suffered due the national recession, the decline in investor value for Washington assets is less severe compared with other metro areas.

We expect the Washington metro area to remain a desirable destination for investors’ cash in the long-run. However, transactions will be very limited through 2010 due to market conditions combined with a lack of credit.

Grocery-Anchored Shopping Center – Cap RateWashington Metro Area | Each Year at October

Source: Delta Associates’ Market Maker Survey; January 2010.

100 Section Eight

Retail Market Outlook: Identifying Opportunities During the Recovery

With this product type so sensitive to consumer sentiment, the successful investor/developer will:



3. Develop new projects before 2011 in select locations with good supply/demand fundamentals like the District of Columbia.

4. Develop more broadly throughout the metro area after

2011.

We believe Washington metro area retail will remain success-ful, even through economic downturns, if the center is:

Located within mixed-use or neighborhood centers in a submarket with solid supply/ demand fundamentals.

Close to transit and jobs.

Focused on everyday necessities and amenities, such as groceries, banking, and entertainment.

We believe retail is poised for a stronger recovery in the Washington metro area than elsewhere, given high incomes and projected job growth during 2010. However, we believe retail sales will remain soft through most of 2010, with a modest rise late in the year.

Recommended Development ActivitiesWashington Metro Area


NCREIF Return Index1 – Retail PropertiesSelect Metro Areas

Metro Area 12-Month Total Return at 3rd Quarter 20091

Washington -12.72%

Chicago -13.88%

Los Angeles -14.73%

National Average -15.78%

Dallas -17.60%

Phoenix -26.96%

1 NCREIF compiles return based on its members’ $54.1 billion retail portfolios.The index includes both current income and capital appreciation returns.Source: NCREIF, Delta Associates; January 2010.


103

Capital Markets andInvestment Trends

9

104 Section Nine

Capital Markets and

Investment Trends

Volume Off Sharply But Uptick Seen at Year-End; Cap Rate Rise May Have Peaked

It was just two years ago that national investment sales set a record – for example, $211 billion in offi ce building sales in 2007. Re-pricing of risk, a profound lack of credit, and a buy-sell price gap have put an end to all of that.

National Investment Sales of Offi ce Buildings2001 Through 2009

*Estimate.Source: Real Capital Analytics, graphic by Delta Associates; January 2010.

Last year at this time we expected that sales would pick up toward the end of 2009 due to the entry of distressed assets into the market. Our expectations were unfulfi lled for the most part. But sales volume did turn up a bit, as buyers recognized that prices for the most part are well below replacement cost and low enough to attract capital in a risk re-priced world.

2009 transactions are characterized as all-cash, or assets with little market risk, or foreign or REIT buyers, or impaired properties with high cap rates or extraordinary discounts.

But several things became evident by the end of the year:

There is a bifurcated cap rate market: A lower rate for low-risk assets and a higher rate for deals with hair.

There are more buyers than sellers. After all, at these prices, owners are either underwater and can’t sell or are choosing to hold – in a sense choosing to buy their own asset at these prices. As a result, the rise in cap rates has paused. Stopped? We are not sure.

With today’s low mortgage interest rates (even with tough terms), and with rates likely to rise over the next several years, there is an increasing urgency to buy.

Capital has been attracted to those few markets with the best fundamentals – with Washington at the head of that list.

Capital Markets and Investment Trends 105

Real Estate: Exceptional Returns

While investment sales struggled in 2009, commercial real estate investment remains a solid long-term play. Over the past fi ve-year and ten-year periods, real estate outperformed stocks and bonds, with annual total returns of 6.16% and 7.84%, respectively. Only during the past 12 months, during the recent bull market on Wall Street, did stocks outperform real estate. This is why the institutions have not re-allocated out of real estate in this cycle like they did in 1990.

So, who has been buying commercial real estate during this downturn? At the national level, private equity was the greatest source of capital for 2009 offi ce sales, with 33.2% of the total. Institutional and foreign buyers – who tend to use little if any leverage – also were signifi cant players in 2009, with a combined 28.6% of offi ce purchases.

The Washington Metro: Holding Up Better Than Others

Despite drastically reduced trading volume, the Washington metro area remains among the world’s top investment markets for real estate.

Offi ce building sales in 2009 in the Washington area reached a total volume of $2.0 billion. This total is 45% below the 2008 total of $3.7 billion. However, this decline is less than that seen in other major markets, and is more a function of the credit crisis and lack of product on the market than it is a refl ection of the desirability of Washington assets.

The yield on Washington area offi ce assets for the 12-month reporting period ending September 2009 was second in the U.S., behind only Houston’s. Returns are, of course, negative due to asset value declines.

Over the long term, returns are more predictable in Washington than in most other metro areas. This led to a fl ood of capital entering the market from 2004-07. Because of the run-up in values for Washington assets during that period – and the downturn in market conditions brought about by the recession – returns have trended negative recently. However, total returns remain ahead of the national average for all four major product types, as shown in the accompanying graph.

Most Active Capital SourcesInvestments in U.S. Offi ce Product | 2009

Investment Alternatives: Commercial Real Estate vs. Stocks vs. Bonds12 Months Ending September 2009


Note: Excludes portfolio sales and properties under contract; through November 2009.Source: Real Capital Analytics, graphic by Delta Associates; January 2010.

106 Section Nine



Total Returns for Offi ce AssetsSelected Metro Areas | 12 Months Ending September 2009

Total Investment Returns: Core Commercial Real EstateWashington Metro Area vs. U.S. | 12 Months Ending September 2009

Washington followed the pattern of other major markets in 2009, experiencing dramatically reduced investment sales volume as the credit crisis brought about risk re-pricing. However, Washington’s stability continues to make it among the strongest investment markets in the country. Washington far exceeded the offi ce investment sales volume in Los Angeles and Chicago, markets of similar size and prominence.

Investors in Washington focused on offi ce and multifamily purchases in 2009 – to the extent credit and product was available. Total volume for the four product types was $3.0 billion in 2009, down 56% from the $6.8 billion of asset value that changed hands in 2008. Flex/industrial and retail sales were particularly scarce in 2009 – we recorded less than $80 million of investment sales for each of those product types.

After Rising Through June, Cap Rates May Have Peaked; Evidence of Bifurcation

Last year in TrendLines we said that we expected cap rates to rise as much in 2009 as they did in 2008, as investors demanded higher returns for putting money at risk. Indeed, in the Washington area, the average cap rate for core offi ce assets rose 85 basis points in 2009, compared to 93 basis points in 2008. For all product types combined, the average cap rate rose 77 basis points in 2009, compared to 92 basis points in 2008.

Product TypeBasis Point Change inCap Rate 10/08-10/09

Industrial/Distribution 112

Shopping Center 105

Hotels 100

Offi ce 85

Apartments 39

Source: Annual survey by Delta Associates, conducted October 2009, of the region’s leading commercial real estate players.


Note: Excludes whole-company transactions.Source: Real Capital Analytics, graphic by Delta Associates; January 2010.

Source: Real Capital Analytics, CoStar COMPS, graphic by Delta Associates; January 2010.

Comparative Investment Sales Volume: Offi ce BuildingsSelected Metro Areas | 2000 Through 2009

Investment SalesWashington Metro Area | 1999 Through 2009

But surprisingly, cap rates in the Washington area peaked around mid-year, and then stabilized or even ticked down during the second half of 2009. For example, the average cap rate for apartment product declined 29 basis points from June 2009 to October 2009. For other product types, see the accompanying table.

Product TypeBasis Point Change inCap Rate 6/09-10/09

Apartments -29

Industrial/Distribution -16

Shopping Center -6

Offi ce 13

Source: Surveys by Delta Associates, conducted June 2009 and October 2009, of the region’s leading commercial real estate players.

This trend is attributable, we believe, to an absence of product on the market relative to the number of buyers at the ready. Prospective sellers simply can’t or won’t sell at these prices. And with accounting rule changes, FDIC regulation changes, and RIMIC rule changes, everyone seems anxious to avoid dumping distress on the market – for now.

We have observed an increasingly bifurcated cap rate and pricing structure:

A lower cap rate and higher prices for assets with lower risk and coupon-like quality (credit tenants, long-term leases, little vacancy, high quality location and fi nishes, etc.).

A higher cap rate and lower prices for assets with risk and value-add features (vacancy issues, short-term lease roll-overs, lower-quality location and fi nishes, etc.).

Trophy properties and other well-leased product will see lower cap rates and more buyer interest as a result of their stability and consistent cash-fl ow, while distressed and high-vacancy product will see higher cap rates, as buyers demand a greater initial return in exchange for taking on greater risk.

108 Section Nine

*Trailing 12 months; through November 2009.Source: Real Capital Analytics, graphic by Delta Associates; January 2010.

Cap Rates for Core Offi ce AssetsWashington Metro Area | 2002 Through 2009

Prices Decline to Levels Well Below Replacement Cost

Volume has turned up at year-end in part because the marketplace realizes that prices are well below replacement cost. And on a stable deal, it signals a time to buy.

For example, since the peak of the market in 2007, Class A apartment prices are down 41% for gardens and 34% for high-rise. This seems to parallel the sum of cap rate decline and performance decline.

More to the point, values today are below replacement cost and this has led to investors awakening at year-end 2009 to the fact it is time to buy again. Hence, volume turned up signifi cantly in the second half of the year. For example, here are the facts for a Class A high-rise:

Average price per unit in 2009: $266,000Replacement cost in 2009 1/ $367,000

1/ $297,000 development cost plus $70,000 land costSource: Annual survey by Delta Associates, conducted October 2009, of the region’s leading commercial real estate players.

*Through November 2009.Source: Delta Associates; January 2010.

Class A Garden and High-Rise ApartmentAverage Sales Price | Washington Metro Area | 2007 Through 2009

Investment Sales Outlook

Cap Rates: In 2010, we expect cap rates to edge up nationally, but most of the increase is likely behind us. Locally, we believe cap rates for most product types peaked in 2009. Lower quality product and deals with hair will see elevated cap rates continue into 2010 and beyond. For high-quality deals we may see cap rates edge down.

Prices: Likely to decline further due to continued deterioration in asset performance. In general, price appreciation in 2010 and beyond will be earned the old-fashioned way – by asset performance enhancement. We expect prices in Washington will decline another 5%-10% before reaching bottom, which should happen in 2010-11.

Volume: We expect a signifi cant amount of the activity in 2010 to be “must-sell,” as some stressed and distressed assets reach the market. Look for volume in 2010 to exceed the 2009 total, anchored by cash deals, foreign buyers, and trophy deals.


Cap Rates in Use at Year-End 2009 by Those Looking to Acquire Assets

Product Type All Respondents Developers of Th is Property Type

Apts.: High-Rise – Class A 6.61% 6.62%

Apts.: Suburban Garden – Class A 7.09% 7.10%

Offi ce: CBD – Class A 7.25% 7.18%

Apts.: Suburban Garden – Class B 7.75% 7.77%

Offi ce: CBD – Class B 8.16% 8.08%

Shopping Center: Grocery-Anchored – Class A 8.51% 8.42%

Offi ce: Suburban – Class A 8.54% 8.53%

Industrial/Distribution: Class A 8.91% 9.07%

Offi ce: Suburban – Class B 9.44% 9.40%

Hotels: Suburban – Class A 9.66% 10.18%

Note: Buyer’s cap rate, based on prior 12 months NOI, before reserves.Source: Annual survey by Delta Associates, conducted October 2009, of the region’s leading commercial real estate players.

The Washington metro area will see more than its fair share of volume. As happened in 2009, those with a stressed national portfolio will fi nd that they can sell a Washington asset to feed troubled assets elsewhere. Therefore, the Washington metro will continue to see more than its fair share of sales in the short run.

Despite the reduced volume, Washington commercial real estate assets will remain among the most desirable in the country. Investors both domestic and foreign will continue to look to Washington fi rst when seeking acquisitions. The stable nature of its tenant base, bolstered by offi ce space demand from the Federal government, will buoy Washington values.

Source: Delta Associates’ Market Maker Survey; January 2010.

Survey of Year-End Cap RatesWashington Metro Area | 2005 Through 2009

111

2010 TrendSetterAward Recipients

112 Section Ten

Each year, Transwestern and its research affi liate, Delta Associates, honor an individual, or individuals, who have made a noteworthy contribution to the commercial real estate industry as a whole, and to the Washington metropolitan area in particular.

This year our Private Sector honoree is Thomas S. Bozzuto, Chief Executive Offi cer of The Bozzuto Group. We are also pleased to honor James E. Bennett, President and CEO of the Metropolitan Washington Airports Authority, as our Public Sector TrendSetter of the Year.

2010 TrendSetterAward Recipients

10

2010 TrendSetter Award Recipients 113

Thomas S. Bozzuto

Chief Executive Offi cerThe Bozzuto Group

Since the formation of The Bozzuto Group in 1988, Tom Bozzuto has led the company’s development, construction and management of almost a billion dollars of income producing and for-sale housing. During his more than thirty-year career, he has overseen and been responsible for the creation of more than 46,000 residential units with a conservatively estimated value of nearly $7 billion. Partners, employees and residents are uniform in their praise of The Bozzuto Group’s standards, integrity and commitment to providing quality housing for all, from luxury homes and apartments to affordable housing residences.

The fi rm’s ongoing success in a diffi cult real estate environment is a testament to their unique ability to combine design appeal, quality construction, property management excellence, and award-winning service with unswerving dedication to the communities they serve. The Bozzuto Group’s many civic, charitable and philanthropic activities underscore their desire to improve the lives of the region’s citizens and families as they revitalize homes and neighborhoods. For his principled and steadfast leadership, particularly in a time of market turmoil, we’re very pleased to honor Tom Bozzuto as our 2010 Private Sector TrendSetter of the Year.

James E. Bennett

President and CEOMetropolitan Washington Airports Authority

Growing traffi c congestion and the need to augment the region’s transportation infrastructure have long been cited as among the chief obstacles to the Washington area’s long term economic vitality. In 2009, after years of effort, fi nal Federal approval was secured to fund the fi rst phase of the Metrorail extension to Dulles Airport and Loudoun County. This critical project will expand access for residents, employers and employees to the entire metro region; provide a viable, dependable alternative to automobile travel; and encourage high-density, transit-oriented development around Metrorail stations.

As President and CEO of the Metropolitan Washington Airports Authority, the entity charged with managing the Metrorail extension, James E. Bennett has been instrumental in moving this project from dream to reality. Construction activity has begun in earnest, fi nancial planning for the funding of Phase II is proceeding on schedule, and smart growth and responsible land use plans are being designed that will be essential to safeguarding Washington’s future. For his tireless advocacy and resolute commitment to making this project a reality, we’re very pleased to honor James E. Bennett as our 2010 Public Sector TrendSetter of the Year.

114 Section Ten

Past

Tre

ndSe

tter

Aw

ard

Rec

ipie

nts

Milton Peterson2006 TrendSetter of the YearChairmanThe Peterson Companies

F. Joseph Moravec2005 Public SectorTrendSetter of the YearCommissionerGSA Public Buildings Service

John E. (Chip) Akridge2005 Private SectorTrendSetter of the YearChairmanAkridge Real Estate Services

Douglas M. Duncan2003 Public SectorTrendSetter of the YearCounty ExecutiveMontgomery County

Clayton F. Foulger2004 Private SectorTrendSetter of the YearPrincipal and Vice PresidentFoulger-Pratt Companies

Bryant F. Foulger2004 Private SectorTrendSetter of the YearPrincipal and Vice PresidentFoulger-Pratt Companies

Congressman Tom Davis2004 Public SectorTrendSetter of the Year11th District of VirginiaU.S. House of Representatives

R. William Hard2003 Private SectorTrendSetter of the YearExecutive Vice President andPrincipal-In-Charge, LCOR

Anthony A. Williams2002 Public SectorTrendSetter of the YearMayor District of Columbia

Robert Gladstone2002 Private SectorTrendSetter of the YearChairmanQuadrangle Development

Th omas M. Garbutt2001 InstitutionalTrendSetter of the YearManaging DirectorTIAA-CREF

Michael J. Darby2001 EntrepreneurialTrendSetter of the YearPrincipalMonument Realty, LLC

Jeff rey T. Neal2001 EntrepreneurialTrendSetter of the YearPrincipalMonument Realty, LLC

Ray D’Ardenne2000 TrendSetter of the YearChief Operating Offi cerLend Lease RealEstate Investments

Daniel T. McCaff ery1999 TrendSetter of the YearPresidentCCR McCafferyDevelopments

Robert E. Burke1998 TrendSetter of the YearExecutive Vice President,OperationsBoston Properties

Raymond A. Ritchey1998 TrendSetter of the YearExecutive Vice President,Head of the Washington, D.C.Offi ce & National Director ofAcquisitions and DevelopmentBoston Properties

Andrew Florance2007 Public CompanyTrendSetter of the YearFounder, Director,President & CEOCoStar Group, Inc.

Benjamin Jacobs2007 Private CompanyTrendSetter of the YearManaging PartnerThe JBG Companies

Oliver T. Carr, III 2008 TrendSetter of the YearPresident & CEOCarr Properties

Michael Glosserman2007 Private CompanyTrendSetter of the YearManaging PartnerThe JBG Companies

W. Christopher Smith, Jr. 2009 Private SectorTrendSetter of the YearCEOWilliam C. Smith & Co.

Donald Wood2009 Public Sector TrendSetter of the YearPresident & CEOFederal Realty Investment Trust

2010 TrendSetter Award Recipients 115

2009 Market Maker Survey Participants

Delta Associates thanks all of its 2009 Market Maker Survey participants, among whom are the following:

Abbey Road Property Group Kennedy Associates Real Estate Counsel

Akridge Kettler Management

Alliance Residential Kodiak Properties

Argo Investment Company LCOR Inc.

Boston Capital Lincoln Property Company

Bozzuto Group Metro Management Services

Broad Street Ventures Mid-City Finance Corp.

Clark Enterprises Inc. NV Commercial

Clark Realty Capital Panattoni Development Company

Colchester Land Company Paradigm Development Co.

Columbia Bank Potomac Investment Properties

Community Realty Company Prudential Investment Management Inc.

Donohoe Companies Quadrangle Development Corporation

DRI Partners Rappaport Companies

Elm Street Development RCDH

Equity Residential Roadside Development

Fairfi eld Residential Rosenthal Properties

First Potomac Realty Trust Seaton Benkowski & Partners

Gates Hudson Shooshan Company

General Growth Properties Sunburst Hospitality Corporation

Gimbert Associates Tower Companies

Green Light Retail Real Estate Services Transwestern

Hines Interests Ltd. Partnership Union Realty Partners

Holliday Fenoglio Fowler Velsor Properties

ING Real Estate Development U.S. VORNADO/Charles E. Smith

John B. Levy & Co. Washington Real Estate Investment Trust

Jonas B. Cooke Interests Woodfi eld Investments

PNC is a registered service mark of The PNC Financial Services Group, Inc. (“PNC”). Lending products and services require credit approval and are provided by PNC Bank, National Association. ©2010 The PNC Financial Services Group, Inc. All rights reserved. CIB PDF 0110-024

SUCCESS.In today’s challenging market it’s more important than ever to make sure you work with a team that can deliver the results you need. With one of the broadest sets of capabilities in the industry, we provide financial solutions and expertise to help you plan and achieve your goals. To discover how we can help you, call Bill Lynch at 202-835-4513 or visit pnc.com/realestate.

Real Estate

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Your goal. Our commitment.

Connect with us: bakertilly.com

!We’ve changed (sort of).

For over 30 years, you’ve known us as Beers + Cutler, one

of the Washington region’s leading accounting and consulting

firms. We have now joined forces with Baker Tilly. And while our

name is changing, our level of commitment and dedication

to our real estate clients remains the same.

Together with Baker Tilly, our strengthened industry expertise

will provide you with greater resources and services to meet

your tax, assurance and business advisory needs into the

future.

Today is a great day.

And tomorrow will be even better.

© 2010 Baker Tilly Virchow Krause, LLPBaker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International.

Accountants and Advisors

MARCH 23, 2010 — Grand Hyatt Washington

8th Annual

Produced by Real Estate Forum and GlobeSt.com

This year, more than 500 attendees will gather to network and gain relevant information on the following topics: What does 2010 and beyond hold for sectors and rising submarkets?

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CONFIRMED SPEAKERS INCLUDE: *Partial list edited due to size

Valerie SantosDeputy Mayor for Planningand Economic Development,District of Columbia

Keynote Address

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J StreetCompanies

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MonumentRealty

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George MasonUniversity

Jair Lynch

Jair Lynch Development

Bob Murphy

MRP Realty

REGISTRATION & AGENDA AT: www.RealShareConferences.com/WashingtonDC

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119

Notes

120

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