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News release

Chicago

Jones Lang LaSalle’s U.S. Mid-Year Capital Markets Bulletin Shows 90 Percent Transaction Drop in First Half 2009 from Market Peak

REIT capital raises and TALF participation could be first signs of liquidity return in second-half 2009


CHICAGO, AUG. 26, 2009 — Jones Lang LaSalle today issued its U.S. Mid-Year Capital Markets bulletin showing transaction activity in the first half of 2009 slumped to just $16 billion, down 80 percent from $79.8 billion in the first half of 2008, and down 93 percent from $231.4 billion in the first half of 2007, when the market was at its peak.
 
Second quarter 2009 sales volume at $5.2 billion was easily the lowest total on record.  This represented an 83 percent decline from $30.7 billion in the same period in 2008 and a 95 percent decline from $114.7 billion 2007.
While the credit crisis started with the residential market, the impact on commercial values will likely be just as dramatic in many key markets and asset classes. A brief examination of Jones Lang LaSalle’s statistical pricing model reveals the present value of current cash flows, compared with the height of market exuberance in the first quarter of 2007 when most markets priced in rental growth based on artificial values, have experienced value declines of more than 40 percent based on rental drops, rising vacancy and the availability, terms and cost of debt.
 
U.S. Property Value Declines
From Peak to 2Q09
Office Face Rents
10-25%
Capital Values
30-55%
Capital Transaction Volume
90-95%
Office Leasing Activity
25-50%
 
“The unprecedented level of public policy support, with $4 trillion already provided of a total $12 trillion pledged to restore the financial markets and create economic stimulus, has effectively halted an economic free-fall.  However,  it has also stalled a recovery in the commercial real estate capital markets as banks continue to extend maturities for their borrowers, avoiding foreclosure in a practice that is becoming more commonly known as ‘delay and pray’,” said Kenneth Rudy, President of Jones Lang LaSalle’s Capital Markets practice. “It is unlikely that any true debt liquidity will return to the market until mid-2010 at the earliest.” 
 
Cap rates also have generally increased at least 250 basis points across major U.S. markets, with scant current transactional evidence to support precise measure of expansion.
 
“Increasing vacancy rates and diminishing rental rates are impacting commercial real estate performance as the drain on fundamentals is reducing net operating income and affecting owners’ ability to satisfy high debt coverage ratio obligations from financings put in place as the market was peaking,” said Rudy. “Further rental rate erosion is expected in 2009 as the real estate market correction lags the general economy by 12 to 18 months. A recovery in values could be delayed until 2012 and beyond based on the lag effect in investment property income resulting from corporate earnings growth, followed by re-hiring, then by absorption of surplus lease space, and ultimately, leasing and absorption of new commercial space.  The retail and lodging markets also will need additional time to recover based on a return of consumer spending and increased business travel once we are well into an economic recovery.”
 
“While we expect the slow investment market to continue through 2009, there are a number of markets that may be nearing a pricing point bottom around the world, with London leading, but that same phenomenon has yet to transfer to domestic markets. As risk appetites increase, domestic investor interest will return slowly beginning by mid-2010, though we may not again reach the heights of the 2005 to 2007 transaction market for a generation or longer.   As the market recovers through the first several years of the next decade, $100 billion in overall commercial property volume may be considered average while $125-150 billion would be a very strong year,” added Josh Gelormini, Vice President of Capital Markets research.
 
Real Estate Lending Environment
 
At this stage in the midst of a two-year credit crunch, debt to finance real estate investment or refinancing of existing obligations is fairly scarce and the terms and conditions are exceptionally conservative.  While many market participants continue to hope that the various government programs will spur liquidity, banks remain largely inactive, holding assets at par or at only slight mark downs, when the actual current market value is much lower.  Few banks are willing to dispose of assets at deep discounts and recognize large losses to clear their books.  This “delay and pray” strategy is preventing most banks from issuing new loans as they prepare their balance sheets for potential future losses.
 
“Banks will eventually sell as they cannot extend into perpetuity and the chances that the market will rebound to their highs are unlikely anytime soon,” said Bart Steinfeld, managing director of the firm’s Real Estate Investment Banking practice.  “We expect the smaller, community banks to begin selling their small balance loans first.”
 
While maturing debt is an issue for both lenders and borrowers for the remainder of 2009, banks are acting benevolently and extending maturities one to two years in many cases. To illustrate the scale of the problem that looms for lending institutions, between now and 2013 an estimated $2 trillion of commercial mortgages are set to mature .  However, certain banks have been boosted by stronger second quarter earnings and are ready to begin originating conservatively underwritten mortgages. “We have met with a number of lenders willing to ‘dip a toe in the water’ and pursue new transactions with gold plated sponsor’s collateralized by top quality real estate. Capital is available but it is directed toward higher returns and prime product and major markets,” added Steinfeld.
 
As the commercial real estate markets continue to work through the worst down-cycle since the savings and loan and oversupply crisis of the early 1990s, Jones Lang LaSalle has also observed an uptick in financial institutions soliciting advisory services.  The firm’s Value Recovery Services team, which spans product specialties and includes receivership, valuation, asset management, note sale, investment sale, and strategic advisory services, has been actively responding to lender requests for data points and expertise in evaluating their loan and REO positions. 
The increased need for Value Recovery Services is a direct result of the continued deterioration of market fundaments (albeit at a slowing pace) and asset values, and the fact that commercial real estate is a lagging indicator of general economic conditions.  Asset types currently exhibiting the most “distress” are hotels (particularly luxury or upper upscale product), construction loans (particularly condominium loans), and retail centers (particularly those which are non-grocery anchored).  However, as the recession’s impact on commercial real estate continues to evolve, other property types, including office and industrial, will experience increasing levels of distress as well.  Still, the inquires for Value Recovery Services are a positive sign for future transaction activity and price discovery – both of which are critical to the ultimate stabilization of the transaction marketplace.
 
Public Market Relief for Real Estate
 
With the recent public sector rally in commercial property REITs, many are looking to REITs to fill a significant portion of the void in real estate debt and equity in the market. 
 
“REIT stock prices have rebounded to some extent, and REITs are amassing capital and could be one of the first investor groups to grab distressed assets and step in as a leading capital source,” said Gelormini. “Improving REIT performance should lead to value recovery in the overall commercial market.  Much like in the mid- 90’s, we’ll likely see an increasing number of private real estate companies or investment funds that need capital look to the public markets by converting into a publicly traded REIT in the next three to five years.”
 
REITs will also be the first to step back into the securitization market by selling bonds through the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF).  According to Bloomberg, National Association of Real Estate Investment Trusts CEO Steven Wechsler expects more than a dozen REITs to take part in TALF
 
Sector Outlook
 
Amidst a challenging market for all commercial property sectors, the seniors housing, healthcare and corporate sale-leaseback markets are holding investor interest.
 
• Seniors Housing:  The interest for seniors housing product remains constant and transactions and new development should increase as stability returns to the residential and credit markets.  Baby boomers will continue to seek ways to downsize and the over 65 age group will grow dramatically.  One of the new trends in this sector combines innovative partnerships between seniors housing and institutions of higher learning, as seniors increasingly demand more access to university stimulation and culture. Since a greater number of seniors desire to remain close to their families and friends, future development will increasingly focus in more diverse geographic area
 
• Healthcare: Medical tourism is emerging as a trend as foreign travelers seek ways to combine medical procedures with family vacations.  Areas like South Beach in Miami and many of the top U.S. vacation spots are rallying from an influx in foreign medical interest. This is supporting the healthcare market which remains an attractive acquisition target for investors.
 
• International capital: Foreign investor interest in the United States is building, as evidenced by Hong Kong’s Keck Seng Investments’ purchase of the W San Francisco.  “There are a select few foreign investors bidding and winning on off-market investments today,” said Steve Collins, managing director of Jones Lang LaSalle’s International Capital Group. “The majority, however, aren’t making it to the second or final round, but it does seem like the Germans open- and close-end funds and the Japanese development companies are getting ready for an investment push in the fourth quarter 2009 and first quarter 2010. The investment environment is starting to materially change.”
 
• Corporate occupiers: Corporate interest in sale-leasebacks as a form of raising capital and balancing portfolios continues. “The level of inquiries remains strong,” said Jay Koster, managing director of Jones Lang LaSalle’s Corporate Capital Markets team. “We’re now seeing a growing trend toward longer term leases beyond 15 years.  I don’t expect significant movement on the price of corporate capital over the next year, although I do expect better visibility into market bottoms, yield expectations and pricing that will give corporations better availability to transact.” Koster added, “Smaller corporate transactions are also receiving warm reception by investors. We have four separate industrial/manufacturing facilities on the market that range in size from $10-25 million and they’re finding these transactions will serve as an alternative mode of raising acquisition capital in this environment.” 
 
On the investment horizon
 
Plight of private equity
 
The return of private equity capital as a key market participant is crucial for market recovery. The private equity world receives a significant portion of its investment capital from pension funds.  There are two key impediments standing in front of pension funds returning to the commercial real estate markets with new investment capital. The first is the denominator effect, which affect funds that have pre-set the level of total investment to be allocated to commercial real estate. As values have fallen for all asset types in a fund’s portfolio, the values attributable to real estate have risen as a percentage of the entire portfolio.  This has necessitated selling real estate to return to a level under the fund’s allocation criteria. While the rise in equities helps stave off the denominator effect, it is expected to impact pension funds for the next 12 months due to market volatility. Moreover, as more commercial real estate gets marked to true market values, the total amount allocated to real estate may start falling back within their parameters.  The second issue is the total amount of capital available from pension funds and other sources of private equity capital resulting from ever-increasing redemption requests from investors in those funds.  Many fund managers are faced with very long redemption queues from investors attempting to get their cash returned for pension obligations or other alternative investments.  These queues are expected to extend for the next 24 months.
 
“While the market is still facing real hurdles to recovery, for the first time this year, we’re seeing more proper alignment between seller and buyer expectations,” said Rudy. “We’re hopeful that more U.S. owners and buyers adjust pricing to realistic levels. Market activity in London has demonstrated that demand can ramp up relatively quickly in a major market once investors gain confidence and markets re-price.  What will help expedite the real estate recovery is that construction has been controlled in this cycle – a clear difference from early 1990s downturn.
 
Jones Lang LaSalle Capital Markets is composed of a broad range of real estate investment debt and equity specialists, and corporate finance experts, working on all property types and in all the major national markets on behalf of major institutional and local investors and developers, as well as corporations.  The firm's Capital Markets professionals are highly skilled at pinpointing and tailoring the right capital solutions for each of these client's needs.  The Development and Asset Strategy team specializes in the sale of non-income-producing properties in their various forms from surplus buildings to raw land to entitled parcels and partially completed subdivisions.  The Investment Sales teams assist investors in developing and executing asset recapitalization strategies for office, industrial, retail, multifamily, healthcare and seniors housing product. The firm’s Real Estate Investment Banking experts raise debt and joint venture equity for investors and developers, and provide derivatives structuring and loan sale advisory services.  The Corporate Capital Markets professionals help corporations develop and execute strategies that bridge their occupancy, capital deployment and financial reporting objectives for their facility portfolios.  The firm's Value Recovery Services assist clients affected by the current financial crisis by creating value while managing risks through evaluating operational and occupancy needs, assisting with challenged assets and liabilities on their balance sheets, providing receivership services, asset management, raising capital through sales-leasebacks and providing leasing and recapitalization strategies for distressed assets. In the past two years, the firm’s Capital Markets team handled $117 billion of transaction volume.
 
About Jones Lang LaSalle
 
Jones Lang LaSalle (NYSE:JLL) is a financial and professional services firm specializing in real estate. The firm offers integrated services delivered by expert teams worldwide to clients seeking increased value by owning, occupying or investing in real estate. With 2008 global revenue of $2.7 billion, Jones Lang LaSalle serves clients in 60 countries from 750 locations worldwide, including 180 corporate offices.  The firm is an industry leader in property and corporate facility management services, with a portfolio of approximately 1.4 billion square feet worldwide. LaSalle Investment Management, the company’s investment management business, is one of the world’s largest and most diverse in real estate with more than $36 billion of assets under management. For further information, please visit our Web site, www.joneslanglasalle.com.
 
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