SAN FRANCISCO M A Y 1 0 , 2 0 1 6 1
MEGATRENDS 1. Commercial real estate moves in cycles, and there is evidence we are approaching the mature phase of the cycle. . . 2. . . .Yet capital continues to flow into commercial real estate 3. There is tension between the preferences of tech talent and occupancy costs 4. Bay Area economic growth will support continuing CRE expansion, even as headwinds shape our future Source: NGKF Research; May 2016 2
M E G A T R E N D # 1 : A P P R O A C H I N G T H E M A T U R E P H A S E O F T H E C O M M E R C I A L R E A L E S T A T E C Y C L E 3
MEGATREND #1: MATURE PHASE Payroll Job Change | United States C H A N G E I N PAY R O L L J O B S Current expansion period: 83 months 4000 2000 ( T H O U S A N D S ) 0 -2000 Average expansion period since 1945: 58 months -4000 -6000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016* *12 months ending in March 2016 Source: U.S. Bureau of Labor Statistics, NGKF Research; May 2016 4
MEGATREND #1: MATURE PHASE NCREIF Property Index | United States Current expansion period: 26 quarters 20% T O TA L C A L E N D A R 15% Y E A R R E T U R N 10% 5% 0% -5% Average expansion period since 1978: 31 quarters -10% -15% -20% 2007 2008 2009 2010 2011 2012 2013 2014 2015 Note: Includes all asset classes Source: NCREIF, NGKF Research; May 2016 5
MEGATREND #1: MATURE PHASE Corporate Profits | United States C O R P O R AT E P R O F I T S $2,500 ( B I L L I O N S ) $2,000 $1,500 $1,000 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: U.S. Department of Commerce, NGKF Research; May 2016 6
MEGATREND #1: MATURE PHASE Non-Farm Business Worker Productivity | United States 8% 6% P E R C E N TA G E C H A N G E 4% 2% 0% 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 -2% -4% -6% -8% Percent change from same quarter a year ago Source: U.S. Bureau of Labor Statistics, NGKF Research; May 2016 7
MEGATREND #1: MATURE PHASE 2% Productivity Loss Offsets Cost Savings From Densification 350% 2% PRODUCTIVITY LOSS AS A % OF RENT SAVINGS 300% 250% 200% 150% 100% 50% 0% 2% productivity loss as a percent of rent savings from densification Equilibrium Note: Ten largest metropolitan areas by employment base in 2015; assumes 10% reduction of rentable space Source: U.S. Bureau of Labor Statistics, NGKF Research; May 2016 8
MEGATREND #1: MATURE PHASE Gains In Productivity Can Offset Cost of Trophy Upgrade A N N U A L V A L U E G A I N E D F R O M $6,000 $6,000 I N C R E A S E D P R O D U C T I V I T Y C O S T O F T R O P H Y U P G R A D E $5,000 $5,000 6% 6% ( P E R E M P L O Y E E ) 6% ( P E R E M P L O Y E E ) 6% 6% 6% 6% 6% 5% $4,000 6% $4,000 6% 5% 5% 5% 5% 5% 5% 5% 5% 5% 4% 4% 4% $3,000 $3,000 4% 4% 4% 4% 4% 4% 4% 3% 3% 3% $2,000 3% $2,000 3% 3% 3% 3% 3% 3% 2% 2% 2% 2% 2% 2% 2% 2% 2% $1,000 2% $1,000 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% $0 $0 Additional annual rent per employee Productivity gain* *Expressed as a percentage of annual wage Note: Ten largest metropolitan areas by employment base in 2015; assumes 5% reduction of rentable space Source: U.S. Bureau of Labor Statistics, NGKF Research; May 2016 9
MEGATREND #1: MATURE PHASE What’s Next? | Discipline is Critical in the Next 12 -24 Months • Bifurcation between leasing performance and capital investment will continue • Investors should be more disciplined as we approach the end of the cycle • Owners marketing trophy space should emphasize value of productivity enhancement to tenants • Now is a time to own and manage high-quality assets Source: NGKF Research; May 2016 10
M E G A T R E N D # 2 : C A P I T A L C O N T I N U E S T O F L O W I N T O C O M M E R C I A L R E A L E S T A T E 11
MEGATREND #2: CAPITAL FLOWING CRE Outperforms Stocks and Bonds A N N U A L I Z E D T O TA L R E T U R N 14% A S O F M A R C H 3 1 , 2 0 1 6 12% 10% 8% 6% 4% 2% 0% 1-Year 10-Year 20-Year U.S. REAL ESTATE: NCREIF Property Index STOCKS: S&P 500 Index BONDS: Bloomberg U.S. Government Bond Index Source: NCREIF, Bloomberg, NGKF Research; May 2016 12
MEGATREND #2: CAPITAL FLOWING Institutional Allocations to Commercial Real Estate Have Increased 9% C O M M E R C I A L R E A L E S TAT E A S A P E R C E N TA G E O F A S S E T S 8% 7% 6% 5% 4% 1996 2007 2014 Note: Includes only private institutional allocations; 2014 is most recent data available Source: PREA, NGKF Research; May 2016 13
MEGATREND #2: CAPITAL FLOWING U.S. Investment Sales Volume May Have Peaked But Remains Robust $600 B I L L I O N S O F D O L L A R S $500 $400 $300 $200 $100 $0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016* Office Industrial Retail Apartment Hotel *2016 YTD through February, annualized and seasonally adjusted Source: Real Capital Analytics, NGKF Research; May 2016 14
MEGATREND #2: CAPITAL FLOWING Bay Area Has Remained Steadfast on AFIRE Investor Survey 2016 2016 2010 2010 #1 #1 #1 #1 New York Washington #2 #2 #2 #2 Los Angeles New York #3 #3 #3 #3 San Francisco San Francisco #4 #4 #4 #4 Boston Washington #5 #5 #5 #5 Seattle/Boston Los Angeles Note: Ranking among U.S. markets Source: AFIRE, NGKF Research; May 2016 15
MEGATREND #2: CAPITAL FLOWING Bay Area Investment Sales Volume May Have Peaked But Remains Robust $40 B I L L I O N S O F D O L L A R S $35 $30 $25 $20 $15 $10 $5 $0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016* Office Industrial Retail Apartment Hotel *2016 YTD through February, annualized and seasonally adjusted Source: Real Capital Analytics, NGKF Research; May 2016 16
MEGATREND #2: CAPITAL FLOWING What’s Next? | Bay Area Office and Apartment Sales in Next 12 -24 Months • Apartment cap rates: Flat or edging up overall • Office cap rates: Edging up for commodity product • Sales volume: Slightly below 2015 levels • Sales prices: Flat or edging down overall Source: NGKF Research; May 2016 17
M E G A T R E N D # 3 : T E N S I O N B E T W E E N P R E F E R E N C E S O F T E C H T A L E N T A N D O P E R A T I N G C O S T S 18
MEGATREND #3: TENSION Residents Commuting Outside Their Home County San Francisco 48,085 23,275 15,550 36,340 17,755 San Mateo 27,975 24,705 East Bay / County Oakland 13,910 40,150 32,850 62,645 Silicon Valley 33,480 Note: Data reflect 2014 commuting patterns for private-sector workers with annual incomes greater than $40,000 Source: Census.gov, NGKF Research; May 2016 19
MEGATREND #3: TENSION Top 20 Innovative Computer Science and Engineering Programs Annual Graduate Output Pittsburgh’s entry - 0 100 200 300 400 500 600 700 800 900 level base salary for computer science Carnegie Mellon University 826 Georgia Tech graduates = 22% less 523 than Silicon Valley’s Univ of Southern California 515 University of Illinois - Urbana 462 University of Washington 451 U Michigan - Ann Arbor 449 UC - San Diego 405 MIT 383 Columbia University 368 Univ of Pennsylvania 331 Stanford University 325 Cornell University 321 Univ of TX at Austin 304 U Wisconsin - Madison 282 UC Los Angeles 263 UC Berkeley 225 Princeton University 112 Harvard University 72 Yale University 71 Caltech 43 Source: Computer Science Degree Hub, NGKF Research; May 2016 20
MEGATREND #3: TENSION Office Market Rent Variability | Selected Tech-Heavy Submarkets at Q1 2016 $140 ( $ / S F / A N N U M , F U L L S E R V I C E ) $120.60 AV E R A G E A S K I N G R E N T $120 $100 $80 $73.27 63% less than Downtown Palo Alto $57.24 $57.12 $60 $44.52 $40 $20 $0 Downtown SOMA Cupertino Sunnyvale Downtown Palo Alto Oakland Source: NGKF Research; May 2016 21
MEGATREND #3: TENSION Share of Office Market Gross Leasing Activity S H A R E O F O F F I C E M A R K E T 100% G R O S S L E A S I N G A C T I V I T Y +380 basis 21.1% 21.2% points in 75% one year 22.2% 26.0% 50% 56.8% 52.8% 25% 0% 2014 2015 San Francisco Oakland Silicon Valley Note: Includes new leases, expansions, consolidations, renewals, and subleases Source: CoStar, NGKF Research; May 2016 22
MEGATREND #3: TENSION What’s Next? | Bay Area Still Appeals to Tech Firms/Talent, But Costs Are An Issue • Oakland and other alternate options for tenants are here to stay, and that creates… • …a more competitive office environment. . . • . . .and also greater utilization of infrastructure Source: NGKF Research; May 2016 23
M E G A T R E N D # 4 : B A Y A R E A E C O N O M I C G R O W T H W I L L S U P P O R T C O N T I N U I N G C R E E X P A N S I O N , E V E N A S H E A D W I N D S S H A P E O U R F U T U R E 24
MEGATREND #4: GROWTH, HEADWINDS U.S. Payroll Job Change | 12 Months Ending March 2016 C H A N G E I N PAY R O L L J O B S 200 ( T H O U S A N D S ) 150 109.6 100 50 0 NY LA/ DFW Bay Was Chi Atl Phi Phx S. Fla Bos Hou OC Area Note: Bay Area includes San Francisco/East Bay and San Jose metro areas Source: U.S. Bureau of Labor Statistics, NGKF Research; May 2016 25
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