commercial real estate: has the tide turned?
TRANSCRIPT
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Asset Managemen
Executive Summary
The 20082009 global nancial crisis brought the real estate markets to a virtual standstill inmost developed regions of the world. The causes of the collapse have been widely covered,including excessive borrowing, inated property prices, heightened unemployment, reducedeconomic growth and overall contractions within many global economies. One of the mostsignicant outcomes of the market dislocations was the negative impact on the mortgage-backedsecurities market, which suffered dramatically in the aftermath of the crisis.
While there is no question that the sector suffered, signs of a sustained revival in commercialreal estate have emerged. As the market regains strength, we believe investors would benetfrom opportunities in select commercial property, a sector that historically has led recoveries fromprevious downturns.
In this paper, we discuss the opportunity and the factors which, in our view, are pointing to arecovery. This recovery, however, is unlikely to be even throughout the world. In fact, we believethat the US commercial real estate market will likely provide the most compelling opportunities inthe rst phase of the recovery as a result of:
Stabilizing debt markets and the re-emergence of commercial mortgage-backed securities(CMBS) issuance;
Property demand improvements, as shown in vacancy and absorption trends; Favorable commercial property valuations;
Macro-economic tailwinds; and
Signicant level of capital ready to be deployed for US real estate.
Many of the worlds largest investment rms, institutional investors and pension plans have beenincreasing allocations to this asset class. Starting in 2009 and throughout 2010, institutionalcapital poured into core and stabilized real estate in primary US market regions in search ofreliable, long-term yield. Public pension plans, such as California Public Employees RetirementSystem (CalPERS), have been restructuring their real estate initiatives to include a greaterallocation to core commercial property.1
This investment activity has led to a meaningful recovery for these properties as yields re-approached pre-nancial crisis levels. The growing liquidity has also made possible the re-openingof the initial public offering (IPO) market for real estate ventures. For example, Archstone, oneof the largest real estate rms focused on the development and management of multi-family(apartment) properties, has been exploring the possibility of a US$5 billion IPO, which would bethe largest real estate IPO in history.2 Low interest rates in the US have also been instrumentalin containing the cost of capital for real estate investors and making property returns attractive incomparison to other asset classes, such as xed-income instruments.
Continued on next page
Commercial Real Estate: Has the Tide Turned?June 2011 WHITE PAPER
For more information onthe views expressed here,please write to us [email protected]
Kelly Williams
Head, Customized FundInvestment Group
Nadim BarakatChief Investment Ofcer,
Customized FundInvestment Group
Peter BraffmanPartner, Customized
Fund Investment GroupReal Estate
Market Research byDavid Weissman, CFA,Customized FundInvestment Group
1 Bloomberg, February 14, 2011.2 Archstone Looks Likely to Go Public Again, Dow Jones, February 23, 2011.
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2|Credit Suisse Asset Management
Meanwhile, our analysis shows that certain regions arestill facing some headwinds. In Europe, sovereign debtconcerns are likely to linger, which could delay the sectors
recovery. In the Asia-Pacic and Latin-America propertymarkets, economic growth has accelerated propertydemand, but rising ination may be a limiting factor as itleads to potentially higher interest rates. China and Brazil,for instance, have each raised interest rates several times in2010 and 2011.
In this light, we believe that investors may be able to take
advantage of the changing real estate conditions in the US
by considering the following strategies:
Acquire over-leveraged opportunistic US commercialproperty (e.g., distressed) that is favorably priced forfuture income growth and capital appreciation, based onexpectations that economic conditions may continue toimprove over time;
Invest in income-generating valued-added commercialreal estatesuch as multi-family and ofcepropertiesas well as select retail and industrial assetslocated in regions of the US with favorable demographicgrowth trends. Other non-traditional (niche market)
income-generating real estate may also be attractive,including senior housing, student housing, medicalofces and self-storage; and
Emphasize private real estate investments for tworeasons: a) public REITs recovered from the globalnancial crisis rst, with signicant performance overthe past year, and appreciating over 130% since theirlows in February 2009 to the end of March 2011.3This was based on both investors desire for currentyield and expectations for improving net asset valuesof the underlying properties; b) private real estate istypically less correlated to equity market conditionswhen compared to public REITs, which are usuallytraded on open nancial markets. Incorporating private
commercial real estate, we believe, can improve therisk/return prole of a diversied portfolio.
This paper also addresses the risks associated with thecommercial real estate market, and how investors shouldconsider developing real estate investments in the context oftheir aggregate portfolio. We believe that success in takingadvantage of nascent commercial real estate opportunitieswill predicate on careful valuations and deep due diligence.With these caveats in mind, we believe the US commercialreal estate opportunity set is compelling.
Continued from cover page
3 US All REITs Real Estate Index Series, FTSE NAREIT, April 2011.
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Display 1: Commercial borrowing and CMBS issuance increasing
4 Credit Suisse Economics Research, Global Economy Review, May 6, 2011.5 The Linneman Letter, Linneman Associates, Winter 2010-2011.6 Glimmer of Better Days for Manhattan Ofces, New York Times, March 30, 2011.7 Lenders Entering 2011 with Rising Optimism, Commercial Mortgage Alert, January 7, 2011.8 CMBS Market Watch Weekly, Credit Suisse Fixed Income Research, March 11, 2011.9 US CMBS Issuance Data, John Lang LaSalle and JP Morgan, March 2011.
Credit Suisse Asset Management | 3
CS
Projection
0
50
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250
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
US$
Billions
US CMBS Issuance
US real estate prices and investment returns for most properties
have been in decline since the beginning of the credit market
collapse in 2007. There are signs, however, that the US real
estate market may benet from a gradually improving economy(GDP growth is expected to reach 4% in 2011 measured
on a Q4/Q4 basis).4 Major urban regions, such as New York
and Washington, are already experiencing heightened leasing
activity for ofce space, and vacancy rates have been trending
lower.5 In New York, for example, some prime ofce markets are
experiencing vacancy rates of only 4%, with average vacancy
rates across New York ofce properties of approximately 12.8%
in the rst quarter of 2011, compared to 13.9% for the same
period last year.6 The prospects for a commercial real estate
revival have emerged consistent with the economic recovery,
and are related to improving trends in commercial lending,
stabilization of vacancy rates and property pricing that appearson the verge of increasing in value.
Debt Conditions Stabilizing and CMBS Issuance Rising
The availability of credit will be essential to a real estate revival.
With interest rates at historically low levels and banks lending
more, the favorable reversal for debt conditions, which started
in 2010, is likely to continue. However, we see the road to a full
recovery as somewhat volatile.
Support for lending has come from insurance companies andother nancial institutions, who are once again increasing their
mortgage allocations. Another stabilizer for debt markets is the
revival of commercial mortgage-back securities (CMBS), with
new issuance expected to triple in the US in 2011 versus last
years levels.7 Key recent developments in CMBS include:
In 2010, total new CMBS issuance in the US rose to
US$5.3 billion, up vefold from the US$3 billion overall
issuance in 2009,8
Total US issuance in 2011 is expected to top US$40billion, which would provide added liquidity to purchasers o
owners with maturing loans to renance; and
The rst quarter of 2011 was off to a strong start with
approximately US$10 billion of additional issuance in the
pipeline (Display 1).9
Signs of a US Revival
Data through March 11, 2011Source: Credit Suisse Fixed Income Research
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Display 2: Commercial mortgage ows may be reversing
As debt has re-entered the market (largely for core properties in
late 2009 and early 2010), cap ratesthe income yield or rate
of return of a propertys income based on its purchase price or
valuehave begun to normalize as valuations started to recover(Display 2). We believe the re-emergence of debt for real estate
transactions marks the beginning of a sustained recovery in
the sector.
Positive trends in loan charge-offs (also known as write-offs),
which have fallen since reaching a peak in November 2010, also
indicate improved commercial-lending conditions. Loan charge-
offs are recorded by the lender when future mortgage payments
or full payoff are no longer likely. Similar to the recent decline in
charge-offs, the trailing six-month-average loss-severity trend
has reversed from the 2009 peak of 70%. Lower charge-off and
loss-severity rates support the case for banks to cautiously openthe window to further lending (Display 3).
A nal considerat ion regarding the improving lending condit ion
in the US is the ongoing inuence of the Federal Reserve and
other government bodies. First, governmental organizations
have continued to pressure banks to increase the volume oflending, although the exact breakout for activity levels between
residential and commercial lending remains clouded. Second,
the Federal Reserve remains committed to the stability of
nancial markets, setting interest rate targets at historically low
levels. As a result, demand for commercial mortgages, and the
renancing of these mortgages, continues to build momentum.
Based on these indicators, there is guarded optimism
percolating at major nancial institutions, especially as debt
liquidity has emerged, and the mortgage securitization market
appears to be reviving.
300
200
100
0
-100
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-300
01 02 03 04 05 06 07 08 09 10
Commercial MortgageNet Capital Flow
Cap Rate
10.0
9.0
8.0
7.0
6.0
%
US$Millions
400
US Commercial Mortgage Flows and Cap Rate
0
10
20
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Feb
09
Feb
10
Feb
11
US$Millions
Trailing six-month numberof liquidated loans
Trailing six-month averageloss severity (RHS)
US Liquidated Loans and Loss Severity
Display 3: Lower CMBS liquidated loans and loan
charge-offs may support further bank lending
Data through December 31, 2010Source: Federal Reserve and Real Capital Analytics
Data through March 31, 2011Source: Trepp and Credit Suisse
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Credit Suisse Asset Management | 5
Commercial Real Estate Demand Outweighing New
Supply Growth
The stabilization of real estate fundamentals is both a function
of economic trends, as well as a favorable supply picture forcommercial real estate. Unlike prior real estate cycles, the
collapse of valuations in 2008 was primarily credit driven, rather
than stemming from oversupply.
Indicating more robust demand, vacancies appear to have
stopped rising at the end of 2010, after increasing nearly
35% since 2008.10 Demand for warehouse/distribution space
within this sector drove the majority of occupancy gains, as the
vacancy rate in this segment fell to 10.9% at the start of 2011.
Overall absorption has been positive for the third consecutive
quarter with annual net gains reaching 13.1 million square feet
(msf) at the end of 2010.
The US ofce market is showing particular strength. In the
fourth quarter of 2010, and for the rst time in more than
three years, the US ofce vacancy rate decreased and net
absorptions increased. Nationwide, the vacancy rate dropped
20 basis points to 16.4%, and appears to be trending back
towards the global average of approximately 14.1% across 104markets globally and 14.6% in the US.11,12
This vacancy trend is supported by corporate cash balances
and earnings, which are robust and expected to promote
corporate spending on expansions. According to the Business
Roundtables CEO Economic Outlook survey, 52% of CEOs
plan to add staff over the next six months (as of April 2011),
the highest reading since the group started its survey in 2002. 1
As a result , we expect shortages of quality space (Class-A
properties) in 2011. Class-B and Class-C properties, however,
may lag in terms of meaningful improvements, especially
outside major urban areas, where employment hiring generallyremains weaker. Nonetheless, the overall trend of increasing
demand is positive (Display 4).
Display 4: Vacancy rates and absorptions point to increasing demand
Source for all charts: CBRE Econometric Advisors Outlook, Winter 2011
10 Bridgewater Daily Observations, Bridgewater Associates, February 28, 2011.11 CBRE Investors, CB Richard Ellis, January 2011.12 Global Market Perspectives 1Q 2011, Jones Lang Lasalle, March, 2011.13 CEO Economic Outlook Survey, Business Roundtable, 1Q 2011.
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0
-20
-40
-60
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-100
SquareFeet(Millions)
20
18
16
14
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8
64
2
0
%
90 92 94 96 98 00 02 04 06 08 10
Absorption Vacancy Rate(right hand side)
450
350
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50
-50
-150
8
7
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5
494 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Absorption Vacancy Rate(right hand side)
S
quareFeet(Millions)
55
45
35
25
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-5
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-25
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8
6
%
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
%
Absorption Vacancy Rate(right hand side)
Vacancy Rate(right hand side)
Absorption
90 92 94 96 98 00 02 04 06 08 10
400
300
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100
0
-100
-200
-300
15
14
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SquareFeet(Millions)
%
Un
its(Thousands)
Office (1990-2010) Multi-Family (1994-2010)
Retail (1996-2010) Industrial (1990-2010)
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14 Moodys/REAL Commercial Property Price Indices, February 201115 Moodys/REAL Commercial Property Price Indices, February 2011
In contrast, new supply has been limited since 2007,
constrained by lower levels of construction activity. In 2010,
for example, only 15.9 msf of commercial real estate was
completed, the lowest level in over a decade. New constructionrepresents only 1.2% of the total stock of available US ofce
properties, as of the rst quarter of 2011. Based on the
consequent reduction in supply and improving demand, we
expect continued declines in vacancy rates to facilitate higher
leasing income and property appreciation in regions most
sensitive to economic expansion. Even if construction should
happen to increase signicantly, the completion of those future
projects would take some time. Therefore, any additional supply
would not be inuential for several years (Display 5).
Favorable Pricing Trends
As a result of these supply and demand conditions, the realestate valuation trends point upward, in our view. In 2010, the
Moodys/REAL All Property Type Aggregate Index declined
2.1%, approaching the lows of 200102.14 However, price
levels have started to recover, with an initial increase of 5.5%
at the beginning of 2011. Despite the improvement, property
valuations remain attractive, in our view. As represented by the
Moodys/REAL Commercial Property Price Index (CPPI), prices
remain 42.1% below the peak of real-estate asset pricing
in October 2007.15 This is a result of: a) the overall decline
in real-estate operating income (which is a primary driver of
valuation); and, b) the failure of non-stabilized and non-core
real estate to participate in the appreciation that was recentlyexperienced by core and stabilized assets. The latest direction
of price improvement and increased transaction activity provide
encouraging signs that the upside potential will likely outweigh
the possibility of further pricing declines (Displays 6a and 6b).
90
110
130
150
170
190
210
Index,
December2000=100
NationalAggregate
NationalApartments
NationalIndustrial
National
Office
NationalRetail
4Q0
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2Q0
1
4Q0
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2Q0
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4Q0
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4Q1
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Commerical Property Price Index
9
87
6
5
4
3
2
1
080 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
%
Office Warehouse Recessionary PeriodsRetail Apartments
Construction as percent of stock
0
1,000
2,000
3,000
4,000
5,000
Thousand
s
ApartmentsProperties Sold
RetailProperties Sold
IndustrialProperties Sold
Office
Properties S
2005 2006 2007 2008 2009 2010
US Properties Sold
Display 5: Low level of new construction hasconstrained supply
Display 6a: Real estate prices are coming off the lows...
Data through June 30, 2010Source: Torto Wheaton Research, REIS (US Top 50 Metros), Jones LangLaSalle and LaSalle Investment Management Research
Data through February 2011Source: Moodys/Real Commercial Property Price Indices
Data through December 2010Source: NCREIF
Display 6b: ...While increased transaction activityis encouraging
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16 Institutional Real Estate Investment Values Release for 4Q, NCREIF, January, 2011.17 Institutional Real Estate Investment Values Release for 4Q, NCREIF, January, 2011.18 US Bureau of Labor Statistics, May 2011.19 Commercial Real Estate Resurgence, Global Market Perspective, Jones Lang LaSalle.20 Managing Fixed Income in a Rising Ination and Interest-Rate Environment, Credit Suisse Asset Management, March 2011.
Credit Suisse Asset Management | 7
Recent real estate return performance has also been reected
in the National Council of Real Estate Investment Fiduciaries
(NCREIF) property index (which includes apartment buildings).
The NCREIF index reported a total return of 4.6% for the fourthquarter of 2010, compared to 3.9% in the third quarter, and a
loss of 2.1% in the fourth quarter of 2009. 16 Specic segments
of the US commercial property market recorded positive results.
For the fourth quarter of 2010, apartment investments returned
6.3%, ofce holdings returned 3.9%, and industrial properties
yielded 3.4% (Display 7).17
US Macro-Economic Tailwinds
Economic indicators appear more positive in early 2011,
supporting more favorable property conditions, as utilization
and vacancy of commercial space is historically correlated to
economic growth and business planning. At the same time,private sector jobs are being added, albeit at a slow pace.
The US Bureau of Statistics non-farm payroll survey reported
private sector job growth of 244,000 for April 2011, following
an increase of 230,000 for March 2011, marking the seventh
consecutive month of non-farm payroll increases.18 Business
condence levels are also trending higher as the US recordedseven consecutive quarters of real GDP growth as of the rst
quarter of 2011. This positive sentiment is often considered a
leading indicator for future business expansion.19
Even with the recent economic improvements, ination growth
as measured by the Consumer Price Index (CPI)in the US has
been near historical lows, indicating pricing pressures of less
than 1% to 2% annualized. Accordingly, we believe US interest
rates are likely to remain low in 2011, facilitating investors
access to advantageous nancing for property purchases.
However, the combination of geopolitical pressures, expansionary
scal and monetary policies and economic growth is likely toignite inationary pressures over time.20
-1
0
1
2
3
4
5
6
7
Hotel Industrial Office Retail Apartment
%
1Q 2010 2Q 2010 3Q 2010 4Q 2010
NCREIF Property Index(Total Returns by US Property Segment Sub-Indices)
Display 7: Real estate returns improved in 2010
Data through December 31, 2010Source: National Council of Real Estate Investment Fiduciaries (NCREIF)
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Commercial Real Estate: Has the Tide Turned?
Capturing Commercial Property Opportunities
8|Credit Suisse Asset Management
Deleveraging. Most real estate assets acquired in 2005
07 are currently over-leveraged, or their owners are
personally over-leveraged. During this three-year period,
while property income remained relatively stable, propertyvalues skyrocketed as debt and equity poured into real
estate. This was because the availability of leverage
was based on property market values, and not on cash
ows. When credit markets collapsed in 2007, valuations
began to fall in tandem, and equity values were largely
wiped out. While valuations have recovered to some
degree for core assets, the same cannot be said for
non-core assets. The debt on these assets is maturing
at a time when it cannot be renanced for the same level
of proceeds. Credit Suisse estimates that over US$400
billion of new equity will be needed to recapitalize theseassets, which may create a signicant opportunity to
acquire assets at discounts to replacement cost. This
could present a substantial base from which attractive
opportunities may arise to acquire high-quality assets at
discount prices through distressed sales (Display 8).
However, the US markets have not seen a signicant
volume of these distressed opportunities until recently.
This is because many lenders extended loans on
distressed assets while they grew their way out of the
problem through earnings to cover losses. Lenders
We turn our focus now to a selected set of opportunities that,
we believe, may benet institutional investors. These are based
on criteria such as identifying underpriced assets, demographic
trends, and other changes in conditions following the nancialcrisis. Specically, we believe that investment strategies in private
real estate value-added and niche investments may best capture
opportunities in the commercial space in the current environment,
depending on investors risk tolerances and objectives.
Value-Added Strategy
The primary objective within the value-added strategy would be
to acquire well-located assets within markets that feature solid
demographics, rising employment and exhibit a strong recovery
in underlying real-estate fundamentals. The implementation
of a value-added strategy in this manner should provide the
portfolio with strong appreciation potential, as well as someinitial current income that should grow meaningfully over the life
of the investment. Value-added assets would typically be those
that are well leased, but not completely stabilized (i.e., 70%
to 80% occupied). In our assessment, the best value-added
opportunities exist within the smaller end of the market. Returns
may be generated within this strategy by: a) acquiring assets at
a meaningful discount to core properties; b) investing capital;
and, c) leasing them up to stabilization, thereby creating core
properties that can be sold into a core market.
We believe that the investment opportunity within value-added
investments is driven by the following trends:
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2007 2008 2009 2010
%
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$Billions
Distressed Sales % of Total Sales (right hand side)
Distressed Sales
Display 8: Distressed property sales increased sharply in late 2010
Data through December 31, 2010Source: US Capital Trends and Real Capital Analytics
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Credit Suisse Asset Management | 9
have also generally maintained a tempered approach
to foreclosures and restructurings of troubled assets.
However, this dynamic is changing now as real estate
prices have begun appreciating from their marked-downvaluations. Lenders have begun to sell assets, while many
owners have nally capitulated and are looking to divest
their properties.
Capital Flight into Core. As discussed earlier, most of
the real estate capital invested over the past 18 months
has ooded into core and stabilized assets in a chase for
yields. This direction of capital ow has moderated prices
in the value-added segment, creating what we believe to
be a compelling purchase environment, and an opportunity
to achieve superior risk-adjusted returns. Furthermore,there is excessive capital currently allocated to the core
space that may take years to deploy. This should create
a deep market of core buyers to whom todays value-
added investors can sell their then stabilized assets at
attractive pricing. The fact that value-added investments,
in general, and smaller assets, in particular, have largely
been overlooked until now, should present an opportunity
to purchase such assets at an attractive cost basis.
Lack of New Supply. We also discussed earlier that new
construction has been minimal. Accordingly, the limitedsupply picture bodes well for a sustained recovery in
valuations, in our view. We have begun to witness this
dynamicinitially among multi-family assets, where
vacancies have disappeared and rent growth has begun
and now with ofce, retail and industrial. This supply-
constraint picture is important in all real estate, but even
more critical for the value-added strategy, which relies on
lease-up and rent growth. We believe the present supply
environment should meaningfully reduce the risk of such
a strategy.
Value-Added Asset Selection
Multi-family properties exhibit the best fundamentals among
the major asset classes by a wide margin. Since debt markets
have been most favorable in multi-family, this asset class hasbeen the most liquid. Consequently, the multi-family asset class
has attracted signicant amounts of capital. This has resulted in
gateway marketssuch as New York, Boston and Washington,
DCbecoming more expensive, although positive leverage
is still available, potentially increasing returns. This trend of
increased capital ow into multi-family warrants a cautious view
on pricing.
While the ofce, industrial and retail sectors have different
drivers, they share a common feature of generally having
long-term lease structures with their tenants. As suchand
as opposed to multi-family assetstheir net operating income(NOI) streams are all continuing to trend downward as leases
roll and rents reset to new levels. Since additional capital is
needed for leasing costs and capital expenditures, even if
owners can pay debt service, they may not be able to infuse
the capital that would be necessary to keep tenants. Therefore,
there should be signicant acquisition opportunities arising from
these asset types over the next few years, as these dynamics
and debt maturities play out.
Ofce. In this sector, Credit Suisse would favor well-
located urban ofce assets in secondary cities, and would
generally avoid suburban ofces. The US ofce market is
showing increased signs of recovery, as demonstrated in
the fourth quarter of 2010 when, for the rst time in more
than three years, the vacancy rate decreased and net
absorptions increased. Credit Suisses focus for value-
added investments would be on small, urban ofces that
require capital expenditure and tenant-improvement capital
to attract and keep tenants in knowledge-driven secondary
markets, such as Atlanta, Miami, Houston, Seattle, Austin
and Portland.
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Retail. The specic location of an asset is of greater
importance within retail than in any other asset class
because location relative to customers is an important
variable that all retailers must account for in their businessstrategy. As a result, well-positioned retail real estate is
irreplaceable and highly sought after by retailers seeking
to gain a competitive advantage, or targeting select
demographics that should support higher-than-average
sales. In this vein, location should be one of the most
important criteria in investors selection of assets within
the retail strategy. Within the US, the tech regions of
Austin, San Francisco, Boston, San Jose and Seattle
are showing favorable fundamentals, such as strong
employment growth projections, robust migration trends
and expectations for strong retail sales.
Industrial. This is a strong asset class for a value-added
strategy when compared to ofce and retail properties,
as it is not expensive to hold due to its low capital
requirements for leasing. On the other hand, maximizing
investment outcomes does require signicant knowledge
of the tenant base. When investing in industrial assets, we
believe investors should take advantage of consolidation
in the industry, and target properties in port cities and
major distribution corridors.
Multi-Family. Given the fact that positive multi-family
fundamentals have attracted increased amounts
of investment capital to the asset class, prices are
appreciating as a result. Therefore, any investment
program would approach multi-family acquisitions on
a selective basis in the value-added strategy, primarily
targeting properties that present a compelling purchase
opportunity due to nancial distress on the part of the
owner. Within the US, weighting should be given to
the Smile States (Washington, DC, down through the
Carolinas and Florida, over to Texas and up the West
Coast). Target markets within these states include Denver,Raleigh, Austin, San Antonio, Houston, Portland, Seattle,
Los Angeles and San Francisco.
Niche Investment Opportunities
Niche assets are those that have generally been overlooked
by the institutional market but which are characterized by
strong demographics and outsized yields. These assets can be
accumulated, stabilized and sold as portfolios to an institutional
market that is currently starved for yield. Since these asset
types are relatively under-represented in the institutional
market, exit opportunities would need to be carefully
understood and mapped out as part of an assets underwriting.
Student Housing. A highly fragmented market with few
established players, student housing should present an
opportunity for well-priced purchases, given the relatively
limited competition in this sector. The off-campus student
housing market has seen a signicant increase in demand
from enrollment growth at public universities. A second
driver of demand is a lack of university capital and
expertise to build or manage new on-campus facilities.
As such, attrac tive student housing opportunities are
likely to be found among cities in the US that have large
student populations like Austin, Charlotte, Chapel Hill
and Philadelphia.
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Senior Housing. This sector consists of multiple forms of
multi-family housing involving residences and/or support
services for individuals age 55 and older. The senior
housing opportunity is driven by an aging population,coupled with limited construction starts, as constrained
capital markets have curtailed development of these
properties. Target locations would be characterized by a
large and growing senior population, such as south Florida,
South Carolina and Arizona, with additional focus on
proximity to hospitals, shopping, public transportation and
senior centers.
Medical Ofce Buildings. These are primarily located
on or near a hospital facility. Tenants typically consist
of physicians, diagnostics providers, imaging and otherhealthcare delivery businesses. An attractive feature of
medical ofce buildings is that tenants make a signicant
investment in their location and rarely move, which has
resulted in this asset class producing long-term stable
occupancy and rent growth over time, compared to the
traditional ofce sector.
Self-Storage Facilities. These serve the needs for storage
space created by family or senior downsizing, or the
accumulation of goods during stronger economic periods.
Self-storage is a defensive sector with a low breakeven
rate (approximately 40% occupancy), low operating
expenses and capital expenditures, and an ability to re-
price month-to-month leases in an inationary environment.
Attractive markets include major employment centers withrelative space constraints like New York City, Washington,
DC and Seattle.
Emphasis on Private Equity Real Estate
The recommended approaches described above involve
private-transaction strategies. Private markets have a much
broader domain of property investments than do public real
estate offerings, such as REITs. An important consideration
of private real estate investments is directed to the return
potential. Reviewing the recent pricing levels between public
REITs and PE real estate investments, we note that public
REITs have appreciated signicantlymore so than the price
of private real estateaccording to most indices. Public REITs
are often valued on market prices that investors are willing to
pay for exchange-listed shares, and usually are accompanied
with a liquidity premium. Therefore, it is important to pay close
attention to the underlying net asset value (NAV) of the REIT
holdings. We see a widening disparity between the underlying
worth of a property (as valued by REITs NAVs or private real
estate products), and the prices given to REITs in the public
markets.22 As of the end of 2010, public REITs were generally
trading at a 20% premium to their underlying NAVs. 23
Commercial Real Estate: Has the Tide Turned?
Credit Suisse Asset Management | 11
22 REITs prices can trade at a premium or discount to their NAVs similar to a closed-end fund.23 Risk Return and Correlation Data, Capital IQ and NCREIF, December 2010
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We use the NCREIF Open End Diversied Core Equity Index returns (ODCE) as a proxy for private real estate.Data through December 31, 2010Source: Capital IQ and NCREIF
Another factor favoring PE real estate is related to market
correlation. Since REITs are traded on open markets, similar
to equities, they are often more correlated with overall equity
market conditions than private real estate. Display 9 showslower correlations to equities for private real estate investments
(as proxied by the Open End Diversied Core Equity Index or
ODCE), and, accordingly, a better mean return per unit of risk
of 0.6 versus 0.1 for US REITs, and 0.2 for US equities.
Risks
There appear to be many compelling incentives for commercial
real estate in the US. However, these opportunities have a
variety of risks that need to be considered in determining
their suitability for an investment portfolio. First and foremost,
the economic environment must continue to improve (this
risk applies to both the national and local markets). Withoutfavorable economic conditions, the identied commercial real
estate trends will most likely become less attractive, and a
further slowdown may impede valuations. Should ination and/
or interest rates move higher, the revival of loans and nancing
for real estate may be negatively impacted. Also, higher real
estate operating costs, such as those for energy and repairs,
will tend to limit returns from income-generating properties.
Global markets are more integrated today than ever before.
Natural disasters, political conict and nancial market
volatility around the world may affect performance of US-
based real estate investments. Since real estate is typically
an illiquid asset, rapid turnover and sales may not constitute
readily available options. This may be one important risk
consideration for insurance companies and other institutions
that need to manage liabilities on a continual basis (sovereign
wealth funds, however, may have more exibility to committing
signicant proportions of their portfolios to longer-term
alternative investments). These are just some of the risks toconsider along with other factors associated with return and
diversication objectives.
NASDAQCompositeIndex
S&P 500Index
MSCI USREIT Index
PrivateRE(ODCE)
Correlation with MSCI REIT Index 0.7 0.8 1.0 0.3
Correlation with Private RE (OCDE) 0.1 0.2 0.3 1.0
Mean Quarterly Return 2.8% 1.8% 1.1% 2.0%
Median Quarterly Return 3.5% 2.4% 2.5% 2.7%
Standard Deviation/Risk 14.0% 8.6% 16.5% 3.5%
Mean Return per Unit of Risk 0.2 0.2 0.1 0.6
Display 9: Private real estate has low correlations to public real estate and US equities
Commercial Real Estate: Has the Tide Turned?
12|Credit Suisse Asset Management
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It appears from a number of trends that we outlined in this
paper that real-estate values have stabilized or are increasing
in many commercial property markets in the US. From the
perspective that commercial property lending is improving,valuation levels may trend higher as demand picks up with
limited new supply available.
The prospects for the commercial real-estate sector remain
positive. Furthermore, the US market may be less risky in
comparison to other global regions, since the US economic
recovery is expected to be more pronounced and more likely to
occur before most other developed economy turnarounds. As
primary markets for commercial real estate have already shown
signs of recovery, it is important to consider select opportunities
carefully, focusing on those that have not yet been fully
adjusted on a valuation basis to the improving conditions.
Conclusion
As a result , we believe that select commercial real estate funds
with ofce, industrial, retail and multi-family property offer
attractive opportunities as favorable economic trends continue,
particularly in the US. In a low interest-rate environment thatmay soon contend with rising inationary pressures, income-
generating commercial properties may offer compelling
investments and help mitigate rising prices.
For many investors, we believe the size, correlation and
income-generating benets of private real estate investment
opportunities may outweigh the liquidity benet associated with
publicly traded REITs.
In our view, several niche commercial real estate markets
offer compelling value, but these areas of opportunity must
be aligned with the investors overall portfolio policy andobjectives. This usually requires a dened investment plan
and a comprehensive understanding of real estate markets to
make sure the diversication benets and return potential are
accessed appropriately.
Commercial Real Estate: Has the Tide Turned?
Credit Suisse Asset Management | 13
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The views and opinions expressed within these publications are those of the authors, are based on matters as they exist as of the date ofpreparation and not as of any future date, and will not be updated or otherwise revised to reect information that subsequently becomes available orcircumstances existing, or changes occurring, after the date hereof.
For a copy of any of these papers, please contact your relationship manager or visit our website at www.credit-suisse.com.
Credit Suisse Asset Management Alternatives Quarterly
Q2 2011Our CIO and portfolio managers weigh in on theimpact on nancial markets of recent events (e.g., earthquake
in Japan, political tensions in the Middle East), and provide anoutlook for investors.
Robert Parker, Credit Suisse Senior Advisor
May 2011 Market Update
May 2011Given the moderation in economic growth andthe lack of a further acceleration in corporate earnings, equitymarkets may consolidate in the near term.
Managing Fixed Income Investments in a Rising Ination
and Interest-Rate Environment
March 2011This paper addresses key challenges facingxed income investors today: How to achieve higher returns ina still low-yield environment while mitigating the rising threats
of ination and interest-rate risks? The ISS teams analysissuggests that diversifying xed income exposure into specicinstruments as well as adding ination hedges may present anefcient way to manage these challenges. A full case study helpsto illustrate the teams ndings.
How Commodities Can Help Investors Face the
Uncertainty of the Ination/Deation Debate
December 2010In this paper, our Commodities Team arguesthat uncertainty about the consumer-price outlook in developedeconomies creates challenges for capital markets to properlyprice in ination expectations. The Commodities Teams researchsuggests that exposure to real assets can help investors cushion
the impact on the portfolio of unexpected changes in theinationary environment in the long run.
The Anatomy of a Modern Emerging Markets Portfolio
November 2010This paper examines the quickly evolvingemerging markets investment landscape and argues that theproliferation of sophisticated investment vehicles in thesemarkets presents an opportunity for investors to augment theefciency of their emerging markets portfolios.
Liquid Alternative Beta:
Enhancing Liquidity in Alternative Portfolios
June 2010How to increase a portfol ios liquidity without
sacricing returns, especially in a post-crisis, low-yieldenvironment? The paper illustrates how institutional investors canuse Liquid Alternative Beta to seek to enhance portfolio liquidity,increase portfolio transparency, short hedge fund sectors andgain hedge-fund-like exposure when investment policies restrictdirect hedge fund investments.
Can Infrastructure Investing Enhance
Portfolio Efciency?May 2010The paper provides an in-depth look atinfrastructure as an investment tool, and analyzes what role theasset class might play in institutional portfolios. Specically, thepaper examines whether infrastructure can be an effective toolto mitigate ination and duration risks, reduce funding gaps and
enhance portfolio efciency.
Credit Portfolio Management in 2010:
A Nimble Approach Needed
January 2010Tracking and timing credit cycles can bechallenging, particularly since todays credit environment appearsto be going through increasingly rapid cycle changes. We believethat xed income investors need to be increasingly nimble andtactical in 2010, while at the same time considering strategicpreparations for medium-to-longer-term regime changes ininterest rates and ination.
Risk Management: A Changing Paradigm
November 2009Renewed interest in risk management andthe creation of a culture of risk awareness are driving currentinvestment committee meeting agendas. This should come as nosurprise in light of market events in 2008 and early 2009. Whileexperience and judgment that have been battle-tested undervarious market conditions prepares CIOs for uncertainty in thefuture, how do they implement risk-based solutions while facingreal-world events?
Risk ParityA Risk-Based Approach
to Portfolio Structuring
November 2009This paper discusses a different approachto portfolio risk management, called risk parity, which aims toequate the contribution of risk across asset classes and, as aresult, create a portfolio which performs better in a variety ofmarket conditions.
Credit Suisse Asset Management Publications
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