Capital Market Updates

REITs MOVE TO HIGHER GROUND

Following strong gains in the third quarter of 2009, REITs continued to outpace the broader market in the fourth quarter as the MSCI US REIT Index posted a 9.1% total return for the period. The recapitalization of the public REIT sector and perceived strengthening of the US economy helped drive significant gains in the second half of the year. In 2009, REITs returned 28.6%versus 23.5% for the S&P 500.

PUBLIC MARKET CAPITAL – THERE’S SOME FOR EVERYONE

In the fourth quarter, REITs issued $1.9 billion of common equity to culminate a year of industry-wide recapitalization, with a total of $18.8 billion of public equity raised in 2009. REITs continued to tap the unsecured debt market as well, issuing $3.7 billion in unsecured notes in the fourth quarter and a total of$10.2 billion for the year. In their entirety, REIT issuance of debt and equity in2009 was more than 2.5x the level of 2008.

IPO PIPELINE SWELLS ... BUT WILL THEY ALL GET DONE?

Between November 2009 and February 2010, 14 equity REITs filed to raise over $4 billion of common equity in initial public offerings (see below). Since December, four of those REITs have executed their IPOs, raising $900 million of equity. Three of the deals were blind pool offerings, which are proving to be increasingly difficult to execute in light of the lack of property transaction activity. Certainty of capital deployment remains elusive.

HYBRID FORMS OF FINANCING RE-EMERGE

Investor demand for REIT hybrid securities (e.g., preferred equity, convertible debt) have increased dramatically along with the rally in stock and bond prices. Yields on REIT preferred securities have tightened by an average of 1,000bps1 since their trough in March 2009, and are currently trading inside of pre Lehman levels. In spite of the rally, there were no REIT preferred issuances during 2009. However, Brookfield Properties, the Canadian office REOC, issued C$275M of perpetual preferred equity at 6.15%. Shortly thereafter, in January 2010 SL Green issued $127M of perpetual preferred securities at a current yield of 8.1%. M3 expects that trend to continue as more REITs tap the preferred market given its relatively attractive cost of capital.

As with the REIT preferred market, the convertible bond market has emerged as an attractive financing option for REITs to consider. A combination of low interest rates and the surge in REIT stock prices (and volatility) has made convertible issues more popular among investors. Over the last 90 days, four REITs issued convertible debentures totaling $853M. Similar to the preferred market, we expect more activity with this financing option.

SLUGGISH TRANSACTION ACTIVITY PERSISTS

In spite of significant sums of capital raised in the public markets, commercial real estate transaction volume remains a fraction of the activity of recent years. Bid-ask spreads remain sizeable as sellers wait for operating fundamentals to recover, and lenders continue to extend loan maturities. Transaction activity has consisted almost entirely of one-off asset sales. In spite of significant anecdotal evidence that institutional investors have returned to the market, very few portfolio investment opportunities have been consummated.