Fall 2007
OFFICE MARKET HEALTHY, DESPITE CREDIT SQUEEZE
The office market continues to improve, although
forecasts for heightened construction and slowing
employment growth into 2008 suggest that the market is
in the late stages of recovery. During the first half of
2007, healthy job gains in the professional and business
services sector resulted in higher occupancy levels and
substantial rent increases in most markets. The
subprime crisis and the resulting credit crunch,
however, have dramatically limited fundamental
growth in the office market. Inherent tenant demand
remains strong, but many corporations are refraining
from signing new leases until the direction of the overall
economy is more certain. Transaction velocity leading
into September, when the effects of the deteriorating
credit market were most strongly felt, was on pace with
2006, and prices were climbing. Since then, however,
financing has become more difficult to obtain, and
investment activity has cooled, causing velocity to fall
as much as 25 percent in some markets.
Hiring in office-using segments has kept pace with the
overall rate of employment, despite weakness in the
housing and mortgage industries that has limited job
growth. Total employment and office-using jobs are
each expected to record 1.1 percent increases this year,
with more mild gains projected for 2008.
U.S. Employment Trends
Total Employment Office-Using Employment
6%
Annual Change
3%
0%
-3%
90 92 94 96 98 00
* Forecast
Sources: Marcus & Millichap Research Services, Economy.com
Vacancy Rates and Effective Rent Trends
$30 Effective Rent Vacancy Rate
20%
Average Effective Rent
$25 15%
Vacancy
$20 10%
$15 5%
98 99 00 01 02 03 04 05 06 07* 08* 09*
* Forecast
Sources: Marcus & Millichap Research Services, Reis
The national vacancy rate is forecast to finish 2007 at
12.8 percent, down 50 basis points from last year. After
declining for 17 consecutive quarters, vacancy is
expected to record a modest uptick in the fourth quarter
of 2007 before recording a slight improvement in 2008.
As vacancy has declined, rents in the office market have
increased at a much faster rate than in other commercial
real estate sectors. Subsequently, asking rents are on
pace to advance 9.2 percent by year end, while effective
rent growth will total 10.1 percent.
With capital more difficult to obtain and fewer
properties changing hands, it is becoming increasingly
important for investors to re-evaluate their strategies.
For some, this could mean realigning real estate
portfolios to mitigate risk and/or increase returns.
Our Office Investment Opportunity Matrix, which can
be found on page 3, is designed to help investors
identify markets that best serve their investment
objectives by examining the relationship between
current price-to-rent ratios and forecast changes in
market conditions. It is important to keep in mind that
the matrix is based on current and projected metro-level
trends and is not intended to predict the performance of
02 04 06 08* any one individual asset. As a result, it is very possible
for a well-chosen investment in a stable or slow-growing
market to outperform a lesser asset in a market that
ranks at or near the top for predicted rent index growth.
Office Market Moves to Late Stage of Cycle Lowest Price-to-Rent Markets
Healthy hiring and steady economic expansion have caused 8
office vacancy to decline more than 400 basis points since

Price-to-Rent Ratio
early 2004, which has led to increased development efforts.
6
Completions are forecast to climb approximately 20 percent
nationwide in 2008, offsetting modestly higher absorption
levels. Deliveries of competitive space over the next two 4
years will total 140 million square feet, highlighted by sever-
al towers in downtown Chicago and Manhattan that are slat- 2

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ed to come online in late 2009. Office construction, while ris-

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ing, is well below levels achieved from 1999-2001, when an

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average of 125 million square feet was delivered annually.

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At its peak in the cycle, sublease space represented more than Sources: Marcus & Millichap Research Services, CoStar Group Inc., Reis

12.5 percent of the total vacant space in the marketplace,
though by the first quarter of 2007, this number had
decreased to just 8 percent. In the last two quarters, however,
the amount of sublease space, while still relatively low, has
increased. Further additions are forecast over the next six to
nine months as mortgage originators, lenders and others con-
nected to the slumping housing industry curtail their needs.
Going forward, slowing revenue growth and tighter lending
standards are expected to restrain sales velocity and could
put additional upward pressure on cap rates, particularly
outside of prime markets. Although cap rates could rise an
additional 50 basis points over the next 12 months, current
trends represent a minor correction in a fundamentally
healthy market, not a significant weakness.

U.S. Office Prices

$180
Matching Strategy to Opportunity
Median Price per Square Foot

It is crucial at this point in the cycle for investors to evalu-

ate their investment strategies and determine if their current
$140
holdings are well matched to their objectives. Both prices
and rents vary widely by market, making it difficult to draw
$100 conclusions from comparisons based solely on dollar fig-
ures. Price-to-rent ratios are helpful, as they take into
$60 account the relationship of these variables. Our Office
Investment Opportunity Matrix on page 3 includes project-
$20 ed rent index1 gains over the next two years, as well as cur-
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07* rent price trends.
* Forecast
Sources: Marcus & Millichap Research Services, CoStar Group Inc., Real Capital Analytics

U.S. Office Rent Index

Modest Cap Rate Increase Under Way
Year to date, improving fundamentals and record capital 20%
flows from private equity funds have pushed the median
price up 8 percent to $203 per square foot. Cap rates in 10%
Annual Change

institutional-grade Class A properties have plunged, and

the multiple reselling of the Equity Office portfolio exhibits 0%
an enormous demand for premiere assets in the top tier.
Revenue growth has been strongest in primary markets -10%
where cap rates have shown little upward momentum.
-20%
The subprime collapse and credit crisis began to cool an 01 02 03 04 05 06 07* 08* 09*
overheated market at the end of the third quarter. Cap rates * Forecast
Sources: Marcus & Millichap Research Services, Reis
have inched higher through that time, recording a typical
increase within the 25 basis points to 50 basis points range,
although secondary and tertiary markets, especially in the
Midwest, have posted modestly higher cap rate gains.
1Rent index is calculated using the change in the product of occupancy rate and effective rent

page 2 Marcus & Millichap ◆ Special Office Research Report

 Office Investment Opportunity Matrix 2008

Washington,

5% 9% 13% 17%
Forecasted Rent Index Growth (YE 2007 to YE 2009)

The rent index is a function of changes in rents and occu-
pancy. It is important to note that results in metros such as
Dallas and Denver are largely dependent upon occupancy
gains, whereas results in markets such as New York and San
Francisco are driven by effective rent growth.
With the rapid appreciation witnessed over the last few
years unlikely to persist, the combination of rent index
growth and affordability has become more important.
Several coastal markets remain expensive, despite dramatic
revenue growth in 2007, but others, where gains have been
more modest, have received less investment demand and
remain affordable in today’s market.
■ San Jose, San Francisco, Austin and Denver comprise four
out of the top five markets with the highest projected rent
index growth. The recent influx of private equity capital
to Austin has dramatically increased prices, making the
metro relatively expensive; Denver, meanwhile, is the
most reasonably priced market in this group.
■ Aggressive building and more modest tenant demand due
to a cooling housing market will apply upward pressure on
Highest Forecasted Rent Index Growth
20%
Change in Rent Index
YE 2006 - YE 2008*
vacancy in Phoenix in the near-term. However, the metro is
expected to record healthy rent index growth in the long-
term, due in large part to robust employment growth.
■ Among the three South Florida markets, only West Palm
Beach has remained relatively inexpensive due to rapidly
improving fundamentals, while strong in-flows of insti-
tutional and private equity capital in Fort Lauderdale and
Miami have significantly raised prices.
■ In Orange County, a market hit extremely hard by the
subprime and mortgage meltdown, a measured increase
in vacancy has been recorded over the last six months.
Rent index growth in the next two years is anticipated to
total 10.4 percent, while significant barriers to entry will
create some attractive value-add opportunities.
■ Almost all of the office markets in the Midwest are fore-
cast to post below-average rent index growth, with the
exception of Minneapolis and Columbus, which are both
near the median. These two markets will receive steady
tenant demand and very little new stock during the next
two years, creating a strong investment opportunity.
■ Seattle remains relatively affordable on a price-to-rent
basis, compared with Portland. With second- and third-

round buyers of former Equity Office properties aggres-

15%
sively driving up rents, revenue growth through 2009 is
projected to be above-average in a market that already
10% features vacancy rates in the single digits.

5% ■ Manhattan is forecast to record some of the nation’s

strongest rent index growth, driven by robust gains in
co

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Midtown properties where vacancy is tight, and strong

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pre-leasing commitments are in place. While rent growth

ew

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Downtown will be more modest, gains are expected to

al
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* Forecast
Sources: Marcus & Millichap Research Services, Reis outpace nearly every other market in the index.

Marcus & Millichap ◆ Special Office Research Report page 3


Marcus & Millichap’s National Office
and Industrial Properties Group
(NOIPG) specializes in advisory and
transaction services for private and
institutional investors nationwide.
Through our national market coverage
and relationships with the largest pool
of investors, we match buyers and sell-
ers from coast to coast, effectively
moving capital across geographic
boundaries and property types.
Alan L. Pontius
Managing Director
Tel: (415) 391-9220
apontius@marcusmillichap.com
Falling Treasury Yields Largely Offsetting Widening Lending Spreads
The office market is buoyed by healthy fundamentals, although the fallout from the
subprime meltdown will remain a chief concern of office investors in the near term.
Development activity will pick up in 2008, with the majority of new deliveries con-
centrated in a few markets. Increased energy costs, however, will help to limit con-
struction levels, allowing for occupancy gains. Markets that have experienced the
most significant housing booms over the last decade, particularly those in the
Southwest, will be impacted the most by the subprime fallout, recording a sharp
increase in sublease space as residential mortgage originators, lenders and con-
struction services companies are forced to trim their space requirements.
Higher financing spreads have been generated by lenders tightening terms in the
wake of turbulence in the credit markets. At the end of last year, spreads for a typ-
ical office property averaged 100 basis points over the 10-year Treasury yield; cur-
rently, spreads average more than 200 basis points over. In the next 12 months,
investors should expect spreads to remain near their current levels, although a
mild pullback is possible by mid-2008. Deteriorating confidence in the CMBS mar-
ket has stymied the conduit market, although life insurance companies and local
banks have increased their activity in an attempt to boost their market shares.

Steeper spreads are having an impact on prices and yields. Cap rates on most Class
B/C assets and properties in secondary and tertiary markets have increased by 25
basis points to 50 basis points through the third quarter. Cap rates on Class A prop-
erties, meanwhile, have remained resilient, as large pools of capital continue to
chase premiere office assets in primary markets. Over the next 12 months, deceler-
ated transaction activity as a result of tighter lending standards is expected to push
average cap rates up another 25 basis points to 50 basis points.

Recent Office Sales Highlights

Total Price/
Property Name Address City, State Sales Price Sq. Ft. Sq. Ft.
Culver Medical Plaza 3831 Hughes Avenue Culver City, CA $17,650,000 51,596 $342
Edited and prepared by: Office Building 539 Bryant Street San Francisco, CA $14,900,000 55,512 $268
Yitzie Sommer
Senior Research Manager, NOIPG Camino al Norte Office Park 5135 Camino al Norte North Las Vegas, NV $12,100,000 45,376 $267
ysommer@marcusmillichap.com Office Building 803 West Broad Street Falls Church, VA $12,610,000 51,626 $244
Tel: (312) 327-5400 Federal Law Center 449 West Market Street Greensboro, NC $22,250,000 93,665 $238
Intel Corporation 9835 Goethe Road Sacramento, CA $11,500,000 52,958 $217
Arkansas FBI Headquarters 24 Shackleford West Boulevard Little Rock, AR $21,000,000 101,136 $208
St. Mary Physicians Center 1043 Elm Avenue Long Beach, CA $13,800,000 66,719 $207
John Chang Riverview Office Building 6196 Oxon Hill Road Oxon Hill, MD $11,500,000 69,823 $165
National Research Manager
Research Services Office Building 6671 Southwest Freeway Houston, TX $22,500,000 148,751 $151
john.chang@marcusmillichap.com Centerpoint Plaza 1926 10th Avenue North Lake Worth, FL $11,250,000 83,163 $135
Tel: (602) 952-9669 Roper Mountain Business Center 430 Roper Mountain Road Greenville, SC $12,400,000 92,419 $134
Office Building 699 North Miami Beach Boulevard Miami, FL $18,000,000 136,468 $132
AT&T Administrative Offices 65 West Webster Joliet, IL $11,770,000 97,115 $121
Stevenson Point Tech 39700 Eureka Drive Newark, NJ $43,750,000 412,994 $106
AT&T 1430 Empire Central Dallas, TX $14,900,000 159,800 $93
Commonwealth Business Center 11001 Bluegrass Parkway Louisville, KY $10,850,000 127,476 $85
Centre at Cypress Creek 20466 Compaq Center Drive Houston, TX $38,000,000 487,591 $78
Elizabeth Place 1 Elizabeth Place Dayton, OH $46,700,000 642,133 $73
Four SeaGate 433 Summit Street Toledo, OH $11,000,000 227,910 $48

Offices Nationwide The information contained in this report was obtained from sources deemed to be reliable. Every effort was made to obtain accurate and complete information; however,
no representation, warranty or guarantee, express or implied, may be made as to the accuracy or reliability of the information contained herein. Note: Metro-level employ-
Local Research Reports Available ment growth is calculated using seasonally adjusted quarterly averages. Sources: Marcus & Millichap Research Services, Bureau of Economic Analysis, Bureau of Labor
Online at www.MarcusMillichap.com Statistics, CoStar Group, Inc., Economy.com, Real Capital Analytics, Reis, TWR/Dodge Pipeline, U.S. Census Bureau.

Marcus & Millichap ◆ Special Office Research Report © Marcus & Millichap 2007