session 5 | market segments

Global Research and ConsultingEconometric Advisors

CBRE Econometric Advisors

Client Conference 2012 October 2, 2012

Session 5 | Market SegmentsWhat Generates Performance:

The Market, Location, and Property Features

Presented by:Serguei Chervachidze, Capital Markets EconomistGleb Nechayev, Senior Managing Economist




Submarket Rent Growth:Can Investors Beat the Wider Market?

CBRE | Global Research and Consulting ● Econometric Advisors

CBRE Econometric Advisors Client Conference 2012

The Question

Submarkets are small areas within an MSA with somewhat homogenous properties.

How much of the yearly rent growth of the average property within a submarket is due to: • Macro economic factors and the national cycle? • The property market cycle of the encompassing MSA (its rent growth).• Structural features of the submarket (such as location, building age, size…)

that do not change?

The residual is due to changing market forces withinthe Submarket that are different from the MSA



Submarket Data

•731 submarkets, residing in 56 MSA, 1988-2011

Office:

•573 submarkets, residing in 53 MSA, 1988-2011

Industrial: •674 submarkets, residing in 58

MSA, 1997-2011

Multi-Housing:

•245 submarkets, residing in 50 MSA, 2000-2011Hotel (full-

service):



Submarket Analysis: Regressions

decliningor flat rents real national if 1 growing, are rents real national if0,

submarket asMSA samein submarkets ofset common :

effects fixedsubmarket : dummies; time: period; time: submarket; :

growthrent annual:

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Example of Regression Analysis: OFC

Variable Coeff Std Error T-Stat Signif

Y1999 0.1722 0.2029 0.8485 0.3962

Y2000 0.2889 0.2027 1.4250 0.1542

…

Y2010 -0.2843 0.2341 -1.2147 0.2245

Y2011 -0.2787 0.1971 -1.4143 0.1573

Growth Market Rent 0.9550 0.0218 43.8815 0.0000

Growth Market Rent x Bear 0.0754 0.0300 2.5121 0.0120

R2 0.54

Adj. R2 0.50

AIC 3.71168

N Obs. 9021

Eq (5): Dependent Variable: Submarket Rent Growth; Fixed Effects Panel Estimation

Source: CBRE Econometric Advisors



Submarket Analysis: OFC & IND

Office

Industrial

0 10 20 30 40 50 60 70

Joint Effects: Time + Market + Submarket; Eq (4)Submarket Effects; Eq (3)Market Rent Growth; Eq (2)Time (National) Effects; Eq (1)

Individual and total explained share of annual variationin submarket rent growth, %

Market Rent Effect: 0.93Signif: p = 0.0000





Submarket Analysis: MH & Hotels

Multi-Housing

Hotels

0 10 20 30 40 50 60 70








Do These Differ by Bull/Bear Rent Phase?

Note: Cyclical Structural Breaks are Identified using the Bai-Perron (2003) Structural Break Tests

1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 910

5

10

15

20

25

30

35

40

OFC, Real Econ Rent, Str. Breaks

1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 910

1

2

3

4

5

6

7

8

IND, Real Econ Rent, Str. Breaks

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 731000

1050

1100

1150

1200

1250

1300

1350

1400

MFH, Real Econ Rent, Str. Breaks



Submarket Analysis by Bull/Bear Phase: OFC & IND

Office Bull

Office Bear

Industrial Bull

Industrial Bear

0 10 20 30 40 50 60 70



IND:Market Rent Effect Bull: 1.00Under Bull: 1.00Difference: Not Stat Sig, p = 0.91

OFC:Market Rent Effect Bull: 0.91Under Bear: 0.94Difference: Weakly Stat Sig, p = 0.11




Submarket Analysis by Bull Bear Phase: MH & Hotels

Multi-Housing Bull

Multi-Housing Bear

Hotel Bull

Hotel Bear

0 10 20 30 40 50 60 70



MFH:Market Rent Effect Bull: 0.96Under Bear: 1.03Difference: Stat Sig, p = 0.01

HTL:Market Rent Effect Bull: 0.86Under Bear: 0.86Difference: Not Stat Sig, p = 0.97




Conclusions Market rent and macro trends drive vast share of submarket performance Submarket-unique factors that are fixed over time have very small effect on rent

growth• Do property/submarket structural features matter? Not a lot!

In the down (bear) phase of the cycle, market rents have a stronger downward effect on submarket performance vs. the up (bull) phase

Remaining unexplained part of submarket performance (50% to 70%)—submarket-specific factors that are changing over time:• Local supply dynamics: building a new road; new large development• Local demand changes: Influx of high-tech firms to submarket; outflow of residents from one

submarket to another Office, Hotel, and Multifamily submarkets—highly integrated with markets

• 50%-60% of submarket variation in rents explained by market variation Industrial—little integration

• Only 30% variation explained• Is warehouse different?• Homogenous property type?



How Do I Pick the “Right” Submarkets?

Step 1: Pick the right market by:• Studying the macro environment very carefully• Understanding rental fundamentals and factors that drive these

fundamentals on the market level Step 2: Within a chosen market, pick the right submarket by:

• Studying and understanding factors that change on the local (submarket) level (including supply)

Do not pick a submarket solely on the basis of some fixed characteristics that do not change over time. For example:

– Invest only in industrial markets only with rail-road access– Edge-of-city multifamily properties on top of hills with a good view– Office properties within 20 miles of CBD

• These characteristics are responsible for a very small share of performance differences vs. the larger market over time




Property Rent Growth:How Much Does Property Characteristics and Location Matter?

Cross-Section Analysis of Multi-Housing Property Performance Since 2007



Property Data Summary

6,487 multi-housing properties in 352 submarkets across 10 markets• property rent in 2007q1 and 2012q1• number of units in property• number of stories in property• age of property• property zip code• submarket rent in 2007q1 and 2012q1• market rent in 2007q1 and 2012q1

Source: Pierce Eislen



Cross-Section Analysis: Questions

1) How much variation in submarket rent growth can be explained by variation in:• market rent growth• submarket characteristics that don’t change (distance to

downtown, submarket size, 2007 rent level relative to market)

2) How much variation in property rent growth can be explained by variation in:• market rent growth• submarket rent growth• property-specific characteristics that don’t change (age, size,

number of stories, 2007 rent level relative to submarket)



Property Data Summary


Units Age Rent 07q1, $Average 210 30 967Std Deviation 158 14 276Minimum 50 2 517Maximum 2,476 111 2,033

Stories Properties % Total Units Avg Units1 to 3 5,728 88.3 1,194,145 2084 to 6 556 8.6 116,227 209

7 and above 203 3.1 52,923 261Total 6,487 100.0 1,363,295 210



Market Data Summary

Number of Number of 2007q1-2012q1Market Submarkets Properties Rent Change, %San Jose 23 388 20.5Denver 39 711 15.8Northern VA 38 386 15.6Seattle 45 812 13.8North Dallas 36 876 10.8San Diego 33 842 6.9Orlando 50 310 -3.2Riverside 32 615 -4.3Phoenix 33 1,024 -6.7Las Vegas 23 523 -12.6Sum of 10 Markets 352 6,487 5.7




Explaining Submarket Performance

Markets explain most of the variation in submarket performance and submarket characteristics explain only a fraction (although they are statistically significant)

Smaller submarkets that are closer to downtown and whose average rent is higher than the market did better in the last 5 years

Equation R2 Variable COEF T-STAT

#1 0.69Constant -0.55 -5.7Market rent change 1.00 121.0

#2 0.71Constant -2.89 -5.5Market rent change 1.00 121.9Submarket rent in 2007 / market 4.37 8.9Distance to downtown -0.06 -8.0Submarket stock as % of market -0.24 -7.7



Explaining Property Performance


#1 0.37Market rent change 0.99 61.7

#2 0.36Submarket rent change 0.81 60.0

#3 0.40Market rent change 0.59 20.8Submarket rent change 0.40 17.1

Market /submarket rent changes explain about 40% of variation in property rent growth

Property rent increases by 1% with every 1% increase in market rent.



Explaining Property Performance (Cont.)

Fixed property characteristics explain less than 10% of variation in property rent growth since 2007, but all of them are statistically significant.


#4 0.09Constant 12.84 9.1Age of property 0.09 5.3Number of units 0.00 -3.5Mid-rise 10.16 14.2High-rise 13.28 11.4Property rent in 2007 / submarket -14.85 13.8Distance to downtown 0.15 7.9

#5 0.41Constant 17.47 15.3Market rent change 0.98 59.2Age of property -0.07 -5.4Number of units -0.01 -5.9Mid-rise 1.35 2.3High-rise 4.21 4.4Property rent in 2007 / submarket -17.05 19.7Distance to downtown 0.03 1.8



Summary of the Results

Markets explain about 70% of variation in submarket performance and submarket characteristics that are fixed in time explain less than 5% (but all of them are statistically significant: smaller submarkets that are closer to downtown and have average higher than the market did better over 2007-2012 period)

Markets/submarkets explain about 40% of variation in rent growth across properties and property characteristics explain less than 10% (but all of them are statistically significant: smaller, older properties with lower rents relative to market, further from downtown did better over 2007-2012 period)



Implications for Investing

Market rent growth matters a lot to submarket and property rent growth, but being in the right market and submarket is not even half of the story when it comes to explaining property performance

Submarket and property characteristics that don’t change over time matter very little, but may help beat a benchmark

Focus on property characteristics that do change over time – such as property management, renovations, etc.




What About Property Investment Performance?NCREIF Building Level Data



The Question—Updated

Now we look at total return.

How much of the building-level annual total return in NCRIEF NPI is due to: • Macro economic factors and the national cycle? • The property market cycle of the encompassing MSA (its rent

growth).• Structural features of property (such as location, building age,

size…) that do not change?

The residual is due to changing features of the individual property



Property Level Returns Data: NPI

Joint project with Jeff Fisher and NCREIF

Office building-level returns data from NPI

Building-characteristics data exclusively from CBRE

1,012 properties over 1989 – 2011

Unbalanced panel with 5,881 observations

Average years a building is the panel: 5.8



Property Returns Analysis: Regressions

growthrent economic annualmarket :; building asMSA samein buildings ofset common :

effects fixed building: dummies; time: period; time: building; :

NPI fromreturn totalannual level Building :

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Parsing Out Building-Level Returns: NCREIF OFC

% Explained Variation

0 5 10 15 20 25 30 35 40 45 50

Joint Effects: Time + Market + Building Fixed Effects; Eq (4)Building Fixed Effects; Eq (3)Market Econ Rent Growth; Eq (2)Time (National) Effects; Eq (1)

Individual and total explained share of annual variationin building level total return, %

Market Econ Rent Effect on Total Property Return: 0.19558

Signif: p = 0.000Ex: A 1000 bps increase in market annual economic rent

growth (e.g. from 5% to 15%) increases total property NCREIF return by roughly 200 bps (from 10% to 12%), con-

trolling for other factors.




What’s Left To Explain?

Fixed property effects: only 20% of variation• Unlike in submarkets, these matter a lot more because investment capital

pays attention to these factors• For two properties with the same rent growth, a new CBD office tower will get

a lower cap rate than older suburban office park

Dynamic property effects: 53% of variation:• These are factors that are property-specific and are changing over time• Similar to dynamic submarket effects in rent studies (39% variation in office)• Property management over time is key

– Signing a lease at top rates right before recession– Blend and extend

• Other dynamic property effects include:– A good tenant leaving– Changes in the cost structure of the building – Changes in the immediate neighborhood of the property (a competitor tower built across the

street)• These are the key elements that will help drive successful investment strategy



Fixed Effects: What Explains the 20% of OFC Investment Performance?

Stage 2 analysis: make a cross section of fixed effects from Stage 1 We regress the fixed effects from stage one on the various property and

submarket characteristics in a cross section This shows us what drives these effects:

sticscharacteriproperty on the scoeficient :property

sticscharacterimarket andproperty ofnumber :property for sticscharacterimarket andproperty are :

Stage1 from scoeficient effects fixed : Where

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Stage 2: Explaining the 20%: Property/Submarket Characteristics

Factor Effect SignificanceFund type (open end fund, closed end fund,

separate account, etc.)Various Effects Mostly Statistically Significant

Distance to CBD Average Property Total Annual Return reduces by 111 bps for every 10 miles away

from CBD

Statistically SignificantPval = 0.016

Building size Making a property larger by 100k square feet reduces annual total return by 75 bps


Number of floors Not significant Not statistically significantPval = 0.17

Submarket Average Rent (1989-2011) A $10 sq. ft. average submarket rent increase implies a 150 bps increase in total

annual return


Submarket Average Stock (1989-2011) A 1 million sq. ft. increase in average submarket stock implies a 17 bps increase

in average total property return


R2 2% - 6%, depending on specification

N Obs. 1,136

Dependent Variable: Fixed Effects Coefficients from Stage 1; Cross-section Setup



Conclusions Results generally in line with what we saw for rent growth analysis The macro cycle has the strongest effect on investment performance

(31% of variation):• Consistent with our research that macroeconomic/capital markets factors drive asset

pricing and appreciation returns Market rent performance still matters, but less: 13% Time-invariant unique building effects now explain more (20%) of

variation, but still not a lot The unexplained dynamic property effects remain key (53%):

• Need to manage the property with an understanding of market dynamics• Tenants, nearby competitors, and other dynamic factors matter more than property

amenities• Factors that change on submarket level (e.g. demand/supply) matter more than fixed

submarket characteristics Further research is on-going: expect additional insights



So What Does It All Mean for Investing? Study the macro/capital markets environment carefully: timing is crucial Study market-level CRE fundamentals (rents and vacancies,

demand/supply and their drivers) Understand submarket/local/building-level dynamics: factors that are

property/location/neighborhood unique and changing are the really hard part, since they are hard to measure.

Use good management to control building-level dynamics• Length of lease, CAPEX timing, etc

Do not rely solely on picking submarkets/buildings on the basis of “unique” fixed characteristics:• Edge city properties with good view, CBD high-rise properties only, etc

By picking a building at the wrong time and/or in the wrong market and/or with the wrong property/location/neighborhood dynamic will trump any investment returns advantages from getting the “right” fixed characteristics

session 5 | market segments

Documents

submarket analysis

submarket datacbre page

regressions cbre page

msacbre page

market rent effect bull

market rents

market segmentswhat

wider market