Capitalization Rate Analysis & Forecast

October 27, 2009

Paul D. Griffith, MAI, MRICS Managing Director Integra Realty Resources - Pittsburgh

What is a Capitalization Rate?

Net Operating Income = Capitalization Rate Value

Example
If a building sells for $1,000,000 and the seller forecasts the building will generate $100,000 in net operating income in the first year of ownership, the indicated capitalization rate is 10%.
Net Operating Income Sale Price $100,000 $1,000,000 10% = Indicated Capitalization Rate

Why is the Cap Rate Important?

Allows investors, lenders, analysts, and appraisers to keep score.
Measures first year rate of return Allows comparison of different property types Allows comparison of different classes of the same property type Allows comparison of rates over time

Capitalization Rates
Sources
Korpaz Viewpoint

Application
Class A properties Well located Stabilized with market oriented income stream Multiple tenants

Multi-Family
9.00% 8.00% 7.00% 6.28% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q3 04 Q3 05 Q3 06 Q3 07 Q3 08 Q3 09 8.00% 7.05% 7.75% 7.00% 5.98% 6.75% 5.76% 6.25% 5.86% 7.84%

6.50%

National Quarter 3 Pittsburgh Forecast for year

Regional Mall
8.20% 8.00% 7.80% 7.60% 7.40% 7.20% 7.00% 6.80% 6.60% 6.40% 6.20% 6.00% Q3 04 Q3 05 Q3 06 Q3 07 Q3 08 Q3 09 7.17% 7.20% 7.02% 6.86% 7.57% 7.50% 7.50% 7.25% 7.00% 6.78% 7.98% 7.75%

National Quarter 3 Pittsburgh Forecast for year

Shopping Center
10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q3 04 Q3 05 Q3 06 Q3 07 Q3 08 Q3 09 9.50% 8.39% 8.00% 7.45% 7.75% 7.36% 7.50% 7.20% 7.50% 7.33% 8.41% 8.25%

National Quarter 3 Pittsburgh Forecast for year

CBD Office
12.00% 10.50% 10.00% 8.48% 8.00% 7.71% 7.07% 6.68% 7.04% 10.50% 10.25% 9.75% 9.50% 9.50% 8.11%

6.00%

4.00%

2.00%

0.00% Q3 04 Q3 05 Q3 06 Q3 07 Q3 08 Q3 09

National Quarter 3 Pittsburgh Forecast for year

Suburban Office
12.00% 11.00% 10.00% 8.91% 8.12% 8.00% 8.25% 7.75% 7.24% 8.25% 7.34% 11.00% 9.50% 8.72% 8.50%

6.00%

4.00%

2.00%

0.00% Q3 04 Q3 05 Q3 06 Q3 07 Q3 08 Q3 09

National Quarter 3 Pittsburgh Forecast for year

Warehouse
10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q3 04 Q3 05 Q3 06 Q3 07 Q3 08 Q3 09 9.50% 8.27% 7.50% 7.03% 6.53% 6.63% 9.25% 8.50% 8.25% 8.46% 8.50% 8.00%

National Quarter 3 Pittsburgh Forecast for year

The FutureWhat causes capitalization rates to change?

Capitalization rates decline when investors forecast the return on investment will increase during the holding period.
Increases occur in the form of
Increases in NOI caused by
employment and population increase contractual rent increases

Favorable financing leverage Undersupply of a product type

The FutureWhat causes rates to change?

Capitalization rates increase when the opposite trends occur. Pittsburgh has had higher cap rates than reported nationally because:
Net income levels have grown more slowly because the region has had limited population and employment growth. Pittsburgh is considered a tertiary investment market which attracts fewer investment dollars than higher tier cities.

Why do capitalization rates differ for the same property type?

Age and condition of the property Length of the lease term Level of rent growth Location of property Balance of supply and demand Cost of re-tenanting Creditworthiness of tenant(s)

The Future
Nationally
Current cap rates are likely to go higher if:
The commercial real estate market becomes oversupplied because of the inability of owners to refinance properties (foreclosures).

Current cap rates are likely to decline if:

Availability of credit and credit terms improve. Demographics improve including higher employment and increasing population.

Forecast
Cap rates nationally are unlikely to change significantly until the
commercial real estate refinancing problem is solved. economy grows, increasing demand for retail space, apartments, office space, and industrial space.

Over the long term, Pittsburgh will continue to have comparatively higher cap rates than the nation as a whole. However, Pittsburghs comparatively stable economy has resulted in current cap rates which are likely to remain closer to national averages in the short run.

Forecast
In Pittsburgh
the multi-family sector will continue to have the lowest rate of the major property types. A lack of new product and comparatively better financing alternatives will limit upward pressure on multi-family rates. cap rates for retail properties are likely to remain historically high because of weak retail demand.

Forecast
In Pittsburgh
cap rates for suburban office properties in the north and south submarkets will be the lowest because demand is the highest. the Pittsburgh CBD office market will continue to see primarily double-digit cap rates because of limited rent growth, increasing expenses, and higher turnover costs.

Questions or Comments
Contact Information Paul D. Griffith, MAI, MRICS Managing Director Integra Realty Resources Pittsburgh 2591 Wexford-Bayne Road, Suite 102 Sewickley, PA 15143 P: 724.742.3324 E: pgriffith@irr.com

Follow-Up
Thank you! For attending this presentation. Please email Mary Amore at mamore@irr.com to receive a copy of todays presentation. In addition, if you are interested in receiving a copy of the upcoming 2010 Viewpoint publication, please indicate that in your email.