[User] TIGHT MARKET CONDITIONS ATTRACTING INVESTOR INTEREST The medical office market has performed well in recent years, registering a lower peak vacancy rate than traditional office properties during the 2008 recession and showing a steady decline in vacancy since that time.

[Assistant] Deliveries of new medical space have also been low relative to pre-recession levels, and medical space currently under construction has decreased slightly from the recent Q2 2016 peak. This construction trend is expected to continue in 2018, with tenant demand supporting the amount of new supply and rents remaining stable. Cost pressure has also resulted from an increase in M&A activity in recent years, with large health care systems acquiring smaller physician groups and solo practices. Reimbursement and regulatory pressures, along with the high cost of acquiring and implementing new technologies, have contributed to this continuing trend. Modern, technologically-enabled medical office buildings capable of facilitating communication between multiple teams of providers will likely benefit from the continued growth of large health care systems. Buildings near large patient populations and that are well-equipped to offer specialized services (e.g., dialysis centers, ambulatory surgery centers, etc.) are also poised for strong user and investor interest. continuing to acquire smaller physician groups and solo practices, potentially dampening demand for smaller medical office buildings and condos.


[User] Overall, we expect demand for medical office buildings to grow, fueled by continued health care job growth, the aging population, tight market conditions and the relative recession- resistance of these properties. These factors will attract even more investors in the years ahead.

[Assistant] Investment trends reflect strong medical-office market fundamentals and a broadening pool of interested investors. DEMOGRAPHICS OUTWEIGH POLICY UNCERTAINTY While uncertainty about health care policy poses a risk to the medical office market, favorable demographic trends point to continued strong health care demand, regardless of any policy changes. MEDICAL OFFICE INVESTMENT VOLUME AND CAP RATES Note: Data includes only closed sales and excludes entity-level transactions. Source: Real Capital Analytics, Q3 2017. SENIORS HOUSING SENIORS HOUSING care—are not yet benefiting from baby boomer demand. Seniors housing occupancy rates will likely edge up in the coming year, and rent growth should stay around the current 2.6% annual rate. MARKET FUNDAMENTALS TO IMPROVE IN 2018 The seniors housing market improved modestly in 2017 and is set to improve further in 2018, largely due to lower construction.


[User] After peaking in early 2016, under-construction levels began falling and should further decrease in 2018. Construction starts also declined in the past two years, promising fewer completions in 2018.

[Assistant] however, baby boomers are creating demand now, making this segment particularly appealing. CBRE INVESTOR SURVEY REVEALS SUSTAINED INVESTOR APPETITE FOR 2018 Strong investor appetite for seniors housing was evident in CBRE’s fall Seniors Housing & Care Investor Survey,12 with 60% of respondents expecting to increase their exposure to seniors housing next year. Only 6% expected to decrease their exposure. Property-level operating costs eclipsed construction activity as investors’ top concern in the fall survey. Construction activity (supply-demand fundamentals) was the second-highest concern. October, acquisitions totaled $13 billion—up 8.6% from the same period in 2016. Based on investor sentiment and market fundamentals, we expect the volume of seniors housing acquisitions to rise modestly in 2018. If the amount of product coming to market is limited, however, the expected increase may not occur. The dominance of portfolio sales is the other significant variable in seniors housing investment. In 2016 and 2017 combined, 61% of seniors housing investment activity occurred via portfolio sales (compared to 20% for conventional multifamily).


[User] Institutional capital’s interest in the seniors housing sector has been rising for a few years (due in part to higher yields) and its market share rose to about 31% in 2017 from 29% in 2016.

[Assistant] While cross-border capital represented only 5% of 2017 investment (based on the year-to-date total through October), it is expected to increase in the years ahead. In particular, we expect Chinese investors—the largest offshore capital source in 2017—to increase their investment in seniors housing over the near term. For health care-focused assets, proposals for health care reform and legislative changes to Medicare and Medicaid generated considerable concern in 2017. These concerns will return to center stage in 2018 should reductions in Medicare and Medicaid funding be re-proposed. The nursing care segment will continue to seek new revenue sources, including expanded rehab facilities.


[User] LIHTC Immediately Impacted That important exception is the low income housing tax credit (LIHTC) market. The lowering of overall corporate tax rates has materially changed the LIHTC market, with the value of the tax credits being diminished. As a reaction to the presidential election, and the expectation that the Trump Administration would lower corporate tax rates, prices for LIHTC began to decline in November 2016, according to data from Novogradac & Company, LLP. Put simply, a lower corporate tax rate means the value of the tax credit element of a LIHTC is diminished, along with its pricing, as illustrated in the chart below.

[Assistant] Low Income Housing Tax Credit Equity Pricing per Credit (January 2016 – December 2017) Source: Novogradac & Company, LLC As a result, Novogradac believes that since “…2017 tax credit equity pricing was widely based on a 25 percent corporate tax rate underwriting assumption… the enacted 21 percent will lead to an additional decline of about 3 percent in affordable rental home production and preservation. The aggregate decline of housing production and preservation per dollar of tax credits attributable to the decline in the corporate tax rate is anticipated to be about 14 percent.” month moving average


[User] of 3 Another major change for LIHTC projects involves those with foreign owners or affiliates. According to Novogradac, the TCJA resulted in an altered tax scheme for foreign companies, as well as domestic companies with major foreign components: “The alternative tax calculation subjects companies to a potential base erosion and anti-abuse tax (BEAT). The BEAT is intended to establish a minimum tax level for certain foreign investors. The BEAT tax rate is 5 percent in percent in 2019 to 2025, and 12.5 percent after 2025.” For a LITHC investor subject to the BEAT, the BEAT has the potential to erode “the benefit from the LIHTC by up to 20 percent through 2025, and up to 100 percent thereafter” and “roughly one-half of the tax benefits from tax losses.” Thus, the BEAT could negatively impact the appetite of certain LIHTC equity investors.

[Assistant] Early Proposals Were Concerning for Multifamily The TCJA impact is expected to be neutral at worst and positive at best for the multifamily sector. While there were early concerns about drastic changes to interest deductibility and depreciation rules, the final reforms were quite marginal, with special consideration for real estate investment being part of the final legislation. And with the overall corporate tax rate having been significantly reduced, investors in commercial real estate should experience mostly positive results. Several of the early tax reform proposals could have upended the multifamily market. One of the most concerning was the potential elimination of 1031 Exchanges. A 1031 Exchange is a tax deferral strategy to delay payment of taxes on capital gains from the sale of property. The rules allow for investors to defer tax payments if sale proceeds are invested in a legally similar asset within a specified time frame. A substantial portion of apartment building sales utilize 1031 Exchanges each year, and its elimination could have caused apartment buildings to be both less liquid from an investment perspective and more expensive to buy and sell due to the taxable event. Fortunately for commercial real estate investors, 1031 Exchanges were unchanged by the TCJA, though they were eliminated for certain non-real estate personal property. Several Positive Changes for Some Multifamily Investors One of the most important changes for the multifamily sector resulting from the TCJA is the change to interest deductibility. While the rules for interest expensing were changed for many corporations, an exception was included that allows companies that are primarily real estate operators to fully deduct the interest they paid from their income. There are conditions that have to be met for real estate companies to qualify for this exception, as well as a requirement that companies use a longer depreciation schedule, but these changes should not dramatically change the cost of owning or operating a rental apartment building. An additional element of the TCJA that should lower the tax bill for multifamily investors is a 20 percent deduction for individuals for qualified business income earned through “pass-through” entities. “Pass-throughs” are common legal structure and includes partnerships, S corporations, and sole proprietorships, structures that can be used by multifamily equity investors. For example, many real estate investment trusts are organized as pass-through entities. And the 20 percent of 3 deduction allows real estate investors to deduct a portion of their commercial real estate income from their individual income taxes. In addition, according to a January report from Goodwin Proctor, LLP, investors in a real estate investment trust (REIT) can also deduct “up to 20 percent of most ordinary REIT dividends and qualified publicly traded partnership income. When the full deduction is available, it reduces the top effective rate on such income (before any additional 3.8 percent Medicare tax) to 29.6 percent.” Other Changes with Potential Impact Other than the impact to LIHTC, there are other TCJA changes that could potentially complicate investing in multifamily. One example is the change to the length of time that an equity investor or partnership manager must hold on to an asset to receive favorable capital gains tax treatment. These “carried interest” investments must now be held for three years before sale, instead of one year, in order to qualify for the lower capital gains tax rates rather than higher ordinary income tax rates. Although this longer hold time should not negatively impact real estate investors with a long-term hold strategy, it will likely affect those investors with assets that gained significant appreciation in just a year or two, as well as “flippers,” those investors that buy properties, renovate them, and then quickly re-sell them at a profit. Conclusion If tax rates had not been reduced, some of the TCJA’s changes could have made it more expensive to be an investor in the multifamily market. But the significant reduction in corporate tax rates will likely overwhelm virtually all of the subtle changes in the underlying economics of apartment building tax strategies. Furthermore, the lack of changes to 1031 Exchange rules likely means that this acquisition strategy should not be significantly altered by the TCJA. While the Internal Revenue Service is expected to issue a substantial amount of rulemaking regarding many elements of the TCJA over the coming months, and there remain lingering concerns regarding the limits on state, local, and real estate tax deductions being scaled back for individuals, the newly-reduced tax rates should result in lower tax bills for the great majority of multifamily investors. Overall, we believe it is unlikely that the TCJA’s reform will negatively impact the income potential for buying, selling, financing, owning, operating, building, or rehabilitating most market-rate multifamily properties.


[User] of 5 Economic Growth Expected to Slow and Housing to Stabilize in 2019 The U.S. economy is expected to grow 2.6 percent annualized in the fourth quarter, a slowdown from the 3.5 percent rate of growth in the prior quarter, as growth in consumer spending moderates. For all of 2018 we project economic growth to reach 3.1 percent, the fastest pace of the current expansion, before slowing to 2.3 percent in 2019 as the boost from federal fiscal policies wanes, the trade deficit widens, and growth in business investment slows.

[Assistant] In the face of slower economic growth and the absence of a break-out in inflation, we expect both mortgage rates and home sales to stabilize. The rise in for-sale inventories to date should contribute to a moderation in home price appreciation, which we forecast to be 5.4 percent in 2018 and 4.1 percent in 2019. Purchase mortgage originations are expected to climb over 2 percent in 2019 but refinance originations should fall nearly 11 percent, resulting in a small decline in total originations to $1.605 trillion. Increases in government spending and business fixed investment are expected to be positive contributors to economic growth in the fourth quarter. However, our forecast of fourth quarter business fixed investment was revised downward partially in response to softness in core capital goods orders and lower oil prices. Continued growth of business investment is key to sustaining the expansion. Over the fourth quarter, we now expect residential investment to be a drag on the economy as we downgraded our home sales and housing starts projections. We also anticipate that trade will likely drag on growth for the second consecutive quarter. The labor market should continue to improve in 2019, with sufficient job growth to bring the unemployment rate lower than in 2018. Our outlook for mortgage originations suggests that lender margins will remain under pressure in 2019 and we will likely see further consolidation. Key risks to our forecast include the uncertainty from trade negotiations between the U.S. and China, the trajectory of oil prices, and stock market volatility. Consumer Spending Growth Strengthens Consumer spending accounted for the largest contribution to headline gross domestic product (GDP) growth in the third quarter. Incoming data suggest that it will continue to play a leading role in the fourth quarter. Real personal consumption expenditures (PCE) rose by 0.4 percent in October, the largest monthly gain since March, with broad-based gains across durable and non-durable goods as well as spending on services. Light vehicle sales slipped slightly in November following a modest rise in the prior month. Since 2015, sales of light vehicles have remained relatively steady, despite rising interest rates. Looking “under the hood,” the stability in light vehicle sales reflects growth in sales of light trucks amid declining auto sales. Light vehicle sales could come under pressure if short-term interest rates continue to climb, raising financing costs. Consumer confidence remains near an 18-year high, despite a small dip in November. Confidence in the present situation rose to a level that was just shy of the expansion high set in August. However, these gains were offset by a slight dampening in expectations for the next six months. The drop in the expectations component was led by a decline in the net shares of consumers expecting improving business conditions and incomes. These results suggest that the trade tensions between the U.S. and China, as well as stock market volatility, so far have had a minor impact on consumer confidence. Government Spending Will Contribute to Growth Increases in local, state, and federal spending contributed to headline GDP growth in the third quarter. The spending and investment support at the federal government level is due in large part to the Budget Reconciliation Act passed earlier this year. Its positive effects on GDP growth are expected to peak this quarter and wane in 2019 through the first half of 2020 before subtracting from growth in the second half of 2020.


[User] of 5 Business Fixed Investment Growth Expected to Tick Up Despite an upward revision in the second estimate of third quarter GDP, business fixed investment growth still slowed markedly. The minutes from the November Federal Open Market Committee (FOMC) meeting revealed that some participants cited anecdotal evidence of higher tariffs and uncertainty about trade policy, slowing global demand, rising input costs, and rising interest rates as possible culprits behind the deceleration in business fixed investment growth. Despite these concerns, encouraging news in the manufacturing sector bodes well for business fixed investment growth this quarter. The Institute for Supply Management manufacturing index rose in November, indicating a faster pace of expansion than in October. Higher readings on new orders, production, employment, and inventories all contributed to the uptick in the headline reading; supplier deliveries was the only subcomponent to register a monthly decline. Small business sentiment has trended down from its record high in August, though it remains historically elevated. Several factors may restrain business fixed investment growth in the near term. Core capital goods orders, the forward- looking indicator of equipment spending, were unchanged in October after two consecutive drops in the prior months.

[Assistant] Spending on structures related to oil and exploration will likely be constrained by lower oil prices. Additionally, many of the risks cited by participants at the last FOMC meeting are unlikely to be resolved soon and may delay investment in business projects.


[User] By contrast, estimates that there are only 3,100 properties in Los Angeles that have 50 or more apartment units each. However, with the average property containing an estimated 126 units, this relatively small number of larger properties represents about 37 percent of all multifamily units in Los Angeles. Interestingly, units in both types of properties are similar in size, averaging about 800 square feet, according to . Steady Increase in Sales Volume As shown in the chart below, since the end of the Great Recession, the sales volume of small multifamily properties in Los Angeles has been rising slowly but steadily. In 2017, the last full year of data, sales of existing small multifamily properties totaled about $3.3 billion on just under 650 properties, averaging about 21 units per property, according to Real Capital Analytics (RCA). However, while this represents an increase of about 38 percent in sales volume since 2009, it is only a 20 percent increase in the number of sales, reflecting the fact that many of these properties are owned by individual operators who tend to hold on to them as longer term investments.

[Assistant] of 6 Sales will likely be incrementally higher this year as the sales volume totaled an estimated $2.9 billion on just over 520 properties for the first nine months of the year. The average sales price per unit has grown by nearly 50 percent since 2010, to about in 2018, reflecting the increasing interest in this asset class by investors in Los Angeles County.


[User] Great Variation in Sales Prices Sale prices of individual small multifamily properties sold since January 1, 2017 have varied greatly. Perhaps surprisingly, the highest overall sales price for a small multifamily property was not in Malibu or Beverly Hills, but in the East Los Angeles/Long Beach submarket. According to RCA, Greentek Investments purchased the 47-unit mid-rise 608 Westlake Apartments in June 2018 for $31.5 million. The highest average prices per unit were still found in Beverly Hills, Malibu, and Santa Monica, however. The lowest sales price reported by RCA was for the six-unit 2743 Fairmount Avenue in Los Angeles, which sold for an estimated $1 million.

[Assistant] Cap Rates Remain Tight Cap rates for all types of multifamily in Los Angeles have been falling since the end of the Great Recession due to healthy job growth coupled with continued low interest rates. As shown in the chart to the right, cap rates on small multifamily properties fell to 4.1 percent in 2017 from 5.6 percent in 2009. Cap rates for small multifamily properties have generally been slightly below cap rates for larger properties. While cap rates inched up in the first nine months of 2018, they remain low at an estimated 4.2 percent and remain slightly below the 4.4 percent recorded for larger multifamily properties. Share of Los Angeles County Small Multifamily Properties by Investor Type (As of November Source: Real Capital Analytics Note: Properties and portfolios $2.5 million and greater 94% Institutional Private Other <unknown> Q3 2018 Small Multifamily Large Multifamily Small vs. Large Multifamily Average Cap Rates in LA County Source: Real Capital Analytics Note: Properties and portfolios $2.5 million and greater


[User] of 5 Fiscal Policy and the Fed: Stimulus/Response Late last year, the President signed the Tax Cuts and Jobs Act into law. Most economists upgraded their economic growth forecasts when they incorporated the impact of a likely or final tax cut bill. For example, more than 90 percent of economists who participated in the Wall Street Journal monthly survey said in January that the tax cuts would increase economic growth over the next two years, similar to their thinking in earlier months when details of the legislation began circulating. Between October and January, the average forecast for 2018 real gross domestic product (GDP) growth is 0.3 percentage points higher, from 2.4 percent to 2.7 percent. Results from the January Blue Chip survey also showed the same expected growth bump during the same period.

[Assistant] The rationale for the improved outlook is that cuts in individual tax rates should help spur consumer spending, while reductions in corporate tax rates and the allowance for equipment investment to be fully expensed for five years are expected to boost business equipment spending. The biggest threat to continued economic expansion cited by Blue Chip respondents is a faster-than-expected rise in interest rates stemming from either higher inflation or a policy mistake by the Federal Reserve. This concern is based on a belief in a tradeoff between employment and inflation—the so-called Phillips Curve. In our view, this tradeoff has little empirical support in recent decades, and thus aggressive monetary tightening intended to preempt inflationary pressure may do more harm than good. History tells us that managing a “soft landing” has been a quite difficult task for policy makers, and the Fed’s reaction to the Tax Act is key to the expansion that is expected to reach its ninth anniversary this June. Thus, our theme for 2018 is “Fiscal Policy and the Fed: Stimulus/Response.” The extent to which stimulative fiscal policy will accelerate growth, and the resulting impacts on the unemployment rate and inflation, are subjects of considerable debate among economists. Although the expansion appears to be late in the business cycle, with the unemployment rate near historical lows, we believe that the labor market contains more slack than suggested by the unemployment rate. The tax bill should create demand for labor, leading to tighter labor market conditions and accelerating wage growth, which should draw more prime-age (25- to 54-year-old) workers into the labor force. The prime-age labor force participation rate has been trending up over the past year but remains well below the pre- recession level, suggesting an untapped reservoir of labor not reflected in the very low unemployment rate. We also expect the tax bill to lead to stronger growth in business equipment investment, which is key to stronger productivity growth. Productivity growth has been anemic on average in the current expansion. However, amid robust growth in equipment investment last year, productivity growth has started to rise from a very depressed rate. Stronger productivity growth, even in the midst of rising compensation, should keep labor costs, core inflation, and inflation expectations contained. Therefore, we believe gradual monetary policy normalization can be consistent with stronger economic growth and a longer expansion. We revised higher our economic growth forecast for 2018 by 0.6 percentage points to 2.7 percent and for 2019 by 0.5 points to 2.3 percent. The improved outlook stems largely from stronger anticipated consumer spending and business equipment investment, which are expected to be partially offset by faster import growth. The unemployment rate is projected to average 3.7 percent in the second half of 2019, three-tenths lower than in the prior forecast and the lowest level in fifty years. However, we expect inflation to remain subdued, due to an anticipated increase in labor supply and a continued pickup in productivity growth from increased capital expenditures that '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 Labor Force Participation Rate (SA, %) Prime-Age Labor Force Participation Rate Has More Room to Run 16 Years and Older 25-54 Year Olds (Right Axis) -2.0% 0.0% 2.0% 4.0% 6.0% '85 '90 '95 '00 '05 '10 '15 Total Nonfarm Productivity (Y-o-Y % Change) Productivity Shows Signs of Life


[User] of 5 should help offset rising worker compensation. We project the annual increase in the Fed’s favored measure of inflation, the Personal Consumption Expenditures Deflator, to remain below the Fed’s two-percent target throughout 2018.

[Assistant] The corporate tax cut should be a boon for business equipment investment. During the third quarter, business investment in equipment posted the strongest quarterly increase in three years. Incoming data suggest it ended 2017 on a strong note, setting the stage for continued acceleration this year amid very high business confidence. While small business confidence edged down in December, the average reading for all of 2017 set a record high since the monthly survey from the National Federation of Independent Business (NFIB) began in 1986. The tax bill should encourage businesses to accelerate capital expenditures, especially given that the 100-percent expensing will expire in five years and will be phased out over the subsequent five years. However, the lowering of the corporate income tax rate to 21 percent from 35 percent also makes the deduction less valuable, countering some of the benefits. We expect little investment impact from the one-time repatriation tax on accrued foreign profits, as past experience suggests that repatriated cash will likely be used for dividends and share buybacks. On the individual taxpayer front, because the tax bill also changed deductions (e.g., doubled the standard deduction and placed a $10,000 cap on combined state and local tax (SALT) and property tax deductions), its impact on final tax payments could vary significantly among households across the nation. Meanwhile, taxpayers can choose to spend the increased disposable income, save it, or use it to pay down debt. Thus, it is difficult to estimate how consumers will react to the windfall. Using the impacts of the 2001 and 2008 tax cuts as a guide, we expect real consumer spending growth to pick up by two-tenths in both 2018 and 2019, to 2.7 percent and 2.5 percent, respectively. The saving rate, which dipped three-tenths in November to the expansion low of 2.9 percent, should trend up as a result of the tax bill. Thus, while the tax cut may not boost consumer spending substantially because some taxpayers will choose to save the windfall or use it to pay down debt, it would help provide a savings cushion for rainy days and strengthen household balance sheets. The labor market ended 2017 on a relatively subdued note, with nonfarm payrolls increasing in December, weakening from the strong back-to-back gains following hurricane disruptions. A small net downward revision for the prior two months put the three- month average gain at . The survey of households was also uninspiring. The unemployment rate and the labor force participation rate were unchanged at 4.1 percent and 62.7 percent, respectively, and the broadest measure of labor underutilization, the U-6 rate, edged up one-tenth to 8.1 percent. of 5 Other aspects of the establishment survey also disappointed. The average workweek was unchanged at 34.5 hours, and average hourly earnings rose 0.3 percent from November and 2.5 percent from a year ago, near the lower end of the 2.4 percent to 2.8 percent range witnessed throughout the year. We believe that wage gains will accelerate this year given a shortage of skilled labor. The December NFIB survey showed that the share of small business owners with few or no qualified applicants for open positions surged 10 percentage points to 54 percent—a record high. For all of 2017, the economy added 2.2 million jobs, marking the seventh straight year with over two million jobs created. We expect another year of more than two million in payroll gains this year, with an average monthly gain of about 10,000 more than in our prior forecast. One bright spot in the December jobs report was the biggest monthly rise in residential construction employment of 2017, raising hopes for some supply relief for housing this year.


[User] The Fed Will Likely Remain Cautious At the December Federal Open Market Committee (FOMC) meeting, the Federal Reserve raised the fed funds rate 25 basis points. The Fed appears to be counting on modest, synchronized global growth to continue as they attempt to get some distance between a zero percent short-term rate and the current policy rate. The shrinkage of the balance sheet, another measure of monetary policy normalization, continues as expected. The Fed also released its updated Summary of Economic Projections (SEP), which revealed a slight upgrade for growth expectations for 2018 and 2019 and a lower unemployment rate forecast. While final details were not known when the FOMC met in December, the tax bill under consideration at the time was quite similar to the final enacted tax legislation. The updated SEP “dot plot” implied that FOMC members expect three rate hikes in 2018, the same as in the September projections. We believe that the Fed will wait for evidence of increased inflationary pressure before responding with a faster pace of rate increases.

[Assistant] We expect the Fed to hike in March and in September of this year; however, a third rate increase this year is quite possible. Housing Roundup The Tax Act will create winners and losers in the housing market. While the individual tax cut should boost housing demand by increasing disposable household income, the tax bill reduces the incentive for homeownership by doubling the standard deduction, reducing the mortgage debt cap on which homeowners may take a mortgage interest deduction to from (with loans made before December 14 being grandfathered in), and limiting SALT and property tax deductions to a total of $10,000. As a result, the bill will lead to substantially fewer itemized returns. Looking back, housing activity through November was upbeat across the single-family segment. Both single-family starts and permits rose in November to the highest levels in more than a decade, while homebuilder sentiment surged to an 18-year high in December. Through the first 11 months of 2017, single-family housing starts were 8.7 percent more than during the same period in 2016. Meanwhile, multifamily building has clearly peaked, as year-to-date multifamily starts through November were 8.2 percent below their 2016 level.


[User] multifamily sector has had a solid run since 2010, with increasing rent growth and low vacancies.

[Assistant] Key fundamentals have propelled the multifamily sector over the past few years: favorable demographic trends, continued job growth, and increasing renter household formations. There are more than 80 million Millennials, making them the nation’s largest population cohort, according to the Census Bureau, and this is the cohort that is expected to continue driving demand for housing, including multifamily rental housing, over the next few years. Demand remained positive in 2017, but that was not the case everywhere. Too much supply of Class A units in some of the nation’s major metropolitan areas resulted in lower rent growth and rising vacancies. In 2018, the national vacancy rate is expected to increase slightly, and, while rent growth should remain positive, it is expected to grow at a more modest pace. Nevertheless, the outlook for the national multifamily sector is that it should remain fairly stable in 2018.


[User] Net Absorption – Continued Slowdown Expected Demand for multifamily rental units remained positive throughout 2017. Net absorption likely totaled about +units absorbed, according to data from . expects net absorption in 2018 to remain positive, although at a lower level than last year, possibly falling to about +units absorbed.

[Assistant] Net absorption is expected to improve beginning in mid-2019, as seen in the chart above. of 7 Vacancy Level Expected to Keep Increasing The national multifamily vacancy rate is expected to rise in 2018, primarily due to the onslaught of new supply expected to complete and come online over the next 12 to 18 months. Since most of this new supply is concentrated in a limited number of submarkets in only about 12 metros, supply is expected to continue outpacing demand in these metros, thereby pushing the national vacancy rate upward, as illustrated in the chart above. The vacancy rate is likely to return to more historical levels and then remain fairly stable further out into the forecast, due to ongoing favorable future job growth and demographic projections. multifamily vacancy rate will remain in the 5.5 percent range during the early part of 2018, from 5.25 percent as of third quarter 2017, and could end the year in the 5.75 to 6.0 percent range. This would bring the national vacancy rate nearer its recent historical average of 6.0 percent. Rent Growth Expected to Remain Fairly Stable Rent growth was positive but likely ended 2017 at about 2.5 percent, slightly ahead of the pace of inflation, which grew 2.2 percent year over year as of the end of November 2017. There has been above average rent growth since 2011, and 2017 was the first time since then that the national estimated rent growth was below 3.0 percent. The expectation for 2018 is that rent growth will once again be positive but is likely to moderate and range from 2.0 percent to 2.5 percent.


[User] In addition, national Class C rent growth in 2017 was at 2.2 percent according to Axiometrics, compared to just 1.7 percent for Class A, indicating that property owners are offering more generous concessions up front for Class C units to lock in higher rents.

[Assistant] As more new supply comes online this year, the national concession rate is expected to increase, and more dramatically in certain metros that are in the midst of an oversupply of Class A units. Yet, some property owners are already starting to forego offering larger concessions and are just dropping asking rents. For example, the New York metro concession rate is well above the national average at -1.3 percent as of December 2017, but its rent growth is also negative at -0.5 percent. And rent growth is even worse for its Class A segment, at -1.0 percent, according to data from Axiometrics. of 7 Multifamily New Supply Expected to Peak in 2018 As seen in the chart on the following page, the amount of multifamily new construction remains elevated, with deliveries expected to peak in 2018.


[User] According to the Dodge Data & Analytics SupplyTrack data, which distinguishes between multifamily properties consisting of apartment and condo units, about apartment units were completed in 2017, with another units expected to come online in 2018. In comparison, only about 59,000 condo units came online in 2017 and there are only about 64,000 condo units expected in 2018. The biggest concern for the multifamily sector is that most of the new apartment rental supply underway is believed to consist of Class A units, which command the highest rent level. But in many metros, it is these Class A units that are already starting to experience declining rents. of 7 The reason that level of multifamily rental demand is not likely to occur is because much of the new supply is primarily concentrated in about 10 to 12 metros, as seen in the chart below, and most of that is further concentrated in certain submarkets.

[Assistant] And the estimated amount of national job growth, and its anticipated accompanying demand, is not going to be concentrated in just a handful of metros, which is why supply is expected to outpace demand in many of these metros over the next 12 to 18 months. Job Growth Slowing in Some Metros with New Supply Although the nation is expected to see positive job growth this year, that doesn’t mean that all metros will experience the same level of employment growth, as illustrated in the two charts below. The New York metro is expecting the largest amount of new supply, with more than 59,000 units underway, of which 45,000 units are expected this year alone. Based on its lackluster anticipated job growth rate, at best the metro could produce demand for only about 23,000 multifamily rental units. Boston has nearly 21,000 units underway, of which nearly 15,000 units are expected to deliver in 2018. Based on an anticipated job growth rate of just 1.2 percent, potential multifamily demand of about 4,100 units will fall far short of upcoming supply. Washington, DC has more than 21,000 units expected Multifamily Apartment Units Underway – Select Metros - Thousands Beyond Source: Dodge Data & Analytics, January 2018 – Metros with 4,000 or more units underway or completed.


[User] of 7 to come online this year, yet anticipated job growth of 1.2 percent will at best produce demand for just 10,000 units.

[Assistant] As a result, all three of these metros began experiencing negative rent growth during the latter part of 2017 and will likely continue to do so in 2018. Other Metros Possibly Undersupplied Job growth in other metros is expected to fare better, as seen below. Some of the Florida metros, including Jacksonville, Orlando, Tampa, and Miami, are expected to far surpass the national average. Dallas and Austin are expected to see job growth of more than 2.0 percent due to continued expansion in the professional services, technology, healthcare, and transportation sectors.


[User] At 3.2 percent, Jacksonville has one of the highest projected job growth rates in the nation.

[Assistant] The metro could easily produce demand for a minimum of 3,600 units, yet fewer than 1,800 units are expected this year. Las Vegas is even more compelling. With expected job growth of nearly 3.0 percent, there could be demand for at least 6,000 units, yet only about 3,000 units are expected to come online in 2018. Phoenix is another “good news” story, with anticipated job growth of 2.6 percent. That could produce demand for at least 10,000 units, yet only about 8,000 units are expected this year. of 7 Cap Rates Likely to Remain Low With multifamily cap rates at historically low levels – currently 5.6 percent, according to Real Capital Analytics – it would seem that they have nowhere to go but up. But with the passage into law of the Tax Cuts and Jobs Act of 2017, will they? Multifamily cap rates have remained in the 5.6 percent range for most of 2017 due to the ongoing influx of capital flows and investor demand. With interest rates also staying low and real estate investment expected to get a boost from the recent tax cut legislation, it seems likely that investors will stay interested in the multifamily sector as well. In fact, according to a November article in National Real Estate Investor, the multifamily sector remains “… a favored property type among commercial real estate investors. When asked to rate the attractiveness of the different core property types on a scale of 1 to 10, [NREI] survey respondents scored multifamily the highest at 7.9….” As a result of this anticipated investor interest, while an uptick in new multifamily construction investment is not expected due to oversupply concerns in many submarkets, investment in existing multifamily properties is expected to remain on par with 2017 levels. Therefore, the projection is that multifamily cap rates are likely to remain stable in 2018. of 7 2018 Outlook: More of the Same The outlook for the multifamily sector in 2018 remains positive but relatively stable. Multifamily mortgage origination volume levels are expected to remain similar to, or slightly lower than, 2017’s activity levels. The Mortgage Bankers’ Association anticipates multifamily originations volume to reach $258 billion, down compared to its estimated $271 billion for 2017.


[User] The amount of new supply expected to come online this year is mostly located in about 10 to 12 metros, some of which are likely to experience a slow-down in demand due to upcoming oversupply.

[Assistant] While there should be job growth spurring continued rental household formations, this concentrated amount of supply – consisting primarily of Class A units – will likely cause a disruption in underlying fundamentals in certain metros. Rising vacancy levels and reduced or negative rent growth could occur in certain submarkets, which in turn is likely to negatively affect overall trends in the nation’s oversupplied metros. It is important to keep in mind that this slowdown is expected to be short-lived, occurring over the next 12 to 18 months. After that time, we expect that the multifamily sector’s underlying fundamentals will improve, as new supply slows and stable job growth and demographic trends continue, resulting in increased demand.


[User] of 5 The Tax Act Boosts Corporate Profits Revisions to gross domestic product (GDP) for the second quarter were uneventful. However, corporate profits, a new piece of data, revealed the improving underlying health of businesses, even absent the recent tax benefits and despite tightening labor markets. Pre-tax profits grew 3.3 percent in the second quarter (not annualized), accelerating from a 1.2 percent gain in the first quarter and marking the strongest quarterly pace in four years. Domestic profits from both the financial and nonfinancial sectors outweighed a decline in overseas profits. On an annual basis, after-tax profits spiked during the first half of this year, a testament to the impact of the large corporate tax rate cut included in last year’s tax act. The biggest quarterly increase in productivity growth in three years of 2.9 percent annualized helped keep unit labor costs contained during the second quarter. However, productivity growth tends to be volatile from quarter to quarter. On an annual basis, productivity grew 1.3 percent during the second quarter, remaining within the tight range of 1.0 percent to 1.4 percent seen since the end of 2016.

[Assistant] Going forward, rising labor and material costs, increasing interest rates, and a flattening yield curve will likely compress domestic profit margins. At the same time, a strengthening dollar and moderating global growth should weigh on overseas profits. Strong Labor Market Continues to Support Consumers Hiring improved in August, with nonfarm payrolls increasing . Despite downward revisions totaling 50,000 in the prior two months, the three-month average job gain came in at a solid . The big news in the jobs report was the 0.4 percent jump in average hourly earnings from July and 2.9 percent from last August, the biggest annual rise since June 2009. The household survey showed a flat unemployment rate at 3.9 percent, but the broadest measure of labor underutilization (U6), which includes discouraged workers and those working part-time for economic reasons, fell one-tenth to 7.4 percent, the lowest level since April 2001. Part-time workers for economic reasons as a share of total employment fell to 2.8 percent, below the average of the prior expansion. In a slight setback, the household survey revealed a two-tenths decline in the labor force participation rate, which fell to the bottom of the narrow range of 62.7 percent to 63.0 percent registered since May 2016. While the teenage participation rate, which tends to be volatile during the summer months, pulled down the overall rate, the rate for prime-age workers (25- to 54-year olds) dropped for the first time in three months. Overall, the household survey suggests ongoing diminished labor market slack.


[User] Myth Busting: The Truth About Multifamily Renters Multifamily Economics and Market Research With more and more Millennials entering the workforce and forming households, as well as foreclosed homeowners turning to renting, rentership in the U.S. has been increasing. It should then come as no surprise that there has been growing interest in the multifamily rental sector over the past few years, from developers, property owners, lenders, investors, and of course, renters. Alongside that growth, there are anecdotal themes or myths in the multifamily sector regarding renters often accepted as fact but not supported by our research. Overall, these myths portray a stronger long- term interest in renting in general and the multifamily sector in particular than is warranted by our analysis. Therefore, those involved in the U.S. multifamily sector should remain vigilant about separating fact from fiction, and more importantly, identifying fact-based future trends involving the nation’s 44 million renter households to better support their strategies. Some Common Renter Myths What are these misconceptions about renters? Some of the more common ones include: 1. Renters primarily rent multifamily units; 2. Young people mostly rent multifamily apartments; 3. Most multifamily renters, especially Millennials, are not interested in homeownership; and 4. Renters rent because they can’t afford to buy a home. In many cases, these “myths” are simply not true. Others are more complex and contain a kernel of truth but ultimately may cause some to form misleading conclusions. Finding Out What Renters Think – and Want There is quite a bit of data available on the multifamily sector from a wide variety of sources, including vacancy rates, asking rents, concessions, and more – some of which we use here. The NHS is the only large, national, monthly survey of consumers focused primarily on housing. The responses of the nationally-representative sample of 1,000 Americans aged 18 or older each month to about 100 survey questions promptly provide information on a wide range of housing-related topics. For the sample to accurately represent the U.S. population, 70 percent of calls are made to cell phones. The survey results highlighted in this report are from the first quarter 2018 NHS, focusing on four key audiences: All Renters, Single-Family Renters, Multifamily Renters, and All Owners, as illustrated below. So why rent if you can afford to buy? As seen in the chart below, there are a myriad of reasons for households to rent. According to the first quarter 2018 NHS, reasons for renting include: more flexibility in housing choices; less “hassle and stress;” living in a “better neighborhood;” and being protected against falling home prices. The majority of renters, most notably younger renters, are primarily renting to save money to put toward buying a home. But it is not just younger renters; many surveyed single-family renters and older renters are also renting to save money toward buying a home. About 22 percent of renters in 2016 could afford to make the monthly principal and interest payments on a home, if they were not paying more than 30 percent of their household income. When that assumption is increased to 40 percent, then the number of renters being able to afford the monthly principal and interest payments on a home increases to 34 percent.

[Assistant] That suggests that, as today’s Millennials age and transition into homeownership, or even rent single-family homes, there won’t be as many new, younger renters to replace them. Additionally, much of the recent multifamily construction expected to deliver in the next decade has been designed with the vacating generation's preferences in mind.


[User] Concessions are one of the ways property owners attract tenants in a competitive market. Concessions are enticements with economic value for renters, such as periods of free rent, free utilities, or other amenities. Concessions data from RealPage continues to show that, on a national basis and in most markets around the country, property owners have not increased the value of the concessions they offer to keep units occupied. Instead, concessions have remained near historically low levels over the last five years, though there is occasional volatility. Overall, the value of concessions (for properties that offer concessions) has remained around 6% of annual asking rents for more than six years. Over the past year, concessions have remained generally stable, with the October 2019 level of 5.9% virtually unchanged from the 6% level in October 2018. That’s down significantly from the peak of more than 11% back in late 2009. And as of the end of the third quarter of 2019, just 14.9% of the properties surveyed by RealPage were offering concessions, down from nearly 66% at the end of 2009, as seen in the chart below. National multifamily concession rate Percent of properties offering concessions Source: RealPage and RealPage Investment Analytics, October 2019 The nation’s multifamily markets continue to see a surge in the supply of new apartments. In 2019, the industry expects to complete nearly new apartment units, according to Dodge Data & Analytics.

[Assistant] That’s after it added nearly units in 2018, as seen in the chart below. Concessions low, though rising modestly in some major markets Although more than new apartment units are expected to be completed in 2019, these units are not evenly distributed on a national basis. In fact, the majority of the new apartment supply is concentrated in approximately 12 metropolitan areas, and primarily in an even smaller set of submarkets within those metros. The most active metros in the country for apartment development continue to be New York, Washington, D.C., Dallas, and Los Angeles. New York has more than 59,200 units under way, while the other three exceed 22,000 each. Boston, Seattle, and Austin follow with slightly fewer units, and Atlanta, Minneapolis, Orlando, Houston, and Chicago round out the top 12. These 12 major metros have seen an increase in the level of new supply over the past few years. Pent-up demand has helped absorb this wave without property owners having to greatly increase concessions, though there have been some steady but modest increases in several of these metros, as seen in the chart below.


[User] Multifamily Concession Rate by Market – Select Metros Source: RealPage, October 2019 For context, a month of free rent is a concession rate of 8.3%. So, although Atlanta has experienced the largest increase in concessions since 2016 among the markets listed above, its concession rate remains a low 5.8%, though that is up from 3.9% in October 2016. Atlanta’s multifamily market remains stable, with a strong underlying economy, vacancy rates moving in the right direction, and asking rent growth positive. But high levels of supply, especially within the Buckhead, Central I-75 West, North Gwinnet, and Midtown submarkets, is likely pushing some landlords to increase concessions. The Dallas and Seattle markets also currently have strong underlying economies and robust new development and have seen a bit of a rise in concessions since 2016, but all remain under one month’s free rent. Orlando and Houston are also in the midst of an economic expansion, coupled with a surge in new apartment deliveries, but these multifamily markets have not seen a rise in concessions. Orlando has seen its concessions rate decline to 4.6% in October 2019 from 5.2% in October 2016. It added around 24,300 units to its market during this period. Houston has had over 33,800 units come online during this same period, and it has seen its concession rate decline to 6.9% from 8.0% over that same time period.

[Assistant] National Multifamily Concession Rate by Property Class Source: RealPage, Q3 2019 Over the past three years, concessions for Class B and C properties have generally remained below 4.0%, and both classes’ respective concession levels have remained below the Class A level since the second quarter of 2016. Over the past year, the overall concession level has been stable: Class B concession level for the third quarter of 2019 came in at 2.6%, down slightly from 2.9% for the third quarter of 2018, though Class C concession levels rose slightly, to 3.0% for the third quarter of 2019, up from 2.9% for the third quarter of 2018. Are rising concessions on the horizon? The nation’s multifamily apartment market has remained quite stable for an extended period. Recent job growth has stimulated sufficient demand to absorb the surge of new units being completed, likely due to the overall shortage of housing across the nation. And the level of concessions that are being offered has remained low by historical standards. As some of the nation’s major metro areas are continuing to see more new supply, some of these markets – like Atlanta, New York, and Seattle – have seen a rise in concessions as new units have entered the market, while others – like Orlando and Houston – have experienced a modest decline. We expect that concessions will increase slightly, but primarily for class A units, as the wave of new supply is delivered over the next 12 months. We also expect that the national concession rate will likely remain relatively stable, since the demand for class B and C units continues to be strong, keeping concessions for those classes of units fairly low.


[User] Market-rate properties that do not receive support from government housing programs, but generally have more affordable rents than Class A properties, are at another point on the spectrum. These units may be more affordable to low- and moderate-income households due to their age, condition, or location, and are usually referred to as Class B and C units. Unlike rent-restricted units, these Class B and C units are not required to maintain housing costs at affordable levels; therefore asking rents are fluid and based on supply and demand. Vacancy Rates for Workforce Housing Remain Low… Ongoing demand for affordable rental units has kept the estimated vacancy rate very low for the types of apartments affordable to many working renters. As shown in the chart above, vacancy rates for Class B and C properties bottomed out in 2015 at 5.1 percent and have barely budged since. The estimated vacancy rate for Class C apartments, which tend to be Class A Class B Class C Rent-Restricted Source: , Reis, Inc. Note: Class A is approximated by five- and four-star category properties. Class B approximated by three-star category. Class C is approximated by two-star and one-star category data. Rent-Restricted data from Reis. of 8 some of the most affordable, was only 4.9 percent as of the end of 2018, according to . Vacancies at rent-restricted properties were even tighter – only 2.3 percent, according to Reis. These include properties with rent-restricted units that benefit from LIHTC and Project-Based Section 8 programs. Even vacancies at middle-market Class B apartments remained low at 5.5 percent. Only vacancies at Class A units remained elevated at 8.5 percent as of the end of 2018. The discrepancy in vacancies shows the demand for units affordable to workforce renters remains strong. The vacancy rate for the Class B and C segments are 3.0 or more percentage points below that of Class A rentals. …and Are Unlikely to Rise The vacancy rates at apartments affordable to workforce households are unlikely to rise anytime soon. According to Reis, vacancies at rent restricted apartments should remain below 2.1 percent through 2020. According to , vacancies at more affordable Class B and C properties should rise to just 5.7 percent and fall to 4.8 percent, respectively, through 2020, which would still leave them below the historical average of 6.0 percent. By contrast, the vacancy rate at Class A properties could rise to as high as 10.3 percent by the end of 2020, as continuing deliveries meet slowing job growth. New Supply Has Not Benefitted Lower Income Working Renters It is expensive to build new units. Construction costs, including labor and materials, continue to rise. According to Multifamily Cost of Regulation, jointly released by the National Association of Home Builders and the National Multifamily Housing Council in June 2018, regulation imposed by all levels of government accounts for over 30 percent of the average cost of a new multifamily development. In addition, local zoning restrictions may limit density, thereby restricting the number of units built. As a result, not only is most new supply expensive, but delivery of new units is not evenly distributed across the country. Development is now concentrated in only about 10 metros, most of which command higher asking rents, such as New York; Washington, DC; and Seattle. The number of new Class A units has grown by just under 1.4 million units from the end of 2009 to the end of 2018 and now totals about 5.3 million units, according to Reis. A renter household would have to earn almost $89,000 a year to be able to afford the average Class A rent of $2,224 on a newly constructed apartment in 2018. Share of Affordable Class B and C has Declined From 2009 to 2013, an estimated Class B and C units were lost on average annually, primarily due to obsolescence or gentrification. More recently, an estimated units per year are lost on average. The slowdown can be attributed to the strong demand for rentals since the end of the recession. According to the May 2018 Joint Center for Housing Studies (JCHS) of Harvard University’s report, Proactive Preservation of Unsubsidized Affordable Housing in Emerging Markets, gentrifying neighborhoods with strong demand for multifamily rentals ended up having many of their older – and therefore usually more affordable – market-rate properties renovated into more expensive Class A units since that is usually more cost-effective than new construction. As a result, the share of more affordable Class B and C units has declined to about 52 percent of stock as of the end of 2018 compared to an estimated 59 percent as of the end of 2009, as shown above. According to , asking rent growth in the Class B and C segments outstripped the Class A segment over the past few years, as shown in the adjacent chart. Rent growth for the Class C segment, where rents are likely comparable to those for rent- restricted units, grew by an estimated 2.9 percent in 2018 to about $1,034 per month. Rent growth for Class B units was even stronger at 3.4 percent, resulting in an estimated $1,190 per month.

[Assistant] Both segments grew well above the pace of inflation, which averaged 2.4 percent in 2018. …and It Is Likely to Continue Going forward, 2019 new supply deliveries are expected to start to spill over to the Class B and C segments thanks to slowing or even negative rent growth on high rent Class A units in some submarkets. This should dampen the rent increases that owners can command on more affordable units. Even so, rent growth for all types of multifamily rentals should remain positive, doing little to improve affordability.


[User] CONTENTS 33 16 SECTORS OFFICES Occupier choice starting to expand as market begins to turn.

[Assistant] 21 RETAIL AND LOGISTICS The growth of ecommerce, combined with economic fundamentals, will be the major driver of performance for the retail and logistics sectors. 29 OPERATIONAL REAL ESTATE Major institutional investors now firmly committed to operational real estate, especially established sectors such as healthcare and student housing.


[User] 55 ECONOMICS AND POLITICS 2019 IN PERSPECTIVE: A TWO-SPEED ECONOMY Europe failed to maintain 2018’s pace of economic growth, with GDP growth expected to be around 1.3% by the end of 2019, slightly below the long-term average. This can largely be explained by slowing international trade and Brexit-related uncertainty which is weighing on export-demand and industrial output in Europe. The UK, Germany and large parts of central Europe have unemployment rates below 5%; while Italy, Spain and Greece, continue to see double-digit unemployment rates. Despite tight labour markets, Euro area inflation has been persistently weak, prompting the European Central Bank (ECB) to lower the deposit rate further into negative territory and reinstate its net asset purchase programme at a monthly pace of €20bn.

[Assistant] Again, aggregate inflation hides local disparities, with countries in central Europe seeing persistently higher inflation. 2020 AND BEYOND IN EUROPE: WEAKER BUT STILL POSITIVE There is still some way to go before international trading arrangements normalise and Brexit-related uncertainties subside, and as such we expect Euro area GDP growth to remain slightly weaker than in recent years, but still modestly positive. While we expect the western economies to show slightly weaker growth for 2020 as a whole, we expect Q4-on-Q4 growth rates to be much the same as 2019. Central Europe is forecast to slow compared with 2019, as the bottoming out of the German industrial sector starts to spill over into those countries that depend on Germany as a source of external demand.


[User] Despite the struggles in Europe’s industrial sector, service sector output has been relatively robust, and we expect this to continue into 2020. Employment growth will slow in response to weaker GDP growth, which will have some dampening effect on consumer demand, but this will mostly be reversed as we move into 2021 and the growth outlook starts to improve. INFLATION AND INTEREST RATES: LOW AND LOWER The near-term outlook for inflation is being influenced by two opposing forces. On the one hand, tight labour markets should help to push up wages and prices. Conversely, moderating commodity prices have acted to pull down inflation. In eastern Europe, the tight labour market is passing through into price Weak global trading conditions continue to weigh on European growth, primarily reflecting a struggling manufacturing sector, but with far greater resilience in services. The main risk to Europe is escalation of US-EU trade tensions, with further falls in demand for European exports. Despite this, labour markets remain robust and wage growth has accelerated in several countries providing further support to consumer demand in Europe. Overall, we expect the stabilisation of commodity prices to raise core inflation moderately, but not enough to push inflation above the target in the eurozone for the next few years. With monetary policy in the eurozone remaining accommodative and continued low interest rates globally, policy normalisation is likely a long way off. As such, we do not expect any increases in short-term interest rates in 2020 and 2021. Indeed, the effectiveness of monetary policy may be nearing its end, which would make the European economy increasingly reliant on fiscal policy in the unlikely event of a downturn.

[Assistant] Long-term interest rates in Europe, and elsewhere, are likely to drift upwards, but this is largely because of developments in US interest rates, rather than an expectation of higher short rates in Europe. Our view that long rates will drift up is a cyclical phenomenon, and not a structural adjustment back to pre-Global Financial Crisis (GFC) levels. Long-term interest rates are still expected to remain at historically low levels for at least another three years, and particularly through 2020. POLITICS IN EUROPE: BREXIT AND ITALY Political risks in Europe will continue to centre mainly on country-specific issues in the UK and Italy, and the continued geopolitical tensions among the US, China and the EU. Business confidence and investment, particularly in the UK, have been eroded by the Brexit process. With the withdrawal stage of Brexit negotiations expected to complete soon, the UK will move into the ‘implementation period’ during which the UK and EU will enter discussions on their long-term future relationship. This is unlikely to be straightforward and may end up being extended beyond the one year currently provided for. In any event the UK will not have as good access to EU markets as it has now. Given current Fed and ECB attitudes, we expect the accommodative policies of central banks to continue. While their real and long-term impact on the economy can be questioned – Mario Draghi has stated that governments with fiscal space should act to support economic activity – it is clearly reinforcing our scenario of lower interest rates for longer. The ‘lower for longer’ scenario is a favourable one as it supports a comfortable real estate premium over government bonds. Having said that, we see two concerning side effects for real estate: • Lower yields mean investors must reduce their return requirements, starting with value-add strategies, and/or consider higher risks • Yields are converging, narrowing risk premia within property as an asset class Bond yields may have gone negative in parts of Europe but prime property yields appear to be nearing their floors, except for our expectation of some further yield compression for the very best assets in Europe. This is likely to be accompanied by a widening spread between London and other European cities, as long as Brexit uncertainty persists. Some specific markets or asset classes (datacentres, senior/student housing etc.) should also experience yield compression as a result of investors widening their criteria beyond mainstream asset types in search of enhanced returns. In the medium term, we do not expect yields will return to the levels that preceded the GFC, as the equilibrium level of interest rates, for various reasons, is now significantly lower. ‘FORCED’ ELEMENT TO INVESTORS APPETITE FOR REAL ESTATE IN will have seen property investment levels in continental Europe slightly lower than the record year of 2018, down by a mid-single digit percentage, due to supply shortages in certain markets, including Germany. The decline, however, will be more pronounced in the UK, given the continuing uncertainty regarding the timing and impact of Brexit. Looking forward, in the context of strong liquidity maintained by central banks, investors are increasingly favouring real estate in their multi-asset allocations, attracted by its yield compared to other asset classes and the safe haven offered in the face of monetary erosion. One study notes an increase in target allocations to real estate (to 10.6%) for a sixth straight year 1. CAPITAL MARKETS 1 Source: Cornell University Baker’s Program in Real Estate – Hodes Weill & Associates The accommodative policies of central banks are reinforcing our expectation of lower interest rates for longer. Prime yields are nearing their floors, although we still expect some compression for the very best assets to continue into 2020. Investors are increasingly favouring real estate in multi-asset portfolio allocations, so we expect 2020 volumes at least around the 2019 level in continental Europe, with a possible rebound in the UK. With investors faced with entry values that are already cyclically-high, the market’s attraction derives partly from property’s favourable return spread over bonds: in other words, institutional investors (insurance companies, pension funds, etc.) will continue to display an almost ‘forced appetite’ for real estate. BEYOND 2020: MEGA TRENDS AND STRUCTURAL SHIFTS IMPACTING REAL ESTATE INVESTMENT The investment outlook for 2020 contains elements of longer-term shifts in the structure of property investment activity. We are seeing a bifurcation of real estate investment comprising two main elements: • On the one hand, a strong search for capital protection with large flows into core assets in highly liquid markets, often at a very low yield • On the other hand, a search for growth by identifying mega-trends and structural shifts, with the aim of formulating strategies to deploy capital on these themes Among the mega trends that already guide real estate investment choices, ecommerce, urbanisation and the ageing population are among the best identified trends. Others include the shift from home ownership to renting or privatisation of social housing or healthcare. ‘Hotelification’ of real estate is a major structural shift in the industry, impacting income streams and investors’ business models. In the years to come, two other secular trends will need to be embraced by investors, even though timing and impact may still be quite uncertain: • Energy transition and sustainability: now a major societal issue and one where changes imposed by occupiers and their labour force could be imposed on real estate investors earlier than expected; • Technological innovation, including the possible impact of artificial intelligence on labour requirements and thus the quantity and location of real estate expected in the medium term The effects of these shifts could come to impact pricing, strength of occupier demand for specific assets, value gradients and the emergence of new types of asset, all of which investors will need to consider as part of a balanced portfolio strategy. KEY INFLUENCES • ‘Lower for longer’ scenario now the consensus, but spread over bonds supporting high levels of real estate investment. • With growth in leasing activity likely to ease, investors will need to be increasingly selective, picking markets with the strongest rental growth expectations. The response of the real estate and construction sector to this deal has been slow and uneven, but more recently momentum has picked up. This is partly a reflection of the requirements of the agreement itself, but also a growing acknowledgment of the need to respond to the demands of their workforce, particularly younger workers. For instance, ethical business practices and environmental credentials both play a significant part in the role selection of millennial workers, and the issue has gained renewed prominence through the actions of the Extinction Rebellion movement in London and elsewhere. For investors, occupiers, and developers, the common aims of optimising the performance of real estate, people and environment mean that sustainability forms an increasingly integral part of decision-making. Evidence of this can be seen in the fact that 93% of investors include Environmental, Social and Governance (ESG) criteria in investment decisions1, and that 72% of occupiers express some degree of preference for WELL-certified buildings2. The precise consequences of this heightened focus will vary as businesses plan their strategies for 2020 and beyond, but we expect to see a growing occupier preference for sustainable buildings, and rising incidence of impact investing.


[User] WHY THE REAL ESTATE SECTOR NEEDS TO DECARBONIZE The construction and operation of buildings contributes to 39%3 of worldwide greenhouse gas emissions: 28% from operational emissions and the remaining 11% emitted during the manufacture, transport and construction of building materials, together with end of life emissions. Embodied carbon has typically been overlooked in the past, but as operational carbon emissions are reduced, embodied carbon will grow in importance as a proportion of total emissions.

[Assistant] • Fund/portfolio level – Organisation-level policies are typically translated into fund level initiatives to manage ESG compliance through the adaptation of a portfolio level action The construction and operation of buildings contributes to around 40% of worldwide greenhouse gas emissions. Driven by a combination of regulatory and social pressures, we expect companies to devote more attention and rigour to ESG policies that integrate organisational, portfolio and asset level objectives. Investors, developers, occupiers and advisors, as well as asset, property, and facility managers all have a role to play in this transition. SUSTAINABILITY plan over a period of 3-5 years. Portfolio owners recognise that they are not always in full control of the fulfilment of their targets, but depend on the attitudes and behaviours of their occupiers, investors and other stakeholders. To accommodate this disparity, we expect a growing focus on stakeholder engagement and reporting transparency.


[User] 17 17 SECTORS OFFICES Office-based employment growth will slow in 2020, with leasing activity starting to turn down and a more balanced, less tech-dependent demand profile emerging. Supply conditions will begin to loosen, with vacancy levels likely to plateau or rise as new development completions accelerate. City-level variations in these trends will, if anything, widen. Look for occupiers to take a more activist approach to their portfolios, with a growing focus on retain-reposition-dispose decisions.

[Assistant] 21 RETAIL AND LOGISTICS The retail and logistics sectors will continue to be supported by slowing but steady economic growth. Retail sector performance will be country-specific, reflecting the current level and speed of growth of internet sales in each market. The logistics sector will continue to benefit from demand from expanding online retailers.


[User] 24 MULTIFAMILY The rise in the scale of capital deploying into Europe’s multifamily sector in the last few years has been substantial and is set to increase in 2020 and beyond.

[Assistant] This reflects urbanisation and demographic trends, with up to two thirds of the global population expected to live in cities by 2050 according to the UN. Currently uneven, the sector is evolving rapidly, and those looking to deploy need to take their cue from markets where the sector is already more mature. 27 HOTELS Europe is outperforming other global regions in terms of hotel operating performance. Strong trading is encouraging more development activity, but the key European cities look well positioned to absorb this new supply. Institutional investors will increase their hotel exposure, acquiring freeholds and other variable income structures, and partner with sector-specialist operating partners. 29 OPERATIONAL REAL ESTATE Operational real estate will remain a key focus for major institutional investors. Shortage of net-leased stock in regulated sectors will drive cross-border and sector diversification, and in turn harmonisation of pricing and structuring. Technological and cultural change are enabling investors to engage in operations directly, with substantial implications for the market.


[User] 31 DATA CENTRES Fuelled by growth in the capacity needs of cloud service providers, the European data centre market will continue to grow in 2020. The increased scale of individual end-user deployments will be a key theme in the year ahead and will need to overcome the significant constraints around land and power availability that exist in some of the most popular data centre hubs. Expect further land price inflation, and some displacement, as a result.

[Assistant] OFFICES SLOWER OFFICE-BASED EMPLOYMENT GROWTH CONSTRAINS TAKE-UP All the major western European economies experienced a slowdown in economic growth in 2018 and 2019, and all are expected to post still lower levels of growth in 2020. Central European economies, which had been stronger, are now also experiencing a slowdown. In line with this view, office-based employment in the major cities, a key driver of user demand for office space, will also see slower growth: we expect an increase of around 1.2% compared with an estimated 1.6% in 2019 and an average of 1.7% per year in the previous three years. This is already beginning to affect leasing activity. Through three quarters of 2019, office take-up across the main European markets was 2.1% ahead of the same period in 2018, but the rolling 12-month comparison is -1.4%. We expect aggregate take-up for the calendar year 2019 to be down around 1%, with a slightly larger decline of perhaps 2.5% in 2020, with supply shortages in some markets also contributing to this outcome.


[User] Behind this overall picture, expect significant variations in the outlook for individual sectors and cities. For much of the recovery period since 2014 leasing markets have relied heavily on the technology sector as a source of demand. Recent data indicates a shift towards a more balanced demand profile. So far in 2019 technology’s share of take-up in the largest markets is down slightly relative to 2018, with financial and business services rising. Geographic variations are also marked, but do not always fall into simple regional groupings. So far in 2019, Central and Eastern Europe (CEE) markets as a group have posted stronger take-up numbers; moving into 2020 this will become more nuanced with Prague, Warsaw and Budapest looking stronger than Moscow and Bucharest. The late-cycle recovery that has boosted take-up levels in Spain and Italy in 2019 seems set to abate. Germany looks likely to be a mixed bag next year, with Frankfurt leading. Occupier choice in some markets is highly constrained by low levels of availability, particularly for large, modern centrally- located buildings. Vacancy has continued to decline across virtually all major European office markets through 2019, and looks likely to end the year at least 0.5 percentage points lower on aggregate. 2020 will be different with the supply side of the market starting to turn and, on our expectations, vacancy levels flat to slightly up over the course of the year, albeit remaining levels under 6% in a number of the larger markets. On balance this is, good news for occupiers as locational choice starts to expand. Owners will need to start to assess supply conditions and income growth prospects more closely.

[Assistant] In this environment we expect growth in prime rents across the region to slow from around 4.0% in 2019 to nearer 2.0% in 2020. In real terms, rental growth remains strongly positive in some cities through 2020 (Berlin, Amsterdam, Barcelona and Brussels), while turning negative in the UK and much of CEE. 19 19 SECTORS: OFFICES Source: CBRE Research INCREASING OCCUPIER RIGOUR As well as change arising from the cycle, we also expect occupiers to take a far more activist approach from towards their real estate portfolios in 2020 and beyond. This reflects the convergence of several trends and trade-offs around space utilisation, talent attraction and management, user experience, digital and technology strategies and portfolio agility and flexibility. • Currently tight supply conditions will ease as new development additions rise above the levels seen over the past two years. Rental costs expected to rise more slowly.


[User] • With space choice expanding, occupiers respond to trend convergence around skills, digital strategy and user experience by taking a more activist approach to their portfolios.

[Assistant] 21 21 SECTORS: RETAIL AND LOGISTICS RETAIL AND LOGISTICS PERFORMANCE DRIVERS: ECONOMIC FUNDAMENTALS AND ECOMMERCE GROWTH In 2020, the performance of both the retail and logistics sectors will be driven by economic fundamentals and the growth of ecommerce across Europe. In northern and western Europe, cultural factors such as high credit card usage and a digitally- literate consumer base will foster further internet spend. So the UK will remain Europe’s most mature online market through 2020, followed by the Netherlands. In most southern and central European countries, internet sales will remain at low levels during 2020, but they are catching up.


[User] EUROPEAN RETAIL OUTLOOK: CONTINENTAL EUROPE MORE POSITIVE Retail will remain a thoroughly examined and heavily discussed sector in the coming year. Negative retail news, mainly from the UK, will make headlines.

[Assistant] UK retail will continue to weather a ‘perfect storm’ driven by a combination of structural (ecommerce), cyclical (GDP growth slowdown) and temporary factors (Brexit, the 2017 business rates revaluation).


[User] So, while prime high street rental values in most cities will either decline or see subdued growth over the year, we expect to see pockets of higher rental value growth in selected markets. These include cities such as Rome, Madrid, Warsaw, Budapest and Stockholm, driven by tourism, lower levels of internet sales, and/or positive GDP growth expectations. Retail investment in continental Europe is declining, and in the third quarter of 2019, it moved below the 10-year average. Negative sentiment from the UK, and the underlying level of uncertainty in the sector, are reducing the number of buyers in the market, mainly in France and Germany. Investors will be more selective in their choice of asset, preferring those that have an experiential, leisure or convenience element to them.

[Assistant] Retail yields are expected to either stay flat, or rise slightly, in most European cities.


[User] The supply side has been responsive to this trend, although speculative developments are significantly lower than 2009 levels and the average vacancy rate remains below 5%.

[Assistant] We expect to see more moderate growth in German and Dutch markets due to lower economic growth expectations and weaker manufacturing output. Supply in the Netherlands is currently limited, but land availability and planning regulations are favourable for development.


[User] Low unemployment rates across Europe have increased the importance of this factor. As a result, new and secondary locations, such as the north-east of England and the south of Italy,

[Assistant] are becoming more attractive for developers and occupiers, especially in the ecommerce sector. We expect greater collaboration between city authorities and logistics operators to tackle urban logistics and the last leg of supply chains. Cooperative hubs for environmentally-friendly delivery vehicles will be encouraged by local authorities. Investment in European logistics has been strong during the last seven years. We expect this positive sentiment to continue in SECTORS: RETAIL AND LOGISTICS 2020, as investors will continue to be attracted by the sector’s yield premium versus other traditional property sectors and government bonds. According to CBRE’s 2019 Global Investor Intentions Survey, investors continue to favour industrial and logistics over other commercial property sectors. We expect logistics yields to stay broadly flat in most major European markets but with continuing downward pressure in some, including Dublin and the main German markets. Instances of yield increase are expected to be scarce and small, limited to markets such as Prague and Bucharest. KEY INFLUENCES • The growth of ecommerce, combined with economic fundamentals, will be the major driver of performance for the retail and logistics sectors. • Availability of labour will continue to drive general location preferences among logistics occupiers. • Logistics innovations will continue to flourish in order to increase efficiencies and meet final consumer convenience. SECTORS: MULTIFAMILY MULTIFAMILY POSITIVE MOMENTUM FOR THE SECTOR TO CONTINUE EVOLVING The multifamily sector continued to gather pace throughout Europe over the past year and is set to continue to evolve and increase in popularity in 2020. This momentum is being driven by two related factors: • A fundamental shift in the number of people opting to rent rather than buy residential accommodation in many countries. One fifth of households in Europe already currently rent and the proportions are higher in cities and certain countries, such as Germany where renting accounts for more than 50% of total occupation • A growing pool of both domestic and international institutional capital looking to deploy into this sector with investment in this sector in Europe expected to exceed €64bn by 2021, an increase of over 18% on the 2018 level What was deemed alternative only a few years ago is now increasingly considered mainstream, with many investors attracted by the favourable return profile from a sector that is generally less susceptible to cyclical movements over the medium to long term – a trait that is particularly attractive at this late point in the property cycle. Over the past decade, multifamily has outperformed the retail and office sectors in a number of European markets including Germany, Norway, Netherlands, Sweden and the UK. In Germany for instance, residential returns have averaged 7.4% per year over the past decade, compared with 5.9% for retail and 3.8% for offices (MSCI). We expect to see this momentum continuing in 2020 with a considerable weight of capital and many new entrants looking for opportunities to deploy at scale into the multifamily sector across Europe. The capital base is becoming increasingly diverse with US private equity investors bidding alongside REIT-type vehicles from Canada as well as European institutional investors and fund managers. Investors are targetting both mature markets where residential investment has been established for some time, including the Nordics and Germany; and also emergent markets such as Spain, the UK and Ireland where new purpose-built stock is now starting to emerge with a strong emphasis on design, amenity and customer experience. As the year progresses, we expect to see increased focus on design and amenity as multifamily developers increasingly incorporate best practice from successful schemes in other jurisdictions. Equally, from an operational perspective, we expect to see greater efficiencies coming to the fore as developers and operators alike build up expertise in this sector and as technological solutions continue to evolve.


[User] REGULATION FOREMOST AMONG THE INVESTMENT CHALLENGES While investors will be encouraged by the volume of end-user appetite for high-quality rental offering, a number of challenges threaten deliverability in some markets. These include: • The availability of land • Planning issues • Rising build cost inflation However, the single biggest concern among investors around the region is regulation in the form of measures such as rent controls that some governments have implemented or potentially will implement, in an effort to address affordability concerns.

[Assistant] However, the sector still suffers from inadequate policy frameworks, and so needs promotion and explanation by sponsors. This will continue to be the case as the sector evolves to include new forms of living such as co-living, micro-living, serviced apartments and later living and becomes increasingly topical in the context of mixed-use development, urbanisation and placemaking. Overall, we remain positive about the prospects for growth and continued investment in the evolving multifamily sector in 2020. • We expect to see new forward-commit and forward-funding structures coming to the fore in 2020 as investors look to deploy in markets where there is limited standing stock available.


[User] 27 27 HOTELS A STRONG STARTING POSITION The European hotels sector begins the year from a position of strength. Europe significantly outperformed the other key global regions in 2019 in terms of hotel operating performance, according to data from STR.

[Assistant] And demand growth is expected to persist. Based on Tourism Economics forecast data, the weighted increase for nights in paid accommodation across European capital and gateway cities in 2020 will be 2.0%. InterContinental Hotel Group and ibis by AccorHotels are proving particularly popular with developers. These limited-service concepts, recognised for their high share of revenue generated through bedroom sales, have established a track record of achieving strong market penetration in a short period of time. They typically have a lean operation, strong profit margin and lower development costs than their full-service counterparts. Most four and five-star projects are limited to gateway cities, outside of which full-service hotel replacement costs often exceed existing asset values. This disparity will continue to be a driver of investor demand for other hotel property types, for example, resorts. INVESTORS MANAGING RISK THROUGH ALLIANCES WITH OPERATING PARTNERS New stock will increase the acquisition opportunities for the growing number of institutional investors considering operational hotel investments. Having invested principally in leased hotel stock in recent years – and therefore not fully benefiting from the improvement in hotel performance – many funds are actively looking to increase their investments in variable hotel income, principally across European cities but also in resort locations. Whilst some institutions have invested indirectly or through debt, and will continue to do so, many are building relationships with operating partners to effectively manage direct investment risk and overcome fund-related challenges including the employment of staff. Schroders acquisition of European hotel management firm Algonquin is an example of ‘bricks and brain’ coming together.


[User] Hotel income and capital values are not immune from market events such as recessions or inflation. However, the availability of granular, real time benchmarking data allows owners and operators to identify opportunities and risks at an early stage and act upon them with immediate effect.

[Assistant] As operators focus more on the optimisation of real estate to forge alliances with capital sources, expect per square meter to replace the traditional per room measures of reporting and analysis. INSTITUTIONAL CAPITAL TO EXCEED 30% OF EUROPEAN HOTEL DEAL VOLUME Furthermore, operational hotel investments do not have voids, and residual value is protected through ongoing maintenance and capex. The increase in global travel and rising proportion of consumer spending on experiences looks set to endure, and this should offset the period of expected low economic growth which lies ahead. These are key pull factors which appeal to the institutions and we expect them to support hotel investment volumes and yields going forward. In 2020, we expect that institutional capital will account for over 30% of the European hotel deal volume. 29 29 OPERATIONAL REAL ESTATE A UNIFIED EUROPEAN INVESTMENT MARKET? The perception of operational real estate sectors (such as healthcare and student housing, as well as retirement living, education and leisure) as just a niche area for opportunistic investment has changed greatly in recent years. This reflects the emergence of investors with advanced sector knowledge, more sophisticated lease underwriting, in the form of financial reporting requirements and more prudent rent-setting, and a proliferation of specialist advisers. Demand for these assets has increased correspondingly, both from specialist and core funds and private equity. In 2020, operational real estate will remain central to many investment strategies, with new and existing investors active in all major European jurisdictions that offer available stock. Indeed, as we foreshadowed in our 2019 forecast, there has already been a marked increase in the number of major investors taking a cross-sector, pan-European view in developing their investment strategies. This will continue into 2020. HARMONISATION IN PRICING Two consequences flow from this. Firstly, there will be increasing opportunities to drive innovation through new partnership models, underwriting approaches, and real estate structuring. Secondly, we believe it is inevitable that this trend will result in a degree of harmonisation in the pricing of well-let, good quality assets across the more heavily-regulated operational sectors. SECTORS: OPERATIONAL REAL ESTATE KEY INFLUENCES • Major institutional investors now firmly committed to operational real estate, especially established sectors such as healthcare and student housing. • Pricing of prime investments in alternative sectors will continue to harmonise across all jurisdictions where significant stock is available. As always in a climate of yield compression, shortage of investable stock and growing exploration of new sectors, caution is vital: proper underwriting of tenants, physical assets, operational setting, and disparate national commercial and regulatory standards will be more important than ever. Identifying opportunities will require ingenuity, a long-term view, and the right strategic partners. There are signs that this is beginning to erode the established paradigm whereby branding and operational expertise has been separate from capital-intensive real estate and its development. Until recently, real estate investors could not readily act as operators, because they had no access to the end-user. This has changed, and investors are no longer reliant on traditional large, branded operators. This is most obviously the case in the hotels sector, where there is increasing recognition that asset ownership is the best route to income security, but is also becoming a theme at the upper end of the private-pay elderly care and retirement living market. Property investors are already seeking to align with best-in-class operating partners. In response, operators are focusing on the optimisation of real estate, to attract and forge alliances with real estate capital. We expect operating partners to increasingly take on the role of investment manager, drawing on their specialist operational and real estate skills. L&G and AXA’s recent entries into the retirement living market are symptomatic of this trend. These trends will extend into mainstream, unregulated, property sectors – effectively the ‘hotelification’ of real estate. Lease lengths are falling and service levels increasing. As operational assets start to look more core and as core becomes operational, the opportunities to ride yield shifts as markets realign will be a growing opportunity for investors. SECTORS: DATA CENTRES KEY INFLUENCES • Further capacity expansion will continue to attract investment capital. • The sector continues to expand through new development, with the stock of the four largest European markets expected to grow by around 15% in 2020. • User demand in 2020 will continue to be driven by the major, largely US-based, cloud service providers. voltage (HV) power and fibre routes. These factors, along with planning approval and controlling physical risk, are crucial to developing a data centre. However, in established markets, being able to achieve these components will be difficult. In Amsterdam, for example, two municipalities have put a temporary ban on the development of new data centres because of the amount of power required by these facilities in areas where it is already scarce.


[User] The effects of these barriers to entry are that data centre developers are either choosing to locate in new, unproven locations or are competing aggressively on price for land opportunities.

[Assistant] We expect both trends to be strong features of the market in 2020. These market conditions have led to one particular site in London, because of its unique attributes, being sold for more than £6m per acre. The year saw the announcement of the largest data centre M&A deal on record: Digital Realty’s $8.4bn acquisition of Interxion which is expected to close in 2020. The strong occupational growth story in Europe in 2020 will continue to entice capital from across the globe with infrastructure funds, institutional capital and private money all competing for the same opportunities. However, due to record levels of consolidation through M&A, the pool of viable platforms to purchase will have shrunk considerably, so accessing the sector will become more difficult in 2020. For more information about particular sections of this report or access to our detailed forecasts, please contact: Henry Chin, Ph.D. Available February UK Real Estate 20 Insight into the key trends affecting the UK property market over the coming year.