THINK US cities - TH Real Estate

THINK US cities Trends and Tactics Q1 2018

This document is solely for the use of professionals and is not for general public distribution.

Economic dashboard: Despite stock market volatility, economy is just fine Positive economic data and signals from the bond market suggest the economy, and real estate, should remain on solid ground. Recent volatility in the equity markets is causing some investors to call in to question the health of this nine year upcycle. Does recent volatility in the stock market indicate a recession is imminent or were those pesky trading algorithms playing games again? All signs point to a positive outlook. The economy accelerated in 2017, posting 2.3% GDP growth compared to 1.5% in 2016 which should support real estate demand. Economists expect annual GDP growth will exceed those levels in 2018. Early signals in Q1 2018 support another quarter of positive economic growth. Job growth is strong and the labor market remains at full employment. The Labor Department reported that the US added a robust 200,000 new jobs in January 2018. Weekly claims for unemployment insurance benefits are also near record lows. Tight labor market conditions are giving rise to wages, which grew by 2.9% YoY in January 2018, the fastest pace in 2009.

Real estate leading economic indicators Indicators

Labor Markets

CRE fundamentals

What do the public markets tell us about the future? Part of the stock market volatility experienced in early 2018 can be attributed to the divergence in fiscal and monetary policy that has caused investors to reset their expectations for returns. The Fed has been hiking rates in response to a strong economy and rising inflation expectations. Meanwhile, Congress recently passed a stimulus measure by way of the tax bill, and they recently lifted a budget spending cap for the next two years. In the near term, recent fiscal stimulus should buoy current market valuations, if not elevate them higher. Real estate market conditions are tempering somewhat, but are solid overall. The US real estate market is poised for another year of positive performance. We expect core unlevered real estate total returns to range between 5% and 6% in 2018. Investors should focus on asset selection and income given our expectations for minimal appreciation in 2018. Source: TH Real Estate, February 2018. 2

THINK US cities: Trends and tactics

Capital markets

Debt availability

Position

Employment growth

Job growth remains positive. The longest streak of monthly job gains on record continued into 2018. Latest job gains totaled 200,000 in January, above 2017 trend.

Unemployment rate

The unemployment rate held at 4.1% in January 2018. This rate is the lowest of the recovery and low relative to history. Tight labor conditions are putting upward pressure on incomes, which rose by 2.9% YoY in January 2018, the fastest pace since 2009.

Vacancy rates

Fundamentals generally moderated or remained steady during Q4 2017, although industrial held near all-time low vacancy. Supply has caught up to demand in most sectors, causing vacancy rates to stabilize or move modestly higher.

Rents and rent growth

Rent growth was mostly positive but is slowing as the US real estate cycle enters the mature phase of its cycle. However, industrial rent growth is outperforming as landlords are in a position of pricing power.

Interest rates

10-year US treasury yields reached 2.9% in February after the Trump tax cuts took effect and inflation expectations moved higher as a result of stronger economic and labor market signals.

Investor risk appetite

The US S&P 500 reached all-time high levels in January 2018, but pulled back by ~11% in February from the highs. Volatility once again returned to equity markets, and investors have taken notice.

Debt for investors

Mortgage debt is readily available for core, income producing assets. Lenders are taking a more cautious look at opportunistic strategies, willing to lend on quality projects with top sponsors.

Debt for construction

Construction lending continues to be available, but banks are more diligent than ever. Well located projects with strong market fundamentals have no trouble getting financed.

Outlook indicator

Office trends: A new way to work The factors that are fuelling demand for a new way to work

Characteristics of co-working

Considered a fad by some, co-working emerged from the GFC as a trendy, collegial office alternative that houses startups, entrepreneurs, freelancers, and small businesses. It has evolved into a noteworthy office subsector that has recently attracted the attention of some of the world’s largest enterprises, including IBM, Microsoft, GE and Spotify.

• • • • •

Desk space or private offices within a shared space Flexible rental agreements A focus on networking and relationships Fosters a close-knit, entrepreneurial, and professional community Growing interest from large enterprises

The demand for co-working stemmed from a confluence of societal, economic, demographic, and technological factors that include a renewed interest in entrepreneurship, the Millennial lifestyle, the harsh realities of technology-driven disruption, changing business priorities, and the contingent workforce.

Rise of contingent workforce

Surge in start-ups Number of start-ups went from 560,000 in 2010 to 679,000 in 2015, a 17% increase

At current growth rates, contingent workers will become the majority of the US workforce in 2027, an increase of nearly 25 million workers

Millennial Magnet

Growing tech innovation

Younger generations are driving the acceleration, 47% of working millennials freelance, more than any other generation

Rise in technology such as cloud-based applications, the web of things, webconference tools, internet and wi-fi, cell phones, laptops and more make it easier to work remotely

Sources: U.S. Bureau of Labor Statistics, Upwork, TH Real Estate, Q3 2017 3


Strong employment

Enterprise growth

At 57.3 million, or 36% of the US workforce, the number of people freelancing has grown 8.1% since 2014 and 4.2% since 2016

Companies with 250 or more employees take up 54% of the market share in 2015, compared to 49% in 1993. To cut costs, many will use co-working space

Rise of the sharing economy Uber owns zero cars and is valued at $62.5B while Airbnb owns zero homes and has a value of $31B

Changing business priorities 80% of global corporations are planning to significantly increase their use of the contingent workforce

Office: Under pressure, landlords focus on place-making and service Office performance

Office market opportunities

Office unlevered property returns averaged 6.0% for 2017, the third highest among traditional property sectors. Appreciation has been largely absent from returns in 2017, contributing just 1.3% to the total return. Vacancy rates gradually declined and reached levels last seen prior to the GFC. Office vacancy rates have held around 13.0% for the past three years.

While the disruption is causing headaches for traditional office owners, they are beginning to fight back with new and innovative spaces themselves. This period of uncertainty will almost certainly provide opportunities for investors who are able to see into the future of the working world and willing listen to the needs of their tenants.

Office rent growth has been far weaker this cycle than in the prior cycle, a trend unlikely to abate given our view that the US office market is undergoing structural changes.

The office sector has been under pressure and is going through structural changes. Those changes are forcing landlords to invest large amounts of capital into their assets to stay relevant, dragging returns lower.

The sector faces headwinds that are constraining demand, despite strong jobs numbers, full employment and a growing economy. The contingent workforce is growing, and they have been moving out of Starbucks stores and into co-working spaces. Demographics are playing a large part. And office tenants require less space per worker. Additionally, mobile technology is enabling workers to complete their jobs from anywhere in the world.

Office owners are finding it increasingly difficult to provide value to their tenants through traditional property management and services, which has given rise to companies like WeWork. WeWork has capitalized on the value proposition gap between tenants and existing landlords and are winning the battle for new tenants. They offer enhanced business services, networking and tight-knit community in unconventional, well designed spaces at hip locations – and they don’t own their real estate.

21%

Downtown

Effective rent growth (YoY), 1994-2017 Suburban

20%

19%

15% 10% 5%

13%

0%

11%

-5%

9%

-10%

7%

-15%

5%

-20%

1994.1 1994.4 1995.3 1996.2 1997.1 1997.4 1998.3 1999.2 2000.1 2000.4 2001.3 2002.2 2003.1 2003.4 2004.3 2005.2 2006.1 2006.4 2007.3 2008.2 2009.1 2009.4 2010.3 2011.2 2012.1 2012.4 2013.3 2014.2 2015.1 2015.4 2016.3 2017.2

17% 15%

Source: CBRE Econometric Advisors, Q4 2017. 4


Downtown

Suburban

1994.1 1994.4 1995.3 1996.2 1997.1 1997.4 1998.3 1999.2 2000.1 2000.4 2001.3 2002.2 2003.1 2003.4 2004.3 2005.2 2006.1 2006.4 2007.3 2008.2 2009.1 2009.4 2010.3 2011.2 2012.1 2012.4 2013.3 2014.2 2015.1 2015.4 2016.3 2017.2

Office vacancy rates, 1994-2017

Industrial: Tailwinds will keep the sector in front of the pack Industrial performance

Industrial market opportunities

Industrial property returns averaged a robust 13.1% for 2017, the highest among traditional property sectors and the only sector to remain in double-digits. Typically this late in the economic cycle, investors begin to shy away from real estate sectors most exposed to growth. But this economic cycle is unlike any other in the past, especially for industrial real estate. The warehouse sector is operating in a cycle all on its own. Strong performance is buoyed by the strong secular trends of e-commerce and omni-channel retailing.

Low levels of available space and high demand provide the perfect conditions for another solid year in 2018. Investor interest in the sector has never been higher due to these favorable conditions and expected performance. Industrial investment sales were up 20% YoY in 2017, while all other major sectors saw moderate declines.

Availability rates held relatively steady in Q4 2017 at 7.4% which we believe will continue in 2018. The steep decline in availability rates from outsized demand for industrial space is finally being met with sufficient levels of new supply, which is evidenced by flattening availability rates in recent years. We anticipate availability rates will continue to flatten or eventually rise modestly, but not to levels that would put pressure on effective rent levels. Rents rose by 5% or more for the second consecutive year in 2017.

From a retailer’s perspective, an efficient supply chain is critical to omni-channel business operations. Today, rent accounts for less than 5% of supply chain costs. As transportation costs (~55% of supply chain costs) diminish with better technology, rents are positioned for growth at facilities located near large populations and close to customers. E-commerce sales represent approximately 9% of total sales today, and we expect that number to grow to 14% in the coming years, driving demand for warehouse space. The proliferation of online sales combined with new pro-growth legislation and a strong global economy will offer support for continued growth in the sector, generating new opportunities to invest.

Industrial availability rate, 1990-2017

Effective rent growth (YoY), 1990-2017

16.0%

8.0%

14.0%

6.0% 4.0%

12.0%

2.0%

10.0%

0.0%

8.0%

-2.0%

6.0%

-4.0% -6.0%

4.0%

0.0%

-12.0% 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

-10.0%



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

-8.0%

2.0%

Source: CBRE Econometric Advisors, Q3 2017

Retail: The view is becoming clearer for landlords and investors Retail performance

Retail market opportunities

Retail unlevered property returns averaged 5.7% for 2017, the fourth highest among traditional property sectors.

There is a growing divide between the performance of prime retail assets and those of lower quality and location. However, this gap is opening up a host of opportunities to invest in retail that is well positioned for growth where pricing is misunderstood by market participants.

Vacancy rates moved higher for the first time in 2017 since peaking at nearly 13% in 2010. Neighborhood and Community Center vacancy pushed up 60 bps YoY to 9.6% in Q4 2017. Despite the increase in vacancy over the year, retail conditions have improved and vacancy rates were low enough for landlords to push rents higher. Low levels of new supply will continue to support positive performance in 2018. The strongest YoY rent growth of this cycle was recorded at 3.1% in 2017. Landlords are increasingly confident in their ability to push rents on tenants who have weathered the wave of storms coming from e-commerce.

Retail availability rate, 1994-2017

At this point in retail’s transformation, landlords have a better understanding of how to manage their properties, tenant mix, and threats from online sales competition. Across the retail landscape, landlords and retailers are forming new partnerships and are aligning their interests in new ways to help protect and enhance the value of retail assets.

Effective rent growth (YoY), 1994-2017

14%

8%

13%

6%

12%

4%

11%

2%

10%

0%

9%

-4%

6%

-6% 1994.1 1994.4 1995.3 1996.2 1997.1 1997.4 1998.3 1999.2 2000.1 2000.4 2001.3 2002.2 2003.1 2003.4 2004.3 2005.2 2006.1 2006.4 2007.3 2008.2 2009.1 2009.4 2010.3 2011.2 2012.1 2012.4 2013.3 2014.2 2015.1 2015.4 2016.3 2017.2

7%



1994.1 1994.4 1995.3 1996.2 1997.1 1997.4 1998.3 1999.2 2000.1 2000.4 2001.3 2002.2 2003.1 2003.4 2004.3 2005.2 2006.1 2006.4 2007.3 2008.2 2009.1 2009.4 2010.3 2011.2 2012.1 2012.4 2013.3 2014.2 2015.1 2015.4 2016.3 2017.2

-2%

8%

Source: CBRE Econometric Advisors, Q3 2017

Multifamily: Markets are normalizing, but opportunities still exist Multifamily performance

Multifamily market opportunities

Apartment unlevered returns averaged 6.2% for 2017, the second highest among traditional property sectors. Garden apartments have continued to outperform the apartment subsectors, with returns of 8.9% in 2017 versus 4.7% for high-rise apartments. Appreciation returns on garden apartments bucked recent downward trends and have accelerated for two consecutive quarters.

Rents in low-rise garden apartments have marched higher over the past few years, outperforming their taller peers. This phenomenon is largely due to excess supply delivered in urban markets where mid-rise and high-rise projects are more prevalent.

Vacancy rates remained below 5.0% in 2017, finishing the year at 4.8% in Q4 2017. Under the weight of new supply, apartment vacancy held up better than many market participants would have guessed as stronger job growth led to better than expected household formations. Nevertheless, apartment vacancy rates moved modestly higher from the lows reached in 2015.

We believe this story will continue throughout the cycle. It will be easier for landlords to get higher rent bumps in markets with limited new supply, and that just happens to be in suburban metro areas. In select metro areas where luxury and Class-A high-rise and mid-rise apartments are seeing vacancy and rental rate pressure, there may be select buying opportunities to purchase quality assets on a relatively attractive basis.

According to CBRE-EA, effective rents were largely steady in 2017. A slight increase in vacancy rates and oversupply in some markets around the country put pressure on landlords‘ ability to raise rents. At this point in the cycle we are seeing supply weigh on rent growth. Most markets ended 2017 at pretty modest growth rates, or even declines. Apartment vacancy rate, 1994-2017 7.5%

10%

7.0%

8%

6.5%

6%

6.0%

4%

5.5%

2%

5.0%

0%

4.5%

-2%

4.0%

-4%

3.5%

-6% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

3.0%


Same-store effective rent growth (YoY), 1990-2017


-8%

Source: CBRE Econometric Advisors, Axiometrics, Q4 2017.

Capital markets: CRE fairly valued relative to bonds, but spreads declining Conditions remain healthy despite rising interest rates

Property price appreciation is expected to slow

A comparison of real estate yields to 10-year treasury bond yields suggests real estate still offers a healthy premium and is fairly priced. The current yield spread remains attractive compared to bonds and sits well above the spreads last seen during the years leading into the GFC. The yield spread to 10-year treasuries was 367 bps as of 4Q 2017, which is roughly on par with the average spread of 370 bps going to back 2002. But recent upward movement in bond yields has caused the spread to decline in recent months. The yield on the 10-year treasury hit a low of 2.06% in early September 2017, but has since risen by 80 bps to 2.86% as of early February 2018. Across property types, US real estate currently yields 5.4% in the major metropolitan areas and 6.1% across the country.

National property price indices all reported slowing appreciation returns in 2017. Green Street’s unlevered Commercial Property Price Index actually recorded a decline of -1% in 2017. Conversely, NCREIF’s unlevered NPI Index and Real Capital Analytics CPPI Index recorded price gains of 2.2% and 7.1%, respectively, in 2017.

Transaction volumes reached $463.9 billion in 2017, down 7% compared to 2016. While transaction activity is lower, prices have widely been maintained. At this stage of the cycle, buyers and sellers are resetting their expectations of future returns, which has widened the price gap between them. Despite the decline in volumes from their 2015 peak, 2017 sales still outpaced 2014 volumes and recorded the fourth highest level over the last 15 years.


2017

2015

2013

Equal Wtd CapRate

2009

2007

2003

2001

1995

2005

Sources: NCREIF, Bureau of Labor Statistics, Moody’s Analytics, Q4 2017.

2017

0%

2015

0%

2013

2% 2011

2% 2009

4%

2007

4%

2005

6%

2003

6%

2001

8%

1999

8%

1997

10%

1995

10%

8

Moody's Corporate Investment Grade Yield

12%

2011

Equal Wtd CapRate

1999

10-Year Treasury

12%

Real estate cap rate versus investment grade bond yield

1997

Real estate cap rate versus 10-year US Treasury yield

We anticipate cap rates will be flat or modestly higher in 2018 with appreciation returns being driven by NOI growth rather than a movement in cap rates. Investors shouldn’t count on appreciation returns at this point in the real estate cycle and should place greater priority on asset quality and income returns. Recent upward movement in bond yields will put some pressure on cap rates going forward, but our expectations are for further economic growth in 2018, supporting net operating income growth and the underlying prices of real estate.

Cities to watch: Los Angeles Tech-tainment takeover

Diversification driver Numerous cultures and backgrounds represented

•

Los Angeles took the lead as the largest US commercial real estate market in 2017 with over $28bn worth of sales transactions

•

As a mega metropolis, the Los Angeles-Long Beach-Anaheim MSA is home to over 13.5 million residents

High volume of imports at Port of Los Angeles and Port of Long Beach

•

Population in the MSA is expected to growth 0.69% p.a. through 2022

Millennial magnet

•

As a coastal champion, the metro shattered records in 2017 for imports at the Port of Los Angeles and Port of Long Beach. Deep San Pedro Harbor enables metro to handle megaships that other ports cannot

•

“Silicon Beach”, comprised of numerous coastal communities along the Pacific Ocean, is home to more than 500 tech startup companies

•

Noticeable evolution from traditional entertainment & media firms into technology-focused “tech-tainment” firms

•

Various top-tier universities including University of California Los Angeles, University of Southern California, and California Institute of Technology attract and retain young and fresh talent into the area

Coastal champion

Several universities attract young and fresh talent

Technology trailblazer

Various tech startup companies originated in the metro

Mega metropolis Metro area spans across over 4,800 square miles

Continental connected Major airports support connectivity within country and other continents

Culture capital Global links through entertainment and fashion

Sources: RCA, ESRI, Moody’s Analytics, TH Real Estate, Q4 2017. 9


Cities to watch: Chicago The windy education elitist •

Chicago was the fourth largest U.S. commercial real estate market in 2017 with over $17bn worth of sales transactions

•

Chicago-Naperville-Elgin MSA is home to over 9.8 million residents

•

Very deep talent pool with well-regarded universities such as University of Chicago, Northwestern University, and Illinois Institute of Technology

•

Over 22% of the population over 25 has obtained bachelor’s degree

•

Chicago’s central location and strong rail, road, and air infrastructure make the market an important Midwestern hub for industrial users

Diversification driver Differentiated employment base and industries represented in metro

Education elitist Home to various toptier universities

Millennial magnet Young, highly-educated employment base especially Downtown


Innovative, talent-rich business and tech hubs

•

Easily connected to rest of country. The metro can service nearly 40% of the US population within 2 days

•

Several relocations and expansions into city include tech giant Siemens with a new digital research and development hub downtown and online grocer Peapod relocating its headquarters downtown from suburbs

Mega metropolis

Various athletic teams such as NFL’s Chicago Bears, NBA’s Chicago Bulls, MLB’s Chicago Cubs and Chicago White Sox attract numerous visitors to the city each year

Continental connected

•

Home to numerous Fortune 500 companies

Central location in U.S. supports connectivity across country

Tourist trap Domestic and international visitors totalled 53.9 million in 2016

Sources: RCA, ESRI, Moody’s Analytics, Green Street Advisors, TH Real Estate, Q4 2017. 10


Cities to watch: New York Big shifts in the Big Apple •

New York is the financial capital of the world with over 590,000 employees in the industry alone

Diversification driver Colourful demographics and various employment opportunities

Tourist trap Multiple attractions capture millions of tourists each year

•

Manhattan was the second largest U.S. commercial real estate market in 2017 with over $23bn worth of sales transactions

•

New York City MSA has over 20 million residents, with 8.6 million people in NYC

•

Welcomed 61.8 million tourists in 2017, a 2% increase from 2016 as well as a new record

Attracts millennials and highly-educated individuals

•

There are 33 city-owned cultural institutions and ~200 other cultural facilities throughout the five boroughs


•

Over 38% of population over 25 has obtained a bachelor’s degree or higher

•

Opening of new “Cornell Tech” campus on Roosevelt Island will attract and retain young and fresh innovative talent

•

Top employers include: JPMorgan Chase & Co., Mount Sinai Medical Center, Macy’s Inc., and Citibank NA

•

Upcoming Hudson Yards development will add over 18 million square feet of commercial and residential space to the West Side

Millennial magnet

Increasing number of tech start ups becoming rampant across boroughs and metro

Mega metropolis Suburbs are growing with a MSA of over 20 million

Continental connected Three major international airports as well as several major ports

Culture capital Numerous cultural institutions and world-class entertainment selections

Sources: RCA, ESRI, Moody’s Analytics, TH Real Estate, Q4 2017. 11


Contact us Alice Breheny Global Head of Research T: +442037278122 E: [email protected]

Melissa Reagen Managing Director, Head of Research, Americas T: 212-916-6643 E: [email protected]

Shannon Wright Senior Director, Strategy & Research T: 212-916-6340 E: [email protected]

Dominic Toth Research Analyst T: 212-916-4304 E: [email protected]

Sara Rothman Research Analyst T: 212-916-4281 E: [email protected]

Daniel Manware Research Analyst T: 212-916-6542 E: [email protected]

John Philipchuck Director, Strategy & Research T: 312-507-7523 E: [email protected]

www.threalestate.com [email protected] @THRealEstate14

Important information This document is intended solely for the use of professionals and is not for general public distribution. Past performance is no guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. Any investment will be made solely on the basis of the information contained in the Prospectus or offering documents (including all relevant covering documents), which will contain investment restrictions, risks and fees. This document is intended as a summary only and potential investors must read the Prospectus or other relevant offering document before investing. Any assumptions made or opinions expressed are as of the dates specified or if none at the document date and may change as subsequent conditions vary. In particular, the document has been prepared by reference to current tax and legal considerations that may alter in the future. This document is not directed at or intended for any person (or entity) who is citizen or resident of (or located or established in) any jurisdiction where its use would be contrary to applicable law or regulation [or would subject the issuing companies or products to any registration or licensing requirements]. TH Real Estate is a name under which Nuveen Real Estate Management Limited provides investment products and services. Issued by Nuveen Real Estate Management Limited (reg. no. 2137726), (incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3BN) which is authorized and regulated by the Financial Conduct Authority to provide investment products and services. Telephone calls may be recorded and monitored. TH Real Estate is a real estate investment management holding company owned by Teachers Insurance and Annuity Association of America (TIAA). TH Real Estate securities products distributed in North America are advised by UK regulated subsidiaries or Nuveen Alternatives Advisors, LLC, a registered investment advisor and wholly owned subsidiary of TIAA, and distributed by Nuveen Securities, LLC, member FINRA. TH Real Estate is an investment management holding company owned by TIAA. This material is intended exclusively for investors who are “qualified purchasers” as defined in the Investment Company Act of 1940. For institutional investor use only. Not for use with or distribution to the public. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Financial professionals should independently evaluate the risks associated with products or services and exercise independent judgment with respect to their clients. 437363-G-INST/MED-O-03/19 12
