Risk Management Trends in the 2nd Act of Market Recovery: Houston Dianne Crocker Houston DDD November 19, 2014

1. 1
RISK MANAGEMENT TRENDS IN THE 2ND
ACT OF MARKET RECOVERY
November 19, 2014
Presented by:
Dianne P. Crocker, Principal Analyst
EDR Insight

2. 2
TODAY’S HIGHLIGHTS
1. RECOVERY IS GAINING TRACTION.
2. RISK MANAGEMENT IS GETTING SMARTER.
3. OPPORTUNITIES ARE BEING CREATED FOR ALL OF US.

3. 3
1. RECOVERY GAINING TRACTION

4. 4
RECOVERY IN REAL ESTATE: 2014
• Q1 WAS AN ANOMALY.
• ECONOMIC ACTIVITY LARGELY PICKED
BACK UP IN Q2 AND Q3.
• IMPROVED OUR OUTLOOK FOR ALL
MAJOR COMMERCIAL REAL ESTATE
SECTORS…

5. 5
BAROMETERS POINTING TO MOMENTUM
• THE JOBS MARKET IS GETTING BETTER.
• CORPORATE EARNINGS ARE GETTING BETTER.
• INVESTMENT ACTIVITY IS BACK IN VOGUE.
• MARKET FUNDAMENTALS ARE IMPROVING.
• INTEREST RATES ARE STILL LOW.
• ALLOCATIONS TO REAL ESTATE ARE GROWING.

6. 6
DEAL MAKING: WHO’S INVESTING?
• MAJOR BUYING CLASSES
• Real estate investment trusts (REITs)
• Foreign investors
• Private equity funds
• Hedge funds
• Traditional developer/owner/operators
2014 Top Buyers, All Core
Property Types
ARCP
Blackstone
JP Morgan
Norges Bank Investment Mgt
Hines
OMERS
Starwood Capital Group
MetLife
Essex Property Trust
David Werner Real Estate

7. 7
CONSTRUCTION IS BACK!
• UPTICK IN NEW CONSTRUCTION MARKS START OF NEW
DEVELOPMENT CYCLE (FINALLY)
• STALLED PROJECTS ARE GETTING THE GREEN LIGHT
• BEYOND KEY METROS (NY, SAN FRAN, BOSTON)
• TOP 10 STATES:
1. Texas
2. Louisiana
3. New York
4. California
5. Iowa
6. Florida
7. Maryland
8. Georgia
9. West Virginia
10. Oregon
•

8. 8
DESIGN SERVICES ARE UP, TOO
ARCHITECTURE BILLINGS INDEX:
• IN JULY, INDEX HIT ITS HIGHLIGHT POINT
SINCE BEFORE THE DOWNTURN
• SUGGESTS THAT CRANES WON’T BE
LEVELING OFF ANY TIME SOON
• POINTS TO MARKED INCREASE IN
U.S. DEVELOPMENT IN 2014

9. 9
Small cap property sales were up 31% through August,
and are on pace to set record volume for the year.
Large property sales were up 33% for the 3rd quarter with
sales accelerating across all sectors.

10. 10
PROPERTY TYPES ATTRACTING INTEREST
• MULTIFAMILY APARTMENT DEMAND STILL LEADS
• Will continue to grow in 2015
• Driven by Freddie Mac’s new small-balance program
• SELF-STORAGE
• REGIONAL MALLS
• OFFICE IS IMPROVING IN MAJOR URBAN MARKETS
• INTEREST PIVOTING TO INDUSTRIAL AND RETAIL ASSETS

11. 11
PROPERTY DEALS TILT TOWARD SMALLER
METROS
• HIGHER PRICING, MORE COMPETITION IN MAJOR MARKETS
• INVESTORS SEEKING HIGHER YIELDS, LESS INTENSE
COMPETITION
• MORE ACTIVITY IN SMALLER METROS…

12. 12
METRO HOT SPOTS, 2014
Top 10 Metro Leaders:
Phase I ESA Growth in 2014
Cincinnati, OH 40%
Austin, TX 23%
Oklahoma City, OK 19%
Pittsburgh, PA 16%
Dallas, TX 16%
Houston, TX 15%
Richmond, VA 12%
Portland, OR 12%
Seattle, WA 11%
Kansas City, MO 10%

13. 13
LENDING: SLOW PACE OF GROWTH IN
ORIGINATIONS
• AVAILABILITY OF CAPITAL IS VITAL TO THE RECOVERY
• BANKS HAVE $ TO LEND, BUT STILL VERY CAUTIOUS
• EXTREMELY COMPETITIVE
• HEADING INTO NEW ROUND OF REFINANCING WITH $360B IN
LOANS MATURING BY 2017

14. 14
POINTS IN LENDERS’ FAVOR
• BANKS’ NET INCOME IS RISING
• BANKS SET ASIDE LESS MONEY TO COVER SOURED LOANS,
HELPING TO BOOST PROFITS.
• LOAN LOSSES ARE FALLING
BOOSTS THEIR CASE FOR INCREASED LENDING ACTIVITY…

15. 15
BANK LENDING HITS ITS STRIDE

16. 16
CREDIT AVAILABILITY IMPROVING…
HOW WOULD YOU CHARACTERIZE THE LEVEL OF CURRENT
FINANCING CONDITIONS TODAY COMPARED TO CONDITIONS ONE
YEAR AGO?
• CREDIT AVAILABILITY HAS MEANINGFULLY IMPROVED: 45%
• CREDIT AVAILABILITY HAS ONLY MARGINALLY IMPROVED: 44%
• JUST AS TIGHT AS LAST YEAR: 10%
• CREDIT AVAILABLE HAS TURNED FOR THE WORSE: 1%
SOURCE: EDR INSIGHT’S BENCHMARK SURVEY: LENDERS'
SCOPES OF WORK FOR COMMERCIAL PROPERTY DUE DILIGENCE,
SEPTEMBER 2014.

17. 17
…MORE SERIOUS BORROWER INTEREST
COMPARED TO THIS TIME LAST YEAR, HOW WOULD YOU
CHARACTERIZE BORROWER INTEREST ON LOANS FOR
COMMERCIAL PROPERTIES?
• MORE SERIOUS INQUIRIES FROM BORROWERS: 46%
• ABOUT THE SAME: 43%
• FEWER SERIOUS INQUIRIES FROM BORROWERS: 11%
SOURCE: EDR INSIGHT’S BENCHMARK SURVEY: LENDERS'
SCOPES OF WORK FOR COMMERCIAL PROPERTY DUE DILIGENCE,
SEPTEMBER 2014.

18. 18
NEAR-TERM LENDING FORECAST
Forecast calls for modest 5-6 percent
growth in commercial/multifamily
originations over next two years.

19. 19
TEXAS’ PHASE I ESA TREND LINE
Up 14% YoY

20. 20
SCOREKEEPER’S METRO FOCUS: TEXAS

21. 21
WHY IT’S GOOD TO BE IN HOUSTON
Houston is
THE #1
“Market to
Watch” in the
U.S.
• Houston is a principal target for offshore
investors, along with Seattle and big CA
markets.
• Completion of the Panama Canal
expansion in early 2016 will drive
demand for industrial sites around the
Port of Houston,
• For office real estate, the competition for
Class A assets has cleared the path for
Class B deals.
“The strength of the
Texas economy
continues to dominate
the rankings.”

22. 22
HOUSTON (CONT’D)
• #1 FOR INDUSTRIAL AND RETAIL
PROSPECTS IN U.S.
• #2 FOR OFFICE AND MULTIFAMILY
• REAL ESTATE MARKET CONDITIONS
ARE “EXCELLENT” FOR 2015 DUE TO:
• Strong local economy
• Available capital
• Investor demand

23. 2. RISK MANAGEMENT GETTING SMARTER
23

24. 24
IN GENERAL, HOW WOULD YOU RATE YOUR
CLIENTS' RISK TOLERANCE IN 2014 VS. 2013?
Less aversion More aversion
SOURCE: EDR INSIGHT SURVEY: SCOPES OF WORK BENCHMARK SURVEY
OF EP’s, SEPTEMBER 2014

25. 25
TRUE/FALSE?
Clients are demanding more thorough environmental due
diligence on deals today than they were last year.
Less aversion More aversion
SOURCE: EDR INSIGHT SURVEY: SCOPES OF WORK BENCHMARK SURVEY
OF EP’s, SEPTEMBER 2014

26. 26
TRUE/FALSE?
Clients are demanding more thorough environmental due
diligence on deals today than they were last year.
“The biggest change we have seen
is in volume of work. Although risk
tolerance has not changed, banks
are conducting more deals.”
SOURCE: EDR INSIGHT SURVEY: SCOPES OF WORK BENCHMARK
SURVEY OF EP’s, SEPTEMBER 2014

27. 27
HOW LENDERS VIEW RISK TOLERANCE
IN GENERAL, HOW WOULD YOU RATE THE
LENDING SECTOR’S TOLERANCE OF
ENVIRONMENTAL RISK IN 2014 VS. 2013?
SOURCE: EDR INSIGHT’S BENCHMARK SURVEY: LENDERS' SCOPES OF
WORK FOR COMMERCIAL PROPERTY DUE DILIGENCE, SEPTEMBER 2014.

28. 28
OTHER SIGNS OF HIGH RISK AVERSION
• DUE DILIGENCE SCOPES ARE BEING MORE TAILORED TO THE
DEAL. NOT ONE SIZE FITS ALL.
• GREATER SCRUTINY OF PHASE I ESA’S BY LENDERS
• AN INCREASE IN PHASE II ESA’S IN 2014
• INCREASE IN ASBESTOS SURVEYS
• MORE PROPERTY CONDITION ASSESSMENTS…

29. 29
INTEGRATION OF DUE DILIGENCE
• NEGLECTED PROPERTIES ARE GETTING ATTENTION FOR
THE FIRST TIME IN YEARS
• RISK AVERSION IS HIGH, SO POTENTIAL INVESTORS ARE
TAKING A MORE THOROUGH LOOK—NOT ONLY AT
CONTAMINATION BUT ALSO AT STRUCTURAL ISSUES.
“BY ADDING THE PCA TO THE DUE DILIGENCE PROCESS, THE
GAPS OR ESTIMATES TYPICALLY FOUND IN THE APPRAISAL
CAN BE BETTER DEFINED IN THE FORM OF REAL DATA FROM
THE SUBJECT PROPERTY.”
~DAVID DRUMMOND, NATIONAL CHIEF ENVIRONMENTAL RISK
OFFICER AND NATIONAL CONSTRUCTION ENGINEERING
MANAGER, KEY BANK

30. 30
PCA’S AND PHASE I ESA’S
• A PCA IS MORE COMMONLY BEING BUNDLED WITH A PHASE I,
ESPECIALLY ON MULTIFAMILY PROJECTS FOR FANNIE MAE,
FREDDIE MAC AND HUD.
• AS OF JULY 2014, FREDDIE MAC IS NOW REQUIRING THAT THE
APPRAISER BE GIVEN THE PROPERTY CONDITION
ASSESSMENTS AND THE ENVIRONMENTAL REPORTS, AND THE
APPRAISER MUST THEN OPINE TO THE IMPACT ON VALUE.
• FIRMS THAT CAN OFFER EXPERTISE IN BOTH PCAS AND
PHASE I ESAS COULD HAVE A DISTINCT ADVANTAGE.

31. 31
3. OPPORTUNITIES BEING CREATED

32. 32
MORE INTEREST IN REDEVELOPMENT
• MUNICIPALITIES HAVE REASSESSED THE POTENTIAL FOR
REDEVELOPING INDIVIDUAL PROPERTIES, AND ARE MAKING
DEVELOPMENT ON THESE PROPERTIES EASIER IN AN EFFORT
TO LURE DEVELOPERS.
• OWNERS, DEVELOPERS AND LOCAL GOVERNMENTS ARE IN
POSITION TO RESTART PREVIOUSLY-STALLED PROJECTS.
• MANY INVOLVE SITES WITH CONTAMINATION DEEMED TOO
COSTLY FOR REDEVELOPMENT.
• MORE DEMAND FOR URBAN LOCATIONS BRINGS
CONTAMINATED SITES INTO PLAY.

33. 33
LOCAL INCENTIVES ARE CRITICAL
“WITH THE COMEBACK ECONOMY, DEVELOPERS
EXPECT THEIR CONSULTANTS TO UNDERSTAND
AND PROCURE ECONOMIC INCENTIVES. WE HAVE
COUNTLESS REDEVELOPMENT PROJECTS
RELYING UPON A NUMBER OF INCENTIVES FROM
EPA SITE ASSESSMENT GRANTS, FEDERAL,
STATE AND LOCAL TAX INCREMENT FINANCING
OPTIONS, STATE GRANTS, LAND BANKS, ETC.”
~MIKE KULKA, CEO, PM ENVIRONMENTAL

34. 34
TECHNOLOGY: LEAPS AND BOUNDS

35. 35
“I AM ALL ABOUT MULTI-PLATFORM TECH THESE DAYS, I’VE GOT MY
LAPTOP, PHONE AND TABLET CONFIGURED TO SYNC ALL MY
CRITICAL FILES AND PRODUCTIVITY APPS AS MUCH AS POSSIBLE
AND (FINALLY) IT IS HELPING ME BE MORE PRODUCTIVE. SOME
PEOPLE ARE GREAT AT BEING PRODUCTIVE IN FIELD BUT AWFUL
WHEN THEY GET BACK TO OFFICE AND VICE VERSA. SO
INTEGRATING EMAILS, TO-DOS TASK MANAGEMENT,
TRAVEL/EXPENSES, PHOTOS STORAGE EDITING, REPORT WRITING
NEED TO BE INTEGRATED.”
~EP IN ATLANTA

36. The FAA predicts that as many as 10,000 commercial drones
36
will be licensed by 2018.

37. “The Phase I ESA industry is so uber-competitive right now that
the firms that are succeeding are the ones open to adopting
new technologies, taking them past the 'wow!' factor and
putting them into practice. The ability to cheaply fly over a
property and get data especially on sites that are inaccessible
by foot can be a major selling point on some projects. Only a
handful of firms have embraced it thus far, so the field is wide
open, keeping an eye out for what the FAA does to regulate, of
course.”
~Bloomberg BNA Daily Environment Report
37

38. 38
Q&A WITH MICHAEL BERMAN
What advice would you give to property assessment
professionals?
“As competition for financing as well as acquisition of CRE assets
continues to increase, margins will be squeezed and efficiency as
to time and cost will be of paramount importance to principals who
are growing their lending and investment businesses. Likely
increases in interest rates over the next year will add more
pressure to this scenario. Accordingly, property assessment
professionals will be under increasing pressure to perform
their work faster and more inexpensively. Technology is an
important tool for these professionals as well as the nurturing
of key relationships, as services to the CRE industry become
increasingly commoditized.”
~Michael Berman, leading expert on capital markets, former
chairman of the Mortgage Bankers Association

39. 39
WHAT’S NEXT?

40. 40
2015 FORECAST
• MARKET HEALTH:
• Back on track after slow start to ‘14
• More $$s, more players, broader geographic reach
• LENDERS ARE GETTING MORE COMFORTABLE RAMPING UP
NEW ORIGINATIONS, AND MOVING PAST THE LOAN WORKOUTS
AND FORECLOSURES THAT DOMINATED THE PAST FEW YEARS.
• RISK
• Still a general sense of risk aversion
• YOUR CHALLENGES:
• Competition, efficiency, speed
2015 FORECAST:
• Modest but steady growth
• Viability to the recovery that we haven’t seen thus far

41. RISK MANAGEMENT TRENDS IN
THE 2ND ACT OF MARKET
RECOVERY
Baby stepping our way back
41