Glenn R. Mueller, Ph.D.

1

• Glenn R. Mueller, Ph.D.
• Johns Hopkins University
• Real Estate Institute
• Director, Capital Markets International
  Programs
  
• Legg Mason, Inc.
• Real Estate Research Group
• Real Estate Investment Strategist
• grmueller_at_leggmason.com

2

• Market Cycle Analysis
• Physical Cycle
• Demand, Supply and Vacancy
• affect Rental Growth

3
Market Cycle Quadrants
Phase 3 - Hypersupply
Phase 2 - Expansion
Demand/Supply Equilibrium Point
Increasing Vacancy
Declining Vacancy
New Construction
New Construction
Occupancy
Long Term Vacancy Average
Increasing Vacancy
Declining Vacancy
More Completions
No New Construction

Phase 4 - Recession
Phase 1 - Recovery
Time
4
Demand/Supply
Equilibrium
High Rent
Growth in
Rent Growth
Rents Rise
Tight Market
Positive But
Rapidly
Declining
Toward New
Construction
Occupancy
Levels
Cost Feasible New
Construction Rents
Long Term Average Occupancy
Below
-
Inflation
Negative
Below
Rent
Physical
Inflation
Growth
Rental
Market Cycle
Negative
Growth
Rental
Characteristics
Growth
Time
5
Historic National Office Rental Growth
11.0
10.5
11
6.1
10
12
6.4
9
13
12.5
3.3
10.0
8
Long Term Average Occupancy
7
Occupancy
6
14
1.7
6.7


5
0.3
15
4.0
4
-1.0
-3.0
1.6
3
2.7
16
2
1
1
30 Year Cycle - Periods 1968-1997

-1.5
Time
6
Historic National Industrial Rental Growth
8.3
6.8
11
4.6
10
12
5.1
9
4.8
5.9
13
8.5
8
Long Term Avg Occupancy
7
Occupancy
3.8
3.0
6
14


5
-2.1
15
4.6
4
-0.4
0.8
3
0.7
0.4
16
2
1
1
30 Year Cycle - Periods 1968-1997

2.8
Time
7
National Property Type Cycle Locations
Phase II - Expansion
Phase III-Hypersupply
Retail 1st-Tier Regional Malls Health Facility
11
10

12
Hotel - Full-Service Hotel - Ltd. Service
9

8
13
Power Center Retail
LT Average Occupancy
7
6
14
Senior Housing1


Retail NH Com
15
5
1
16
4
1
3

2
Factory Outlet Retail
4th Qtr 2003
Retail 2nd Tier Regional Malls
Office - Downtown Office - Suburban Industrial-
RD Flex
Industrial Warehouse Multifamily
Phase I - Recovery
Phase IV - Recession
Source Mueller, 2004
8
Office Market Cycle Analysis
4th Quarter, 2003
Nashville-1 N. New Jersey New Orleans New York
Norfolk Oklahoma City Orlando Philadelphia Ph
oenix Pittsburgh Portland Raleigh-Durham Sacra
mento Salt Lake San Antonio San Francisco San
Jose Seattle Stamford St. Louis Tampa Wash DC
W. Palm Beach NATION
Albuquerque Atlanta Austin Baltimore Boston
Charlotte Chicago Cincinnati Cleveland Columbu
s Dallas FW Denver Detroit East Bay Hartford
-1 Houston Indianapolis Jacksonville Kansas Ci
ty Las Vegas Long Island Los Angeles Miami Mi
lwaukee Minneapolis
11
10
12
9
8
13
LT Average Occupancy
7
6
14

15
5
1
16
4
1
3
2
Ft. Lauderdale Honolulu Memphis Richmond San D
iego1
Wilmington
Source Mueller, 2004
9
Industrial Market Cycle Analysis
4th Quarter, 2003
Milwaukee Minneapolis Nashville New York Oklah
oma City Orlando-1 Philadelphia Phoenix Pittsb
urgh Portland Raleigh-Durham Richmond Salt Lak
e San Francisco San Jose Seattle Stamford St.
Louis Tampa NATION
Atlanta Austin Baltimore Boston Charlotte Ch
icago Cincinnati Cleveland Columbus Dallas FW
Detroit East Bay Hartford Indianapolis Kans
as City Las Vegas Long Island Memphis Miami


11
10
12
Los Angeles Orange County W. Palm Beach1
9
8
13
LT Average Occupancy
7
6
14
15

Riverside1
5
16
1
4
1
3
2
San Diego
Denver Ft. Lauderdale Honolulu Houston Jackson
ville1 New Orleans1 Norfolk1 N. New Jersey
Richmond
Sacramento San Antonio Wash DC
Source Mueller, 2004
10
Multifamily Market Cycle Analysis
4th Quarter, 2003
Atlanta Charlotte Cincinnati Columbus Denver
Detroit Hartford Houston Indianapolis Kansas C
ity
Long Island Memphis
Miami Minneapolis Nashville New Orleans New Yo
rk Portland Raleigh-Durham Richmond St. Louis
Salt Lake San Jose Seattle NATION
11
Riverside
10
12
9
8
13
LT Average Occupancy
7
6
14
Jacksonville
Philadelphia1 San Antonio1 Tampa1

15
Norfolk Las Vegas2 Los Angeles1 Orange County
1
Orlando2 San Diego
5
16
1
4
1
3

2
Boston Honolulu Sacramento W. Palm Beach Wash
DC

Austin1 Baltimore1 Chicago1 Cleveland Dalla
s FW1 East Bay Ft. Lauderdale Milwaukee N. Ne
w Jersey Phoenix Pittsburgh Oklahoma City San
Francisco Stamford
Source Mueller, 2004

11
Retail Market Cycle Analysis
4th Quarter, 2003
Baltimore Chicago Milwaukee Minneapolis Norfol
k Orange County Pittsburgh Riverside San Anton
io
Stamford St. Louis NATION
Atlanta Boston Charlotte Detroit Houston Indi
anapolis Los Angeles Memphis N. New Jersey Na
shville
Richmond1 W. Palm Beach1
11
10
Wash DC
12
9
8
13

LT Average Occupancy
7
6
14
East Bay Ft. Lauderdale Miami New York Phoenix
Portland Sacramento Salt Lake San Diego San
Francisco
Seattle Tampa

15
5
1
4
16
1
3
Denver1 Honolulu1 Long Island-1 New Orleans1


2
Austin Cincinnati Cleveland Columbus-1 Dallas
FW Hartford Jacksonville Kansas City Las Vegas
Oklahoma City Orlando Philadelphia Raleigh-Du
rham San Jose
Source Mueller, 2004
12
Hotel Market Cycle Analysis
4th Quarter, 2003
Atlanta Austin Boston Cleveland Columbus-1 Da
llas Detroit East Bay Hartford Indianapolis-1
Kansas City Minneapolis Pittsburgh-1 St.
Louis San Jose
Honolulu Jacksonville Las Vegas Nashville New
York Oklahoma City1 Orlando1 Philadelphia Ph
oenix-1
Seattle
11
10
12
9
Norfolk
8
13
LT Average Occupancy
7
14
6
15
5
Los Angeles1 Riverside San Diego
16
1
4
1
3
2
Baltimore1 Long Island Orange County1 Sacrame
nto
Wash DC1 W. Palm Beach1
Charlotte Chicago Cincinnati Denver Ft. Laude
rdale Houston Memphis Miami Milwaukee New Orl
eans

N. New Jersey Portland Raleigh-Durham Richmond
Salt Lake San Antonio San Francisco Stamford
Tampa
NATION
Source Mueller, 2004
13
1970s Cycle

• Factors Driving The First Half Cycle (5 Year)
• Strong Demand from the 1960s that stopped
• Recession 1974
• Capital Flow Mortgage REITs produces oversupply

• Factors Driving The Second Half Cycle (5 Year)
• Baby Boom Generation Goes to Work
• Capital Flow Shut Down as Lenders Recover
• Markets tighten and reach peak occupancy 1979

14
Oversupply Years
Baby Boomers Go To Work
Source FW Dodge, CB Commercial, BLS, Mueller
15
1980s Cycle

• Factors Driving The First Half Cycle (5 Year)
• Tight market in 1979 pushes rents and prices up
• Tax Act of 1981 attracts taxable investors supply
  up

• Factors Driving The Second Half Cycle (5 Year)
• Thrift Deregulation allows capital to flow
• Inflation pushes real estate prices higher
• Tax Act of 1986 slows taxable investors, but not
  tax free
  
• Poor stock market attracts Pension Foreign
  capital
  
• Rising R.E. prices masks poor income returns

16
Oversupply Years
Source FW Dodge, CB Commercial, BLS, Mueller
17
1990s Cycle

• Factors Driving The First Half Cycle (5 Year)
• Moderate but stable demand growth (1991
  recession minor)
  
• Oversupply and Foreclosures shut down
  construction
  
• Excess space absorbed - bringing markets back

• Factors Driving The Second Half Cycle (5 Year)
• Moderate Demand growth Continues
• Oversupply absorbed and return performance
  improves
  
• Construction constrained causing rents prices
  to rise
  
• More efficient markets match supply to demand

18
Demand Supply Matched
Oversupply Absorbed
Source FW Dodge, CB Commercial, BLS, Mueller
19
2000s Cycle

• Demand
• Globalization - creates stable U.S. economy
• Job Growth out of Technology Change
• 2.4 million population growth per year for 10
  years
  
• Baby boomers at highest income earning years
• second home market wave
• Echo boom children college, first job,
  renting
  
• Aging population not a major factor till 2014
• Employment growth - determines demand - WHEN

20
2000s Cycle
Demand
Baby Boom
Echo Boom
Gen X
21
2000s Cycle
Baby Boom
Echo Boom
Gen X
22
2000s Cycle

• Supply Constraint
• Public Markets make R.E. Capital markets
  efficient
  
• Economically driven capital - low spec
  construction
  
• Research watchdogs
• Constrained Supply (economically driven capital)
• construction labor harder to find
• materials costs increasing
• infrastructure problems constrain growth
• Feedback loop keeps demand and supply in better
  balance
  
• greater transparency
• Faster reaction to demand slowdown

23
National Property Type Cycle Forecast
Phase II - Expansion
Phase III-Hypersupply
Health Facility
11
Retail Neighborhood Community
Retail - 1st-Tier Regional Malls
10
12
9
Factory Outlet Retail Senior Housing
8
13
LT Average Occupancy
7
6
14
Office Downtown-1 Office Suburban Industria
l - RD Flex


15
5
1
16
4
1
3
2
Hotel - Full-Service Hotel - Ltd. Service Indus
trial -Warehouse
Multifamily Power Center Retail
Retail 2nd -Tier Regional Malls
4th Qtr 2004 ESTIMATE
Phase I - Recovery
Phase IV - Recession
Source Mueller, 2004
24
2000s Office Demand Supply
FORECAST
Supply Reacted to Demand Slow Down
Source FW Dodge, CB Commercial, BLS, PPR, Mueller
25
(No Transcript)
26
Office Market Cycle FORECAST
4th Quarter, 2004 Estimates
New Orleans Norfolk N. New Jersey Oklahoma City
Orlando Philadelphia Phoenix Pittsburgh Port
land Raleigh-Durham Sacramento Salt Lake San A
ntonio San Francisco San Jose Seattle Stamford
St. Louis Wash, D.C. W. Palm Beach-1 NATION
Atlanta Austin Charlotte Chicago Cincinnati C
leveland Columbus Dallas FW-1 Denver Detroit
East Bay Hartford Houston Indianapolis Jackson
ville Kansas City Long Island-1 Los Angeles Mi
ami Milwaukee Minneapolis Nashville
11
10
12
9
8
13
LT Average Occupancy
7
6
14
15
5
16
1
4
1
3
2
Orange County1 Riverside2
Baltimore-1 Boston New York Tampa-1
Albuquerque Ft. Lauderdale Honolulu Las Vegas
Memphis
Richmond San Diego1 Wilmington
Source Mueller, 2004
27
LT Average 82.2
28
Industrial Market Cycle FORECAST
4th Quarter, 2004 Estimates
Atlanta Charlotte Chicago Cincinnati Cleveland
Columbus Dallas FW Detroit Indianapolis Kans
as City Las Vegas-1 Long Island Memphis Miami
Minneapolis
Nashville New York Oklahoma City Orlando Pitt
sburgh Portland Raleigh-Durham Richmond Salt
Lake San Francisco San Jose Stamford St. Louis
Tampa-1
11
Denver Los Angeles Milwaukee Orange County San
Diego
W. Palm Beach
10
12
Riverside
9
8
13
LT Average Occupancy
7
6
14
15

5
16
1
4
1
3
2
East Bay-1 Houston-1 N. New Jersey-1 Norfolk P
hiladelphia
Washington, D.C.
Austin-1 Baltimore-1 Boston-1 Hartford-1
Source Mueller, 2004
Ft. Lauderdale Honolulu Jacksonville1 New Orle
ans 1 Phoenix-1 Sacramento San Antonio Seattl
e
NATION
29
LT Average 92.3
30
Multifamily Market Cycle FORECAST
4th Quarter, 2004 Estimates
Chicago Ft. Lauderdale Jacksonville Las Vegas1
N. New Jersey Norfolk-1 Philadelphia2 Rivers
ide
Tampa W. Palm Beach1
Austin Baltimore Cleveland Dallas FW1 East Ba
y Indianapolis1 Kansas City-1 Milwaukee Minne
apolis-1 New Orleans New York Phoenix St. Loui
s NATION
11
10
Orlando3
12
Denver Hartford Houston-1 Miami-1 Portland Ra
leigh-Durham
Richmond
9
8
13
LT Average Occupancy
7
6
14
Los Angeles Orange County1 Sacramento San Anto
nio
San Diego1
15
5
16
1
4
1
3
2
Atlanta-1 Boston Honolulu Nashville Oklahoma C
ity
San Francisco Washington, D.C.
Charlotte Cincinnati Columbus1 Detroit Long I
sland Memphis Pittsburgh San Jose Salt Lake S
eattle
Stamford
Source Mueller, 2004
31
LT Average 92.3
32
Retail Market Cycle FORECAST
4th Quarter, 2004 Estimates
Boston-1 Honolulu Houston-1 Indianapolis Long
Island Los Angeles New Orleans Riverside San A
ntonio-2
Stamford St. Louis W. Palm Beach1
East Bay Norfolk Phoenix San Francisco Salt La
ke
San Diego Tampa
Austin Charlotte Cincinnati Cleveland Columbus
-1 Dallas FW-1 Hartford Memphis N. New Jersey-
1
Philadelphia San Jose-1
11
10
12
9
8
Ft. Lauderdale1 Miami1 Washington DC
13
7
6
14
LT Average Occupancy
Baltimore Chicago Denver1 Milwaukee Minneapol
is New York-1 Orange County Pittsburgh-1 Portl
and-1
Sacramento-1 Seattle NATION
15
5
16
1
4
1
3
Atlanta Detroit Nashville1 Oklahoma City Orl
ando2
Richmond2
2
Jacksonville Kansas City Las Vegas Raleigh-Durh
am

Source Mueller, 2004
33
LT Average 84.5
34
Hotel Market Cycle FORECAST
4th Quarter, 2004 Estimates
Chicago Cincinnati Ft. Lauderdale Las Vegas Mi
lwaukee Nashville Orlando Portland Raleigh-Dur
ham
San Antonio Seattle Stamford NATION
Baltimore1 Jacksonville Long Island New York
Oklahoma City2
Orange County1 Philadelphia
11
Atlanta Boston-1 Detroit East Bay Hartford Ho
uston-1 Indianapolis-1 Kansas City Pittsburgh
San Jose
St. Louis
10
San Diego
12
9
8
13
LT Average Occupancy
7
6
14
Los Angeles Norfolk Riverside W. Palm Beach
15
5
16
1
4
1
3
Honolulu Phoenix Sacramento Washington DC1
2
Austin Charlotte Cleveland Columbus Dallas FW
1 Denver Memphis Miami Minneapolis New Orlean
s N. New Jersey1 Richmond Salt Lake San Fran
cisco Tampa
Source Mueller, 2004
35
LT Average 63.8
36
Real Estate Financial Cycles

• Capital Flows
• Affect Prices

37
Market Cycle Capital Flow Impact
Capital Flows to Existing Properties
Cost Feasible Rents Reached
LT Occupancy Avg.
Property Market Cycle
Total Capital Flow Cycle

Capital Flows to New Construction
38
National Office Physical Market Cycle vs
Financial Cycle - New Permit Values
Physical
Financial
Source CB Commercial, Census Bureau
Source BEA, CB Commercial, Mueller
39
Flow of Funds Commercial MortgagesAll Sectors
(1976 - 2001)
False Price Appreciation Support
( Mils)
?
Public Market Volatility
Source Federal Reserve
40
Historic Property Cap Rates
41
Historic Property Cap Rates
42
Transaction Pricing
36/1636 deals 25/1319 deals
33/1624 deals 37/1798 deals
Source Real Capital Analytics, New York
www.rcanalytics.com
43
Where is U.S. Real Estate Capital Coming From
2000 2001 2002 2003
Source Real Capital Analytics, New York
www.rcanalytics.com

44
Reduce Bond Allocation to Minimum Level as Rates
Rise
45
2003 Physical Cycle

• Demand Supply Affect Vacancies Rental
  GrowthDemand Growth - MUCH SLOWER for How long?
  
• Supply Slowing - how long to absorb?
• Return to Growth Phase in 2006?
• Wars stop progress - Create Economic Recovery
  after ?
  
• 2003 Financial Cycle
• Capital Flows Affect Prices Stock Market Fear
• Real Estate the SAFEST Investment Alternative?
• Interest Rates are driving investments in the
  short run
  
• R E Equity dominated by private markets
  (currently international)
  
• Public Market Debt Biggest RE Capital Source
• Confidence will return in 200?

46

• For an electronic copy
• of the
• Legg Mason
• Real Estate Market Cycle Monitor
• Email
• grmueller_at_leggmason.com