2012–2013Commercial Real Estate Forecast:OpportunityisKnockingBy: Ray Alcorn

Copyright 2012 by H. Ray Alcorn, Jr.—All Rights ReservedPublished by Golden Key Investments Ltd., Blacksburg, VirginiaNo part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted underSection 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher.Requests to the Publisher for permissions should be addressed to Golden Key Investments Ltd., P.O. Box 5,Blacksburg, VA 24060, tel. 540-552-5533.Limit of Liability/Disclaimer of Warranty: The publisher and author have used their best efforts in preparing thistext, but they make no representations or warranties with respect to the accuracy or completeness of the contentsand specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warrantymay be created or extended by sales representatives or written sales materials. The advice and strategiescontained herein may not be suitable for your situation. Past performance is not a guarantee of future results. Youshould consult with a professional where appropriate. Neither the publisher nor author shall be liable for any lossof profit or other commercial damages, including but not limited to special, incidental, consequential, or otherdamages.For additional information about the author, reference materials and products, please visit our websiteat DealMakersGuide.comFor questions or inquiries about obtaining permission to distribute this material, please send an email [email protected] the author.Ray Alcorn is CEO and a principal of Park Real Estate Inc., acommercial real estate development and investment firm based inBlacksburg, Virginia. The company owns and manages a portfolio of retail,office, and hospitality properties.Ray has been in the commercial real estate industry for over 30 years. Hehosts the Commercial Real Estate Discussion Forum at,where he answers questions and participates in discussions with investorsfrom across the US and the world.In his home study course, DealMaker’s Guide to Commercial Real Estate he shares alifetime of experience investing in commercial real estate. This book provides real-worldinformation written by a true dealmaker, including how to design your personal investmentcriteria to fit your overall life goals. It is an invaluable resource for creating and buildingwealth in commercial properties of all types.

2012–2013 Commercial Real Estate Forecast:Opportunity is KnockingBy Ray AlcornTable of ContentsPart 1: The Big PicturePage #Introduction3Uncertainty on Grand Scale4Macro Economic Conditions6Housing, Employment & Income8Capital Markets: Conditions and Outlook23Interest Rates: Trends and Forecast32Era of Equity: Follow the Leaders35Part 2: Forecast by Region and Property TypeGeneral Commercial Real Estate Performance: 201137Current Conditions and Outlook: Multi-family Office Retail39Investment Strategies for the Era of Equity46Resources52 H. Ray Alcorn Jr. All Rights ReservedPage 2

2012-2013 Commercial Real Estate ForecastOpportunity is Knocking"The ladder of success is best climbed by stepping on the rungs of opportunity." - Ayn RandPart 1: The Big PictureIntroductionUncertainty on a Grand ScaleMacro-economy: Low-growth best caseHousing, Employment & Income: Bad, Better, and DepressingCapital Markets: A Goat RodeoThe Era of EquityFriends & Colleagues:Before getting into this year’s forecast I want to thank the many people who have contactedme through my new website at It’s been good to reconnect with alot of old friends and add new ones as traffic grows. If you have friends who would enjoythe content please take a moment and forward the link.On the site you’ll find my blog, Dirt Merchant Digest. My goal is to use the blog to postthoughts on current events, and give you a look over my shoulder at my personalinvestment strategies. Please post comments to the posts that most interest you. And letme know what’s on your worry list, the things that keep you awake at night. Those are thetopics I want to write about to help us all make better investment decisions.And while we’re talking about connecting with each other, you can also find me on thefollowing social media sites:Facebook at’s Guide on Facebook at at at Ray AlcornPlease send me a friend or connection request and I will immediately accept it. (By the way:I also have a Twitter account, @ray alcorn. Several friends (?) have brow-beat me intotweeting. So far I’ve tweeted maybe a dozen times. Not sure why, but there, I did it.)And for 12 years and counting I am still hosting the CREOnline Commercial Real EstateForum. The site was revamped last fall and if you haven’t checked it out you should. Thenew forums have much better functionality, including user profiles, private messaging andpersonal archives. I invite you to join the discussion.Enjoy my outlook for an exciting period in real estate, “Opportunity is Knocking” H. Ray Alcorn Jr. All Rights ReservedPage 3

Uncertainty on a Grand ScaleFor those who were around in the early eighties the current times have a familiar tone—asense of foreboding that comes with the uncertainty of not knowing what lies around thecorner in business, politics or world affairs.Uncertainty was a secondary factor in last year’s outlook, overshadowed by the moreimmediate headwinds of housing, unemployment and stagnant income growth threateningthe nascent recovery from the Great Recession. However by mid-year I tempered mypessimistic outlook, and actually feel good about the prospects that my call for negativeGDP growth would be wrong (and it was, though 1.7% growth is hard to get excited about).On a personal level our company experienced an increase in leasing activity in our officebuildings and retail properties. Our banks were eager to make loans—though on decidedlymore conservative terms—and we closed funding for two construction & improvementprojects. Things were looking up.But I underestimated the ability of politicians to do exactly the wrong thing. Starting in latesummer, Congress and the White House engaged in a cage match worthy of the WWE overthe debt ceiling. Then came a first-ever ratings downgrade of US Treasuries, which spurreda contradictory rally in Treasuries, bringing interest rates to historic lows. Not to bedissuaded from making things worse, the politicians closed the year with a two-month dealto extend a 2% payroll tax break (extended for one year in January), and the Fedannounced their zero-percent interest policy will remain in force for three years, throughlate 2014, telegraphing their expectation of slow growth for the foreseeable future.This had a marked effect on the capital markets and in real estate. The year started with ahuge increase in transaction volume, but every report in the second half was of slowingactivity. In most situations, a confused mind says “no”.Playing Kick the Can in a Cul-de-sacIf the number of decisions being deferred by our leaders doesn’t make you nervous, you’renot paying attention. The inability of Congress and the Obama administration to make anysubstantive progress is beyond the scope of how I previously defined gridlock.Given the current state of affairs, here’s what we know won’t happen in 2012: Congresswon’t pass a budget, or cut spending, or do anything that might play badly in the mediaduring the election cycle. In fact if the economy slows down in the latter half of the year Iexpect to hear a lot of noise about additional market-distorting stimulus programs. (QE3anyone?)In the past I have considered gridlock a good thing. Gridlock creates a type of certaintywhich supports the axiom, “If nothing changes, nothing changes”. It certainly makesforecasting a lot easier. But the current brand of gridlock could prove to be disastrous. Thelist of “kicked cans” (see chart on next page) is enough work for two congressional terms,and they all hit at once in January 2013. This is uncertainty on a grand scale, and the H. Ray Alcorn Jr. All Rights ReservedPage 4

that it’s an election year insures nothing will be done to address the real problems until theyhave to.Policies set to expire or takeeffect under current lawSequester Automatic Cuts(Discretionary Spending)Sequester Automatic Cuts(Mandatory Spending)Bush Tax Cuts ( 250k Incomes, Estate Tax)Bush Tax Cuts (MiddleIncome)Alternative Minimum TaxPayroll Tax CutEmergency UnemploymentCompensationAffordable Care ActTotal Fiscal DragSource: JP MorganChase; EOTM 4/9/12Fiscal Drag (%of 2013 20%-3.50%The chart at left lists the deferred decisionsthat will be on the agenda of the Departmentof Can-Kicking, I mean Congress, in January2013. (“Sequestration” is the term used forthe mandatory cuts agreed to by the DebtReduction Committee formed to resolve thedebt ceiling “crisis last summer.)Analysts at JP Morgan estimated the fiscaldrag of all the provisions scheduled to expireand kick in during 2013 if Congress doesnothing. The estimated total drag on potentialGDP growth is about 3.5%. To put that inperspective, total growth for all of 2011 was1.7%. Please note this is regardless of theelection outcome.Add to the list the likely need for anotherincrease in debt ceiling. Prepare to be amused.But if Congress and the President elect to extend current tax rates, retain lower payroll taxrates and extended jobless benefits, the adjustment would not be as big.The following graph only reflects expiration of Recovery Act provisions, the recently passedBudget Control Act, and some other smaller provisions. There are of course plenty ofpermutations in between. Bet on more can-kicking wherever H. Ray Alcorn Jr. All Rights ReservedPage 5

An interesting report about the K-Street lobbying firms in Washington indicates 2011 was adown year (10% to 25% decrease in revenue), and they don’t expect 2012 to be any betteruntil the election is over.Several lobbyists predicted 2012 would be another slow year. Lawmakers aredistracted by election-year politics, and legislation is unlikely to move after the firstfew months of the year. Rich Gold of Holland & Knight said things could speed up inthe second half of 2012, especially after campaign season comes to a close.“You will have the holy trinity of lame-ducks, which is sequestration, the Bush taxcuts and the debt limit. It doesn't get much better than that,” Gold said. —The Hill,On K Street, 2011 was Year to Forget, 1/20/12The article above goes on to say that while legislative lobbying may be in a slump, revenuesare rising to influence regulatory actions. Given the legions (139 at last count) of boardsand commissions currently writing thousands of rules to implement the Dodd-Frank financialreform bill and the Affordable Health Care Act, there are ample opportunities for industrieswith vested interests to influence the outcome in their favor.Macro-economic ForecastsLest we be fooled, inaction in Washington does not mean we’re safe at home. Of the threedozen or so financial and economic sources I subscribe to the opinions are split about as towhether we will fall back into recession. The following chart lists forecasts from well-knownsources to illustrate the point:SourceA. Gary ShillingGoldman SachsFederal ReserveKiplingerCasey ResearchMortgage BankersAssoc.John MauldinJP MorganFinancial y1.5%-2%RecessionYes / 8.3%N/A2%NoNo-1%3.7%9%2.7%-4%Yes1.8%2% 2%2.0%8.5%2.3%3%8.5%2%No60/40 NoNo-0.1%3.4%8.8%3.3%YesEach of the forecasters makes a good case for their position. The conclusion I draw is thatthe best case scenario is “below trend” growth (defined as 2%), and worst case a H. Ray Alcorn Jr. All Rights ReservedPage 6

However, it’s worth noting that a controversial recession call came out of the blue fromECRI (Economic Cycle Research Institute). On September 30th 2011 ECRI publiclyannounced that the U.S. is tipping into a recession, a call the Institute had announced to itsprivate clients on September 21st. Here is an excerpt from the announcement:“Early last week, ECRI notified clients that the U.S. economy is indeed tipping into anew recession. And there’s nothing that policy makers can do to head it off. [ ] Infact, the most reliable forward-looking indicators are now collectively behaving asthey did on the cusp of full-blown recessions, not “soft landings.”[ ] It’s important to understand that recession doesn’t mean a bad economy – we’vehad that for years now. It means an economy that keeps worsening, because it’slocked into a vicious cycle. It means that the jobless rate, already above 9%, will gomuch higher, and the federal budget deficit, already above a trillion dollars, willsoar.”Here’s what ECRI’s recession call really says: if you think this is a bad economy, you haven’tseen anything yet. And that has profound implications for both Main Street and Wall Street.The next chart is from the best economic forecasting tool you’ve never heard of, theChicago Fed National Activity Index.The CF-NAI has a sterling track record of accuracy in predicting recessions 6–12 monthsout: 96.2% correct, with 0 false positives over the last seven recession cycles. The March2012 report above included the following H. Ray Alcorn Jr. All Rights ReservedPage 7

The index’s three-month moving average, CFNAI-MA3, increased from 0.22 inJanuary to 0.30 in February—its highest level si