Presentation byTad Philipp

1
Virginia Commonwealth UniversityReal Estate
Trends 2003

• Presentation by Tad Philipp
• Managing Director
• Moody's Investors Service
• October 21, 2003

2
Role of Rating Agencies in the Capital Markets

• Opinions of credit risk
• Comparison across sectors
• Pricing efficiency
• Use in regulation

3
Moody's Ratings Symbols
Rating 10 yr Default Rate
Investment Grade
Below Investment Grade
4
A Few Examples of Ratings

• Commonwealth of Virginia Aaa (review for
  downgrade)
• City of Richmond Aa3
• Virginia Commonwealth University A1
• Philip Morris/Altria Baa2
• Capital One Financial Baa3
• Gap Inc. Ba3
• Delta Airlines Inc. B3

5
Scale of CMBS

• US Commercial Mortgage Market 1,500 billion
• Commercial MBS 500 billion

6
CMBS in Virginia

• Volume MM of loans
• Virginia 8,893 1,157
• 6 in US 9 in US
• Richmond 1,007 168
• Norfolk 1,562 277

7
Virginia Delinquency Report Card

• DQ Rate DQ Index DQ
  Rate DQ Index
• Virginia 1.9 131 1.0 61
• Richmond 1.3 89 1.2 70
• Norfolk 0.8 58 0.7 42
• 2 hotels delinquent

8
Composition of Universe By Loan Size
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Delinquency Index By Property Type
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Delinquency Index By Size of MSA
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Delinquency Index by Vintage
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Share of Loans Per Loan Size With LTV Below 65
Share of each Loan Size
13
Delinquency Index By Loan Size
14
Credit Drift Current Status of Loans 90 Days
Past Due One Year Ago
By Count
15
What is Red-Yellow-GreenTM ?

• Each market is scored on a scale of 0 (weak) to
  100 (strong).
• Scores of 0-33 are red, 33-66 are yellow, and
  67-100 are green.
• Score is prospective for a 1-2 year horizon
  updated quarterly
• Based on variables appropriate to each property
  type, including
• 1 years forward supply pipeline
• Demand growth expected for the next year
• Vacancy
• Change in vacancy
• Population and income (retail)

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Sample Diagnostic
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Red-Yellow-GreenTM Report Card

• Overview
• Important role in monitoring and rating
• Not all Reds bad, not all Greens good
• Few false positives (No good Red markets)
• Lag between market performance and delinquency
• Through the cycle Red to Yellow to Green to
  Yellow to Red
• Continue to refine, back-test, add markets and
  asset classes

18
Performance by Sector

• Office and Industrial - corporate demand driven
  sectors
• No Reds improved, few Greens had major declines
• Multifamily and Retail consumer demand driven
  sectors
• Few Reds to back-test, Green outperformed Yellow
• Hotel Few Greens to back-test

19
Red-Yellow-GreenTM Report Card
Average Change in Office Vacancy
Vacancy Rate Vacancy Rate
Change 1Q01 1Q03 Red Markets 8.7 19.3
10.6 Yellow Markets 11.4 17.6
6.2 Green Markets 9.6 15.0 5.4 All
Markets 10.7 17.2 6.5
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Change in Vacancy in Office Markets Over Two-Year
Horizon
21
Change in Vacancy in Industrial Markets Over
Two-Year Horizon
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Change in Vacancy in Multifamily Markets Over
Two-Year Horizon
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RYG Composite Score
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RYG Drift
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Summary of Key Stats - Multifamily

• Richmond US
• Construction Inventory 2.3 1.6
• Absorption Inventory 1.1 0.6
• Demand/Supply Balance -1.2 -1.0
• Vacancy 2Q02 5.7 5.1
• Vacancy 2Q03 6.0 6.0
• Change in Vacancy 0.3 0.9

26
Richmond Multifamily Market Diagnostic
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Summary of Key Stats - Retail

• Richmond US
• Construction Inventory 0.5 1.9
• Absorption Inventory 0.9 0.4
• Demand/Supply Balance 0.4 -1.5
• SF/Capita Year Earlier 10.8 10.1
• SF/Capita Current 10.7 10.1
• Change in Vacancy -1.22 0.08

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Richmond Retail Market Diagnostic
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Summary of Key Stats - Industrial

• Richmond US
• Construction Inventory 1.5 0.6
• Absorption Inventory -3.6 -0.1
• Demand/Supply Balance -5.1 -0.7
• Vacancy 1Q02 13.5 10.5
• Vacancy 1Q03 13.5 11.3
• Change in Vacancy 0.0 0.8

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Richmond Industrial Market Diagnostic
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Summary of Key Stats - Office

• Richmond US
• Construction Inventory 0.8 1.0
• Absorption Inventory 2.5 0.4
• Demand/Supply Balance 1.7 -0.6
• Vacancy 1Q02 12.0 15.4
• Vacancy 1Q03 10.6 16.9
• Change in Vacancy -1.4 1.5

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Richmond Office Market Diagnostic
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Role of Cap Rate in CMBS Credit

• DSCR and LTV primary constraints on proceeds
• DSCR more objective - driven by NCF and interest
  rate
• LTV less objective - driven by NCF and cap rate
• Low cap rates negate effectiveness of V in LTV
• DSCR drives term risk and LTV drives balloon risk
• Not all 75 LTV loans equal, the case for
  consistent cap rates
• Rising number of offenders

34
Cap Rate Drivers

• Borrowers cost of equity
• Borrowers cost of debt/positive leverage
• Demand for property vs. alternative investments
• Outlook for growth/upside
• Perception of risk

35
The Cap Rate/ Fundamentals Disconnect

• Expenses for taxes and insurance on the rise
• Income side soft due to lag effect
• Impact varies by asset class
• Apartment outlook solid but cap rates falling
• Office fundamentals weak but cap rates sticky
• The high price of quality

36
Cap Rates by Property Type
Source ACLI
37
Commercial Mortgage Rates
Source John B. Levy / Commercial Mortgage Survey
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Office SectorDisconnect between Vacancy Rate and
Cap Rate
Source ACLI and Torto Wheaton
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Where Do Cap Rates Go From Here?

• Too high in early 90s
• Big CRE downturn, weak sales market, poor
  liquidity, higher interest rates
• Too low now
• Moderate CRE downturn, strong sales market, good
  liquidity, lower interest rates
• Moodys call
• Cap rates to rise, but not back to levels of
  early 90s
• Cyclical issues (rates, investment alternatives)
  outweigh secular issues (liquidity, perception of
  risk)
• Long term alignment of cap rates and fundamentals
  with occasional disconnects