jay nowlin o connor houston office investment market presentation 01 12 11
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2011 Overview of Houston Office Building Investment Market and Capital MarketsTRANSCRIPT
Jay NowlinJay NowlinPresident
Nowlin InterestsNowlin Interests
O’Connor & AssociatesJanuary 12th, 2011J y ,
Let’s talk golf….
The Commercial Real Estate Market in 1Q 2011 shares many characteristics with the game of golf.
The conditions are sometimes unpredictable and may change at any timeGolf – weather, course conditionsCRE – Capital Markets, Supply Demand Fundamentals, Regulatory Issues
You have to know your environment/marketGolf – Course management matched with ability and risk /reward decisionsCRE ‐ Understand the market, capitalize on strengths and make appropriate risk reward decisions
You sometimes end up off the original game planGolf – literally off the fairway, in the rough, the woods or even under waterCRE ‐ financing constraints, occupancy challenges, market fundamentals and ….underwater!
You can recover from the rough Golf – having a recovery plan, practice, getting help and executing the shotCRE – having a recovery plan, good support staff and vendors and execution
d f d d l lAttitude, focus and discipline are essentialGolf – a cluttered mind usually leads to lots of poor decisions. Practice and course management.CRE – Striving for positive solutions, clear focus, disciplined management & financial controls
Current Economic (Weather) ConditionsCurrent Economic (Weather) ConditionsHouston Economy: ‐
Created 9 500 jobs 11/09 11/10 (lost 103 500 jobs previous 12 months)Created 9,500 jobs 11/09‐11/10 (lost 103,500 jobs previous 12 months)Trade continues to grow $173 billion through port (top 5 in country)PMI 14 months of positive growthRi t i b tt i i J t 8 6 W i th Rig count up over 1,700 since bottoming in June 2009 at 876. We engineer the world from Houston. $90 oil is good. Gas $4.50 is stable, above $5.50 will grow jobs.4.9% forecasted oil service employment growth 2011.4.9% forecasted oil service employment growth 2011.50% of Houston companies are small companies occupying less than 3,500 SF.
Texas Economy Employer friendly inexpensive central time zone sunbelt improving education Employer friendly, inexpensive, central time zone, sunbelt, improving education system.Has added over 430,000 since June, 2008. and 192,100 in Nov. 10‐Nov. ‘11Current Unemployment is 8.1% (flat year to year) versus 9.4% US (down 0.6%)Cu e t U e p oy e t s 8. % ( at yea to yea ) ve sus 9.4% US (do 0.6%)State projects to grow 2.8% in FY 2012 and 3.4% in 2013.Benefits from high tech manufacturing growth.Texas to add 1.5M jobs by 2016 and grow at 2.1% annuallyTexas to add 1.5M jobs by 2016 and grow at 2.1% annuallyBudget deficit of $15 billion in 2012‐2013.
Current Market (Course) ConditionsCurrent Market (Course) Conditions
Houston Office Market: ‐Values dependent on future expectations of incomeValues Reflect relative health of tenant base
Dependent on absorption, which is directly tied to job growthClass “A” – looks pretty good with corporate profits high and corporations with lots of cash and low debt levels Energy job corporations with lots of cash and low debt levels. Energy job growth expected to be 4.9% in 2011.
Class “B” & “C” – looks a little less certain. Dependent on small business, local and regional company growth. These companies have been hit hard by lack of financing. December p y gsmall business growth was positive, but still a lot of pain and lack of financing for struggling companies (and real estate)
Houston Fundamental Demand DriverHouston Fundamental Demand Driver
Forecast for 2011 (gradual warming)Forecast for 2011 (gradual warming)Economy improving…but slowly
Rig count above 1,711 up from 1,282 one year ago and 876 in June, 2009. (Peak 2,031 September ‘08)Rig count above 1,711 up from 1,282 one year ago and 876 in June, 2009. (Peak 2,031 September 08)Hiring to be lead by Corporate hiring. Corporations have strong balance sheets, lots of cash, cheap debt and starting to reinvest in core business.Small business growth to pick up in response to corporate growth. Also, new business growth through startups has been slow with curtailed small business lending. This is anticipated to slowly improve as the p g p y peconomy is viewed to have bottomed.
Capital Markets improving, but slowlyMore new lenders. All looking for cash flowing properties. Too many lenders looking for the same things putting squeeze on interest rate margins Big banks will win over new conduits same things putting squeeze on interest rate margins. Big banks will win over new conduits, credit companies on rate, not on dollars.Conduits will return and provide safe securitized debt with good yields. Underwriting loans on much lower basis. Most underwriting to a 10% yield to the debt contant.f b bl d f d h b h b l dLife companies continue to be stable. Hard to find enough strong borrowers with stabilized
properties.Equity starts to play the distressed game in earnest. Shut out of the “A” market by PF’s and REITs’ that have cheaper cost of capital, equity dives in at new “bottom” basis. Invests through gseasoned sponsors and directly to take advantage of the play.Portfolio’s continue to extend and rework/recapitalize loans reducing exposure in the future. Unregulated lenders (Hard money), “debtquity” and private equity fill part of the gap. P ti i ti l t t ill t t t d l tParticipating loan structures will emerge as we start to see upward value movement.
Forecast for 2011 (gradual warming)Forecast for 2011 (gradual warming)Transactions up
More properties come to market as lender’s start to realize stabilized value and capitulateMore properties come to market as lender s start to realize stabilized value and capitulate.More buyer’s emerge recognizing that values have stabilized (bottom out) and see opportunity.
Sales pick up with right pricing (bid/ask narrows) leasing picks up more in 2nd halfOpportunity buys…BIG discounts in vacant properties. Quality Leased Assets sell at BIG premium to current market basically at full value compared to pre‐crisis. Lenders return to market in recovering markets that show sustainable job growth and reasonable supply/demand fundamentals Red line certain marketsreasonable supply/demand fundamentals. Red line certain marketsSeller’s become lenders, some to enhance value, some to sell at all.
Offering 80% debt at 5‐6% for 10 years to enhance value for buyer’s, close bid/ask gap. (lower’s cost of capital to 8.0% = (20% equity x 20%)= 4.0% + (80% x 5%) = 4.0%versus 11.6% = (40% equity x 20%)= 8.0%) + (60% debt x 6%) = 3.6%
Occupancies varyClass “A” captures most absorption.
Corporations expandp pClass “B” big boys, move up at attractive rates (although rates are not down as much as they expect)Class “B” & “C” depend on small business growth. Expect choppy first half as continued failures offset growth. 2nd half increased absorption.
Retail surprisingly strongp g y g
Office Building Class Divergenceg g
Houston Office Occupancy by Classp y y
Houston Office Market OccupanciesClass "A"
Class "B"
100.0%
Houston Office Market Occupancies Class B
Class "C"
90 0%
95.0%
85.0%
90.0%
80.0%
70 0%
75.0%
70.0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
US Transaction Volume
S C ( )
600
US CRE Transaction Volume (Billions) Deal Volume CMBS Issuance
500
300
400
200
100
02001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Houston Transaction Volume
H CRE T i V l (Milli )
9000
Houston CRE Transaction Volume (Millions) Deal Volume
7000
8000
5000
6000
3000
4000
1000
2000
02001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Bid Ask Gap in Real EstateSimilar to bond dynamics 2 years agoSimilar to bond dynamics 2 years ago
Typical Value/Debt ScenarioL f 80% t 108% LTV b t iLoan from 80% to 108% LTV but narrowing
Distressed AssetValue
120
Distressed Asset Debt
80
100
60
80
40
0
20
02006 2007 2008 2009 2010 2011
Overregulation of the Capital Markets?
Is the Fed smarter than the average bear?Can you put too much honey into the system? Inflation or stimulus
Typical Value/Debt Scenarioyp /
Typical Value/Debt Scenarioyp /
Total Cost of Capitalp
Capital Structure Costs Weighted Equity Cost
Weighted Debt Costs
12 00%14.00%16.00%
p Weighted Debt Costs
6.00%8.00%
10.00%12.00%
0.00%2.00%4.00%
2007 200800 20082009
20102011
2007 2008 2009 2010 2011Equity Required in Deal 20.0% 40.0% 40.0% 35.0% 30.0%Equity Total Cost 22.0% 25.0% 25.0% 20.0% 18.0%Equity Deal Cost 4.4% 10.0% 10.0% 7.0% 5.4%Debt Required 80.0% 60.0% 60.0% 65.0% 70.0%Debt Costs 6 75% 7 00% 6 50% 5 75% 5 50%Debt Costs 6.75% 7.00% 6.50% 5.75% 5.50%Debt Deal Cost 5.4% 4.2% 3.9% 3.7% 3.9%Weighted Average Deal Cost of Capital 9.8% 14.2% 13.9% 10.7% 9.3%% change 44.9% -2.1% -22.8% -13.9%
-5.6%
Total Cost of CapitalpThe previous slide shows the general overall cost of capital in CRE in an effort to show the impact on values via affordability. Targeted returns increased as a function of risk perception. As risk of further declines is y g p preduced, the overall capital costs have also come down as have expectations.
In the residential market, a similar dynamic was at play. Lower interest rates drove people to purchase more expensive homes because they could “afford it”. They were focused more on payments than total cost.p y y p y
Part of the overall fed strategy for the economy is to keep rates low to allow for recovery, in essence, a workout for the American consumer. Those with strong credit are able to benefit, while those not able to qualify are not. q y
This also translates into the business environment. The primary beneficiaries of the lower cost of capital in the debt markets have been corporations that have de‐leveraged, refinanced at lower rates and are in a much healthier position today. p y
Small business credit has not been as easy to attain and thus, the small business sector, which traditionally has led the way to recovery in previous cycles, is lagging in its growth abilities. Small business job growth is anticipated to pick up 12‐18 months later than usual. Capital from private equity and through M&A will is anticipated to pick up 12 18 months later than usual. Capital from private equity and through M&A will help as will increased business activity from corporate customers. New technology and startups will likely provide more than anticipated job growth as these ventures mature over the next 2‐3 years.
This should parlay into a lag in the class “B” and “C” real estate sector, however, depending on the location This should parlay into a lag in the class B and C real estate sector, however, depending on the location and the operator, there will be wide variance in performance.
BUYER PROFILESSAFETY RETURN
Classified Core Core & Core Plus Quality Value Add Middle Market Opportunistic
Profile Risk AverseSleep Well
lf
Strong CRE Asset Managementf d
Higher RiskReward Focused
More GolfNo Mgmt
function and property
management platform
Intensive MgmtHard WorkAsset Mgmt
Patient
ROE/ROI Current Income Income oriented Income & Income & more IRR Driven/Target Return of equity
5‐8% 7‐12%Appreciation
8‐15%upside12‐20% 15‐30%+
Income Profile NNN IncomeLong Term Lease
Stable long termQuality credit
Gross Rents
Lease Profile 10 Years + 7 years + Strategic rollover
VariesUpside in leaseup
VariesCaters to local and regional business
Bond EquivalentStock Equivalent
AAA BondIncome Blue chip
AABlue Chip
BBB+Large Cap
BBB and downMid‐Cap/Small Cap
Junk BondSmall Cap ValueStock Equivalent p p
Total Returng p
Total Returnp/ p
Total Returnp
Buyers Institutions &Private
Institutions Institutions & Private Institution with Private partners
Private
b llInvestment Size $500,000‐$5 billion $50‐$500m $25m‐$500m $2m‐30m Varies
Properties Bond leases10+ yearsIndustrial
“A” multi‐family , industrial, office, Retail, full service
A & B multi‐family , industrial, office, Retail, full service,
A & B Value add opportunities,multi‐family ,
All classesDistressed DebtDistressed ORE
OfficeRetailMedical
hotel upscale Ltd service hotel
industrial, office, Retail, full service hotel, mini‐storage
ForeclosuresLand
All Property typesDevelopment
Core AssetsLocation & QualityQuality Income
Core Plus AssetsLocation & QualityMarket Income
Value AddGeneral RE>80% occupancy
Opportunistic“Distressed”General RE Q y
High DemandInstitutional$50mm and up
Increasing DemandInstitutional & Private$25mm and up
p yMarket Income Low DemandPrivate
< 80% occupancyNo DemandPrivate
Scarcity of Product$25mm and underConventional debt
$25mm and underCostly to finance
The Target from the tee Risk versus RewardRisk versus Reward
Still market efficiency, just wide spread
The Current Fairway ‐ Buy Corey y
Seeking Safety by buying Core AssetsSeeking Safety by buying Core AssetsLocationQualityQualityMost predictable & Stable income streamStable income streamMost predictable valueWilli t A t l tWilling to Accept lower return
Problem: not enough supply to meet demandR l L l ll ROIResult: Low caps, lower overall ROI
The Next Fairway – Core PlusThe Next Fairway Core Plus
Seeking Safety but also want more yieldg y yLocationQuality but with accept some occupancy riskQuality but with accept some occupancy riskLess guaranteed incomeLong Term ValueLong Term ValueSeeking higher returns
Problem: not enough product to go around
The Next Fairway Value AddThe Next Fairway – Value AddSeeking Safety but also want more yieldg y yLocationQuality but with accept some occupancy riskQuality but with accept some occupancy riskLess guaranteed incomeLong Term ValueLong Term ValueSeeking higher returns
P bl Bid A k dProblem: Bid Ask spread.Hard to underwrite lease‐up and forecast turnaround exit cap rates and get attractive turnaround, exit cap rates and get attractive financing.
The Next Fairway – Opportunisticy pp
Seeking higher returnsSeeking higher returnsTaking advantage of underperforming assets
Operational underperformingOperational underperformingOccupancy challengesCurable Physical problemsCurable Physical problemsDistressed Seller
S ti L dSometimes LenderSometimes ownerP bl H d d h h h Problem: Hard to wade through the
junk/ seller bid/ask spread.
Playing today has its risks…, but they are identifiable hazards.
Sponsor Risk – Can be mitigated. Many high quality operators in each product type
Market Risk ‐ Mostly dependent on job growth in every sector
Asset Risk – changing tenant market dynamics, functionality, quality
Financing Risk – Rollover of oustanding debt to make financing more difficult.
Value Risk‐Mitigated by low entry basis
So even when things are looking dark
Or all hail is breaking loose
Or you are not sure how to navigate the hazards…..
Or you are up to it with alligators
Or you feel like you are going to the birds ….or they are coming after you!or they are coming after you!
Or you are just being dogged on…..
Knowing what you have and having a executable plan
With a strong management team….
And good financial controls
Even if you are a little under water
Or even lost in the rough
Like golf……you can recover from the “rough”
And sometimes….
With focus, hard work and persistence…..
You can come out ahead.
Texas Real Estate CenterTexas Real Estate CenterMark Dotzur speech 12/01/10
CBRE Global Consulting & Research TeamB i S ff C i l M k P iBrian Stoffer Capital Market Presentation
Grubb & Ellis 2011 Houston ForecastDallas Federal ReserveCostarO’Connor & AssociatesQ10 Kinghorn Driver Ray DriverQ10 Kinghorn Driver, Ray DriverGraham Investments, Dean Castelhano
Strategic Real Estate Execution
CapitalCapital AcquisitionsDispositionsTenant Representation
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Contact:Jay Nowlin, President
Consulting
713‐409‐[email protected]
www.nowlininterests.com