CAP RATE REPORT: 2Q2015

VOLUME GROWTH REMAINS HEALTHY FOR THE QUARTER; CAP RATES IMPROVE MODERATELY

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Prepared by:

Hasan Rahim Real Estate Market Research PNC Real Estate 249 Fifth Avenue Pittsburgh, PA 15222 (412) 762-8683 [email protected]

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VOLUME: Commercial Real Estate (CRE) sales totaled $104.5B during 2Q15, down 12.0% sequentially, but up 28.0% annually according to Real Capital Analytics (RCA). Domestic and international investors continued to relish the industry’s sustained fundamental improvement and strengthening US economy, which resulted in continued capital flow into CRE at a quickening pace. ”Foreign investment in the US property markets is soaring,” according to DTZ’s chief economist Kevin Thorpe, per CoStar. Mr. Thorpe also added that “international capital is now involved in nearly 20% of total sales volume in the US, more than double the historical norm.” The office sector remains the favored subtype, with $33.4B in sales this quarter, followed by the apartment sector, which posted $28.1B in sales. According to the Moody’s/RCA CPPI index, prices for all properties have appreciated 15.6% YOY and are 12.7% over the previous peak in 2007. CAP RATES: According to the latest PwC Real Estate Investor Survey, average cap rates decreased in 26 segments, held steady in 4 and increased in 4. Changes for each property segment are discussed within the report. FOREIGN CAPITAL IN THE USA: As mentioned earlier, foreign capital continues to flow into the United States at a historical pace. Foreign investors are willing to pay premiums for top-quality real estate assets, as evidenced by CoStar noting that pricing for assets purchased by international buyers was 28.0% above the average purchase price by domestic investors. Additionally, foreign investors have begun to venture beyond the Major Metros into nontraditional markets such as Denver and Minneapolis, where foreign investment accounted for 53.0% and 40.0% of total volume respectively per CoStar. Capital preservation, relative yield which favors the US, or the positive economic trajectory in CRE are among the multiple reasons as to why foreign capital is attracted to US CRE. Despite the increase in US CRE prices (as measured by the CPPI) are rising above 2007 peaks, cap rates here are higher than other developed countries, driven by the higher benchmark US Treasury rates. The trend of increasing foreign capital in the USA is expected to continue as the CRE market is expected to shatter pricing and transaction volume records this year, per Mr. Thorpe. FOR PROFESSIONAL USE ONLY: Outside of property fundamentals, the continued appetite for certain transactions and aggressive efforts to employ capital has impacted capitalization rates. While anecdotal stories of exceptionally low rates may have a basis in fact, each rate will represent conditions particular to that transaction. Care needs to be used in appropriately extending rates beyond the related sale.

PNC and PNC Bank are registered service marks of The PNC Financial Services Group, Inc. PNC Bank and certain of its affiliates, including PNC TC, LLC, an SEC registered investment advisor wholly-owned by PNC Bank, do business as PNC Real Estate. PNC Real Estate provides commercial real estate financing and related services. Through its Tax Credit Capital segment, PNC Real Estate provides lending services, equity investments and equity investment services relating to low income housing tax credit (“LIHTC”) and preservation investments. PNC TC, LLC provides investment advisory services to funds sponsored by PNC Real Estate for LIHTC and preservation investments. Registration with the SEC does not imply a certain level of skill or training. This material does not constitute an offer to sell or a solicitation of an offer to buy any investment product. This document is for general informational purposes only and is not intended as specific advice or recommendations. The information contained herein is gathered from public sources believed by PNC to be accurate and reliable at time of publication, but neither PNC nor any of its affiliates is providing any guaranty or warranty as to the accuracy, completeness or reliability of that information or of the conclusions presented in this document. In addition, markets do change. Opinions expressed herein are subject to change without notice. The information set forth herein does not constitute legal, tax or accounting advice. You should obtain such advice from your own counsel or accountant. Any reliance upon the information provided herein is solely and exclusively at your own risk. ©2015 The PNC Financial Services Group, Inc. All rights reserved.

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Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

The following examines trends within each property segment. The average cap rates were based on the latest PwC Real Estate Investor Survey, and Real Capital Analytics (RCA). Sales volume figures were obtained from RCA data and represent transactions over $5.0M.

OFFICE

300

Office Suburban

$80

$60 200 $50 $40 150 $30 $20

Index (4Q00 = 100)

250

$70

100

$10

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

50

2002

$-

Note: Major Office Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Sources: Real Capital Analytics, PNC Real Estate Market Research

Capitalization Rates CBD Office - United States Through Second Quarter 2015 11% 10% 6.07% - PwC CBD Office

9%

 4 bps, +0.7% 8%

5.60% - RCA CBD Office

 7 bps, +1.2%

7%

6.53% - RCA Total Office

6%

 5 bps, -0.7%

5%

5.34% - ACLI Office

 42 bps, +7.3% 2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

4% 2005

Both RCA and PwC indicate that suburban and CBD office cap rates posted sequential and annual declines. Cap rate compression for both suburban and CBD product is more apparent on an annual basis.

Office CBD

Billions ($) $90

2004

Despite being a major seller in 1Q15, Blackstone Group purchased Willis Tower in Chicago for approximately $1.3B ($343 psf), the highest price ever paid for an office tower in the USA (outside of New York City). Blackstone plans to invest heavily in the retail portion of this tower and upgrade the 103rd-floor Skydeck to make it a comprehensive tourist destination. Another major transaction was RXR Realty purchasing 230 Park Avenue for $1.2B ($990 psf) from Invesco, one of the largest office building sales transactions year to date in New York City.

Office

2003

The interest in suburban properties is partially the result of investors seeking higher yield and attractive pricing. The CPPI for the office sector shows that overall prices grew 7.2% from 1Q15. Over this period, the office CBD sub-index rose 10.3%, while the suburban office sub-index shows prices rose 3.8%. As of 2Q15, CBD office prices were 39.2% above their 1Q08 peak, while suburban office properties remain 10.0% below their 3Q07 peak.

Office CPPI & Transaction Volume Through Second Quarter 2015

Transaction Volume > $5M

2002

According to RCA data, institutional quality sales volume grew 2.5% sequentially to $33.4B and YOY sales are up 26.0% from 2Q14’s $26.5B. Sales of suburban properties comprised the bulk of this quarter’s volume, growing 4.9% from last quarter to $18.4B; a 43.9% YOY increase. CBD properties accounted for $15.0B in sales this quarter, flat from 1Q15, but rose 9.3% YOY.

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

Capitalization Rates Suburban Office - United States Through Second Quarter 2015 11%

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10% 6.50% - PwC Suburban Office

9%

 14 bps, +2.1%

8%

6.80% - RCA Suburban Office

 2 bps, +0.2%

7%

6.53% - RCA Total Office

6%

 5 bps, -0.7%

5%

5.34% - ACLI Office

 42 bps, +7.3%

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

4% 2002

Office sector fundamentals continued to post modest improvements during the quarter. However, investors remained cautious, given the large construction pipeline. This partially explains the modest cap rate appreciation in CBD and suburban product, compared to previous quarters. CoStar noted that nationally, 133.5 million square feet (msf) of office space was under construction at the end of 2Q15. Absorption for the quarter was healthy, as both CBD and suburban sectors posted positive absorption numbers per CoStar. In addition to the healthy absorption rate, vacancy continued to tick lower and rents continued to grow for CBD and suburban office, signaling continued strength in the sector.

3

Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

INDUSTRIAL

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210

Non-Major Industrial

190 $20

150

$15

130 $10

110

Index (4Q00 = 100)

170

90 $5 70 $-

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

50

Note: Major Industrial Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Sources: Real Capital Analytics, PNC Real Estate Market Research

Capitalization Rates Industrial Warehouse - United States Through Second Quarter 2015 10%

9%

5.65% - PwC Warehouse

 12 bps, +2.1%

8%

6.50% - RCA Warehouse

 19 bps, +2.8%

7%

6.66% -RCA Total Industrial

 22 bps, +3.2%

6%

6.69% - ACLI Industrial

 29 bps, +4.2% 2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

5%

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

Capitalization Rates Industrial Flex/R&D - United States Through Second Quarter 2015 10%

9% 7.23% - PwC Flex/R&D

22 bps, +3.0%

8%

6.93% - RCA Flex

 49 bps, +6.5%

7%

6.66% - RCA Total Industrial

22 bps, +3.2%

6%

6.69% - ACLI Industrial

 29 bps, +4.2%

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

5% 2004

Despite warehouse posting a strong performance in recent quarters, investors are keeping a close watch on the construction pipeline. CoStar noted that construction levels remain moderate, with approximately 17.1 msf of industrial space under construction as of 2Q15. CoStar, however, indicated that fundamentals for the industrial sector continue to strengthen, despite the pipeline. Absorption for the industrial sector was positive for both sub-types, vacancy rates have ticked down, and rental rates have seen a modest increase. While the warehouse sector remained the favored sub-type, healthy appreciation in fundamentals is expected to increase demand for flex/R&D product.

Major Industrial

Billions ($) $25

2003

Cap rates for the flex and warehouse sectors have posted quarterly and annual improvements per PwC and RCA, indicating that investors still see plenty of value in the industrial sector. Buyers remain focused on the warehouse sector, as evidenced by the large transaction volume for the quarter. Investors remain interested in warehouse product near ports (Los Angeles in particular), but are also interested in acquiring assets in secondary cities (Charlotte/San Antonio) as pricing and competition are more attractive, per PwC’s Real Estate Investor Survey. Demand for flex/R&D product remained strong in major infill locations given the supply constraint and healthy rent growth potential.

Industrial

2002

Pricing for industrial assets, as measured by the Moody’s/RCA CPPI is up 13.0% YOY and is 1.2% higher than the peak pricing seen in 2007. Foreign capital continued to look at the US industrial sector for stable yield, as evidenced by Norges Bank partnering with Prologis to acquire KTR Capital’s industrial portfolio accounting for approximately $5.9 billion in volume. The portfolio consists of more than 300 warehouse/distribution properties, with locations in Los Angeles, Chicago, South Florida, Seattle, and Dallas. Another large portfolio transaction this quarter was Northstar REIT’s purchase of an industrial portfolio from Exeter Property Group for approximately $318 million. Properties in this portfolio are located in seven states, with the largest concentrations in Indiana, Kentucky, and Tennessee.

Industrial CPPI & Transaction Volume Through Second Quarter 2015

Transaction Volume > $5M

2002

Sales volume, per RCA, decreased 22.8% sequentially to $14.8B, but increased 41.6% YOY. RCA noted that majority of the transaction volume for this sector was attributed to portfolio activity. There were a few large portfolio transactions in 1Q15 which inflated volume to an all-time high.

4

Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

RETAIL Retail CPPI & Transaction Volume Through Second Quarter 2015

Transaction Volume > $5M Retail Major Retail

Billions ($) $30

250

Non-Major Retail

230 $25

210 190

$20

170 $15

150 130

$10

110 90

$5

70 $-

Note: Major Retail Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Sources: Real Capital Analytics, PNC Real Estate Market Research

Capitalization Rates Retail Mall - United States Through Second Quarter 2015 10%

9%

6.13% - PwC Mall

25 bps, +3.9% 8%

Given the decline in transaction volume, cap rates across the sector have posted mixed results per RCA; however, PwC noted that cap rates continued to gradually improve. Cap rate changes are more apparent on an annual basis according to both RCA and PwC.

2015

2014

2013

2012

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2010

2009

2008

2007

2006

2005

2004

2003

50

2002

The Moody’s/RCA CPPI index indicated that prices are up 11.1% YOY, but are still 8.0% off the peak levels reached in 2007. The six Major Metros are the only markets where prices have appreciated above their 2007 peaks. Despite the higher pricing, investors have not shied away from investing in Major Metros, as evidenced by Blackstone acquiring the Sky View Parc complex in Flushing, New York for $400 million ($714 PSF), a shopping mall anchored by a Nike outlet store, Nordstrom Rack, and BJ’s Wholesale Club. Investment in nonMajor Metros was strong as well, with Prudential Real Estate Investors acquiring a 75% stake in the Bella Terra Shopping Center (an outdoor shopping mall anchored by a Whole Foods, Kohl’s, Costco, and REI) in Huntington Beach, CA for $385 million ($458 PSF).

Index (4Q00 = 100)

Overall retail investment was $16.8B in 2Q15, a 24.1% decrease from 1Q15, but a 30.3% increase YOY. Mall properties led the retail segment in volume this quarter at $10.1B, a 30.3% decrease from 1Q15, and a 59.4% gain from a year ago. Volume for strip properties declined 12.4% this quarter to $6.7B but remains up 2.0% YOY.

5.82% - RCA Mall

 10 bps, -1.8% 7%

6.46% - RCA Total Retail

 9 bps, -1.5% 6% 6.18% - ACLI Retail 0 bps, +0.0%

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

5% 2002

The retail sector continued to move out of the recession phase of the real estate cycle and sector fundamentals are poised to improve. CoStar noted that vacancy tightened 10 bps from 6.0% to 5.9% and rental rates ticked up to $15.04 compared to $14.96 from last quarter. Additionally net absorption in the retail sector saw a moderate improvement (26.8 msf absorbed) in 2Q15 compared to 1Q15 numbers (15.4 msf).

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

Capitalization Rates Retail Power and Strip Center - United States Through Second Quarter 2015 10%

6.91% - PwC Strip Center

 9 bps, +1.3% 9%

6.84% - RCA Strip Center

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

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11 bps, +1.6% PwC reported that strong economic growth 8% 6.54% - PwC coupled with employment gains is helping increase Power Center consumer traffic and spending at regional malls.  2 bps, +0.3% 7% Participants interviewed for the PwC Real Estate 6.46% - RCA Total Retail Investor Survey indicated that retail sales per 9 bps, -1.5% 6% square foot have grown in regional malls, with 6.18% - ACLI Retail Class A malls experiencing the fastest growth, 0 bps, +0.0% enabling mall owners to raise rents. Power 5% centers continue to post marginal improvements, despite supply constraints. This sector continued to be challenged by big-box closings from retailers like JC Penney, Sears, and Jones New York. There have been some marginal improvements in power center fundamentals, as rents averaged $16.49 PSF per CoStar, up from $16.37 PSF in 1Q15.

5

Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

APARTMENT Apartment CPPI & Transaction Volume Through Second Quarter 2015

Transaction Volume > $5M Apartment Billions ($) $40

Major Apartment 350

Non-Major Apartment

$35 300 $30 250 $25 200

$20 $15

150

the significant increase in property prices, demand for this property type remained strong.

Index (4Q00 = 100)

Despite the decrease in volume, total apartment investment remained healthy this quarter, totaling $28.1B, an 11.8% decrease from 1Q15, but up 16.2% YOY. The Garden sector led the way this quarter, with $18.8B in sales, flat from last quarter, but up 28.2% on an annual basis. Total high-rise volume was $9.3B in 2Q15, a 28.8% decrease sequentially and a 2.3% decrease annually, as investors remain more interested in acquiring garden product. RCA noted that despite

$10 100 $5

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Note: Major Apartment Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Sources: Real Capital Analytics, PNC Real Estate Market Research

Capitalization Rates Apartment - United States Through Second Quarter 2015 9%

5.30% - PwC National Apartment

6 bps, +1.1%

8%

6.21% - RCA Garden Apartment

 1 bps, -0.1%

7%

4.60% - RCA Mid/Highrise

1 bps, +0.3%

6%

5.96% - RCA Total Apartment

 18 bps, -3.2%

5%

5.74% - ACLI Apartment

 38 bps, +7.1% 2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

4% 2003

that the volume decline in the mid/high rise segment is partially due to limited portfolio and entity level transactions. One of the largest transactions this quarter was Blackstone divesting a portfolio consisting of 4,600 apartments to Strata Equity Group and Mexican investors, for approximately $650 million per RCA (approx.. $141.3K per unit). Strata plans to renovate most of the 12 apartment complexes in this portfolio, which were built between 1989 and 2012 and located in Atlanta, Denver, Houston, and Austin, TX. Another notable transaction this quarter includes a partnership of Rockpoint Group and Maximus Real Estate Partners purchasing the One Rincon Hill apartment tower in San Francisco for $410 million (approximately $1.3 million per unit), the highest price paid for an apartment building in the Bay Area since 2007.

50

$-

2002

Property prices continued to rise, as evidenced by the Moody’s/CPPI index for apartments, which is now up 14.6% YOY and is 30.4% ahead of the peak prices last seen in 2007. RCA noted

Sources: PwC Real Estate Investor Survey, Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

Cap rates for this sector have declined on a quarterly and annual basis per PwC and Real Capital Analytics. Despite the

record high pricing and conservative underwriting in this segment, investors still find returns to be attractive. On a national level, supply remains at an all-time high, but is balanced with demand per REIS. Approximately 46,000 units came online in 2Q15 of which 44,000 units absorbed, resulting in the national vacancy rate holding steady at 4.2% according to REIS. The national vacancy rate has held steady between 4.2% - 4.3%, since 2013, suggesting the apartment sector is in equilibrium. Investors are keeping a close eye on supply and PwC reported that investors have been more careful when underwriting rents and rent growth. The current environment for the apartment market is very healthy as vacancy rates remain at historic lows. Given that Class A assets may be priced at a premium to replacement costs, investors may seek development or renovation options in order to obtain a better yield.

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6

Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

HOTEL Hotel CPPI & Transaction Volume Through Second Quarter 2015

Transaction Volume > $5M Hotel

Billions ($) $35

170

$30

150

$25 130 $20 110 $15 90

Index (4Q00 = 100)

On the tail of the US economy expanding in the second quarter, hotel owners continue to achieve real gains in revenue metrics. Demand for hotel product weakened this quarter as hotel investment totaled $11.4B this quarter, down 12.4% compared to 1Q15, but remains up 50.0% YOY. Full-service hotels remained the favored subtype at $9.1B, accounting for 79.6% of total 2Q15 sales. Volume in the limited-service segment totaled $2.3B, a 45.4% sequential decrease and a 1.2% decrease YOY.

$10 70

$5

50

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2002

According to the Moody’s/RCA CPPI index for hotels, prices have appreciated 36.9% YOY and are 5.5% above their 2007 peak. ADR and RevPar are expected to continue, as demand in this segment is expected to continue going forward, resulting in a significant increase in pricing power for hotel owners, according to PwC. One of the larger transactions this quarter was Moody National REIT acquiring a 149-hotel portfolio for approximately $1.7B which consisted of 14,000 rooms spread across 32 states, with a concentration in California, Arizona, Texas, and the Northeast. The majority of this portfolio consists of Marriott and Hilton branded select-service hotels, the bulk of which have undergone renovation. Another large transaction was Blackstone’s purchase of two Orlando properties, the Ritz Carlton and JW Marriott Grand Lakes for approximately $1.3B.

Note: Major Hotel Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Sources: Real Capital Analytics, PNC Real Estate Market Research

Capitalization Rates Hotel - United States Through Second Quarter 2015 15% 14% 13% 7.71% - PwC Full Service

12% 11%

0 bps, +0.0%

10%

8.15% - RCA Hotel

9%

 21 bps, -2.7%

8%

8.95% - PwC Limited Service 0 bps, +0.0%

7%

Sources: PwC Real Estate Investor Survey (published semi-annually), Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Research

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5.66% - ACLI Hotel Underscoring the heated market for lodging 6% acquisitions is strong demand across all the hotel  9 bps, +1.6% 5% subsectors per PKF Hospital Research (PKF). PKF forecasts that average room rates will climb by 5.3% this year and have forecasted that average occupancy will rise to a 27-year high of 65.6%. Marcus & Millichap reported that US Hotels are currently setting pace for an annual occupancy record. Construction in this sector represents the largest risk, as supply in this sector will continue to accelerate; however an increase in room demand is expected to offset additions to hotel stock. Additionally, hotel owners are expected to retain pricing power, resulting in ADR and RevPar improvements. Cap rates for the quarter have moderated per RCA.

Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

7

NATIONAL CAP RATE ESTIMATES (2Q2015)

Sources: American Council of Life Insurers (ACLI): Publishes periodic reports on the commitment profiles and credit performance of commercial mortgages originated and held by life insurance companies. Beginning in 1965, ACLI data offers the longest aggregate time-series of loan performance spanning several CRE market cycles. Real Capital Analytics (RCA): Provides property-level transaction data on price and cap rates for any commercial property transaction valued over $5.0 million. PricewaterhouseCoopers (PwC) Real Estate Investor Survey: Publishes real estate survey information gathered from a cross section of major institutional equity real estate investors, who invest primarily in institutional-grade property. Survey information is gathered through on-line questionnaires and telephone interviews.

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8

Volume Growth Remains Healthy for the Quarter; Cap Rates Improve Moderately

All Properties CPPI & Transaction Volume Through Second Quarter 2015

Transaction Volume > $5M National (All-Property)

Billions ($) $160

300 Core Commercial

$140 Major Markets (AllProperty)

250

$100

200

$80 150

$60

Index (4Q00 = 100)

$120

$40 100 $20

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

50

2001

$-

Note: Major Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Sources: Real Capital Analytics, PNC Real Estate Market Research

Sales Transaction Volume By Property Type United States Through Second Quarter 2015

Billions ($) $80

Office ($33.4B) Industrial ($14.8B)

$70

Retail ($16.8B) Apartment ($28.1B)

$60

Hotel ($11.4B) $50

$40

$30

$20

$10

Note: Volume represents properties and portfolios valued at $5 million and greater. Hotel volume results from 2001 through 2004 modeled as a percentage of total volume. Sources: Real Capital Analytics, PNC Real Estate Market Research

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