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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 in 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 forecast 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
OFFICE: Strong Recovery Cycle Gives Way to
Moderate Softening as Economy Cools
U.S. office vacancy ended 2007 at 12.6 percent,
down 70 basis points from 2006 and 430 basis Office Supply and Demand Trends
from its most recent peak in early 2004. Though Completions Vacancy
160 25%
vacancy decreased on a year-over-year basis, the
market did record a minor 10 basis point uptick
120 20%
during the fourth quarter as housing- and banking-

Millions of Sq. Ft.

Vacancy Rate
related industries contracted. The greatest
vacancy improvements last year were registered 80 15%
in Houston, San Francisco, Boston, Kansas City,
Chicago and Minneapolis, all of which posted 40 10%
decreases of 200 basis points or more. Markets hit
hardest by the housing market downturn
0 5%
experienced the most significant increases in 90 92 94 96 98 00 02 04 06 08*
vacancy; these include Orange County, Riverside-
* Forecast
San Bernardino, Phoenix, Las Vegas, Sacramento Sources: Marcus & Millichap Research Services, Reis
and several Florida markets.
Rent growth accelerated dramatically in 2007, with the market recording the strongest gains
since 2000. Asking rents rose 9.6 percent, reaching $28.55 per square foot by year end, while effective
rents climbed 10.7 percent to $24.60 per square foot. A handful of markets fueled last year’s double-
digit spike in effective rents, with Denver, Los Angeles, Houston, Seattle, Boston, San Jose, New York
City and San Francisco all posting effective rent growth of more than 10 percent.
Private equity fund activity is expected to decline after a banner year in 2007, which included
Blackstone’s acquisition of Equity Office Properties. A re-pricing of risk following the capital
markets shock in late July has caused greater distinctions in pricing and cap rates based on property
performance, quality and location. Office cap rates currently average from the low-6 percent range for
higher-quality assets in primary markets to 9 percent for lower-quality properties in secondary/tertiary
markets.
Forecast:
Developers will deliver 68 million square feet in 2008, up from 55 million square feet last year.
Office-using job growth is forecast to reach just 0.5 percent in 2008, after 1.2 percent expansion in
2007. The combination of rising new supply and reduced demand is expected to cause vacancy to rise
80 basis points to 13.4 percent. The development pipeline is thinning, however, with 45 percent less
office space in the pre-planning phase today than one year ago.
Office absorption is expected to slow in the first half of 2008, but should pick up later in the year
as businesses regain confidence. In the near term, office closures, layoffs and reduced hiring will
result in a growing sublease market. Overall, increased competition in the marketplace will limit asking
and effective rent growth to 5 percent this year.
Cap rate increases this year will be heavily dependent on property and market quality. Despite a
moderate increase in vacancy, supply/demand fundamentals will remain relatively healthy by historical
standards this year, and supply-side risks will diminish further due to tighter lending. As a result, we
anticipate there will continue to be a significant amount of capital seeking quality office investments.

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

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