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Will Rising Interest Rates Pummel Your Portfolio? ULI Fall Meeting – Chicago - November 2013

Dr. Richard Barkham, MRICS

Global Research Director,

Grosvenor Group

Europe

Eileen Marrinan, CRE

Director of Research,

Grosvenor Americas

North America

2

Will Rising Interest Rates Pummel Your Portfolio? The International Perspective

ULI Fall Meeting – Chicago

November 2013

3

The Global Recovery is Gaining Strength

4

Interest Rates are Set to Increase Over the

Next Five Years

Source: IHS Global Insight, Grosvenor

Central bank interest rate, %

0

2

4

6

8

10

12

14

16

18

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Japan

United Kingdom

Hong Kong

Eurozone

United States

5

Long-Term Bond Rates Already Have Started

to Move

Source: IHS Global Insight, Grosvenor

10-year bond rates, %

0

2

4

6

8

10

12

14

16

18

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

Japan

United Kingdom

Hong Kong

Eurozone

United States

6

What Will Be the Impact on Capitalization

Rates?

Interest

rates

Economic growth

(rental pressure)

7

This is New Research

8

0

2

4

6

8

10

12

14

16

Mo

scow

Be

ijing

Wars

aw

Bu

dapest

Lyo

n

Sh

anghai

Lis

bon

Brisbane

LA

Me

lbo

urn

e

Oslo

Pra

gue

Bru

sse

ls

Birm

ingham

Sydney

Gla

sgow

Rotterd

am

Hels

inki

New

York

Ed

inb

urg

h

Ma

ncheste

r

Rom

e

Am

ste

rdam

Dublin

Copenh

agen

Lo

ndo

n C

ity

Ma

drid

Sto

ckh

olm

Mila

n

Ba

rcelo

na

Dusseld

orf

Pa

ris: C

BD

Be

rlin

Fra

nkfu

rt

Ham

burg

Mu

nic

h

London

WE

Hong K

on

g

To

kyo

+/- one standard deviation

Long-run average office yield

What Drives Global Cap Rates?

Source: Grosvenor

Cap rate, %

9

International Long-Run Cap Rate Model

Bond rates and inflation are the

key drivers (R2 = 74.5%)

100 basis point change in bond

rates leads to a 62 basis point

change in cap rates

Bond rate Cap rate

100

bps

62

bps

10

274

165 159 159 159 159 159 158 158 156 156 156 156 156 156 148 145 142 142 139 139 139 139 134 134 134 128

82 72

56 50 50

24 24

3 3

-47

-67

-168 -200

-150

-100

-50

0

50

100

150

200

250

300

Hong K

on

g

Hels

inki

Be

rlin

Dusseld

orf

Fra

nkfu

rt

Ham

burg

Mu

nic

h

Sto

ckholm

Copenh

agen

Birm

ingham

Ed

inb

urg

h

Gla

sgow

London

: W

est E

nd

London

: C

ity

Ma

ncheste

r

Oslo

Bru

sse

ls

Lyo

n

Pa

ris: C

BD

Am

ste

rdam

Rotterd

am LA

New

York

Sydney

Brisbane

Me

lbourn

e

Pra

gue

To

kyo

Dublin

Wars

aw

Mila

n

Rom

e

Ba

rcelo

na

Ma

drid

Sh

an

gha

i

Be

ijing

Bu

da

pest

Lis

bon

Mo

scow

Forecast Cap Rate Shift Due to Bond Rate

Movements

Source: Grosvenor

Cap rate shift until 2018 implied by bond rate movements, bps

11

Long-term Analysis of Selected Markets

Bond rates and rental pressure

over time

London, Paris, Hong Kong,

New York, Los Angeles

12

58%

79%

65%

89% 81%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

London WestEnd

Paris Hong Kong New York Los Angeles

0.45

0.74

0.30

1.17 1.04

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

London WestEnd

Paris Hong Kong New York Los Angeles

Bond Rate Impact in Each Market

Coefficient of bond yields Adjusted R2

Source: Grosvenor

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4.81 4.25

2.91

5.50

6.18

6.25 5.90

3.60

6.25 6.48

0

1

2

3

4

5

6

7

London West End Paris Hong Kong New York Los Angeles

Office Cap Rates, Forecast with No Rental Growth

Cap rate, %

Source: Grosvenor

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4.81 4.25

2.91

5.5

6.18

6.20

5.50

3.60

6.22 6.19

0

1

2

3

4

5

6

7

London West End Paris Hong Kong New York Los Angeles

Office Cap Rates, Forecast with Rental Growth

Cap rate, %

Source: Grosvenor

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An International Perspective

Conclusions

Bond rates are always a

powerful and significant driver of

cap rates

Rental pressure variable

relatively weak

If interest rates normalize, we

should expect cap rates to follow

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But … Will Interest Rates Normalize?

Fiscal contraction could last 18

months

The Great Wall of China

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Will Rising Interest Rates Pummel Your Portfolio? The View from the US

ULI Fall Meeting – Chicago

November 2013

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-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Real GDP

10-Yr Treasuries

Expected Performance of the Economy

Our forecast calls for stronger economic growth after 2013.

Interest rates will normalize by 2016.

‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17

Real GDP and 10-year Treasuries

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0

100

200

300

400

500

600

’01Q1 ’02Q1 ’03Q1 ’04Q1 ’05Q1 ’06Q1 ’07Q1 ’08Q1 ’08Q1 ’10Q1 ’11Q1 ’12Q1 ’13Q1

Cap Rates vs. Treasuries

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Average Cap Rate (All Sectors) 10-Yr Treasury Rate

’01Q1 ’02Q1 ’03Q1 ’04Q1 ’05Q1 ’06Q1 ’07Q1 ’08Q1 ’08Q1 ’10Q1 ’11Q1 ’12Q1 ’13Q1

Average Cap Rates and 10-Yr Treasuries Source: Real Capital Analytics (2Q13)

Average Cap Rate Spread over Treasuries Source: Real Capital Analytics (2Q13)

Cap rate spreads over Treasuries are cyclical, not fixed

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0

100

200

300

400

500

600

Gateway Apartment Non-Gateway Apartment Gateway Office Non-Gateway Office

Average Spread Current Spread

Apartment Spreads over 10-yr Treasuries Gateway and Non-Gateway Metros

Office Spreads over 10-yr Treasuries Gateway and Non-Gateway Metros

Cap Rate Spreads – Apartment vs. Office

The apartment sector has the smallest average spread to Treasuries -- office has the largest.

* Gateway Metros = Boston, Manhattan, Washington DC, Chicago, San Francisco, Los Angeles Non-distress transactions $15M+

Historic Range

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-12%

-9%

-6%

-3%

0%

3%

6%

9%

12%

Apartment

Office

Retail

Rent Growth Across All Sectors

Real estate fundamentals will continue to improve, favoring

spread compression.

‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17

Average Effective Rent Growth Trends by Sector Source: CBRE-EA (2Q2013), GA Research

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Real Estate Transaction Volumes – All-Sector Source: Real Capital Analytics

0%

2%

4%

6%

8%

10%

12%

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

Bil

Total Sales Volume (L)

Cross-Border Sales Pct of Total (R)

Rising Investment Activity

Capital will continue to flow into real estate.

With rising foreign interest, a “crowding in” of capital?

’01Q1 ’02Q1 ’03Q1 ’04Q1 ’05Q1 ’06Q1 ’07Q1 ’08Q1 ’08Q1 ’10Q1 ’11Q1 ’12Q1 ’13Q1

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CBOE Market Volatility Index (VIX) Source: Moody's Analytics (through 10/07/13)

0

10

20

30

40

50

60

70

80

90

Execution Will Be Key...

The speed and timing for Fed unwinding of monetary policy

will be critical.

’01Q1 ’02Q1 ’03Q1 ’04Q1 ’05Q1 ’06Q1 ’07Q1 ’08Q1 ’08Q1 ’10Q1 ’11Q1 ’12Q1 ’13Q1

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The View from the US

Conclusions

US economic growth will

strengthen over the next five

years – interest rates will

normalize (+ 200 – 250 bps)

Rising interest rates will be largely

offset by cap rate compression

Capital flows into US real estate

may result in no upward

adjustment in cap rates

Sustained investor confidence will

be critical to achieve this outcome