Rate Cuts, Stimulus Package to Underpin Growth in Second Half

GDP increased by an estimated 2.2 percent in

2007, compared to 2.9 percent the previous Interest Rate Trends
year. Housing continued to weigh on the economy 8% Fed Funds Rate 10-Year Treasury
in 2007, subtracting 1 percentage point from the
annual expansion rate. The trade sector, however, 6%

Interest Rate
became a contributor to growth for the first time
since 1991 as the weak dollar bolstered demand 4%
for U.S. goods and services. Net exports tacked
on 0.6 percentage points to GDP last year. 2%
Consumer expenditures continued to rise, albeit at
a slower rate, as did business spending. 0%
Continued weakness in the housing sector and 97 98 99 00 01 02 03 04 05 06 07 08*
financial market volatility are dragging down * As of mid-February
both consumer and business confidence. Sources: Marcus & Millichap Research Services, Economy.com
Writedowns in the financial sector have topped
$125 billion to date, and additional subprime losses still lay ahead. Residential subprime loans account
for a relatively small share of the overall mortgage market, but the psychological impact on consumers,
investors and businesses has been dramatic. An overall flight to quality has emerged across
investment sectors, and investors are generally shying away from mortgage-backed securities. Since a
wide range of residential mortgages were pooled and sold as mortgage-backed securities, quantifying
and re-pricing the high-risk portion of these investments is difficult. Commercial mortgage-backed
security (CMBS) delinquency is still near historical lows but has ticked up recently, adding fuel to
concerns regarding later-vintage commercial loans that were subject to lax underwriting standards.
Recent Fed rate cuts and the economic stimulus package are unlikely to prevent further
economic slowing or recession in the near term, but they provide a solid foundation for a
recovery to take shape in the second half of the year. There are positive forces at work in the
economy that should be noted, including healthy export activity, low business inventories and a
relatively sturdy corporate sector outside of banking- and housing-related industries.
Forecast:
After slashing the fed funds rate 225 basis points since last September, any future rate cuts are
likely to be in relatively small increments. Despite near-term slowing, GDP is forecast to rise 1.8
percent in 2008, down from 2.2 percent last year. A potential side effect of the Fed’s rapid easing is the
re-ignition of inflation, which points to a Fed reversal quickly upon normalization of the economy.
Employment trends will reflect weaker economic conditions through the first several months of
2008 but are expected to improve as the impact of rate cuts and tax rebates takes hold. Nonfarm
job growth this year is forecast at 0.8 percent, or 1.1 million jobs, compared to 0.9 percent in 2007.
Retail sales are expected to rise in 2008, but at a slower rate. Reduced home equity withdrawal and
high energy prices are putting a squeeze on consumer spending; however, lower interest rates should
relieve some of the pressure on household budgets, as credit cards and home equity lines are often
tied to the prime rate, which tends to track the fed funds rate. In addition, if history holds true, 60
percent of tax rebates will be spent in the same quarter they are received by households.

The information in this report is deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no
representation, warranty or guarantee, expressed or implied, may be made as to the accuracy or reliability of the information contained herein.
Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Economy.com, Federal Reserve, NAR, Real Capital Analytics, PPR, Reis.

Erica L. Linn
Marcus & Millichap Research Services March 2008
elinn@marcusmillichap.com Copyright 2008 Marcus & Millichap
 APARTMENT: Vacancy Stable as Declining Homeownership Rate
and Tighter Lending Offset Weak Employment Market
U.S. apartment vacancy declined 20 basis points Apartment Sales Trends
in 2007 to 5.6 percent. Improvement was isolated $160 9%
to the third quarter, though vacancy held steady in
Median Price per Unit

Median Price per Unit (000s)

the fourth quarter despite a slowing economy and Average Cap Rate
$120 8%
the delivery of 27,000 units – one-third of last year’s

Average Cap Rate

total new supply. Strong demand for apartments
allowed for a 4.5 percent increase in asking rents in $80 7%
2007, pushing the national average to $1,025 per
month. Concessions edged down slightly during the $40 6%
year, supporting a 4.7 percent rise in effective rents
to $975 per month. $0 5%
Residential ARM resets and foreclosures have 00 01 02 03 04 05 06 07*
forced many homeowners back into the renter * Estimate
Sources: Marcus & Millichap Research Services, CoStar Group, Inc.
pool. The U.S. homeownership rate plunged 110
basis points last year to 67.8 percent, its lowest level since early 2002. It is important to note, however,
that the slowdown in the housing market has also resulted in a growing shadow-rental market. At year-
end 2007, there were an estimated 3.8 million vacant housing units for rent. An additional 2.2 million
vacant units were for-sale, some of which will become rentals if home sales remain weak.
Sales velocity declined last year due to reduced activity in the $1 million to $10 million price
range. The median price last year was almost equivalent to the 2006 figure at approximately $113,000,
though cap rates edged up 20 basis points to around 6.2 percent. Annual marketwide figures mask the
shifts that occurred following the late summer capital markets shock. Tighter lending conditions and
investors’ reassessment of risk have resulted in a flight to quality, putting upward pressure on cap rates
for lower-quality assets and those in secondary/tertiary markets. Cap rates for high-quality assets in
supply-constrained markets have recorded minimal cap rate increases, a trend that will persist as
foreign investors and lower-leverage REITs and institutions ramp up activity.
Forecast:
Approximately 100,000 apartments are expected to come online in 2008, up from 87,000 units in
2007 but still below construction activity in the late 1990s and earlier this decade. Apartment
vacancy is forecast to hold relatively steady, with mild softening in the Class A sector offset by tighter
conditions in the more affordable Class B/C market.
Economic and demographic trends support a bright outlook for apartments. Echo boomers will
be a key driver of renter demand over the next several years, as they have only just begun to enter
their 20s. Unlike 2001 to 2005, when homeownership in the 25 and younger age group rose 400 basis
points, lending standards are more stringent and most will be unable to qualify for a mortgage. In
addition, baby boomers will provide a boost to the apartment investment market as they acquire quality
cash-flow investments in advance of retirement.
Quality will drive values this year, causing further divergence in pricing and cap rates by market
type and property class. The more limited value-add buyer pool, however, will create strong buying
opportunities for investors with cash in hand. Overall, the healthy balance between supply and demand
in most markets will prevent major upward correction, holding cap rates well below long-term averages.

The information in this report is deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no
representation, warranty or guarantee, expressed or implied, may be made as to the accuracy or reliability of the information contained herein.
Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Economy.com, Federal Reserve, NAR, Real Capital Analytics, PPR, Reis.

Erica L. Linn
Marcus & Millichap Research Services March 2008
elinn@marcusmillichap.com Copyright 2008 Marcus & Millichap