Volume VI Issue 1 A Publication of Paramount Capital

Corporation Jan 15, 2014

Strategy and Insight for the Commercial Real Estate Industry

Inside This Issue:

Real Estate Focus:

2014 CRE Outlook

and Investment

Recommendations.

Summary of 2013

REIT Stock

Recommendations.

Economic Focus:

Sir John Templeton’s

Rules for Investment

Success.

Historical Graph of

10 Year US T-Bond

Yields.

REIT Focus:

Cedar Realty Trust,

Inc., a Retail REIT.

REAL ESTATE FOCUS

2014 CRE Outlook and Investment Recommendations

Summary

The CRE industry is starting to heat up with many of the non-core markets seeing

activity for the first time in six years. Our local city of Walnut Creek, CA, with a

population of only 65,000 and located about 25 miles east of San Francisco in the East

Bay, has more than 800 apartment units under construction and a major 300,000 sq. ft.

expansion/renovation of the Broadway Plaza regional mall in the city’s downtown. As

we look forward to 2014, we here at VOM are very optimistic on the CRE market and

believe that all major sectors; office, retail, apartment and industrial and transaction

volume of leasing, sales and financings will outperform this year. There should be plenty

of debt capital available with banks and other lenders increasing their 2014 funding

allocations. Equity capital should also be obtainable from HNW investors, private equity

funds, sovereign wealth funds, RIA’s and other investors.

Interest Rates

GDP growth, which was 4.1% for Q3 of 2013 should average 2.5%-3.5% in 2014. Even

though interest rates have increased with the 10 Year T-Bond at around 3% from a low of

1.6% in the summer of 2013, the demand for all property types should increase. We

expect the 10 Year T-Bond to increase to 3.25% in March 2014 and 3.5% by the summer

of 2014, with a yearly closing rate between 3.5% and 3.75%. A graph of the 10 Year T-

Bond and Swap rate is shown below and a longer term chart is featured in the Economic

Focus section.

Development

New development has been muted, except for apartments, and we expect demand to

outpace new construction in many markets. However, development of office and

residential properties in core markets like New York, Miami and San Francisco is

booming. There are more than 20 cranes up for construction in the Bay Area of CA,

primarily for office and residential developments. Investors need to be selective in new

construction opportunities and be aware of the risks associated with new development.

Stabilized cap rates on the cost of new developments for office and apartments are very

thin at 4%-7% in the core markets and these skimpy returns do not leave room for any

cost overruns, higher interest rates or slower absorption. A number of REITs are also

increasing their construction programs like Kilroy Realty Corporation for office buildings

and Mack-Cali Realty Corporation for apartments.

REITs

REITs had a difficult year in 2013, with the FTSE All Equity REIT Index up only 2.26%

through November 2013. This was primarily due to the rise in interest rates. However,

REITs have had a robust five year average annual return of 20.37% as shown in the table

below courtesy of NAREIT. Please note that the 20 year REIT return of 10.28% has

beaten the major stock indexes for that period. An allocation of 10%-20% of every

person’s investment portfolio should be in REIT stocks. This will not only increase

return but reduce risk as REITs have a low correlation with other asset classes.

Additionally, the average REIT dividend is 3.77% versus 2.02% for the S&P 500 which

adds stability and additional return to REIT stocks.

Cap Rates

Although cap rates have been compressed for apartments and institutional quality core

office and retail properties, we expect them to moderate somewhat due to new

construction and higher market interest rates. We are also recommending that investors

seek CRE investments in non-core and smaller real estate markets where the cap rates are

2% to 4% higher. Investors need to consider risk adjusted cap rates when investing in

different markets around the country. Investors in Class A properties should be

indifferent (assuming there are no liquidity issues upon sale), in acquiring a $50 million

property at a 5% cap rate in downtown San Francisco or New York and the same type of

property in Tucson, AZ or Oak Brook, IL at an 8.5% cap rate. Each investment is relative

to the respective market and is equalized by the risk adjusted cap rate. Acquiring CRE at

low cap rates is one of the main reasons for poor performance and equity losses by

investors. A low cap rate CRE investment is like buying a hot stock at a price earnings

ratio of 100. There is little room for error if the investment does not perform according to

over optimistic projections. A chart of Class A cap rates for 2013 and 2012 courtesy of

Integra Realty Resources, Inc., a valuation firm, is shown below.

Financing

Financing for CRE is expanding and there should be ample funds available in 2014. The

CMBS market has come back with approximately $50 billion in new issuance n 2013 and

more than $60 billion projected for 2014. Other lenders including banks, the GSE’s, life

companies and REITs will be very active in 2014. Below is a table of commercial real

estate loans outstanding by lender courtesy of the Mortgage Bankers Association Third

Quarter 2013 CRE Report. Even though commercial lending is increasing, the mortgage

debt outstanding of $2.4 trillion is down 37% from the 2007 Q4 MBA Report amount of

$3.3 trillion

Property Types

Apartments are still the favored property type but there are more than 346,000 units

projected to come to market in 2014 from 221,000 units completed in 2013. Hefty rent

increases of 3%-8%+ as seen in the last few years in constrained markets like San Jose,

San Francisco, Miami and New York may be coming to an end. One of the hottest

apartment markets in the country a few years ago was Washington D.C., however, it is

now one of the softest. There have been thousands of new units built in D.C. during the

last few years, primarily by the apartment REITs, and it will take four years to absorb all

the new construction. Existing projects are offering one to two months free rent on a one

year lease and average occupancy has fallen to 96%. Investors should focus on the rehab

and renovation of Class B&C properties and acquisitions in non-core markets where risk

and return are more favorable.

Office markets in the core cities of New York, Miami, Boston, San Francisco and Seattle

have seen brisk activity and low cap rate during the last few years, while suburban

markets have been very difficult. Many of the REITs that own suburban office buildings

like Highwoods Properties, Inc. and Mack-Cali Realty Corporation are trading at

attractive net asset values with 5%+ dividend yields. We think suburban office should

begin to outperform urban properties and they can be purchased at attractive cap rates of

8%-10%. Investors need to underwrite and buy these properties based on less than 95%

stabilized occupancy as many of these buildings may never achieve full occupancy. A

negative trend that seems to be accelerating is the reduction in office space per worker.

Currently, the average space per worker is about 190 sq. ft., however, many new

buildings are being developed with reduced space per worker at 160 sq. ft. or less.

The retail sector has continued to recover and should see increased development and

investment activity in 2014. One of the hottest sectors in 2013 was the net lease retail

sector with billions of investment transactions, primarily by the public and private REITs.

Most of this robust investment activity was spurned by the drop in interest rates and the

flood of money provide by the Fed’s ZIRP and quantitative easing. Shopping trends such

as show rooming, bricks and online, mobile and seamless experience over all platforms

will continue to change the industry. There were also many retailer bankruptcies and

store closings in 2013 including Fresh & Easy, Loehmans, Blockbuster and Fashion Bug.

Retailers with shaky financials, poor management and business models that may

negatively affect the retail investment business in 2014 include JC Penney, Sears/Kmart

and the office supply companies. Many retailers are reducing their real estate footprint to

reduce space costs and counter online sales as they create a seamless brick and online

retailing experience. For example, Wal-Mart and Target have reduced their store sizes

from 180K sq. ft. to 150K sq. ft, Lowes is going from 160K sq. ft. to 150K sq. ft and Best

Buy from 50K sq. ft. to 41K sq. ft.

Industrial real estate is also building momentum into 2014 with the increase in global

trade and investment especially in the major port areas of Los Angeles, New Jersey,

Oakland and Houston. Average cap rates and vacancy rates are 7.5% and 10%,

respectively. The most vibrant activity is in large 1million sq. ft. regional

distribution/fulfillment centers that are being built around the country. Amazon for

example is building 90 million sq. ft. of these large distribution facilities across the

country by 2016.

Summary of 2013 REIT Stock Recommendations

The table below shows our REIT investment recommendations for the year.

REIT Date of

Valuation

Cap Rate

Used in

Valuation

VOM Stock

Recommendation

VOM

NAV

Per

Share

Price Per

Share at

Valuation

Price On

1/15/14

Camden Property

Trust

1/15/13 7.5% Sell $40 $69 $59

Hudson Pacific

Properties, Inc.

2/15/13 7.50% Sell $10 $22 $22

CBL &

Associates

Properties, Inc.

3/15/13 7.5% Buy $20 $23 $18

Essex Property

Trust, Inc.

4/15/13 6% Sell $101 $155 $152

Commonwealth

REIT

5/15/13 8% Buy $22 $20 $23

Douglas Emmett,

Inc.

6/15/13 7% Sell $14 $25 $24

UDR, Inc. 7/15/13 7% Sell $16 $25 $23

Inland Real

Estate

Corporation

8/15/13 7.5% Buy $9 $10 $10

Highwoods

Property, Inc.

9/15/13 7.75% Buy $29 $35 $36

Mack-Cali Realty

Corporation

10/15/13 8% Buy $27 $21 $20

Home Properties,

Inc.

11/15/13 7% Buy $53 $54 $55

Kilroy Realty

Corporation

12/15/13 7% Sell $37 $48 $51

ECONOMIC FOCUS

Sir John Templeton’s 16 Rules of Investment Success

The great investor, Sir John Templeton, was a global pioneer in investment management

and founded the Templeton Mutual Funds, a successful mutual fund company. As a

pioneer in both financial investments and philanthropy, Sir John, who passed away in

2008, but spent a lifetime encouraging open-mindedness. If he hadn’t sought new paths,

he once said, “he would have been unable to attain so many goals.” We here at VOM

thought it would be educational to list Sir Johns 16 rules for investment success. Even

though Sir John was in the investment management business, these rules apply to

commercial real estate investment as well.

16 Rules for Investment Success:

1. Invest for total maximum “real” return.

2. Invest-don’t trade or speculate.

3. Remain flexible and open minded about types of investment.

4. Buy low.

5. When buying stocks, search for bargains among quality stocks.

6. Buy value, not market trends or the economic outlook.

7. Diversify in stocks and bonds, as in much else, there is safety in numbers.

8. Do your homework or hire wise experts to help you.

9. Aggressively monitor your investments.

10. Don’t panic.

11. Learn from your mistakes.

12. Begin with a prayer.

13. Outperforming the market is a difficult task.

14. An investor who has all the answers doesn’t even understand all the questions.

15. There’s no free lunch.

16. Don’t be fearful or to negative too often.

Historical Look at 10 Year T-Bonds

An interesting chart on the 10 Year T-Bond from 1790 through 2013 is shown below and

courtesy of www.csinvesting.org. The chart reveals the bull market in bonds beginning in

1981 that may be set for a reversal and reversion to the mean with many bond gurus

projecting a 10 Year T-Bond yield of 6%-6.5% in the next few years.

REIT FOCUS

Summary

This month’s REIT Focus is on Cedar Realty Trust, Inc. (“CDR”), a publicly traded

REIT engaged in the ownership and operation of primarily grocery-anchored shopping

centers in the Boston, MA to Washington, DC corridor. CDR owns 67 properties

containing 9.8 million square feet of space and the average occupancy and lease renewal

revenue growth as of 9/30/13 was 92% and 7.3% , respectively. CDR’s properties are

located in PA, MA, CT, MD, VA, NY and NJ. CDR owns a 99.7% economic interest and

is the sole general partner in its UpReit general partnership, Cedar Realty Trust

Partnership, L.P.

CDR completed a secondary common stock offering in January 2014 for 6.9 million

shares and net proceeds of $41.3 million. The proceeds will be used for general corporate

purposes, acquisitions and repayment of debt.

CDR was organized in 1984, is incorporated in Maryland, is traded on the NYSE, is

based in Port Washington, NY and its debt is not rated. CDR has 68.8 million common

shares outstanding and a market capitalization of approximately $447 million.

Management

CDR’s management team includes Bruce J. Schanzer, President, Chief Executive Officer

and Director since June 2011 and prior thereto and since 2007, Mr. Schanzer was

employed by Goldman Sachs & Co and Philip R. Mays, Chief Financial Officer, who

joined CDR in June 2011 after six years with Federal Realty Investment Trust.

Financial Data

Select financial data for CDR as of the 9/30/13 10Q and supplemental data for the period

1/1-9/30/13 is as follows (in millions where applicable):

Real Estate Assets, Gross $1,468

Total Assets $1,336

Mortgages Payable and Credit Facility $741

Common Stockholders’ Equity $529

Revenue $107

Net Loss ($3)

Net Loss Per Share ($.06)

Cash Flow from Operations $34

Unsecured Line of Credit ($310 with $180 used) $130

Market Capitalization $447

Property Debt to:

Gross Real Estate Assets 50%

Market Capitalization 165%

Enterprise Value 62%

Dividend and Yield ($.20/sh.) 3.1%

Valuation Methodology:

First Nine Months Revenue Per Above Annualized $143

Less: Operating Expenses Annualized (excluding depreciation,

amortization & interest expense, plus G&A expenses and other

income)

56

Annualized Net Operating Income 2013 $87

Projected Inflation Rate at 3.5% x103.5%

Projected Forward NOI for Next Year $90

Projected Cap Rate 7.5%

Projected Value of Real Estate Assets $1,200

Add: Net Operating Working Capital 77

Total Projected Asset Value $1,277

Less: Total Debt Per Above (741)

Series B Preferred Stock (at book value) (191)

Minority Interests in Consolidated JV’s (at book value) (5)

Projected Net Asset Value $340

Common Shares Outstanding 69.63M (68.8M common stock

shares, 584K incentive plan shares and 248K operating partnership

shares)

Projected NAV Per Share $4.88

Closing Market Price Per Share on 1/15/14 $6.50

The gross real estate assets, property debt, revenues, net income (loss), funds from

operations and dividends per share for the years 2009 through Q3 2013 are shown in the

table below:

(millions except per

share amounts)

2009 2010 2011 2012 Q3 2013

Gross Real Estate

Assets

$1,555 $1,591 $1,364 $1,460 $1,468

Property Debt $1,053 $839 $878 $784 $741

Revenues $140 $131 $135 $140 $107

Net Income (Loss) ($25) ($51) ($118) $10 ($3)

Funds From

Operations

$52 $29 $26 $27 $27

Dividends Per Share $.20 $.36 $.36 $.20 $.05(1)

(1) Per quarter

As shown above, our net asset value per share for CDR is $4.88/sh. versus a market price

of $6.50 per share. Current average cap rates for retail properties per our experience and

CBRE are in the 6% to 9% range, depending on the location, tenancy and quality of the

property. We have used an average cap rate of 7.5% due to CDRHH’s portfolio being

primarily Class A food and drug neighborhood retail properties.

CDR’s strengths include; lease renewal rental growth of 7.3% in Q3 and stable

occupancy of 92%. Weaknesses include; low dividend yield of 3.1%, high stock price

which equates to about a 6.8% cap rate, a decline in asset growth of 5.5% from 2009, no

revenue growth from 2009 and poor investment and growth strategy.

We are not recommending the purchase of the stock at the current price of $6.50 and the

low dividend yield of 3.1%, especially with minimal growth in assets and revenue.

Food/drug retail centers are excellent investments as they are usually very stable and are

in high demand by institutional investors. However, they trade at low cap rates and the

income is fairly flat with minimal rental increases and are considered bond type

investments. CDR needs to be more aggressive in acquiring assets to grow the company

and should consider investments in other markets than the current Northeast corridor. If

cap rates are too low for food/drug centers, then CDR should consider other retail

properties to acquire at higher returns to grow the company. We think there are more

value oriented retail REITs for investment at values below NAV and 5%+ yields

including Inland Real Estate Corporation and CBL & Associates Properties, Inc.

A five year price chart of CDR is shown below:

REIT Focus reviews in prior issues of VOM are as follows:

1. BRE Properties, Inc., June 15, 2011

2. Boston Properties, Inc., July 15, 2011

3. Simon Properties Group, Inc., August 15, 2011

4. First Industrial Realty Trust, September 15, 2011

5. Public Storage, October 15, 2011

6. Ashford Hospitality Trust, Inc., November 15, 2011

7. AvalonBay Communities, Inc., December 15, 2011

8. Alexandria Real Estate Equities, Inc., January 15, 2012

9. Federal Realty Investment Trust, Inc., February 15, 2012

10. Digital Realty Trust, Inc., March 15, 2012

11. Lasalle Hotel Properties, April 15, 2012

12. Apartment Investment and Management Company, May 15, 2012

13. Equity Residential Apartment Company, June 15, 2012

14. The Macerich Company, July 15, 2012

15. SL Green Realty Corp., August 15, 2012

16. Kimco Realty Corp., September 15, 2012

17. Cole Credit Property Trust II, Inc., October 15, 2012

18. Realty Income Corporation, November 15, 2012

19. Piedmont Office Realty Trust, Inc., December 15, 2012

20. Camden Property Trust, January 15, 2013

21. Hudson Pacific Properties, Inc., February 15, 2013

22. CBL & Associates Properties, Inc., March 15, 2013

23. Essex Property Trust, Inc., April 15, 2013

24. Commonwealth REIT, May 15, 2013

25. Douglas Emmett, Inc., June 15, 2013

26. UDR, Inc., July 15, 2013

27. Inland Real Estate Corporation, August 15, 2013

28. Highwoods Properties, Inc., September 15, 2013

29. Mack-Cali Realty Corporation, October 15, 2013

39. Home Properties, Inc., November 15, 2013

40. Kilroy Realty Corporation, December 15, 2013

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Paramount Capital Corporation and edited by Joseph Ori, Executive Managing Director.

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The price and value of securities referred to in this newsletter will fluctuate. Past

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