CAPITAL MARKETS UPDATE

By John Salustri
In June, some of the industry's most high-powered advisors got together in Hilton Head, SC to discuss the state and future of the capital markets, shifts in acquisition and disposition flow and the outlook for the business going forward. Not surprisingly, the meeting was tinged with a good-news/bad-news sensibility--especially as all of us await the long anticipated turning of the real estate market's fortunes. An edited version of that
conversation follows.


PANELISTS:

Ross Cowan
Vice President
Transwestern Investment Co.
Chicago

Tim Ellsworth
Director
The RREEF Funds
Chicago

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Ted Klinck
Principal
Lend Lease Real Estate Investments
Atlanta

Peter Nicoletti
Vice President
J.P. Morgan Investment Management Inc.
New York, NY

Dale Taysom
Managing Director
Prudential Real Estate Investors
Atlanta

MODERATORS:

Steven E. Pumper, President-Owner Advisory Services, Transwestern Commercial Services, Dallas
John Salustri, National Online Editor, GlobeSt.com, New York City


Capital Markets Panelists

Q: Let's start with an update on what each of you is doing.

NICOLETTI: We are a rather large advisor with up to $14 billion under management. Most of it is institutional either in three large funds or through myriad separate accounts. Annually, we'll buy $1.5 billion and sell about $1 billion. This is in all property types--except hotels--and it's in most of the major markets.

KLINCK: As you know, Lend Lease has announced the definitive agreement for Morgan Stanley to buy the majority of our equity business in the US, which consists of all of or separate accounts and the majority of our commingled funds. It does not include our value-enhancement funds. From a transaction standpoint, for our fiscal year ending June 30, 2003, we will end up with between $1.3 billion and $1.4 billion in closed acquisitions. It's been a strong year. On the disposition side, we're probably going to end up with $2.4 billion or $2.5 billion. It's been a great time for us to get a lot of properties out in the market on behalf of our clients, and we're getting great execution.

TAYSOM: We don't have any of Prudential's money except as a co-investor in funds we sponsor.

We're currently active with about eight or nine portfolios. Total assets under management after the TMW acquisition last year was about $15 billion. We traditionally do about $2 billion a year in acquisitions. This year we'll do $1.5 billion to $1.8 billion. A lot of other people are chasing real estate out there so it's a challenge to buy. Including the TMW capital, we are looking to do about $2.5 billion per year. Dispositions run anywhere from $700 million to last year's record $1.8 billion.

ELLSWORTH: Our assets under management right now are about $17 billion. We invest on behalf of 15 separate clients and three co-mingled funds. Typically, we'll acquire $1.5 billion to $2.5 billion a year in all property types--office, industrial, retail and multifamily. Our annual disposition volume is plus or minus $1 billion.

COWAN: We're currently on our seventh commingled fund, which is a $680-million valued-added fund. Since 1996, when we started our funds, we've bought about $3.5 billion in property. So far this year, we've been a net seller. I think we sold $242 million and bought $225 million in product, and much of that was carryover from last year. Over the next few years, we hope to do over $1 billion.

Q: Let's talk about your joint-venture relationships. Please tell us how each of your operations approach that strategy.

NICOLETTI: We use joint ventures as a very important tool to grow our business. Our existing relationships with REITs and private operators contribute to an active new-business deal flow. The JVs are almost exclusively for value added and development risks where an operator's expertise is valuable. In the current capital market, what was once considered low development returns--9%--now make sense in a low exit cap-rate market. This is especially true in the large regional mall category, where 8% to 9% development or expansion returns

are attractive, considering a mid-6% exit cap is achievable for the highest quality product.

TAYSOM: Joint ventures have been key to our business for six or seven years now, more on the developmentside than on an earnout structure. We currently have more core capital than we've had in a long time, especially with TMW and our German clients. We're building a fair amount of residential, most of it in urban locations. A high percentage of our projects will never see the light of day as rentals; we'll convert them ourselves or sell it to someone else at a price and cap rate you probably can't justify as a rental. In all, we've done less with public companies because control has been an issue. We're looking at them, but it's been less attractive to us than private partnerships.

ELLSWORTH: JV's are a smaller portion of our business. We've traditionally been a core investor and over the past five years have expanded into value-added investments. We have clients who are interested in joint ventures. Our development projects are primarily short-cycle investments where we can get in and out, which means industrial and multifamily to a lesser extent.

COWAN: Over the years, we've done a number of 50/50 deals.

The most active now is a JV with MONY on a mezz program. It's a $300-million fund--$150 of equity and
$150 of debt. We're going up 90% on the capital. Usually its 85 to 90.

Q: How has European money impacted your strategies?

KLINCK: Foreign capital has been probably 40% to 45 % of our acquisition volume this year--comprised of Australian, German and Middle Eastern capital. There's a lot of money flowing in from all three of those, particularly in the office sector.

TAYSOM: We haven't changed a lot of our criteria. We have more core money than in the past. The biggest change for us is adjusting our yield expectations. Maybe this is a secular trend. But everybody, including our German clients, has decided they are going to have to move significantly down on their yield expectations. We still try to maintain our 150-to-200-basis-point spread when we develop. I do believe single digit IRR's are extremely common today.

Q: Update us on how you are trying to underwrite the tenant's credit--especially after Enron and Arthur Andersen.

COWAN: We're just trying to be very careful, and we do it tenant-by-tenant. We hire a service to assist us in
our due diligence in addition to our own equity analysis for each individual tenant.

KLINCK: We do the same thing. We try to do our own internal credit analysis, but we are not experts, so we have a service that helps us understand the underlying credit tenancy of each building.

Q: Let's turn to the economy and real estate's recovery. Will it be as far out as '05?

KLINCK: Our company thinks things will pick up by the beginning of next year. Rates have bottomed and will move up slowly and we will see a slow increase in economic activity I think over the past 30 or 60 days, we've become more optimistic, meaning that the real estate recovery might occur in mid to late '04 and probably not much before that. Regarding individual property types, office is properly the last sector that will come back. There's simply too much overhang.

In terms of real estate, I wish I could be more positive about office, but with the shadow space and companies taking less
space per employee, no one really sees it. I think over the past 30 or 60 days, we've become more optimistic, meaning that recovery might occur in mid to late '04 and probably not much before that. But we're starting to see a few signs that recovery could happen maybe in the next 12 months or so. Regarding individual property types, office is properly the last sector that will come back. There's simply too much overhang.

TAYSOM: Our head of research says that by the fourth quarter of '04 or the first quarter of '05, we'll be back pretty close to where we should be.

KLINCK: But in terms of the economic cycle, did any of us ever think we'd see the one-, three- and five-year returns in real estate exceed stocks and bonds? Real Estate looks very good these days.