Market Analysis Overview

8/6/2019 Market Analysis Overview

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Real Estate Market Analysis: Chicago(Plus my overall market forecasts)

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Real Estate Market Analysis: Why do it?

Real estate market analysis refers to analyzing a variety of real estatedecisions.

Where to locate a branch office?

What size or type of building to develop on a specific site?

What type of tenants to look for in marketing a particular building? What the rent and expiration term should be on a given lease?

When to begin construction on a development project?

How many units to build this year?

Which cities and property types to invest in so as to allocate capital whererents are more likely to grow?

Where to locate new retail outlets and/or which stores should be closed?

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Broadly Speaking

Real estate market analysis usually requires quantitative or qualitativeunderstanding (& prediction) of both the demand side and supply side of thespace usage market relevant to some real estate decision.

The focus might be micro-level, such as a feasibility analysis for a specificsite or property

Or, the focus might be more general, such as a general characterization ofthe supply/demand conditions in a particular space submarket.

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Variables of Interest in Market Analysis

To evaluate a real estate space submarket, analysts tend to focus on a fewprimary indicators that characterize both the supply and demand sides of thesubmarket and the balance (equilibrium) between them.

Vacancy rate

Market Rent

Quantity of new construction starts

Quantity of new construction completions

Absorption of new space

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Vacancy Rate

By definition, the vacancy rate refers to the percentage of the stock of spacein the market that is not currently occupied.

Vacancy Rate = Vacant Space/Total Space

The vacancy rate reflects the balance between supply and demand.

In most markets, it is normal for some vacancy to exist (the naturalvacancy rate) even when supply and demand are in balance.

When actual vacancy rises above the natural vacancy rate, rents tendto fall.

When actual vacancy falls below the natural vacancy rate, rents tendto increase.

Natural vacancy rate can be 6-12%6

Market Rent

By definition, market rent is the level of rents being charged on typical new

leases currently being signed in the market.

asking rents may differ from effective rents

Market rent is another indicator of the balance between supply and demand

in a market.

Can be tricky to measure because

it is private information and

lease terms may differ dramatically from tenant to tenant

Result: Sometimes hard to get accurate rent measures usually

collected via surveys.


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Constructions Starts and Completions

Construction is an important supply side indicator.

Starts indicate the amount of space currently in the pipeline and likely to

be added to the supply in the near future

Completes indicate the amount of space just arriving in the market.

Of course, we need to consider the net addition to supply (after taking

demolition and renovations into account).

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Absorption of New Space

By definition, absorption refers to the amount of additional space that becomesoccupied during a year.

Absorption is a demand side indicator (i.e., does not account for amount ofsupply available).

Gross absorption total amount of space leased, regardless of where tenantscome from

Net absorption net change in the amount of space occupied in a market.

Positive net absorption rates: Demand increasing in market

Negative net absorption rates: Demand falling in market

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The Concept of Months Supply

The variables we just reviewed are commonly used indicators of supply/demandconditions in space submarkets.

The concept of months supply combines several of these variables to help usunderstand a market even better.

By definition, months supply is the sum of current vacant space in the marketand new construction started but not completed, divided by 1/12 th of the annualnet absorption in the market.

This measure tells how long it will take (in months) for all of the vacant space inthe market to be absorbed, driving the vacancy rate to zero.

Analysts compare the months supply to the length of time it takes tocomplete new construction to see if the market can support a new project. If

the months supply is much greater than the average construction period, themarket is oversupplied. Otherwise, it might be time to start a new projectin this market.

Meaningless measure if net absorption is negative

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VacanctSpace ConstructionSpace Months Supply

NetAbsorption

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Some Tips for Market Analysis

Define the market carefully along geographic and usage dimensions,

recognizing that most metropolitan areas form markets that can be usefully

divided into smaller submarkets. The next slide describes how the Atlanta office

market can be divided.

Carefully consider the time period to be covered in the analysis

510 years into the future is desirable

3 years is more feasible in most cases

Recognize the differences between and the benefits of a simple trend

extrapolation and a structural analysis

Trend extrapolation predicts the future purely based on historical trends and

patterns Structural analysis attempts to predict the future by identifying and

quantifying the underlying determinants of market trends.

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Performing/Understanding a Market Analysis

In both types of analysis (extrapolation and structural) the steps are:

First, inventory the existing supply and evaluate the pipeline.

Second, relate the demand sources to the space usage demand.

Third, forecast future demand for and supply of space

Compare the forecasted demand for space with the forecasted supply of

space to see if the market will be over or under supplied in the future.

In tight markets (under supplied, landlord market), we expect to see higher rents

and lower vacancy rates.

In loose markets (over supplied, tenant market), we expect to see lower rents and

higher vacancy rates. 12

Recent Hot Office Property Markets


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Recent Cool Office Property Markets

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U.S. Office Market Vacancies 2002Q12005Q1

(Average Gross Asking)

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U.S. Office Market Net Absorptions 2002Q12005Q1


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Chicago Office Market (Downtown and Suburbs): 2005Q1

Chicago Office Inventory (2004): 117 million sf

Chicago Office Vacancy(2005Q1): 15.7% (highest rate since 1996)Downtown Vacancy (2005Q1) = 18.4% (21.4 million sf of space available for leasing)


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Chicago Office Market (Downtown and Suburbs): 2005Q1

Net absorption rate for downtown 2005Q1 was -1 million sf. 18

Chicago Office Market (Downtown): 2005Q1

Construction Activity Due to Become Available in 2005-2006: 4 million Sq


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Asking Net Rent Prices Chicago 2004

Class A (prime): $18 - $25 per sf

Class A (broad): $9 - $25 per sf

Class B $7 - $15 per sf

Predicted to fall further through 2005 given the high vacancy rates

Concessions will increase (free month rent)

Large amount of activity by tenants to extend leases (look in lower rates while

they have the power).

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Chicago Market Break Down

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Forecast from the Chicago Office Market (Downtown)

Chicago unemployment rate not decline (as of yet) looking for a recovery? 22

Chicago Forecasts

Imminent Demand

No signs of a dramatic increase in demand on the local level (no industry

shift moving towards chicago)

U.S. economy may be fragile oil prices/global economic uncertainty

acting on a drag on U.S. economy (see recent trend in stock prices)

Demand predictions moderate at best

Supply

Lots of slack in the office market (vacancies high and construction

continuing)

Rents will not pick up for awhile (good for tenants).

Still profitable to build (new construction is filling up quickly (at expense of

existing properties) however rents in new construction still low).

I would not develop office space in chicago at this time! Interest rates likely to

rise (to fight inflation) decreases returns to owning (along with low rents and

high vacancies).

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Chicago Office Forecasts

Imminent Demand

No signs of a dramatic increase in demand on the local level (no industry shiftmoving towards chicago)

U.S. economy may be fragile oil prices/global economic uncertainty acting on adrag on U.S. economy (see recent trend in stock prices)

Demand predictions moderate at best

Supply

Lots of slack in the office market (vacancies high and construction continuing)

Rents will not pick up for awhile (good for tenants).

Still profitable to build (new construction is filling up quickly (at expense of existing

properties)however rents in new construction still low).

I would not develop office properties in Chicago at this time! Interest rates likely to rise

(to fight inflation) decreases returns to owning (along with low rents and highvacancies).

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Chicago Retail Forecasts

Retail development is a better opportunity

Vacancies are lower

Effective rents have been increasing slightly

People still consuming in Chicago (both natives and tourists). Residential areas of

Chicago are still developing (south/west loop).

Interest rates will still likely increase as a result, financing costs will still rise.


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Other Markets: Downtown Office Boston

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Other Markets: Downtown Office Boston

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Other Markets: Downtown Office San Francisco

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Other Thoughts.

My macro assess ment

Fundamentals solid not strong

Oil and Inflation (has me worried)

Consumers and Business (going strong)

Government (too much debt)

Net Exports (of no concern to me)

Business investment is most stable! Lots of capacity to expandthey are hesitantgiven past mistakes (late 1990s) and oil/political uncertainty.

Residential Property Markets

They will come down (either bubble burst or supply adjusts) Increase in interest rates may quicken this effect

Re-adjustment will occur slowly (it always does)

Will investors adjust to/plan for a higher (normal) interest rate regime?

Documents

Market Analysis Overview