AEW Research Market Outlook September 2014 - REIT · Financial Services 3.6% 0.6% Information 1.3% ... 1994Q4 1995Q4 1996Q4 1997Q4 1998Q4 1999Q4 2000Q4 2001Q4 2002Q4 2003Q4 2004Q4

Real Estate Market OutlookAEW ResearchSEPTEMBER 2014

The U.S. Carbon Renaissance, the Aging of America

and the End of the Fed’s QE

September 2014

This material is intended for information purposes only. It does not constitute investment advice or a recommendation. The information and opinions presented in this material have been prepared internally and/or obtained from sources which AEW believes to be reliable, however AEW does not guarantee the accuracy, adequacy, or completeness of such information. Opinions expressed reflect prevailing market conditions at the time this material was completed and are subject to change. Neither this material, nor any of its content, may be used for any purpose without the consent and knowledge of AEW.

AEW U.S. Real Estate Market Outlook2

What is Shaping the Outlook Today?

Near‐term outlook dominated by two things:

– U.S. economy accelerating as employment moves from recovery to expansion

– Federal Reserve beginning the long process of normalizing monetary policy

Medium and long‐term outlook also dominated by two things:

– Carbon Renaissance creating entirely new global energy paradigm

– Rapid and far reaching demographic changes both in the U.S. and globally


Where are We - GDP?

Source: Bureau of Economic Analysis (NIPA)

U.S. REAL GDP ($ BILLIONS)U.S. real GDP now $1 trillion above pre‐crisis level, but more than $1 trillion below pre‐crisis trajectory

$8,000

$9,000

$10,000

$11,000

$12,000

$13,000

$14,000

$15,000

$16,000

$17,000

$18,000

1990Q2

1991Q1

1991Q4

1992Q3

1993Q2

1994Q1

1994Q4

1995Q3

1996Q2

1997Q1

1997Q4

1998Q3

1999Q2

2000Q1

2000Q4

2001Q3

2002Q2

2003Q1

2003Q4

2004Q3

2005Q2

2006Q1

2006Q4

2007Q3

2008Q2

2009Q1

2009Q4

2010Q3

2011Q2

2012Q1

2012Q4

2013Q3

2014Q2

Real GDP Growth Rate1992 Q4 ‐ 2007 Q4 = 3.2%

Real GDP Growth Rate 2009 Q2 ‐ 2014 Q2 = 2.2%


Where are We - Employment?

Source: BLS, Moody’s Analytics

TOTAL EMPLOYMENT, INDEX = 100 IN MONTH RECESSION BEGANU.S. total employment now above pre‐crisis levels

Employment growth since trough (Feb. 2010) has averaged 1.6% per year, slightly faster than 1.4% during last recovery period

9293949596979899100101102103104105106107108109110111112

‐ 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80

Current Cycle 2001 1990

2010 2013201120092008 2012 2014


Which Sectors are Growing?

Source: BLS, Moody’s Analytics, July 2014

U.S. job growth being driven by mining (energy), hospitality sector, health and education and trade

Current Employment vs Financial Crisis Trough

Year‐Over‐Year Employment Growth

Total Employment 7.2% 1.9%Mining 40.8% 5.6%

Professional and Business Services 17.6% 3.5%Leisure and Hospitality 13.3% 2.6%

Transportation and Warehousing 12.3% 3.4%Construction 11.2% 3.6%

Education and Health Services 10.7% 1.8%Wholesale trade 8.0% 2.2%Retail trade 7.4% 2.0%

Manufacturing 6.2% 1.5%Other services 3.7% 0.9%

Financial Services 3.6% 0.6%Information 1.3% ‐1.1%Utilities 0.9% 0.0%

Local Government 0.9% 0.7%State Government 0.8% 0.8%Federal Government 0.1% ‐1.5%


Markets at New Employment Peaks

Source: BLS, Moody’s Analytics, July 2014

Strongest markets are centers of fastest growing industries: energy, high tech, health care and housing sectors

Many of these markets will need new commercial space soon, if not already

Rents will have to rise to levels that support new construction

MajorMarkets

Current Employment vs Pre‐Recession Peak

Year‐Over‐Year Employment

Growth

Austin, TX 15.3% 3.6%Houston, TX 10.8% 3.8%San Antonio, TX 8.6% 2.1%Nashville, TN 7.8% 2.4%Dallas‐Fort Worth, TX 7.5% 3.7%Raleigh, NC 7.2% 4.8%Oklahoma City, OK 6.7% 2.9%Denver, CO 6.2% 3.1%Salt Lake City, UT 6.0% 3.2%San Jose, CA 6.0% 2.3%New Orleans, LA 4.6% 2.3%San Francisco, CA 4.4% 2.9%Columbus, OH 3.7% 0.0%Boston, MA 3.5% 1.8%Charlotte, NC 3.4% 2.8%Indianapolis, IN 3.1% 1.8%Washington DC 2.7% 0.8%Baltimore, MD 2.6% 2.1%Seattle, WA 2.6% 2.4%New York, NY 2.2% 1.5%San Diego, CA 1.8% 2.7%Portland, OR 1.8% 2.6%Louisville, KY 1.8% 2.0%Richmond, VA 1.6% 1.9%Pittsburgh, PA 1.3% 0.8%Minneapolis, MN 1.2% 1.6%Orlando, FL 1.2% 3.0%Atlanta, GA 0.3% 2.6%

SmallerMarkets

Current Employment vs Pre‐Recession Peak

Year‐Over‐Year Employment

Growth

Midland, TX 27.1% 6.7%Odessa, TX 17.3% 4.4%Bismarck, ND 16.2% 2.7%Fargo, ND 14.2% 4.7%Greeley, CO 12.8% 4.6%


Rental Rate Recovery Underway

Source: CBRE‐EA

U.S. AVERAGE RENTAL RATE BY PROPERTY TYPE (INDEX = 100 AT PRIOR PEAK LEVEL)Average apartment rents at all time high

Average office rents 10% below peak

Industrial and retail rents still 15% below prior peak.

50.0

55.0

60.0

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85.0

90.0

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100.0

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2014

Office Industrial Apartment Retail


Property Market Fundamentals Improving Slowly

Source: CBRE‐EA

VACANCY RATES (%)With the exception of shopping centers, average vacancy rates are now close to or below long term averages

4.4%

10.8%11.8%

15.9%

11.7%

0

5

10

15

20

25

Apartment Industrial Office ‐ CBD Office ‐ Suburban Shopping Centers


New Supply Remains Muted (in Most Markets)

Source: CBRE‐EA

COMPLETIONS OVER PAST FOUR QUARTERS AS PERCENTAGE OF CURRENT PROPERTY STOCKPre‐crisis, growth in U.S. property stock averaged 1.5%‐2.0% per year (1999‐2007)

Apartment construction moving back above 1% of stock

All other major property types remain below 0.5%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

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2002

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2006

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2014

Office Industrial Retail Apartment


Markets Where New Supply Is A Concern

Source: CBRE‐EA

COMPLETIONS/UNDER CONSTRUCTION AS A SHARE OF EXISTING STOCKOnly a handful of markets have notable supply concerns (so far)

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%

RiversideAllentownTrenton

Fort Worth

RaleighCharlotte

AustinSan Antonio

NashvilleDenver

HoustonSan JoseAustin

San FranciscoFort Worth

Seattle

New YorkLas Vegas

Delivered in2014 Q1 & Q2 Under Construction

Industrial

Apartment

Retail

Office


Perfect Window for Fed to Taper

Source: Congressional Budget Office ‐ April 2014

PROJECTED ANNUAL FEDERAL DEFICITNew projections by CBO show rapidly shrinking U.S. deficit in near term

‐10%

‐8%

‐6%

‐4%

‐2%

0%

2%

4%

‐$1,600

‐$1,400

‐$1,200

‐$1,000

‐$800

‐$600

‐$400

‐$200

$0

$200

$400

1974

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2014

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2018

2020

2022

2024

Annual Budget Deficit (Billions) Deficit as a Share of GDP


What Will the End of QE do to Asset Values?

Source: Federal Reserve, Bloomberg

BASE MONEY SUPPLY AND THE DOW JONES INDUSTRIAL INDEXPrior to 2008, there was no relationship between the size of the Fed’s balance sheet and asset values

Can the Fed normalize monetary policy without undoing asset re‐flation?

$0

$500

$1,000

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$3,500

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$4,500

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18,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Dow Jones Industrial Average (Left Axis) Federal Reserve Balance Sheet ($Billions, Right Axis)


When Rates Move, They Often Move Quickly

Source: Federal Reserve

12 MONTH CHANGE IN TEN‐YEAR TREASURY YIELD (BASIS POINTS)Over the past 60 years, the average 12 month increase in rates has been 75 basis points and the average decrease has been 85 basis points

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‐100

0

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2014

Largest One Month Change

in Yield22‐Feb‐80 20429‐Feb‐80 20126‐Oct‐79 15115‐Feb‐80 1307‐Nov‐80 127

15‐Oct‐82 ‐2012‐May‐80 ‐20525‐Apr‐80 ‐21020‐Nov‐81 ‐21227‐Nov‐81 ‐213


If the Fed is Normalizing, Why are Rates Falling?

Source: Bloomberg

TEN‐YEAR GOVERNMENT BOND YIELD (%)The world is a scary place

Growth and inflation expectations falling in most other countries

Puts downward pressure on all sovereign bond yields

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

2007 2008 2009 2010 2011 2012 2013 2014

US Japan Germany


What Rising Rates Might Look Like

INTEREST RATES (%)

Source: Moody’s Analytics

0.00

1.00

2.00

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5.00

6.00

7.00

8.00

9.00

10.00

11.00

1989Q4

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2012Q4

2013Q4

2014Q4

2015Q4

2016Q4

2017Q4

2018Q4

10 Year Treasury Yield Baa Corporate Yield Fed Funds Rate

Fed begins moving on short rates in 2015

Yield curve steepens as long end responds

Yield curve eventually flattens reflecting long‐term slower growth

‐


Near-Term Implications for Property Pricing

CAP RATE BY PROPERTY TYPE (%)

Source: AEW Research, NCREIF

Near‐term cap rate expansion will be limited by strong capital in‐flows

Property yield spreads expected to compress through 2016 as Treasury yields rise

4.00

4.50

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

2000Q4

2001Q4

2002Q4

2003Q4

2004Q4

2005Q4

2006Q4

2007Q4

2008Q4

2009Q4

2010Q4

2011Q4

2012Q4

2013Q4

2014Q4

2015Q4

2016Q4

2017Q4

2018Q4

2019Q4

2020Q4

Apartment Office Retail Industrial


Global Capital Flowing to U.S. Property May Drive Pricing for Some Time

Source: Federal Reserve

Global inflows to U.S. increased 75% during 2013

4.00

5.00

6.00

7.00

8.00

9.00

10.00

‐$200

‐$100

$0

$100

$200

$300

$400

1979Q2

1980Q2

1981Q2

1982Q2

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2010Q2

2011Q2

2012Q2

2013Q2

2014Q2

Real Net Capital Flow Average Cap Rate

NET FLOW OF CAPITAL INTO COMMERCIAL MORTGAGES ($ BILLIONS) AND AVERAGE CAP RATE (%)


The U.S. Carbon Renaissance

U.S. now produces more total petroleum products than Saudi Arabia

Texas oil production now more than 3 million barrels per day – more than any OPEC country except Saudi Arabia

U.S. also produces more petroleum than all of the countries in Europe, Central America, and South America combined

U.S. likely to be a net exporter of natural gas by the end of this decade and a net exporter of oil during the following decade

Growth in the domestic energy industry is expected to create more than 3.5 million U.S. jobs by 2035Source: U.S. Energy Information Agency

Major U.S. Shale Oil & Gas Areas


The Hydro Fracturing Technology Revolution

Source: Department of Energy

U.S. ACTIVE OIL RIGSNearly all new oil wells are horizontal wells (i.e. fracking)

0%

10%

20%

30%

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50%

60%

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80%

‐

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2010

2011

2012

2013

2014

Total Rigs Percent Horiztonal Rigs


Why the U.S. Energy Renaissance is Disruptive

Source: Department of Energy

MILLIONS OF BARRELS PER DAYU.S. oil imports have fallen 50% since 2006

Expenditures on imported oil have declined from an annual rate of $450 billion to about $200 billion per year

‐$450

‐$400

‐$350

‐$300

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‐$200

‐$150

‐$100

‐$50

$0

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Annu

alized

Cost o

f Oil Im

ports

Oil Im

ports

U.S. Oil Imports (Millions of Barrels Per Day) Annualized Cost of Oil Imports ($ Billions)


America’s Energy Cost Advantage – Natural Gas

Source: Bloomberg

PRICE OF NATURAL GAS ($ PER MILLION BTU)U.S. natural gas prices have decoupled from global prices

U.S. cost now as little as ¼ the cost for global competitors

Energy‐intensive manufacturing moving back to U.S.

$0

$2

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$18

$20

2006 2007 2008 2009 2010 2011 2012 2013 2014

U.S. Price Japan Price


Demographic Changes

U.S. baby boom cohort entirely between age 50 and 70

10,000 Americans turn 65 every day for next 20+ years

60% of boomers will not to stay in their current home

26% of boomers intend to move to urban centers

27% of boomers intend to move to senior housing

80 million millennials born between 1980 and 2000

Millennial cohort now entirely between age 15 and 35

Young people always move to cities – how long will they stay?


The Rapidly Aging Developed World

Source: United Nations, World Bank

SHARE OF POPULATION OVER AGE 65 (%)

‐

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10

15

20

25

30

35

40

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

China Japan U.S. Western Europe WORLD

35.2 M

51.1 M314.2 M

81.3 M

1.422 B

U.S will not age as rapidly or as much as Europe and Japan


The Math Doesn’t Work

Source: Bureau of Labor Statistics, Census

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0

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60

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90

1900

1908

1916

1924

1932

1940

1948

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1980

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2004

2012

2020

2028

2036

Population Over Age 65 (Millions, Left Axis)

Working Age Population Per Person Over Age 65 (Right Axis)

PEOPLE OVER AGE 65 (MILLIONS) AND WORKER PER RETIREEThere will soon be less than three working age people for every older American

Today’s younger workers will need to be far more productive than prior generations


Majority Minority America

POPULATION DISTRIBUTION (%)

Source: U.S. Census

By mid century, there will be no majority group in America

Large current “majority minority” counties include:Los Angeles ‐ CACook ‐ ILHarris ‐ TXSan Diego ‐ CA Orange ‐ CAMiami‐Dade ‐ FL Kings County, NYDallas ‐ TXQueens ‐ NYRiverside ‐ CASan Bernardino ‐ CAClark ‐ NVSanta Clara ‐ CAWayne ‐MIBroward ‐ FLBexar – TX Philadelphia ‐ PA Alameda ‐ CASacramento ‐ CA

2000 2010 2015 2020 2025 2030 2035 2040 2045 2050White 68.4% 62.8% 61.8% 59.7% 57.6% 55.5% 53.3% 51.0% 48.8% 46.6%

Black 12.2% 12.4% 12.4% 12.5% 12.6% 12.7% 12.8% 12.8% 12.9% 13.0%

Hispanic 12.4% 16.1% 17.8% 19.1% 20.5% 21.9% 23.4% 25.0% 26.5% 27.9%

Asian 3.6% 4.7% 5.1% 5.5% 5.8% 6.1% 6.5% 6.8% 7.1% 7.4%

Other 3.4% 4.0% 3.0% 3.2% 3.5% 3.8% 4.1% 4.4% 4.7% 5.0%


Consumer-Based Economy Needs Consumers

SHARE OF TOTAL HOUSEHOLD INCOME BY INCOME GROUP (%)

Sources: Emmanuel Saez, U.S. Census Bureau, Bureau of Labor Statistics

20.00

25.00

30.00

35.00

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45.00

50.00

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65.00

70.00

1946

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Top 10% Bottom 90%


Technology Before and After the I-Phone

Source: NBC News

2005 2013


Embrace Change – There is a lot coming!

Source: NBC News


Wrap Up

Source: Census

Near‐term outlook shaped by shift from employment recovery to employment expansion and Fed’s attempt to normalize monetary policy

At least two big trends driving the U.S. economy and property markets over the next 20 years:

– Paradigm shift in energy production

– Enormous demographic changes, particularly in age structure

Rapid increases in energy production benefit nearly all markets and property types, but will be particularly beneficial to energy markets and energy‐intensive manufacturing‐dominated markets

Greatest driver of residential demand today is coming from Gen Y in urban areas, but the retiring baby boom is beginning to add to urban demand and, ultimately, to senior housing demand

Accelerating advances in the use of technology quickly changing the way space in all properties types is used and configured. General trend is towards less space and energy per person/dollar of output


Biographical Information

Please feel free to contact Mike regarding any of the information contained herein

[email protected] or 617-261-9577

Two Seaport LaneBoston, MA 02210+1 617 261 9000

www.aew.com

MICHAEL J. ACTON, CFA®

Managing Director, AEW Research

Michael J. Acton, CFA, is Director of Research for AEW Capital Management, L.P. with responsibility for directing the activities of AEW Research, the firm’s highly regarded in-house research group. Mike joined the firm in 1990 and has nearly 30 years of experience as an economic analyst and forecaster and is a standing member of the firm’s Investment Committee and Management Committee. The resources of AEW Research are an integral part of AEW’s investment process and Mike works closely with senior professionals in all areas of the firm to develop investment strategies that match clients’ risk/reward objectives with market opportunities. Mike is also a member of the firm’s Compliance Committee and Risk Management Committee. Prior to joining AEW, he was with DRI/McGraw-Hill where he managed the Metropolitan Area Forecasting Service. He is a graduate of Bates College (B.A.) and a CFA charterholder.

CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.

Documents

AEW Research Market Outlook September 2014 - REIT · Financial Services 3.6% 0.6% Information 1.3% ... 1994Q4 1995Q4 1996Q4 1997Q4 1998Q4 1999Q4 2000Q4 2001Q4 2002Q4 2003Q4 2004Q4