S1E7 - Min Suh - Assess+RE

S1E7 - ASSESS+RE - MIN SUH

Min has worked for and advised leading institutional real estate investment and development firms for 8 years.  He has also been a regular lecturer of real estate finance and financial modeling at Columbia University for 7 years and has lectured at other leading academic institutions such as New York University.  He has extensive experience in real estate acquisitions, development, real estate private equity vehicles, joint venture structures, expert testimony, and analytical systems. 

Min started his career at Manchester Real Estate & Construction, a multi-strategy ultra-high net worth investment office investing in real estate equity and debt across gateway cities. In this role, he was responsible for acquisitions, underwriting, and asset management. Thereafter, Min spent time with Louis Dreyfus, a $60 BN commodities conglomerate, where he was responsible for acquisitions, underwriting, research, and portfolio analytics for value-added and opportunistic real estate strategies including office, full service luxury hotels, and mixed-use assets. 

Min is a recognized domain expert in real estate finance and is the founder of ASSESS+RE, a financial technology platform for real estate valuation. He also regularly advises real estate investment and development companies.  Some of Min's previous clients include the Canadian Pension Plan Investment Board, AECOM Capital, BASCOM Group, and Hawthorne Partners. H

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Print all In new window REITs: Tides of Trade - Remain bullish on Industrials @ STRH

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REITs: Tides of Trade - Remain bullish on Industrials
Sector: Industrial REITs

What's Incremental To Our View

Net-net: We remain bullish on industrial fundamentals through 2017 due to: 1) expected favorable lease mark to market profiles (up to 20% on new leasing, see Figure 18), 2) continued strong demand growth from E-commerce (at least 30bps of net new demand, our assumption-unchanged since 2011), 3) relatively low/stable GDP growth of ~2% and 4) disciplined new supply growth.

Remember, there is a 71% correlation between changes in container traffic and changes in industrial demand, with container traffic leading industrial demand by 3 qtrs. And similarly, there is approximately a 77% correlation between changes in trucking volumes and industrial demand, with a 3 quarter lead via trucking volumes. U.S. container traffic decreased -2.2% YoY in Sept versus +0.8% YoY in Aug. When excluding empty containers, volumes actually increased +2.3% in Sept versus +3.5% in the previous month. Following the Hanjin Shipping (10% of Long Beach TEU traffic) bankruptcy last month, we may see lingering results, as West Coast ports reported a -5.8% decline in volumes in Sept vs. +3.2% increase in the eastern ports (Houston leading the way). Trucking tonnage: +5.0% YoY Not Seasonally Adjusted (NSA) in August vs. prior month’s +0.3% YoY (77% historical correlation to industrial demand growth).

Based on regression model (GDP/trade regression, plus layering in our estimate of e-commerce contribution, 30bps per year or 40msqf), we estimate industrial demand (occupied sqf) to grow roughly 1.6% over the next year; this is in addition to 2015’s (estimated) 2.1% increase in demand (according to CBRE; 253msqf,). With supply expected to grow 1.3% in 2016 and 2017 (CBRE), we continue to view favorable supply/demand dynamics in the industrial space. While the growth rate in demand (relative to supply) may peak post 2016, this does not mean an immediate return to low net absorption environment necessarily or no rent growth.

Other leading indicators:

• Trucking tonnage: +5.2% YoY Seasonally Adjusted (SA) in August vs. prior month’s +0.3% YoY.
• Rail: -1.0% in Aug YoY vs. -9.2% in July
• Air Cargo: Global traffic +3.5% in August YoY vs. +4.6% the prior month, North America Air cargo traffic increased +4.6% YoY vs. +1.3% the prior month.
• ISM Index: 51.5 in Sept vs. 49.4 the prior month; New Orders (the most forward looking) are at 55.1 for Sept, up from 49.1 the prior month.
• Case-Shiller 20-Price Index: +5% in July YoY vs. +5.1% the prior month.

CBRE – 3Q16 Market Snapshot

Based on CBRE’s latest 3Q16 industrial market snapshot, the industrial market picked up an additional +20bps of occupancy to reach 91.2%, quarter over quarter and +80bps YoY. Overall, the demand-supply equation remains favorable for the industrial sector, with lowest vacancy level for some markets in decades. Specifically, markets such as New York (-240bps YoY), Detroit (-250bps), Tampa (-200bps), Boston (-180bps), and Philadelphia (-150bps) had noticeable decrease in vacancy.
 

REITs – Things we are thinking about as we head into 2017

Approximately, 25% of the $4.5 trillion Federal balance sheet matures by the end of 2019. The quantitative easing program is not a single shot program, it is a treadmill, and as the securities mature the Fed will have to decide to rollover the debt (by buying another $1.1 trillion in debt, or let some portion of the debt mature and thereby roll back the original scope of the QE program.)

There are a couple of opposing forces: 1) At this junction, inflation is a slightly growing concern in the U.S. as CPI has increased noticeably and wage growth has accelerated. This is in contrast to countries like Japan that is facing deflationary pressures, where maintaining aggressive QE is more understandable. 2) One of the problems with rolling back QE relates to the interest expense (6% of annual spend) the treasury has been paying to fund the US government. This has been quite low, at 1.7% (2.3% if including intergovernmental debt) on $19.5 trillion of debt. But with constant budget shortfalls, we think the government has to remain on the treadmill for the most part and likely maintain a larger balance sheet at the fed.

Our early opinion is that, there has been significant focus on what the fed will do with the fed funds rate, but not enough focus on decision the fed will make with the $4.5trillion inflated balance sheet. And if this becomes more topical in the future, we see increased volatility for REITs. We see moderate risk the fed decreases the size of its balance sheet due to inflationary pressures. We do not pretend to know what is going to happen, but it’s the unknown that creates risk that may impact the REIT market. At the end of the day, budget deficits, interest expense concerns, and the fear of yield spikes are likely to pressure the fed in maintaining a large balance sheet (QE program), for the longer haul.

ARMADA HOFFLER PROPERTIES, INC. (AHH: $13.10)

Armada Hoffler Properties, Inc. (AHH: $13.10) Equity REITs October 14, 2016 Flash Note: Notes From the Road Flash Note Rating: Buy Price Target: $15.50 Market Cap: $438.9 Full Report

Japan housing & real estate sector - Vacancies improving on rising demand, demolitions

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Completion of major buildings in October may cause vacancy rates to deteriorate temporarily

Major office brokerage Miki Shoji released its report on office supply-demand conditions in Tokyo’s five central wards in September 2016 on 13 October. The vacancy rate was down 20bp m-m at 3.70%, and moreover rising demand was cited as the reason for the improvement for the first time in four months, unlike in Jun-Aug, when the demolition of empty buildings was given as the reason. We think this is a positive for real estate leasing-related stocks such as Mitsui Fudosan [8801]. The total increase in the amount of office floor space required in Jan-Sep was 114,077 tsubo (1 tsubo = 3.3m²), up 45% on the increase in the same period in 2015, and equivalent to 88% of our initial estimate of a 130,000 tsubo increase in demand. This works out at an annualized rate of increase in demand of 2.2%. However, with October seeing the completion of Kyobashi Edogrand (34,000 tsubo of floor space, 20,000 tsubo of leasable floor space), and the grand opening of Sumitomo Fudosan Roppongi Grand Tower (61,000 tsubo, 31,000 tsubo), we think the vacancy rate may deteriorate temporarily.

Industrial REIT Demand – Remaining Ahead of Supply, But Slowing Down - TRNO, REXR, MNR

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Industry Report – Industrial Demand – Remaining Ahead of Supply, But Slowing Down    

·         Industrial REIT deep dive – surveyed top 25 markets meaningful to industrial REITs (capture average ~80% sq. ft. in these markets) from the perspective of rent growth relative to occupancy, demand (as measured at the MSA level by changes in goods producing employment), and supply (both existing and under construction) in order to determine the primary drivers of rent growth over the past year,  those markets which are showing accelerating (or decelerating) fundamentals as we look into 3Q16 and beyond, and what that means for industrial REITs (both under coverage and non-covered) in order to project 2H16 and FY17 rent growth trends.

·         Our analysis has found that industrial demand is remaining ahead of supply for all REIT portfolios ($50B market cap sector) but showing some deceleration.  Rent growth remains more a function of tight occupancy than demand, but both are intertwined, with a break point at about 94%. 

o   Basically those at 90% but strong demand still lagging, while rent growth with demand once hit 94%.  Some markets (LA, SF) have very high occupancy (97%-98%) and, with demand, seeing huge increases (SF +17%) while LA is seeing weak demand but tight occupancy keeping rent growth high (8%+)

·         Useful piece for industrial REIT investors – identify top markets (SF is tops, Orlando, Denver, Jacksonville, and Nashville all look poised to see tightening fundamentals).  Texas markets all look like getting overbuilt relative to demand (Houston, Dallas and San Antonio) while Inland Empire supply growth gives us some pause.

·         Bottom line here is with the sector running at 3.8% SS NOI YTD and trading at 103% of NAV good values here, especially Terreno Realty Corporation (TRNO-$26.32, Buy), which we believe will have the most attractive underlying fundamentals of any industrial REIT for the foreseeable future and trades in line with our $26.41 NAV, while Rexford Industrial Realty (REXR-$21.99, Hold) is seeing below average demand substantially offset by very high market occupancy, while our analysis is less germane to Monmouth Real Estate Investment Corp. (MNR-$13.51, Buy) given its lease structures and build-to-suit focus but we remain enthusiastic given trading at 97% of NAV and given the visibility of its earnings growth and high quality tenant base.

Dividend --> G&A Trade-off. 3Q16 Earnings Preview.

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• Wearing our shareholder fiduciary hat, we note that 1) real estate is 'end of cycle' for most property types, 2) internal value creation via solid leasing gains is subsiding, 3) as is development or acquisition driven value creation, 4) most balance sheets have been solidly improved, 4) net asset value premiums and discounts appear to be less important, 5) while yield and multiples appear to be of increased importance. Accordingly, it appears that now is an excellent time for those shareholder fiduciary (and shareholder return) minded REIT boards to gently shift dollars from G&A (down) to provide healthy dividend increases (up).
• As usual, as companies report earnings this quarter, we plan to focus on 1) submarket strength, 2) operating fundamentals, 3) real leasing economics, 4) value creation (or destruction), 5) replacement cost, and 6) the investment sales market.
• With numerous forces colliding including: 1) evasive cost of capital advantages, 2) funds flow data indicating the marginal buyer may have to be generalists rather than the tried and true REIT-dedicated investors, 3) fundamentals, which have received a nice boost off of low comps earlier this decade, are mixed, 4) global investment markets apparently in a risk-off mode while re-calibrating global growth and interest rate expectations, 5) 2015 was the strongest investment sales market since the 2005-2007 period, but 2016 has started off slowly, 6) numerous REITs we follow have outperformed YTD despite a lack of internal growth or a value-add platform - we remain concerned that a risk-on investment mentality, coupled with a slight fear that a lower, longer interest rate environment is not guaranteed will cause REIT shares to lag through YE16.
• REITs tend to do well in a low and declining interest rate environment combined with a risk-off mentality. Macro drivers and top down analysis sure seem to outweigh fundamentals and bottom up valuation currently.

Office REITs

• For office REITs, we think fundamentals and net asset value mattered less than dividends and low multiples during 1H16. This switched in 3Q16. Our investment thesis is that the Gateway City office REITs will largely post solid mark-to-market leasing, good SSNOI growth and be fairly active with asset recycling. Conversely, we think low barrier office REITs will mostly generate average numbers while incurring heavy capital expenditures.
• Per our recently introduced Lease Economics Analysis, we expect the Gateway City names to post positive leasing statistics which, together with development delivering, leads to value creation. However, in 4Q16, we think this should be coupled with a nice dividend increase.
• Per our 3Q16 Office Fundamentals wire entitled 3Q16 Office Fundamentals. Late in the Cycle. Weak Net Effective Rents. Widely Varying Lease Economics. we were pleasantly surprised with the statistics for 1) most submarkets in the San Francisco Bay area and Greater Boston, and 2) Sunbelt absorption, while being aware of the elevated starts.
• Conversely, 1) Washington, D.C. is experiencing a spike in development and may be bouncing along the bottom for years, 2) Houston, unless oil spikes, could monopolize negative headline news for a decade, and 3) West Los Angeles absorption and vacancy statistics were uninspiring, causing us to question the West LA hype.
• We should point out that company operating numbers often do not correlate with the macro statistics. This has been the case for Manhattan-centric office REITs for a few quarters. With 8.1mm SF of the 9.2mm SF under construction in Midtown located west of Penn Station, we are not too concerned about supply. We are, however, increasingly concerned about demand; particularly at over $100/SF.

Industrial REITs

• For industrial REITs, we expect fundamentals to continue to surprise to the upside and for these REITs to modestly outperform through YE16. We note that Amazon (AMZN, Buy, $812.95, covered by our colleague Scott Devitt) continues its rapid growth, and others in the e-commerce world are rapidly following suit.
• Per our 3Q16 industrial fundamentals wire entitled 3Q16 Industrial Real Estate Fundamentals Strong. Continued Strength into 1H17 Expected., we 1) remain convinced that SoCal industrial will continue to benefit from 'not building anymore land', 2) were pleasantly surprised with the statistics for the barrier-to-entry industrial markets of East Bay/Oakland, Palm Beach/Broward County, South Bay/San Jose and Boston, all of which witnessed vacancy declines in excess of 100 bps y/y.
• Within the seven Primary Distribution markets, there was 101.7mm SF under construction (1.7% of total stock) vacancy + under construction decreased 10 bps Q/Q to 7.4% as of 3Q16. Supply has ramped but demand remains strong and net absorption is keeping vacancy in check across the Primary Distribution markets.
• The amount of industrial SF under construction in the Energy-driven industrial markets declined from 24.8mm SF to 22.1mm SF Q/Q while vacancy + under construction declined by 20 bps to 6.9%. The total SF under construction in the secondary markets increased by 1.4mm SF to 27.8mm SF Q/Q but vacancy + under construction declined 40 bps to 6.5% over that time - a strong performance.
• Prologis (PLD; Buy; $51.20) is one of the first to report and we expect good underlying operating fundamentals and active asset recycling activity.

Investment Sales

• Interestingly, we continue to hear that the few core office assets for sale are attracting bids similar to 2015 valuations. There continues to be a shortage of quality office assets where investors can underwrite long-term rental rate growth and reasonable capex with confidence.
• Conversely, for the sale of generic suburban and urban office assets -- 'nine is the new eight'; meaning that what would fetch an 8% cap rate in 2015 is now 9% cap rate real estate. For these assets, investors now realize that landlord pricing power is limited, capex is climbing and there is real principal risk.
• We think the important issue is -- what is the cap rate for assets where investors can underwrite rent growth and value creation with confidence. It appears that the cap rates for this type of real estate are sub 5%. This means that the acquisition environment is still difficult.
• Development yields appear to by 6-7%; thereby still affording value creation to those platforms with development capabilities.

Incremental, Actionable News & Changes in Perspective

• REITs where we expect there to be actionable, incremental news (for a variety of reasons) include: SL Green (SLG, Buy, $105.17), Douglas Emmett (DEI, Sell, $35.81), Kilroy Realty (KRC, Buy, $70.68), Vornado (VNO, Buy, $95.37), Corporate Office Property Trust (OFC, Hold, $27.68), Equity Commonwealth (EQC, Hold, $30.63), Mack-Cali (CLI, Buy, $26.26). See below for company specific commentary.
• It is increasingly obvious that single-digit GAAP or cash rental rate growth is offset by re-leasing capex and operating expense increases. We are looking for those markets and portfolios strong enough to generate net effective rental rate growth after those pesky capital and opex drags. In terms of share price returns, these nuances are appearing to matter more.

Company-Specific Commentary:

• Douglas Emmett (DEI, Sell, $35.81): YTD, DEI has done well relative to the other Gateway City office REITs as it is perceived to be West Coast office REIT with limited technology tenant exposure with improving core fundamentals. The bar is now set fairly high given the current real estate valuation metrics. As debt issuance, without corresponding equity issuance, can make any investment earnings accretive, we are focusing on the operating numbers. We believe it will take excellent operating metrics to maintain momentum in the shares.

• Boston Properties (BXP, Buy, $126.51): While we note that non-REIT dedicated investors tend to focus on stock valuation metrics like FFO/FAD growth and multiples, we ask "Should FFO matter for this net asset value creation stock with an active disposition and special dividend strategy?" While we think FFO/FAD valuation metrics are secondary to value creation for BXP, we are aware that in-place rents are very high in Manhattan and San Francisco and -- while the assets are exceptional -- the core office submarkets in both cities are moving away from BXP's primary assets. And, BXP is taking more development and lease-up risk than they have historically.

• SL Green (SLG, Buy, $105.17): We believe SLG remains a Manhattan office proxy. While we have always liked the TEV/SF and NAV discount, the prevailing risk-averse mood has put 1) leverage, 2) Manhattan deceleration, 3) One Vanderbilt, and 4) the structured finance business front and center. We expect strong leasing and execution geared toward delevering, and making SLG as investor friendly as possible. Given the low rents in place at SLG assets, we believe the leasing deceleration will have minimal effect on mark-to-market spreads.

• Empire State (ESRT, Buy, $20.22): We continue to like the Empire State story given its ability to grow internally via embedded rent growth and the consolidation of underutilized, below market space, which is then redeveloped and re-let at market rates. Quantifying these opportunities translates to $27mm for signed leases not commenced, $23mm for redeveloped space, $40mm for the lease-up of vacant office and $18mm for retail space - combined, over $0.30/sh of FFO growth. The Qatar Investment Authority recently acquired 9.9% of ESRT's outstanding shares (a $622mm investment), further buttressing an already solid balance sheet. We expect questions on the earnings call will focus on use of the proceeds from the Qatari investment, the timing of the embedded NOI growth, and the magnitude of Observatory and broadcast earnings offset. Similar to SLG, given the low rents in place at ESRT's assets, we expect continued strong operating and leasing metrics.

• Vornado (VNO, Buy, $95.37): With great fanfare at the NYC NAREIT, Vornado produced clear guidance for as much as a $200mm increase in cash NOI off a $900mm base and a good outline of Net Asset Value. Despite this additional disclosure, VNO shares continue to underperform most Gateway Office peers YTD and over the past 90 days. We believe investors remain cautious in front of an expected Washington, D.C. spin-off and a slowing NYC leasing environment. As with SLG, we expect a decelerating office and retail rental rate environment in NYC will have little impact on the operating metrics VNO reports given the below market leases in place. We believe this, plus the growing cash NOI should create a tailwind for VNO shares.

• Kilroy Realty (KRC, Buy, $70.68): With 45% of Kilroy NOI coming from the San Francisco Bay area, KRC has become an office REIT proxy for the health of the West Coast tech scene. We expect asset generally healthy leasing throughout the portfolio - enough to surprise very low expectations on the Street.

• Corporate Office Properties (OFC, Hold, $27.68): Management changes have partially resulted in a very bullish commentary on the strength of the core business of leasing to government and private defense-related tenants. We believe the market will continue to endorse the strategy, but will need to eventually have results accompany the commentary. With asset sales now of secondary importance, we expect investors to focus on leasing economics.

• Brandywine Realty (BDN, Hold, $15.35): We expect BDN to be a net seller in 2016 and, through development, become an increasingly Philadelphia CBD, Radnor, Austin and Northern Virginia-centric portfolio. While major asset sales are expected in secondary markets such as Maryland, Delaware and Southern NJ, we would not be surprised to see fewer than expected. While the slimmed down portfolio looks good on the portfolio summary pages, concerns remain regarding the level of earnings dilution. On the positive side, office fundamentals in the Philly CBD, "crescent" markets and Austin are strong relative to other non-Gateway office markets.

• Mack-Cali (CLI, Buy, $26.26): With corporate disclosure improving dramatically, we believe the Street seeks to better understand the existing and potential economics of the multi-family platform, and execution on the evolving office portfolio strategy. Tangible progress with portfolio lease-up, addressing 2017 lease expiries, explanation of sources and uses through YE 2017, a stronger balance sheet, acquisition versus share repurchase rationale all would help build investor confidence, in our opinion. Seeing is believing and we think the August 2016 property tour made a good impression of CLI's "Gold Coast" waterfront assets. Continued execution and 2017 guidance meeting or exceeding Street expectations will be key to share outperformance going forward in our opinion.

• Equity Commonwealth (EQC, Hold, $30.63): Sales activities in 2015 surpassed investor expectations with sales approaching $2B, and are expected to hit $3B by YE 2016. The primary questions we believe are: 1) What will the remaining portfolio look like once the current tranche of asset sales are completed and how will that compare with EQC's implied NOI cap rate? 2) Is EQC already acting like a low levered, partially seeded, opportunity fund? 3) How will EQC's growing cash hoard be put to work and when? 4) Will G&A decline at all as assets are sold?

• Piedmont Office Realty Trust (PDM, Sell, $21.00): Until recently, the ability to generate NAV with share repurchases has been an easy story to tell and has helped the share price. The possible sale of long-term leased (to NASA) Two Independence Square in Washington, D.C. may be accretive to NAV. We are focused on lease-up execution of key assets in Houston (spec development), Chicago and Washington, D.C., and the actual lease economics of assets remaining within the portfolio.

• First Potomac (FPO, Hold, $8.89): We think FPO needs to address the fact that 1) leasing and asset sale execution risk, 2) a small market cap, 3) excess leverage, 4) and a very average portfolio, aside from the D.C. CBD assets, is not a great combination. Delevering can occur and is more likely to do so with a sizable investment from one large equity investor.

• Franklin Street (FSP, Hold, $11.93): We remain concerned about the longer-term implications of the short term, low cost debt currently financing FSP's business. A well-timed, 3Q16 equity raise partially reduced those concerns but with over 70% of the proceeds earmarked for an acquisition and a redevelopment, not much was left over for actual de-levering. Franklin Street continues to have a high dividend yield, which is marginally covered. The RGA move-out and the TCF vacancy in Minneapolis will be a headwind to FFO, FAD and NAV growth. We believe FSP's higher dividend yield has helped to propel the shares this year.

• Highwoods Properties (HIW, Hold, $50.58): This clean, easy to understand story is the quintessential risk-off stock and has performed well YTD relative to most other office REITs. Good office submarket fundamentals are likely needed to retain investor interest. The pending HCA move-outs in Nashville totaling 206k SF in 1Q17 will likely hurt SSNOI growth year-over-year. With Nashville currently one of the strongest office markets in the U.S., we would expect minimal downtime and solid re-leasing metrics for these two spaces.

• Parkway, Inc. (PKY, Sell, $18.67): Post merger/spin, Parkway, Inc. is a new entity, owning 8.7mm SF of office assets located solely in Houston, TX. We believe the negative headlines and fundamentals resulting from an office supply glut in Houston will prevent PKY shares from outperforming over the near to medium term.

• Cousins Properties (CUZ, Hold, $7.91): Now that the merger with Parkway Properties and spin of Parkway, Inc. has occurred, we believe investors expect to see a full update on the new Cousins Properties including a post merger pro forma balance sheet, operating metrics and integrated supplemental. We believe share performance will be improved by adequate disclosure and a well-presented, go-forward strategy; including a discussion on asset sales, and re-investment into their development pipeline.

• Liberty Property Trust (LPT, Hold, $39.83): With the early 4Q16 sale of 108 assets totaling 7.6mm SF for $969mm ($127/SF), Liberty has largely completed the transition to becoming a primarily industrial-focused REIT. Years in the making, this transition should reduce the overall CAPEX weight of the portfolio, while allowing LPT to more fully participate in the industrial real estate bull market. Adjusted for the portfolio sale and valuing the remaining office assets separately, we believe Liberty shares are fairly valued relative to peers.

• Duke Realty (DRE, Buy, $25.82): For the past five years, Duke Realty has been a leading asset recycler, and has been rewarded for that effort. While we think business as usual, a strong balance sheet, solid fundamentals and a disciplined development machine is good enough, others might be expecting additional visible catalysts - especially with Liberty's portfolio transformation now complete.

• DCT Industrial Trust (DCT, Buy, $46.61): We continue to believe positive mark-to-market rents and accretive development will continue. SSNOI should accelerate to about 7% in 2H16 for DCT to achieve its 5% SSNOI growth guidance. This clean, easy to understand story is the quintessential risk-off stock and has performed well YTD. We expect a short and sweet earnings call.

• EastGroup Properties (EGP, Hold, $69.39): Perhaps the industrial REIT with the cleanest and most successful investment strategy, EastGroup has historically been rewarded with a premium valuation. However, EGP's operating metrics have consistently trailed peers of late, and the shares have suffered. Investors will be looking for a glimmer of late-cycle operational acceleration on which to hang their hats.

• First Industrial (FR, Buy, $26.62): FR shares had a rough 3Q16 relative to most industrial peers. As the most attractively priced industrial REIT we cover, we believe good operating fundamentals should help close a now wider valuation gap.

• Terreno (TRNO, Buy, $26.33): While big supporters of the TRNO six market, in-fill investment strategy, we are very focused on the company's ability to secure significant positive mark-to-market rents on re-let space and grow NAV. The occupancy rebound we expected has occurred as TRNO announced 3Q16 portfolio occupancy of 96.4%, up 370 bps Q/Q. Same-store occupancy was 97.9% at 3Q16 up from 95.1% in 2Q16 while cash rents on renewed leases increased 20.9%. We believe cash NOI will begin ramping as free rent burns off at several assets through YE16. The completion and occupancy of the Carson, CA redevelopment will also add some momentum.

• Rexford Industrial (REXR, Buy, $21.99): We continue to think the SoCal industrial market is one of the strongest in the country and we expect Rexford's 100% SoCal portfolio to generate excellent numbers. We and others continue to await the lease up of the repositioning portfolio. REXR needs to start showing some positive momentum with those assets.

• Prologis (PLD, Buy, $51.20): As a proxy for global economic growth and industrial demand, Prologis shares are more volatile than their domestic industrial brethren. PLD's shares recovered nicely after the Brexit vote, posting one of the best total return results among industrial REITs over the past 90 days. We expect good operating numbers and view PLD shares as a good relative value.

• Lexington Properties (LXP, Hold, $9.98): The Lexington story is becoming less complicated with the sale of its NYC ground lease holdings, continued pruning via asset sales and conveyance of over levered assets to lenders. The high dividend has been very good for the LXP share price year to date. While we think the strategy of buying high cap rate, special purpose and uniquely located assets will have to be fully vetted, perhaps a covered dividend of over 7% will outweigh this perceived need.

• Armada Hoffler (AHH, Buy, $13.60): While we believe the Street will continue endorsing the company, we think the nuances of their new mezzanine debt lending strategy on development projects will need to be more completely understood. YTD share appreciation has been very strong for an otherwise slow core asset growth, development-driven company, in our opinion.

• Washington REIT (WRE, Hold, $30.25): We continue to believe WRE serves as a D.C. real estate proxy and is positioned to outperform if and when the Washington, D.C. market fundamentals improve and REIT investors take notice. While we believe certain office submarkets within the D.C. Metro region have stabilized, actual office and apartment rental rate growth remains challenging in most locations.

STIFEL: Office/Industrial REITs - 3Q16 Office Fundamentals. Late in the Cycle. Weak Net Effective Rents. Widely Varying Lease Economics.

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3Q16 Office Fundamentals. Late in the Cycle. Weak Net Effective Rents. Widely Varying Lease Economics.

Based on conversations with brokers and investors, and the leasing statistics and development starts discussed and outlined in the exhibits, we think 1) Boston is solid overall, with Cambridge being perhaps the strongest office submarket in the country, 2) Houston had overbuilding concerns in 2013, well before the oil price decline, and is a long way from hitting bottom (think falling knife), 3) Manhattan and San Francisco leasing velocity has moderated with face rates remaining steady, but net effective rates slipping a bit, 4) the Los Angeles hype is not showing up in the statistics and 5) the Washington, D.C. MSA is very submarket specific with most non-CBD submarkets subject to some of the highest re-leasing costs in the country without any rental rate growth.

• We see a very interesting top down vs. bottom up paradox. While brokers tell us that net effective rents are down almost everywhere including Manhattan and San Francisco, we note that our Lease Economics Analysis indicates widely varying degrees of value creation and destruction at the lease level.

• Per pages 9-14 of the embedded link: Conference Call 9/7/16 - Value Creation or Destruction and Lease Economics Analysis. SLIDES ATTACHED. Dial-in Info Below. the Manhattan and Gateway City REITs we cover have solidly positive lease economics while the low barrier office REITs we cover continue to struggle at the lease level.

• The result is a situation where a market can look relatively unattractive from a top down perspective, but the office REIT is creating value at the lease level. Manhattan leasing statistics and lease economics are the most visible example.

• Based on the statistics presented here and our Lease Economics Analysis, we are biased to the positive on Boston and San Francisco; while concerned about Washington, D.C, Houston and Los Angeles. While we believe San Francisco rent growth has moderated, we think San Francisco is the technology capital of the world and some larger space requirements continue to seek homes.

Gateway Cities -- Rent Growth Moderation but Strong Lease Economics Remain --- See Exhibit A

• No material changes Y/Y as vacancy has ticked down 10 bps from 3Q15/3Q16 to 11.0% in the Gateway City markets, and Vacancy + UC (vacancy + under construction) of 13.7%, which was up 20 bps on a Q/Q basis.

• Manhattan vacancy increased on a Y/Y basis, up 50 bps to 8.7%. Vacancy + Construction increased 60 bps on a Q/Q basis to 11.5% as well. Noteworthy changes included Midtown vacancy up 130 bps to 9.1% on a Y/Y basis. Another data point to note is the wave of development (8 buildings at 9.2mm SF and 1.9% of stock) coming in Midtown.

• Note that 8.1mm SF of the 9.2mm SF under construction in Midtown is actually Hudson Yards or Manhattan West; both to the west of Penn Station and south of 34th Street.

• Based on numerous conversations, we think there is increased sensitivity to rental rates and re-leasing costs will remain embedded in the leasing economics. While we think Hudson Yards and Jersey City are in the next time zone and public transportation is not ideal, they offer competitive optionality. Hudson Yards is on the right side of the Hudson River, but Jersey City offers transportation amenities and significantly lower rental rates.

• Boston remains solid; led by Cambridge with only 3.3% vacancy and 3.4% of stock under construction. On a Y/Y basis, Cambridge had an astounding 380 bp decrease in vacancy. Similarly, the Inner Suburbs are 6.1% vacant, but with 4.3% under construction as a percent of stock.

• Year over year, the Boston Financial District suffered a 60 bp vacancy increase to 9.5% while Back Bay enjoyed a 90 bp vacancy decline, to 8.7%.

• Having just returned from the San Francisco/Silicon Valley area, we think that the long term positives will outweigh any near term weakness. Overall, the 230mm SF San Francisco Area market is healthy with vacancy down 50 bps to 8.2% since 3Q15 but Vacancy + UC has increased 40 bps to 12.4% since 2Q16.

• Square footage under construction in the San Francisco CBD is now 3.0mm SF (5.4% of stock) and South Bay/San Jose continues to maintain a very active construction pipeline at 10.1mm SF (11% of stock and a red flag). Approximately 78% of this new supply is preleased but it remains unclear how much of that equates to net new demand (growth) versus space preleased (up from 74% last quarter) by tenants expecting to vacate their existing space upon delivery.

• As one should expect, new and growing companies are driving vacancies down and new development up. The real estate fundamentals appear reasonable in San Francisco (for now) but is becoming more of an issue in Silicon Valley and San Jose with vacancy + U/C now at 19.5%, which is up 140 bps Q/Q, double the jump in vacancy + U/C from 2Q16.

• Oakland, on the other hand, has experienced a great recovery with vacancy down another 270 bps since 3Q15 and now is at 5.1% with under 100K SF under construction.

• In Los Angeles, the market hype does not appear in the macro numbers with vacancy down 80 bps to 12.1%, but with only one submarket -- San Gabriel Valley (9.9%) below 10%. The Vacancy + U/C metric improved (declined) in most markets Q/Q but remained flat for the LA County overall at 13.3%. Development starts remain in check at only 3.5mm SF and 1.2% of stock; due to both low rents in some submarkets and extreme zoning constraints in others.

Washington, D.C. -- Development Continues and Capex Conundrum -- Exhibit B

• We recently published a report on the Washington, D.C. MSA which goes into great detail on the individual submarkets as well as companies under coverage in the region. Please find a link to the report here: Conference Call -- 11 AM. 8 April 2016. Washington D.C. Office and the Cap Ex Conundrum. SLIDES ATTACHED

• For the 469mm SF greater Washington, D.C. region, vacancy was up 30 bps to 15.1% since 3Q15, and Vacancy+UC was up 40 bps to 17.4% since 2Q16. Assets under construction remains surprisingly high at 2.3% of stock (vs. a still high 2.1% of stock in 2Q16). This is driven by sizable GSA build-to-suits and transit-oriented speculative development.

• A telling statistic was that in 2015-2016 -- 96% of all leases signed in excess of 20k SF were in buildings located within 1/2 mile of an existing or planned METRO stop. We should note that the general rule of thumb is that a 1/4 mile walk is acceptable for most tenants.

• Development within the core D.C. office markets - the CBD and the East End - equates to 3.0mm SF and 3% of stock. Given the soft leasing environment, even in core submarkets, we would not be surprised to see rising vacancy in the CBD and the East End in the near future.

• Major submarkets where vacancy + UC exceeds 20% include: Rosslyn (an alarming 34.0%) Eisenhower/I-395 Corridor (31.3%), Capitol Hill (26.3%), Merrifield (25.3%), Tysons Corner (23.6%), Pentagon City/Crystal City (21.5%), NoMa (21.5%), Ballston (21.2%), Rock Spring (21.0%) and Clarendon/Courthouse (20.0%). That is 10 out of the 27 sub-markets we cover in this analysis that are over 20% on a vacancy + UC basis.

• The bright spot was the cyber and defense contractor driven B/W Corridor with vacancy down 60 bps since 3Q15. However, assets under construction amount to 2.7% of stock.

• Regarding the D.C. market overall, we are seeing: 1) "A" tenants are willing to pay "A" rents for "A" quality space, but the "A" tenant pool is not that deep, 2) relocation by the GSA out of the CBD/East End and into the SE/SW and NoMa submarkets, 3) however, the CBD/East End is being back-filled by the private sector, 4) cyber security and intelligence expansion, 5) the defense contractors are largely done downsizing, but are now extremely price sensitive, 6) law firm rightsizing is winding down, 7) solid private sector job growth, and 8) new development to average 3.0mm SF per anum.

• Discussions with brokers indicated increasing GSA leasing activity as the agency attempts to address expensive hold-over leases. Over the next five years about 25mm SF of GSA leases will expire, most of which are smaller in size, reducing the likelihood of Congressional involvement (interference). These smaller GSA leases will still have a higher probability of moving than staying in place (estimates hover around 50-60% will move upon lease expiry versus the 75% of large GSA tenants that have vacated for new space over the past 18 months). The GSA is still under a mandate to shrink its footprint (10%-20%), however, and gross rental rate caps ($50/SF in DC, $29/SF in MD and $35/SF in NoVA) remain in place.

• While job growth in the DC metro continues to strengthen, it appears that with continued GSA downsizing and defense contractor stabilization, there are few large tenants in the market to quickly back-fill significant levels of vacancy across many submarkets.

• On a positive note, we expect the flight to quality assets will continue with tenants increasingly focused on assets located in amenity-rich locations and in close proximity to METRO locations. However, we note that METRO access without strong amenities, such as Rosslyn with a 34.0% vacancy + UC, will likely be slow to improve.

Suburban Markets -- Improved Modestly -- Exhibit C

• Suburban office markets experienced a decline in vacancy of 60 bps to 12.1% 3Q15/3Q16 and 10 bps Q/Q sequentially.

• Not surprising, Houston is the second worst market with vacancy up 240 bps since 3Q15 to 16.1%. Vacancy + Under Construction is 17.4%. Unfortunately, both are expected to increase.

• The best suburban market in terms of decline in vacancy was Tampa/St. Petersburg, with a 250 bp improvement to 9.5%.

• Overall, Vacancy + UC decreased 10 bps to 13.7% Q/Q sequentially. Construction as a percent of stock remains very low at 1.6%, with only 5 of the total 27 markets over 2.5%; Dallas-Ft. Worth, Raleigh-Durham, Denver, Seattle and Charlotte.

• Not seen in this data set: we continue to think that the more urban, amenity-oriented submarkets have some pricing power, but most generic suburban submarkets do not.

• One point of emphasis is the tumble the major Southwest markets have taken on a vacancy + U/C basis over time. They now rank at or near the bottom: Dallas-Ft. Worth at 18.6%, Houston at 17.4%, and Phoenix at 17.3%. Houston has been battered by the drop in oil prices, while Phoenix and Dallas suffer from more self-inflicted wounds as a result of continuing development.

Urban Markets -- Build It and They Will Come? -- Exhibit D

• Let's hope that demand can come from more relocation into the urban core.

• Six of the twenty-four Urban markets we follow break the threshold of 2.5% construction as a percentage of stock. Some of the most egregious numbers come out of Austin (8.4%), Seattle (6.9%), Raleigh-Durham (6.5%) and Charlotte (5.8%).

• Vacancy in the urban office markets improved by 40 bps to 12.2% from 3Q15 to 3Q16. Several markets saw vacancy decrease Y/Y by 200 bps or more: Detroit (2.2%), Seattle (2.3%), Phoenix (2.4%) and Stamford CT (3.0%)

• Assets under construction total 2.4% of stock. However, Vacancy + UC was down 20 bps Q/Q to 14.5%. Note that 9/24 markets have Vacancy + UC of over 15%.

LEASING DYNAMICS -- Shift to Quality - a Decade-Long Trend

• The office fundamentals 'bull case': 1) quality (amenity and transportation rich) office space at reasonable price points has real rental rate growth potential, 2) growth industries take more space than needed and are less price sensitive, 3) office-using job growth continues to improve nationally, 4) locations with a low cost of living and pro-business attitude (Sunbelt) are seeing positive absorption, and 5) functionally challenged office space is being converted to other uses.

• The office fundamentals 'bear case': 1) tenant improvement costs essentially provide off balance sheet financing for the lessor's operations, and is increasingly evident in larger leases, 2) due to the need to compete with newly developed buildings, re-leasing costs have remained stubbornly high throughout the country, 3) commodity office space has little ability to generate rental rate growth and capex costs continue to escalate in these now 30 +/- year old buildings, 4) when top line or gross rents are increasing, investors tend to look the other way on stubbornly high capex and re-leasing costs, and increasing operating expenses, 5) the downside associated with previously fully occupied buildings being vacated and the functional challenges being too great to re-lease as office space, 6) development is clearly increasing nationally, and 7) densification continues.

• We think the shift in tenant preferences to urban, public transportation, amenity rich and LEED-certified buildings may cause 1) rents in the best submarkets to increase modestly, but 2) that some functionally obsolete, soon-to-vacate office buildings may never re-lease and thus find their way into the proverbial 're-development' bucket.

• We think that landlord pricing power is expanding. We believe landlords 1) have pricing power in markets with less than 8% vacancy and positive absorption, 2) have pricing power in Class A properties in markets with <10% vacancy and 3) have no pricing power in markets with 15% + vacancy.

• Interestingly, the vast majority of development in this cycle is creating a new and improved version of Class A space; space that appeals to growing and expanding industries with a focus on light, air, open space plans, collaboration, etc. Seems as though Teslas vs 1980's Cadillacs are being built.

• We continue to believe that tenants are more likely to seek out space from the strongest, most well-capitalized landlords when relocation is necessary. Most office REITs 1) have improved their portfolios over the past cycle (and continue to do so via active asset recycling), 2) own some of the best product in their respective markets, 3) are the landlords of choice, 4) have solid local teams that see every lease deal, and 5) have the advantage of re-leasing capital vs cash-constrained private owner/operators.

• Office rents, particularly in suburban and secondary markets, tend to not move very often, but other incentives (tenant improvement packages, free rent, etc.) are more volatile. Industrial assets, on the other hand, do not need as much in the way of tenant improvement or technology costs, so the rental rate component is more volatile.

• We expect that commodity office buildings in 20% vacant submarkets will be leasing with 3-5 year paybacks or low single digit net present value economics. By this, we mean that the total cost to entice a quality tenant to relocate into a building including tenant improvements, leasing commissions, moving allowances, technology allowance and free rent, will likely equate to 3-5 years of net rent.

Janney/REITs: Weekly REITCap: Portfolio Managers Guide to Property REITs

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REITS

Weekly REITCap: Portfolio Managers Guide to PropertyREITs – October 14, 2016

Our Weekly REITCap Portfolio Managers Guide provides general corporate information, total returns, valuation and balance sheet measures for 150+ property REITs across the major asset types (e.g. office, multifamily, retail, industrial), as well as more esoteric REITs (such as the prisons and towers).

• For the week ending October 14, the MSCI US REIT Index (RMZ) return was +1.4% versus the S&P 500 return of -1.3%. The NASDAQ was -1.8%, the DJIA was -0.9%, the Russell 2000 was -2.4%, the DJ Utilities were +1.9%, and the S&P Financials were -1.5%.

• The best-performing REIT subsectors last week were Student & Manufactured Housing (+3.8%), Data Centers and Towers (+3.5%), and Triple-Net Lease (+1.9%), while the worst were Single-Family Rentals (+0.0%), Office-CBD (+0.2%), and Apartments (+0.5%).

• The best-performing REIT stocks last week were CUZ (+11.5%), DFT (+9.0%), and COR (+7.3%), while the worst were PKY (-19.3%), ALX (-6.4%), and CLDT (-6.0%).

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• YTD REITs are now outperformingthe S&P 500 by150bps. The REIT sector is now +7.6% in 2016, while the S&P 500 is +6.1%, both on a total return basis. YTD the Russell 2000 total return is +7.0%, the NASDAQ is +4.1%, the DJIA is +3.9%, the DJ Utilities are +13.4%, and the S&P Financials are +1.5%.

• The best-performing REIT subsectors YTD are Triple-Net Lease (+25.7%), Industrial (+25.2%), and Data Centers and Towers (+17.8%), while the worst are Storage (-12.0%), Apartments (-4.0%), and Office-CBD (+1.0%).

• The best-performing REIT stocks YTD are SNH (+59.0%), NXRT (+44.5%), and ADC (+43.0%), while the worst are CXW (-42.4%), FPO (-19.0%), and NYRT (-16.3%).

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• Over the past 12 months, the REIT sector total return is +10.3%, while the S&P 500 is +8.8%. Over the last 3 months, the REIT sector total return is -7.5%, while the S&P 500 is -0.4%.

• The US is outperforming Europe, but underperforming Asia among the major global real estate markets YTD. The YTD US REIT total return of +7.6% compares to -7.8% for Europe, +8.3% for Asia, -12.5% for the UK, and +10.3% for Australia.

• REIT sector’s average cash dividend yield is3.9%. This compares to the average yields on the 10-year Treasury (1.7%) and Moody’s Baa Corporate Bond Index (4.4%).

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• We remain Neutral on the US Property REITs. With a 10% total return expectation for 2016, we remain Neutral on the US Property REITs, as solid internal growth and continued access to inexpensive and plentiful capital are somewhat offset by strong valuations, greater levels of new supply, and the threat of higher interest rates.

• In terms of our subsector views, we are positive on the Multifamily, CBD Office, and Industrial subsectors; neutral on Data Centers, Regional Malls, Self-Storage, Shopping Centers, Student & Manufactured Housing, Tower, and Triple-Net; and negative on Diversified, Healthcare, Hotels, Suburban Office, and Single-Family REITs. Specific company ratings and operating details can be found inside.

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• Our favorite small-cap REITs are ADC, AHH, CIO, and MNR. We also like MAA and NNN among the mid-cap names, and AIV and O among the large-cap REITs.

• We have updated our earnings and fair value estimates this week for CIO and EQR. The reduction in our EQR Fair Value estimate reflects the payment of a $3 special dividend today.

Janney/ADC: Why ADC remains one of our favorite REIT names

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REITS

Robert Stevenson,

Agree Realty Corporation (ADC) - BUY

Why ADC remains one of our favorite REIT names

Flash Takeaways:

We believe ADC has one of the best retail-focused triple-net REIT portfolios. Today its portfolio of 341 properties is located across 43 states and accounts for over 6.7M of square feet. Importantly, 46% of revenue comes from investment grade tenants, and its average remaining lease term is just under 11 years. We continue to expect above average earnings and dividend growth over the next few years, and combined with an attractive valuation, ADC remains one of our favorite names.

Analysts Notes:

• We expect ADC to maintain its strong growth profile. Despite its strong growth over the last few years, ADC is still under $1.2B of equity market capitalization. With management expecting to acquire $250M+ of assets at cap rates in the 7.5%-8.0% range, coupled with a modest level of internal growth, we expect ADC will continue to produce one of the strongest earnings growth rates in the retail-focused triple-net REIT space.

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• While still a small part of the current growth story, we expect ADC to expand its development and partner capital solutions businesses in coming years. In addition to acquiring assets, ADC also develops assets for its own balance sheet, as well as partners with private developers to provide capital and control assets long-term. While still a small part of the growth story today (3 projects totaling $14.5M were added to its pipeline in early October), we expect ADC to continue to grow this business over the next few years.

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• We expect ADC will continue to lower its Walgreens (13%) and pharmacy (18%) exposuresover the next few years. We expect greater diversification will come via both the disposition of selected Walgreens/pharmacy assets, as well as the acquisition of new assets. Overall, we view ADC's capital recycling activities favorably as the company seeks to take advantage of market inefficiencies.

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• Maintaining our investment thesis. We believe that with continued strong earnings growth, a more diverse tenant base, a long history of dividend increases, and a BBB investment grade debt rating, ADC will be able to further close the valuation gap relative to industry leaders NNN and O.

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• Maintaining our Buy rating and $53 Fair Value estimate. Based on a 5.3% implied cap rate, a 4.1% dividend yield (that is well-covered), and 2017 FFO and AFFO multiples of 17.0x and 17.1x, respectively, we continue to believe ADC is attractively valued at the current stock price. ADC remains one of our favorite names, not only in the retail-focused triple-net space, but within the small-cap REIT space overall.

First Look - Kandenko (1942 JP) (Neutral) - Guidance revisions, transmission line fire

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Kandenko announced upward revisions to its profit projections for 17/3 H1 and the full year after the close of markets on 13 October. We attribute this to an improvement in margins on electrical engineering work and solid orders for power line engineering. As was the case with the upward revisions announced alongside Q1 results, these revisions are less than the 30% threshold for mandatory revision disclosures. The company also hiked its full-year DPS forecast from ¥16 to ¥18.