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Presented at RTM Conference,

Philadelphia, PA

October 7, 2014

Presented by:

Dianne P. Crocker, Principal Analyst

EDR Insight

RISK MANAGEMENT TRENDS IN THE 2nd ACT OF MARKET RECOVERY

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1. RECOVERY IS GAINING TRACTION.

2. RISK MANAGEMENT IS GETTING SMARTER.

3. OPPORTUNITIES ARE BEING CREATED FOR ALL OF US.

TODAY’S HIGHLIGHTS

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1. RECOVERY GAINING TRACTION

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RECOVERY IN REAL ESTATE: 2014

• Q1 WAS AN ANOMALY.

• ECONOMIC ACTIVITY LARGELY PICKED BACK UP IN Q2 AND Q3.

• THE OVERRIDING MARKET THESIS IS THAT THE ECONOMY IS IMPROVING.

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• THE JOBS MARKET IS GETTING BETTER.

• CORPORATE EARNINGS ARE GETTING BETTER.

• INVESTMENT ACTIVITY IS BACK IN VOGUE.

• MARKET FUNDAMENTALS ARE IMPROVING.

• INTEREST RATES ARE STILL LOW.

• ALLOCATIONS TO REAL ESTATE ARE GROWING.

BAROMETERS POINTING TO MOMENTUM

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• MAJOR BUYING CLASSES

• Real estate investment trusts (REITs)

• Foreign investors

• Private equity funds

• Hedge funds

• Traditional developer/owner/operators

DEAL MAKING: WHO’S INVESTING?

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• UPTICK IN NEW CONSTRUCTION MARKS START OF NEW DEVELOPMENT CYCLE (FINALLY)

• STALLED PROJECTS ARE GETTING THE GREEN LIGHT

• BEYOND KEY METROS (NY, SAN FRAN, BOSTON)

• TOP 10 STATES:

1. Texas

2. Louisiana

3. New York

4. California

5. Iowa

6. Florida

7. Maryland

8. Georgia

9. West Virginia

10. Oregon

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CONSTRUCTION IS BACK!

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ARCHITECTURAL BILLINGS INDEX:

• IN JULY, INDEX HIT ITS HIGHLIGHT POINT SINCE BEFORE THE DOWNTURN

• SUGGESTS THAT CRANES WON’T BE LEVELING OFF ANY TIME SOON

• POINTS TO MARKED INCREASE IN U.S. DEVELOPMENT IN 2014

DESIGN SERVICES ARE UP, TOO

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• SMALL CAP PROPERTY SALES:

• $37B at mid-year

• Ahead of last year’s pace by impressive 33%

• 2013 was highest in 7 years

• LARGE SALES OF PRINCIPAL PROPERTIES:

• $186 billion at mid-year

• Up 23% over 2013

• Nearly rivaling the mid-year total in 2006

CRE DEAL FLOW STATS

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• MULTIFAMILY APARTMENT DEMAND STILL LEADS

• SELF-STORAGE

• REGIONAL MALLS

• OFFICE IS IMPROVING IN MAJOR URBAN MARKETS

• INTEREST PIVOTING TO INDUSTRIAL AND RETAIL ASSETS

PROPERTY TYPES ATTRACTING INTEREST

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• PROPERTY SALES CONTINUE TO TILT TOWARDS SECONDARY MARKETS.

• HIGHER PRICING, MORE COMPETITION IN MAJOR MARKETS

• INVESTORS SEEKING HIGHER YIELDS, LESS INTENSE COMPETITION

• MORE ACTIVITY IN SMALLER METROS…

DIFFERENT MIX OF PROPERTY DEALS IN ‘14

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Top 10 High-Growth Metros for Phase I ESA Volume (2014, YonY)

Cincinnati, OH 40%

Austin, TX 23%

Oklahoma City, OK 19%

Pittsburgh, PA 16%

Dallas, TX 16%

Houston, TX 15%

Richmond, VA 12%

Portland, OR 12%

Seattle, WA 11%

Kansas City, MO 10%

METRO HOT SPOTS, 2014

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• AVAILABILITY OF CAPITAL IS VITAL TO THE RECOVERY

• BANKS HAVE $ TO LEND, BUT STILL VERY CAUTIOUS

• HEADING INTO NEW ROUND OF REFINANCING WITH $360B IN LOANS MATURING BY 2017

• EXTREMELY COMPETITIVE

LENDING: SLOW PACE OF GROWTH IN ORIGINATIONS

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• BANKS’ NET INCOME IS RISING

• BANKS SET ASIDE LESS MONEY TO COVER SOURED LOANS, HELPING TO BOOST PROFITS.

• LOAN LOSSES ARE FALLING

BOOSTS THEIR CASE FOR INCREASED LENDING ACTIVITY…

POINTS IN LENDERS’ FAVOR

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BANK LENDING HITS ITS STRIDE

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HOW WOULD YOU CHARACTERIZE THE LEVEL OF CURRENT FINANCING CONDITIONS TODAY COMPARED TO CONDITIONS ONE YEAR AGO?

• CREDIT AVAILABILITY HAS MEANINGFULLY IMPROVED: 45%

• CREDIT AVAILABILITY HAS ONLY MARGINALLY IMPROVED:44%

• JUST AS TIGHT AS LAST YEAR:10%

• CREDIT AVAILABLE HAS TURNED FOR THE WORSE: 1%

SOURCE: EDR INSIGHT’S BENCHMARK SURVEY: LENDERS' SCOPES OF WORK FOR COMMERCIAL PROPERTY DUE DILIGENCE, SEPTEMBER 2014.

CREDIT AVAILABILITY IMPROVING…

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COMPARED TO THIS TIME LAST YEAR, HOW WOULD YOU CHARACTERIZE BORROWER INTEREST ON LOANS FOR COMMERCIAL PROPERTIES?

• MORE SERIOUS INQUIRIES FROM BORROWERS: 46%

• ABOUT THE SAME: 43%

• FEWER SERIOUS INQUIRIES FROM BORROWERS: 11%

SOURCE: EDR INSIGHT’S BENCHMARK SURVEY: LENDERS' SCOPES OF WORK FOR COMMERCIAL PROPERTY DUE DILIGENCE, SEPTEMBER 2014.

…MORE SERIOUS BORROWER INTEREST

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2. RISK MANAGEMENT GETTING SMARTER

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IN GENERAL, HOW WOULD YOU RATE YOUR CLIENTS' RISK TOLERANCE IN 2014 VS. 2013?

Less aversion More aversion

SOURCE: EDR INSIGHT SURVEY: SCOPES OF WORK BENCHMARK SURVEY OF EP’s, SEPTEMBER 2014

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TRUE/FALSE?Clients are demanding more thorough environmental due diligence on deals today than they were last year.

Less aversion More aversion

SOURCE: EDR INSIGHT SURVEY: SCOPES OF WORK BENCHMARK SURVEY OF EP’s, SEPTEMBER 2014

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TRUE/FALSE?Clients are demanding more thorough environmental due diligence on deals today than they were last year.

“Banks are more risk averse

overall, developers are slightly less

risk averse.”

“The biggest change we have seen is in volume of work. Although risk tolerance has not changed, banks are conducting more deals.”

“With my lender clients, I would say there has been a noticeable concern by smaller regional/community banks to understand environmental risk more and manage it.”

SOURCE: EDR INSIGHT SURVEY: SCOPES OF WORK BENCHMARK SURVEY OF EP’s, SEPTEMBER 2014

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SOURCE: EDR INSIGHT’S BENCHMARK SURVEY: LENDERS' SCOPES OF WORK FOR COMMERCIAL PROPERTY DUE DILIGENCE, SEPTEMBER 2014.

IN GENERAL, HOW WOULD YOU RATE THE LENDING SECTOR’S TOLERANCE OF ENVIRONMENTAL RISK IN 2014 VS. 2013?

HOW LENDERS VIEW RISK TOLERANCE

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• DUE DILIGENCE SCOPES ARE BEING MORE TAILORED TO THE DEAL. NOT ONE SIZE FITS ALL.

• GREATER SCRUTINY OF PHASE I ESA’S BY LENDERS

• AN INCREASE IN PHASE II ESA’S IN 2014

• MORE PROPERTY CONDITION ASSESSMENTS

• INCREASE IN ASBESTOS SURVEYS

• MORE INTEREST IN ENVIRONMENTAL INSURANCE TOOLS…

OTHER SIGNS OF HIGH RISK AVERSION

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• SIGNIFICANT GROWTH IN THE USE OF INSURANCE IN PAST 12-18 MONTHS

• IMPACT OF THE GREAT RECESSION ON LENDERS:

• A substantial increase in claims from loans in default that had contamination on site. Some lenders chose to clean it up to sell it at a higher price.

• More awareness about environmental risk, lessons learned from downturn.

• Banks are balancing need to make more loans, but remain disciplined.

Source: Comments made by presenter Debra Hausser, Zurich VP, EDR Insight webinar on environmental insurance, October 1, 2014.

INSURANCE USE ON THE RISE

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• YESTERDAY U.S. EPA ISSUED FINAL RULE TO REMOVE REFERENCE TO THE HISTORIC E 1527-05 STANDARD FROM THE AAI RULE

• INTENT WAS TO “…REDUCE ANY CONFUSION ASSOCIATED WITH THE REGULATORY REFERENCE TO A HISTORICAL STANDARD THAT IS NO LONGER RECOGNIZED BY ITS ORIGINATING ORGANIZATION AS MEETING ITS STANDARDS FOR GOOD CUSTOMARY BUSINESS PRACTICE.”

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3. OPPORTUNITIES BEING CREATED

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INTEREST IN CONTAMINATED PROPERTIES

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• MUNICIPALITIES HAVE REASSESSED THE POTENTIAL FOR REDEVELOPING INDIVIDUAL PROPERTIES, AND ARE MAKING DEVELOPMENT ON THESE PROPERTIES EASIER IN AN EFFORT TO LURE DEVELOPERS.

• EXAMPLE:

• CT has invested more than $62 million in cleaning up brownfield sites across the state in the last two years, almost six times the amount spent in the previous seven years.

• OWNERS, DEVELOPERS AND LOCAL GOVERNMENTS ARE IN POSITION TO RESTART PREVIOUSLY-STALLED PROJECTS.

• MANY INVOLVE SITES WITH CONTAMINATION DEEMED TOO COSTLY FOR REDEVELOPMENT.

• MORE DEMAND FOR URBAN LOCATIONS BRINGS CONTAMINATED SITES INTO PLAY.

FORCES CONVERGING

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“ WITH THE COMEBACK ECONOMY DEVELOPERS EXPECT THEIR CONSULTANTS TO UNDERSTAND AND PROCURE ECONOMIC INCENTIVES.  WE HAVE COUNTLESS REDEVELOPMENT PROJECTS RELYING UPON A NUMBER OF INCENTIVES FROM EPA SITE ASSESSMENT GRANTS, FEDERAL, STATE AND LOCAL TAX INCREMENT FINANCING OPTIONS, STATE GRANTS, LAND BANKS, ETC.”

~MIKE KULKA, CEO, PM ENVIRONMENTAL

SAMPLE BROWNFIELD PROJECT:

 

 

 

 

 

LOCAL INCENTIVES ARE CRITICAL

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WHAT’S NEXT?

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• TECHNOLOGY IS MOVING BY LEAPS/BOUNDS TO BRING BUYERS/SELLERS TOGETHER TO FACILITATE DEAL MAKING

• Auctions

• Crowdfunding

• E-tailing

• Mobile offices

• THE CROWDFUNDING MARKET IS AT $10B NOW, COULD REACH ABOUT $96 BILLION BY 2025

DISRUPTIVE TRENDS

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MARKET HEALTH:

• Back on track after slow start to ‘14

• More $$s, more players, broader geographic reach

• Loan origination volumes should increase over time

RISK:

• Still a general sense of risk aversion

YOUR CHALLENGES:

• Competition, efficiency, speed

FORECAST:

• Sanguine about the growth outlook

• Viability to the recovery that we haven’t seen thus far

4Q AND 2015 FORECAST

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Q&A