Local and National Economic and Real Estate Outlook

1. Local and National Economic and Real Estate Outlook Dr. James P. Gaines Research Economist Real Estate Center at Texas A&M University

2. Topics • The Economy • The Real Estate Markets: National and Texas • Future Prospects for Texas

3. The Crack REC Economic and Housing Forecasting Team

4. Length of US Recessions 1900-Present Average Recession is 15 months Current Recession is 26 months and counting Source: NBER

5. Not a Typical Recession • We have a 0% funds rate, a $1.4 trillion budget deficit, a super-weak exchange rate, and a $2.2 trillion Fed balance sheet • Between one-fourth and one-third of homeowners with a mortgage have negative net equity • 1 in 6 are either unemployed or underemployed. • 1 in 7 homeowners with a mortgage either in arrears or in the foreclosure process • Small business failures are up 44% y/y • 1 in 8 Americans on food stamps and there are 239 counties where at least 25% of the population is on the program • A 30% slide in home prices; a 50% plunge in commercial real estate values; and a 20% mall vacancy rate nationwide

6. Is There a Secular Attitudinal Change Going On Given Economy, Credit Collapse and Household Net Worth Implosion? • Debt • Savings • Discretionary spending patterns • Homeownership

7. Percent Growth in Real GDP Since 2000 Seasonally Adjusted Annual Rate First quarter of expansion averages +7% after a recession As much as 90% of the 2.2% growth was Fed induced Source: Bureau of Economic Analysis

8. Overall Inflation Rate November Total CPI was up 1.9% from a year earlier, due to energy increase of 7.4% (especially gasoline of more than 24%) Core CPI was up 1.7% (new and used cars up 4.9% and 5.8%, respectively) Source: Bureau of Labor Statistics Yr/Yr Rate of Change in the Monthly Index, US Urban, All Items, Seasonally Adjusted

9. Personal consumption represents about 70% of US economy and is showing signs of recovery Personal Consumption Expenditures Source: Department of Commerce, SAAR

10. Corporate After-Tax Profits( SAAR Quarterly With Inventory Valuation & Capital Consumption Adjustment) Source: Bureau of Economic Analysis

11. Change in Monthly Employment 7.2 million total job losses since December 2007 Source: BLS, SAAR

12. Broadest Measure of Underemployment Percent NSA Source: BLS, U-6 Unemployment Rate NSA

13. Figuring Out the Economy Around the Ole Water Cooler

14. Beginning of 2010, Where Are We? Banks/Banking Fin/Capital Markets Housing Employment Comm. RE Retail consumption Business Spending Manufacturing Value of $1 Land Bottomed – Probably not Recovering – Some Cause for Concern – Yes Immediate Prospects – Not Good True Recovery? Speculation & Inflated P/Es Not on Fundamentals Exports up because $1 is down Heavy speculation, low value of $1, demand down Stock Market Commodities Imports/Exports Energy - gas & oil • Trillions spent with limited results • Little to no multiplier effects from $$ spent • Out of $$ - record deficits • Probably saved banks & WS, little else • Housing impact minimal • 3Q2009 GDP growth all Fed induced • Reckoning coming for value-less assets • Government Stimulus • Programs: • Following Japanese model despite claim not to • Long-term consequences may be significant

15. Three Key Questions • When will recession end? • Already ended? End of 2009, 2010 …? • What shape will the recovery take? • V, U, W or an L ? A “jobless” recovery • What are the risks of a relapse? • Government’s exit strategy, investor speculation driving commodity prices to unreasonable levels; capital market conditions – who’s providing capital?

16. What Is Holding Up A Recovery? • Inability of big banks to lend – credit freeze continues • Household’s reducing debt, not spending • Unemployment in double digits • Home prices declining – housing is not leading a general recovery as with past recessions • Commercial real estate drag on community and regional banks • State and local governments financially strapped • Everyone speculating on what Federal Government will do next

17. The Best Case Scenario • Favorable corporate earnings 4Q09 • Sustained stock market rally • Rise in consumer confidence and spending • Layoffs end by the end of the 2009 • “Jobless recovery” in 2010 • Higher interest rates and inflation in 2010-11

18. The Worst Case Scenario • The securitized lending market doesn’t reopen • Bad banks and businesses propped up • No price discovery for “toxic” mortgages • Political risk for business stays high • Business / investors “sit on their hands” • Unemployment goes well over 10% • Commodity deflation and price deflation continue and get worse

19. 2010 • Low interest rates for at least six months; ~ 100-200bp increase • Job losses decline during first half of year, then flat – little job gains of note; unemployment could reach nearly 11% • Some improvement in the housing market – flat to low growth despite low interest rates, low prices and tax credits – high potential for “double dip” • High foreclosures from high unemployment, ARM resets and re-defaults on loan workouts • Personal consumption up slightly during the year from pent-up demand – enough for major recovery?

20. 2010 • High number of bank failures; banking system forced to “carry” CRE problem into 2011; major reckoning of low-to-no-value assets looming, can’t extend & pretend much longer • Government stimulus spending only what’s left of original programs with little significant improvement to overall economy • Minimal 2010 impacts of healthcare and cap-and-trade legislation, but potentially significant impacts into 2011 • Deflation for at least first six months with potentially significant inflation for next several years • State and local governments financially strapped; schools broke

21. A Thought from Maxine "BAIL EM OUT! ????” Wow, back in 1990, the Government seized the Mustang Ranch brothel in Nevada for tax evasion and, as required by law, tried to run it. They failed, and it closed. Now we are trusting the auto industry, the banking system and healthcare to the same nit-wits who couldn't make money running a whore house and selling whiskey!

22. Texas Scenarios for 2010-2011 • Texas lagged into recession, may lag coming out • Job losses stop and new jobs start being created, maybe • Flat housing market – sales and prices until economy truly recovers • Small and regional bank failures worked out • In-migration re-invigorates economic growth and housing markets

23. Texas Index of Leading Indicators (1987=100) Source: Federal Reserve Bank of Dallas

24. Annual Employment Growth Rates for US, Texas and Dallas Dallas Texas US Source: BLS, TWC, Real Estate Center at Texas A&M University

25. Real Estate Markets

26. The Housing Market

27. Implications for Housing • “Tax credit” appears to have stimulated buying about 10% to 12% • Lower demand, foreclosures and homebuilder concessions affecting value changes • Appraisals are major issue in purchases • Lenders making purchase mortgages difficult to obtain • Jumbo home loans and ADC loans virtually non-existent in most of the country • Affordability operative market word

28. New and Existing SF Home Sales U.S. Sources: US Census Bureau , NAR, NAHB, NBER, 000s of SA units

29. Monthly Foreclosure Filings Source: RealtyTrac, Inc. Data include Notices of Trustee Sales plus Notices of Foreclosure Sale

30. Foreclosure Filings and the U.S. Unemployment Rate Sources: BLS, RealtyTrac, Inc. Foreclosure Filings include Notices of Trustee Sales plus Notices of Foreclosure Sale

31. Foreclosure Filings and the Texas Unemployment Rate Sources: TWC, RealtyTrac, Inc. Foreclosure Filings include Notices of Trustee Sales plus Notices of Foreclosure Sale

32. Annual U.S. Median Existing Home Price Percent Change Through June 2009 the median existing home price was down 14.8%; Through November 2009 the median existing home price is down 4.4%; 12-Month moving average is down 12.7% Source: NAR

33. US Median Home Prices Since 1990 National House Price Bubble 2000 Trend The national housing boom started around January 2002 creating a house price bubble that peaked at around $230,900 in 2006 Source: NAR, Real Estate Center at Texas A&M University

34. Has the Housing Market Bottomed? Answer: maybe, hopefully, probably. But we still may not really know for sure for another several months. • Can the market sustain itself without massive Federal government help •  Foreclosures will stay high. A large number of Option-ARM and prime ARM mortgages reset starting this quarter and going through all next year and into 2011. • The health of the housing market, nationally and locally, depends on a general economic recovery - especially stopping the loss of jobs and preferably adding new jobs. • The housing market may have bottomed out, but will probably have a long, slow recovery – think 5 to 10 years, not just one or two.

35. Future Home Sales Volume Job Growth Mortgage Rates and Credit Terms Home Price Affordability

36. Texas Single-Family Market Source: Real Estate Center at Texas A&M University

37. Annual Texas Home Sales 2007 = about 6% decline from 2006. 2008 = 16% less than ’07 2009 = sales down 10% to 15% from 2008 to 2001-2003 levels Source: Real Estate Center at Texas A&M University

38. Texas SF Building Permits 1984 82% of 1983 peak 1985 66% of 1983 peak 1986 57% of 1983 peak 1987 43% of 1983 peak 1988 35% of 1983 peak 2006 98% of 2005 peak 2007 72% of 2005 peak 2008p 48% of 2005 peak 2009e 36% of 2005 peak Source: US Census Bureau, Real Estate Center at Texas A&M

39. US and Texas Median Home Price Texas remains a housing bargain, but not by as much. The gap between the US and Texas median price widened to 38%, but has narrowed to 16% U. S. Median Home Price Texas Median Home Price Source: NAR; Real Estate Center at Texas A&M University

40. Texas Median Home Price12-Month Moving Average Current prices are about 7% below trend Source: Real Estate Center at Texas A&M University

41. Texas Households by Highest Affordable Price and the Number of Owner-Occupied Units 4% 3% 7% 6% 10% 6% 7% 8% 20% 30% Source: US Census Bureau 2008 American Community Survey; Real Estate Center at Texas A&M University

42. Dallas Single- Family Market Source: Real Estate Center at Texas A&M University; NTREIS * 12-month moving average to date

43. Dallas Monthly Home Sales12-Month Moving Average Sales Bubble Current sales are about equal to 2000 levels Source: Real Estate Center at Texas A&M University

44. Dallas Annual Home Sales 2009 sales at pace of 45,000, an 11.5% decline from 2008. 2010 sales about the same Source: Real Estate Center at Texas A&M University

45. Dallas Median Home Price12-Month Moving Average Moving-average Price down 1.5% from year earlier and 3.3% from November 2007 peak. Source: Real Estate Center at Texas A&M University

46. Dallas Median Home Prices Average annual increase of 3.0% 1998-2008. 2009e flat from 2008 2010p essentially flat, maybe up 1% Source: Real Estate Center at Texas A&M University

47. Dallas Single-Family Building Permits 1983-1988 = 58% Decline 2004-2008 = -62% -75% to 2009e ~8,000 Source: US Census Bureau, Real Estate Center at Texas A&M University

48. Dallas Multi-Family Building Permits 134 permits issued in the last 5 months Source: US Census Bureau, Real Estate Center at Texas A&M University

49. Implications for Commercial Real Estate • Heavy downward rent pressure in industrial, office and retail • Cap rates revert back to pre-2002 levels • Potential wave of foreclosures without extend & pretend • No new office, retail or industrial construction until 2012 or 2013 • FRANNIE financing led to gross overbuilding in multi-family which has fallen off significantly

50. DFW Overall Office New Space & Net Absorption Completed Space Absorption Source: CoStar; Real Estate Center at Texas A&M University