Delta Associates Trend Lines 2008

Creating Opportunities in a Changing Market

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trendlines® 2008

Creating Opportunities in a Changing Market

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Trends in Metro Washington, DC Commercial Real Estate | February 7, 2008

trendlines® 2008

To our friends, clients and colleagues:

We are pleased to provide you this eleventh annual edition of TrendLines: Trends in Metro Washington, DC Commercial Real Estate. This is a collaborative publication of Transwestern and its research affiliate, Delta Associates. Our purposes are to distill the trends of 2007 and to shed light on pivotal forces and issues that we believe will affect the region’s economy and real estate in the period ahead.

In 2007, we experienced a cyclical change, moving from the robust part of the economic cycle to what some believe may be a pre-cursor to a recession. And our real estate market seems to be shifting from one that favors the landlord to one that favors the tenant. Both shifts are overstated to our way of thinking, but a shift is in fact underway – from the less-challenging part of the cycle to one that takes more insight to survive and make money. The icon of this shift is the Credit Crunch that occurred in August. And so this annual publication, TrendLines, is of even more importance –- as it can shed light on the path forward during a tumultuous time in our industry.

More challenges are on the horizon for 2008. Market conditions are expected to deteriorate modestly for most asset classes yet remain sturdy overall. High operating, financing, and development costs remain hurdles. While money will be available to invest in commercial real estate in 2008, it will not be like we got used to in 2007. Also of note, the Washington area economy is dealing with the slowing growth rate of Federal procurement spending, which has and will dampen job creation and office leasing activity.

Our expectations for 2008 include:

n National Economy: Further deceleration with the possibility – though not likelihood – of recession.

n Regional Economy: Slower but steady growth, driven by our core industries.

n Office Market: Continued expansion, but at below-average levels of demand, accompanied by rising vacancies and rents that only edge up.

n Flex/Industrial Market: Steady growth. However, new supply may exceed demand by year-end.

n Housing Market (including condos): Methodical recovery as excess inventory is reduced. But we do not look for meaningful price traction until 2009.

n Rental Apartment Market: Strong conditions, but rising vacancy due to an expanding pipeline.

n Retail Market: Robust market conditions continue as above-average income and an inadequate development pipeline perpetuate low vacancy and rising rents, although this asset class is vulnerable to a recession.

n Capital Markets: Continued healthy performance, though at reduced volume. Prices should hold steady due to improved operating performance. Cap rates may edge up modestly.

n Overall: We will find as many opportunities in our industry in 2008 as we did in 2007. But it will take more equity, more insight, more work, and more skill.

We hope the information that follows helps provide insight into these opportunities. We look forward to helping you interpret everything you see in the market, and to being your service partner in the successes we know you will achieve in the period ahead.

February 2008Foreword

Delta Associates

Gregory H. Leisch, CREChief Executive Officer

Transwestern

Thomas NordlingerPresident, Mid-Atlantic Region

To Our Clients and Business Associates:

Once again, the Washington real estate market is among the strongest in the country as our area continues to thrive and grow. Visionary companies, many of whom are our clients, our taking the lead in this growth by reinvesting in the region and fostering economic development through their commercial and residential developments. These real estate projects generate jobs and provide the foundation for our communities.

As always, the future holds uncertainty but there is much anticipation as we begin 2008. The opening of Nationals Park, first openings at National Harbor, the continuing revitalization of Rosslyn, and further development of Reston are events that will shape our region for decades to come. Projects near Nationals Park, Mount Vernon Triangle and NoMa areas will continue the resurgence of DC neighborhoods. In addition, continued development near current and planned transit corridors offer the potential for improved traffic flow throughout the region. An increased emphasis on green design and development will reshape how each of us works in the future. These initiatives give promise to the Washington region in 2008 and the years to follow.

As business and tax advisors to the real estate industry for over 30 years, we draw upon our experience serving many of the region’s top real estate companies to assist owners in creating tax-efficient ownership structures and developing planning alternatives. We identify opportunities by being experts in the areas of Federal and state tax laws that affect our clients.

We look forward to continuing to work with the real estate entrepreneurs who are the foundation of the metropolitan Washington real estate industry as well as investors – foreign and domestic – who recognize our area as one of the most desirable investment markets in the United States.

As changes affect the real estate industry, we will be right here with you, advising you on ways to profit from those changes and use them to give you a competitive edge. To learn more about how we can help you manage your business in today’s changing marketplace, please contact us.

Very truly yours,

Kelly P. Toole

Direct Dial 703 923 [email protected]

February 2008

trendlines® 2008

Dear TrendLines Participant,

PNC is once again proud to sponsor the 2008 TrendLines Report, one of the premier resources for the area’s commercial real estate professionals.

We understand that in today’s rapidly evolving markets you need lenders and advisors who can do more for you. Lenders who have experienced varied economic cycles before and have been consistently available to their customers. PNC is one of those lenders.

We are very proud to be a member of the Washington-Baltimore real estate community. PNC has been a presence in this market for two decades, strengthened by our recent acquisitions of Mercantile and Riggs National Bank.

We look forward to continuing to serve the real estate communities of this area, delivering one of the industry’s broadest platforms of products and services - including construction, interim, and permanent financing, along with access to the capital markets, treasury management services and best-in-class loan servicing provided by Midland Loan Services. And with last year’s acquisition of ARCS Commercial Mortgage, we can now deliver access to one of Fannie Mae’s top DUS lenders.

At PNC, we combine a wider range of financial resources with a deeper understanding of your business to help you achieve your goals.

To learn how we can bring ideas, advice and solutions to you, call us or visit www.pnc.com/realestate.

Sincerely,

Michael N. Harreld William R. Lynch IIIPresident Senior Vice PresidentPNC Bank – Greater Washington Area PNC Real Estate Finance202-835-5513 [email protected] [email protected]

February 2008

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Table of Contents

Section 1 Creating Opportunities in a Changing Market Page 12

Section 2 The National Economy Page 24

Section 3 The Washington Area Economy Page 34

Section 4 The Washington Area Office Market Page 42

Section 5 The Washington/Baltimore Flex/Industrial Market Page 54

Section 6 The Washington Area Apartment Market Page 64

Section 7 The Washington Area Condominium Market Page 74

Section 8 The Washington Area Retail Market Page 80

Section 9 Capital Markets and Investment Trends Page 92

Section 10 TrendSetter Award Recipient Page 98

Acknowledgments: The editor, Gregory H. Leisch, CRE, wishes to acknowledge and thank this project’s research team at Delta Associates: Alexander (Sandy) Paul, President of the Transwestern Support Group and National Research Director; and Elizabeth Norton, Mid-Atlantic Research Director. The creative design team at Transwestern and the administrative staff at Delta have our gratitude. Most of all, our appreciation is hereby expressed to the dozens of industry leaders who spent their valuable time responding to questions about the future of our industry here in the Washington area.

Representations: Although the information contained herein is based on sources that Delta Associates (DA) and Transwestern (TW) believe to be reliable, DA and TW make no representation or warranty that such information is accurate or complete. All prices, yields, analyses, computations, and opinions expressed are subject to change without notice. Under no circumstances should any such information be considered representations or warranties of DA or TW of any kind. Any such information may be based on assumptions that may or may not be accurate, and any such assumption may differ from actual results. This report should not be considered investment advice.

TrendLines®: Trends in Metro Washington, DC Commercial Real Estate was designed in-house for Transwestern and Delta Associates by Ji Chang, Verónica Sandoval and Jessica Newman.

CREATING OPPORTUNITIESIN A CHANGING MARKET

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CREATING OPPORTUNITIES IN A CHANGING MARKET

The purpose of TrendLines® is to distill the trends of 2007 and shed light on pivotal issues that shape our commercial real estate opportunities in the Washington marketplace in 2008 and beyond.

In order to understand the full picture of what challenges and opportunities lay ahead, let’s first understand the status of the economy – both at the national and regional level – and its effect on real estate market conditions.

Last year in TrendLines we said we had transitioned into a full-fledged period of mixed messages for the U.S. economy. This year, those messages continue to cloud the outlook for 2008. The following messages are so mixed that 69% of Americans believe that the nation is headed into a recession whereas only 2 in 54 leading economists believe so.

n Corporate profits remain healthy, although the number of industries under profit pressure has increased.

n GDP growth was a healthy 4.9% on an annualized basis in the 3rd quarter, although we know this rate cannot last.

n Consumer confidence, which in turn governs retail spending, is at a cyclical low.n Housing, which seemed poised for a recovery in the Summer, was knocked on

its ear by the August Credit Crunch.n The employment picture remains healthy, with 1.8 million net new payroll jobs

added in 2007. However, the growth rate slowed dramatically late in the year.n Inflation remains under control, but it increased late in the year.

What can we decipher from the muddled economic picture? What clues can we seize upon that will help us invest wisely in the period ahead?

A Changing Market: Trends of 2007

Identifying key trends of 2007 – in the national economy, the regional economy, and Washington area commercial real estate – will assist us in making smart decisions in 2008. Let’s start with five key national economic trends.

CREATINGOPPORTUNITIESIN A CHANGINGMARKET

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National Economic Trends

1. Subprime Crisis / Housing Weakness / Credit Crunch

Where did all the liquidity go? And what do sub-prime mortgages have to do with commercial real estate? In August 2007, buyers of bonds securitized by real estate assets lost faith in the value of the collateral behind those bonds. It started with pools of residential mortgages but spread to other asset classes. Once spread, the bond market seized up like an over-heated engine. The Fed increased liquidity and lowered inter-bank borrowing rates to help cool and restart the engine, but that will go only so far. We need faith again in the valuation of the collateral that secures these bonds. That will take time and re-pricing, which has begun and will continue throughout the first half of 2008.

The share of subprime mortgage holders unable to pay off their loans tripled from June 2005 to August 2007, leading to the Credit Crunch. The share of delinquencies and foreclosures continued to rise into early 2008, as shown in the graph below.

Share of Subprime Mortgages in Delinquency or Foreclosure

Share of U.S. Targeted Mergers and Acquisitions with Foreign Buyers

*As of March 2007 Source: MSNBC, Federal Reserve, Delta Associates; January 2008

Source: Bloomberg News, Delta Associates; January 2008

The Federal government designed an aid package for those homeowners hit hardest by the subprime crisis, especially those who took on tremendous debt at the urging of some lenders. However, it could take much of 2008 or beyond for the crunch to fully work through the economy, as the Fed has said that an average of 450,000 subprime ARMs are scheduled to undergo their first rate increase each quarter in 2008.

In our view, this will work itself out over the course of 2008. In the meantime: Cash is king.

2. The Weak Dollar

A weak U.S. dollar, while inconvenient for the American traveler abroad, has fostered exports and related domestic jobs. And for the commercial real estate industry, it has encouraged foreign buyers to step into the breach left by leveraged domestics in the wake of the Credit Crunch. And the same is true for U.S. companies of all types: nearly half of U.S. M&A activity in the 4th quarter of 2007 was by foreign buyers. We are truly becoming a global marketplace.

The dollar fell 10% against the euro in 2007. The slowing U.S. economy means that continued weakness in the dollar’s value against other major currencies is likely to continue in 2008, keeping U.S. assets attractive to foreign buyers. In the meantime, capitalize on foreign money flowing into U.S. real estate deals.

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U.S. Inflation

*12-month percentage change through November 2007 Source: Bureau of Labor Statistics, Delta Associates; January 2008

3. Inflation on the Rise; Mortgage Rates to Follow?

The threat of inflation kept the Federal Reserve from cutting interest rates early in 2007, even though the U.S. economic expansion seemed to be slowing. Through this decade, inflation had remained under 4% per year, even as gasoline prices drove the overall barometer higher. However, after the Credit Crunch hit in August, and consumer sentiment declined dramatically, the Fed took action, cutting the Federal Funds rate in September, and then again in October and December. This loosening of monetary policy takes on the added risk of a rising inflation rate, and indeed, the rate for the 12 months ending in November 2007 rose to 4.3% – the highest 12-month period in 17 years.

Odds makers are betting on further rate cuts. And the Congress and White House are discussing an economic stimulus package. These activities will likely push inflation higher. And with higher inflation would come two problems for the economy and our industry:

n Inflation would debilitate some consumers, further handicapping a resumption of a more robust GDP growth rate.

n Inflation often is baked into long-term borrowing rates, so mortgage rates may rise above their current low levels. That would be bad for the economy as well as the real estate industry.

In our view inflation will remain elevated – 4% or so – but not high. In the meantime, lock in fixed-rate low borrowing rates and take a defensive posture regarding inflation.

4. Slowing GDP and Job Growth

Last year was a strange one for the broadest gauge of American economic performance: gross domestic product (GDP). After a 2.9% growth rate for all of 2006, the rate dropped to 0.6% (annualized) for the 1st quarter of 2007, then jumped to 3.8% and 4.9% for quarters 2 and 3. Most observers believe the final numbers for the 4th quarter will be in the 1.0% to 1.5% range, which will make the annual average in the 2.2% to 2.6% range.

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U.S. Gross Domestic Product Growth

Source: Wachovia Bank, Delta Associates; January 2008

U.S. Payroll Jobs

Source: Bureau of Labor Statistics, Delta Associates; January 2008

Decelerating job growth, credit market uncertainty, and related housing market problems should act as a drag on GDP growth in 2008. With weakening consumer spending, which constitutes two-thirds of GDP, Wachovia Bank economists estimate U.S. GDP growth will be 2.2% in 2007 when final figures are tallied, and 2.0% in 2008. We concur with these estimates. The long-term average growth rate for real GDP is approximately 3% per annum.

What does a 2.2% GDP growth rate mean for job creation? Job growth was a healthy 1.8 million jobs in 2007 on an average annual basis, but the rate of growth was only 1.3 million jobs for the 12 months ending in December. We expect that range for job creation in 2008 – approximately 1.2 million to 1.5 million new payroll jobs.

In our view, this level of job creation will not generate enough jobs to sustain office absorption levels consistent with current construction activity in most metro markets – including Washington. With markets therefore favoring tenants, in the meantime, we recommend an aggressive leasing posture and a selective development outlook.

5. 40% Chance of a Recession in 2008; What Relevance to Recession-Resistant Washington?

As the calendar turned to 2008, the consensus of economists seemed to be that there was a 40% chance of a recession in 2008. Most economists define “recession” as two consecutive quarters of negative growth in GDP. A Business Week poll reports that 69% of adults think a recession in 2008 is likely, yet in its survey of economists, only two of 54 respondents believed a U.S. recession would occur this year.

At the same time, Global Insight, an economic forecasting firm, puts the chance of a recession this year at 40%. We concur.

And the leading economic indicators index showed a modest decline during 2007, suggesting slow growth in 2008.

Something to keep in mind: the overall U.S. economic performance can obscure the conditions in certain regions of the country, or even certain states and cities. Even if the U.S. as a whole avoids recession in 2008, some states with slow-growth or no-growth industries – like Michigan and its auto industry, for example – may feel recessionary pain. Conversely, even if the U.S. does fall into recession this year, the Washington region is almost certain to avoid one, with gross regional product rising at nearly 3%.

In our view, the U.S. will avoid a recession. And more to the point, Washington will remain recession-resistant.

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Regional Economic Trends

Three trends stood out in the regional economy in 2007, as discussed below.

1. Reduced Federal Procurement Activity

The annual change in Federal procurement spending within the Washington metro area has reverted to modest growth rates. After experiencing an unprecedented spike in procurement spending from 2002 through 2004 – the aftermath of 9/11 – the annual change in spending has inched up from $1 billion in 2005 to an estimated $1.4 billion in 2007.

The Federal government is the number one core industry in the region. And procurement spending is the number one driver of Federal economic activity. As such, a slow down in this activity does not bode well for the regional economy. And the slow down in this activity in fact led to a slow down in job growth in the region.

In our view there will not be a resumption of procurement spending growth in this decade to the levels seen earlier in this economic cycle. That means we should be prepared for a more modest rate of job growth in the region.

Leading Economic Indicators Index

*12-month percentage change through November 2007 Source: Bureau of Labor Statistics, Delta Associates; January 2008

Annual Change in Federal Procurement SpendingWashington Metro Area

*Estimate Source: GMU Center for Regional Analysis, Delta Associates; January 2008

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2. Slowing Job Growth

The easing of procurement spending growth has affected metro area job creation, as $1 billion in additional Federal contract spending creates roughly 7,000 new jobs. Since 2004, annual employment growth in the Washington metro area has edged down each year. In the 12 months ending November 2007, job growth fell below the 15-year average of 45,000 jobs per annum.

Regardless, the Washington metro area experienced a 1.4% rate of job growth over the past 12 months, compared to 1.1% nationally.

With slower job growth should come a reduced development pipeline, but that has not happened.

3. Vulnerability to U.S. Economic Cycle

The Federal government helps to buffer the Washington metro area from national economic cooling, given the vast number of Federal agencies located in the metro area. Despite this buffer, the metro area is vulnerable to national economic cycles. As national GDP growth wanes, Washington metro GRP growth follows suit, in part due to the greater diversity of the regional core industries, compared to 30 years ago. Regardless, the Washington metro area consistently outperforms the growth of the nation by an average of 170 basis points.

Regional Real Estate Trends

So, how did the region’s real estate perform in 2007? And what might it mean for 2008?

At year-end 2007, the product types in the Washington metro area were at different positions in the real estate cycle. Two product types, retail and

flex/industrial, continue their ascent in the expansion phase, while multifamily and office product are making their way through the contraction phase of the cycle.

1. Retail and Flex/Industrial Markets

Despite a cooling economy, the retail and flex/industrial markets continue to expand, as vacancy declined, rents rose, and the pipeline was controlled during 2007. The flex/industrial market is further along in the expansion phase

Payroll Job Growth Washington Metro Area | 1981 - November 2007

GDP and GRP Growth U.S. vs. Washington Metro Area | 2000 - 2007

*12 months ending in November 2007 Note: Data restated since 2000 consistent with redefinition of metro area in March 2005 Source: Bureau of Labor Statistics, Delta Associates; January 2008

Source: Global Insight, GMU Center for Regional Analysis, Delta Associates; January 2008

compared to retail. The flex/industrial market has the potential to enter the contraction phase over the next 12 months, as we project new supply will outpace demand in 2008. Retail remains robust, with ample room for expansion, given the limited amount of retail space in this underserved metro area.

2. Office and Apartment Markets

Although among the best markets in the nation, the office and apartment

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product types have made their way into the contraction phase of the market cycle. These product types experienced rising vacancy, softer absorption than the long-term average, restrained rent growth, and an engorged pipeline in 2007.

3. Condominium Market

The Washington metro area condo market is at the tail-end of the contraction phase. This product type is now self-correcting, as developers have either cancelled or reverted projects to apartments given current market conditions. This action helped to reduce the pipeline and stabilize prices in the second half of 2007.

4. Investment Sales

Investors continued to funnel record amounts of capital to Washington metro area assets in 2007, most notably to office and multifamily product. The metro area experienced record investment sales volume from 2005 to 2007 for all product types listed in the adjacent graph, as each year outperformed the 10-year annual average of $8.6 billion.

Washington area cap rates declined slightly in 2007 for each product type listed in the following graph. However, cap rates in use at year-end for shopping purposes were above the rates in use a year earlier. This is a result of the August Credit Crunch.

Commercial Real Estate Market PositionWashington Metro Area | Year-End 2007

Source: Delta Associates; January 2008

Average Cap RatesWashington Metro Area | 2002 - 2007

Source: Real Capital Analytics, Delta Associates; January 2008

Investment SalesWashington Metro Area | 1999 - 2007

Note: Whole-company and portfolio sales are excluded

Source: Real Capital Analytics, CoStar COMPS, Delta Associates; January 2008

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Three Key Factors to Watch in 2008

1. The Economy: Job Growth and Consumer Sentimentn They have the potential to drive the recovery of the housing market. Job

growth has been healthy but decelerating, while consumer sentiment has been declining rapidly. Both need to stabilize to support a housing market rebound.

n Will they fuel office demand? With job creation the most closely linked indicator to office demand, a more optimistic outlook by the business community is essential for demand to remain near our region’s long-term average absorption of 8.1 million SF per year.

2. Supply Trends: Developer Disciplinen Groundbreakings have ebbed – good news for supply/demand

fundamentals going forward.n The future of rental rates depends on how well inventory remains under

control.

3. Capital Flows: The Credit Crunch Effectn All assets are being re-priced. How will real estate compare with stocks?n Deal volume will determine cap rates, and prices will be driven by

performance. With the Credit Crunch forcing highly-leveraged buyers from the market, how aggressive will the remaining bidders be?

Focus on Operating Performance and Re-Positioning

Focus on improving the performance of what you own. Or buy to reposition.

An example of re-positioning in the current cycle is Vornado’s approach in Crystal City. When it became clear that the Patent and Trademark Office was leaving for Alexandria, and that the Pentagon’s BRAC plan was going to force other tenants out as well, Vornado turned its focus to rehabilitating Crystal City’s image. It invested in the streetscapes and brought a renewed sense of life to the neighborhood through restaurants, entertainment, and retail. It also began to consider alternative uses for existing assets, such as residential options for some of the older office stock.

Another example of re-positioning and improving operating performance, while accessing underutilized FAR: the height additions to the K Street office inventory. Owners along that major corridor are taking full advantage of FARs to maximize their return on investment.

And still others are buying tired Class B apartments and neighborhood shopping centers and upgrading them with improved rental results.

The Path Forward: Creating Opportunities

If these are the trends of 2007 and the signposts of 2008, what is the path forward?

We see two major avenues to success:

n Focus on performance enhancement.

n Invest and develop in niches.

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Development and Investment Niches:Brains Will Beat Brawn

On the development and investment side of the business, it is a tricky time. But there are opportunities even as the overall pipeline in some product types is engorged.

Cash Is King. After the Credit Crunch, the highly-leveraged buyers found that their financing was too expensive or simply dried up, and they largely withdrew from the market. There is still competition bidding for superior assets, but the buyers are those with cash to spend. And development margins are thin enough that cash will be rewarded over those with a heavy debt burden.

Be a Niche Player. Success in 2008 will come to those who have the market knowledge and skill to ferret out deals that will outperform market-wide averages. Keep in mind that niche players come in three varieties: those who work in geographic areas, those who focus on specific product types, and those who find the narrow intersection between those two worlds.

Geographic Plays. Examples of this niche include development and investment:

n Near transit infrastructure, especially Metro. As traffic congestion gets worse and the remedies remain long-term (such as HOT lanes on the Beltway, and the ICC), sites proximate to Metro remain highly desirable.

n Close to jobs, such as inside the Beltway, where employment prospects remain strongest. There are sound opportunities outside the Beltway, but they are harder to find and come with greater risk.

n In submarkets with better supply/demand fundamentals. While office construction in the District remains high, the vacancy rate remains low enough that rent growth should continue throughout 2008 and perhaps beyond. On the residential side, new condominiums in the District continue to experience rising prices, despite sluggishness elsewhere.

Product Type Plays. Examples of this niche include development and investment in:

n Mixed-use communities with access to everyday necessities and amenities, such as groceries, banking, and entertainment. With rising traffic congestion in the metro area, residents increasingly desire a community with work/play convenience.

n Infill areas, which will become paramount in the coveted core submarkets, as existing buildings age past usefulness and people continue to seek out urban communities for homes and offices.

n Environmentally friendly buildings with LEED certification, which are becoming a trend in the metro area. We expect this trend to continue, with government regulation and demand from tenants.

n Industrial submarkets near ports, airports and interstate highways. These nodes are favored, as product distribution to the metro area remains high, backed by a robust retail market.

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n Demographically-supported product, such as senior/student housing and medical offices. With 15 universities and colleges in the metro area, each with a growing student body, demand for student housing is on the rise. As the baby boomer demographic ages, demand is rising for senior housing and medical offices, as a greater population will be taking advantage of health care resources.

The Right Product in the Right Submarket. We believe development and investment opportunities continue to exist in the Washington metro area for all asset classes, as a handful of submarkets are ripe for development due to superior supply/demand fundamentals.

For example, the following submarkets are ready for multifamily and office development due to low vacancy, rising rents, and limited pipeline:

n Bethesda/Chevy Chase n Rosslyn-Ballston Corridorn Tysons Corner

The Bethesda/Chevy Chase and Rosslyn-Ballston Corridor submarkets are popular close-in submarkets that offer multiple Metro-served, 24/7 environments and access to retail. The future expansion of Metro to Tysons Corner will position Tysons as a favored location. These submarkets do have drawbacks, but on the whole they are still ripe for well-considered development projects.

Although not established as a submarket yet, the Capitol Riverfront (a.k.a. The Ballpark District) will be a notable competitor for multifamily and office in the near-term as entertainment and commercial development transforms this submarket into a 24/7 destination.

We hope the information in the rest of this report aids you in making the best possible decisions to meet your particular business objectives. Best wishes for success in 2008 and beyond.

THE

NATIONAL ECONOMY

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THE NATIONAL ECONOMY

Economy Remains Sturdy Enough to Avoid Recession

U.S. economic growth slowed in late 2007, as the Credit Crunch resulted in layoffs and retarded improvement in what had been a stabilizing housing market. As 2008 begins, nearly half of polled economists believe the nation is headed into a recession in 2008. We are not among them, but 2008 will be a slow-growth year. So slow it may feel like a recession. To us, numerous positive indicators suggest the expansion will continue, at least at a modest pace:

n The employment picture remains healthy, with 1.8 million net new payroll jobs added in 2007. However, the growth rate slowed dramatically late in the year.

n Inflation remains under control, yet it increased late in 2007.n Corporate profits remain healthy, although the number of industries under

profit pressure has increased.n GDP growth was a healthy 4.9% on an annualized basis through the 3rd quarter,

although we know this rate cannot last.n A weak U.S. dollar, while inconvenient for the American traveler abroad, has

fostered exports and related jobs. And for the commercial real estate industry, it has encouraged foreign buyers to step into the breach left by leveraged domestics in the wake of the Credit Crunch.

n Interest rates remain low – both long-term as well as short-term rates. This bodes well for the economy as a whole as well as our real estate industry in particular.

By contrast, however, numerous negative indicators suggest caution for 2008:

n The credit market is tight, with lenders strengthening loan requirements and some forms of debt simply not available. A near-term rebound in the housing market is less likely.

n Consumer confidence is at a 26-month low – and the second lowest since the early 1990s. A spooked stock market is not helping. And with our economy 70% driven by the consumer, this does not bode well for GDP growth in 2008.

n Oil prices remain high, squeezing consumers on gasoline and home heating costs.

n The leading economic indicators index is at its two-year nadir. This also suggests 2008 will see tepid growth.

THE

NATIONALECONOMY

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While the national economy is fragile, on balance we see more positive than negative. Specifically, we expect the economy to perform as follows in 2008:

n GDP growth: 2.0% to 2.3%.n Payroll job growth: 1.2-1.5 million.n Monetary policy: Accommodating.n The housing market: Gradual

stabilization leading to traction by 2009.

Although Washington is often described as recession-resistant, the slowing national economy plays a role in Washington’s performance through its influence on interest rates, capital flows, and pricing/cap rates. Thus, our review of the real estate market begins with the national economy.

Construction costs remain a problem for developers, as many new projects are unlikely to achieve the rents needed to generate an adequate return on cost. Developers have been trying to push rents to make pro formas work, but considerable new supply in the office and apartment pipelines have made that harder to do for properties in more congested sub-markets. Compounded with credit problems, we expect some projects to be shelved for now.

Oil prices hit $100 per barrel in November and again in the earliest days of 2008. (The average price for 2007 was $72.34 per barrel.) Prices have tripled since 2003. The consensus of energy industry analysts is that OPEC would like to see the price settle between $70-80 per barrel.

Gasoline prices were on the rise again early in 2008. In early January, the national average for regular-grade gasoline was $3.11/gallon.

Inflation and Interest Rates. Inflation rose toward the end of 2007. Prices were up 4.3% during the 12 months

Oil Prices

*Price as of December 31, 2007 Note: 12 month averages of WTI NYMEX prices Source: GASearch; January 2008

U.S. Gasoline Prices

Note: Prices are for regular-grade gasoline as of year-end Source: Department of Energy; January 2008

U.S. Inflation

* 12-month percentage change through November 2007 Source: Bureau of Labor Statistics; January 2008

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ending in November after rising 2.5% during 2006. The Fed’s strategy from 2003-06 of raising short-term interest rates kept inflation for core goods and services under control. With inflation still fairly low and increased volatility in the financial markets, the Fed cut the Federal Funds Rate by 50 basis points to 4.75% on September 18, then another 25 points to 4.50% on October 31, then another 25 points to 4.25% on December 11.

Job growth is moderating as credit is tightening, leading to the rate cuts. The reductions in the Federal Funds Rate should benefit consumers, investors, and homebuyers, although consumers’ perception of a slowing economy is likely to offset some of the benefit derived from a looser monetary policy.

Housing. Although U.S. housing is better described as hundreds of local markets rather than a single national market, the overall housing market had appeared to be stabilizing in the Summer – until the August Credit Crunch. Existing homes sold at an annualized volume of 5.0 million units through November 2007. This figure declined throughout 2007, and the decline was exacerbated by the disruptions in the credit market.

On the bright side, mortgage rates have been declining lately – to 5.87% for a fixed-rate 30-year mortgage. While many potential buyers are taking more time to make a decision than they were earlier in this cycle, prices have not declined substantially in most major markets, particularly those with barriers to new construction and significant job growth.

Credit. The August 2007 Credit Crunch has yet to work its way through the housing market. However, the December agreement between the White House and the nation’s largest lenders should offer some relief for

Federal Funds Rate

Source: Federal Reserve Board; January 2008

U.S. Existing Home Sales

Note: Through November 2007; annualized Source: National Association of Realtors; January 2008

Annual Change in Existing Home Sale Prices

* 12-month percentage change through Q3 2007 Source: National Association of Realtors; January 2008

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subprime borrowers who face sharp increases in their adjustable interest rates. We expect improving conditions for the housing market in 2009.

Nationally, according to the National Association of Realtors (NAR), the average price of a home that sold during the 3rd quarter of 2007 declined 2.0% compared to a year earlier. Among major metros, price changes ranged from -7.1% (Las Vegas) to +8.6% (San Francisco/Oakland) during the 12 months ending in September. Las Vegas prices had risen to unsustainable levels (with 48.7% growth in 2004 and 14.4% growth in 2005), and were almost certain to decline. By contrast, job growth in the SF Bay Area has been stronger this year, generating demand for housing.

Business spending on equipment and software continues to increase. Spending in this category was $988.7 billion in 2006, and was $1.019 trillion for the first nine months of 2007 on an annualized basis. As a result, professional services companies are hiring at a steady pace to fulfill demand, keeping the unemployment rate at or below 5%.

Manufacturing. Production in the Manufacturing sector slowed in late 2007. The Purchasing Managers’ Index was at 47.7 in December 2007, compared to 51.4 at the end of 2006. (A rating under 50 indicates sector contraction.) Even when the manufacturing sector expands, it has been shedding jobs due to productivity gains. This sector lost 212,000 jobs during the 12 months ending in December 2007.

Payroll jobs rose by 1.8 million in 2007 on an average annual basis, compared to an increase of 2.5 million during 2006. The pace of job creation eased in the second half of 2007. The growth of well-paying jobs remains solid, however: over the 12 months ending

Capital Investment in Equipment and Software

*Through Q3 2007, annualized Note: Figures are seasonally adjusted Source: Bureau of Economic Analysis; January 2008

Purchasing Managers’ Index

Note: Through December 2007 Source: Institute for Supply Management; January 2008

U.S. Payroll Jobs

Source: Bureau of Labor Statistics; January 2008

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in December, the Professional/Business Services sector accounted for 24% of new jobs. Even though some service fields are experiencing slower growth, the well-educated service workforce is exerting growing dominance over manufacturing in terms of job creation.

The U.S. unemployment rate is 5.0% as of December 2007, comparable to a decade ago. The unemployment rate has been at or below 5% since November 2005. However, it was on the rise late in the year, contributing to recession fears and a decline in consumer confidence.

The trade deficit pulled back a bit in 2007, as the cheap dollar made U.S. exports more attractive to foreign consumers. The deficit was $704 billion in the first ten months of 2007 on an annualized basis. The federal budget deficit contracted in 2006, but spending still exceeded revenues (2007 data was not available as of this writing). The Congressional Budget Office (CBO) estimates the 2006 budget deficit was $248 billion; the wars in Iraq and Afghanistan, as well as homeland security efforts, are driving massive government spending. The CBO currently projects that the budget will return to surplus territory in FY 2012, but that assumes no recession before then and no major additional spending beyond what is currently planned. The CBO’s estimated U.S. budget deficit for 2007 was $158 billion.

U.S. Trade Deficit

* Through October 2007; annualized Source: U.S. Census Bureau, Bureau of Economic Analysis; January 2008

Federal Budget Deficit

* Projected by the Congressional Budget Office Source: Office of Management and Budget, Congressional Budget Office; January 2008

U.S. Unemployment Rate

Note: Through December 2007; seasonally adjusted; shaded bars represent recessions Source: Bureau of Labor Statistics; January 2008

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Dow Jones Industrial Average

Note: Through December 2007 Source: Dow Jones, Yahoo! Finance; January 2008

Stock Market. After a strong September and October, the Dow Jones Industrial Average has slid since, closing the volatile year at 13,265, up 802 points, or 6.4%, but down from its Autumn peak. Problems in the credit markets largely were responsible for the tumult. Additional rate cuts from the Fed in early 2008 may stabilize the Dow, but most observers feel the bull market is over for a while.

Consumer sentiment declined precipitously during 2007. The high price of oil, modestly declining home prices, and the roiled financial markets took a toll on consumer confidence. The University of Michigan’s monthly index of consumer sentiment registered 75.5 in December 2007. This is the lowest level since October 2005 and the second-lowest since the early 1990s. Consumer expectations have declined in part due to expectations of higher inflation, a likely result of the Fed’s rate cuts. In line with weakened consumer expectations, the holiday shopping season was sluggish, with just 1.7% growth compared to 2006, the lowest rate of growth since 2002.

The leading economic indicators index edged down in November, to 136.3. The index is now at its lowest point since March 2005. The index declined modestly through most of 2007, suggesting that the national economic expansion will continue – but will be sluggish – in 2008. We are seeing evidence of that: a healthy but decelerating job growth rate along with a variable (but still up for 2007) Dow.

Consumer Sentiment

Source: University of Michigan, Federal Reserve Bank of St. Louis; January 2008

Leading Economic Indicators Index

Note: Through November 2007. 1996 = 100 Source: The Conference Board; January 2008

30


Economic Outlook

We expect the U.S. economy will expand over the next 12 months, although at a very modest rate. Decelerating job growth and credit market uncertainty should act as a drag on GDP growth. The policies of the Federal Reserve should keep inflation under control, though it is likely to accelerate modestly.

Real GDP growth (on an annualized basis) was 4.9% in 3rd quarter 2007, according to the Bureau of Economic Analysis, after a 3.8% annualized rate in 2nd quarter 2007. The 3rd quarter rate was revised upward from BEA’s preliminary estimate of 3.9%. Despite the improvement, Wachovia Bank economists estimate U.S. GDP growth will be 2.2% in 2007 when final figures are tallied, and 2.0% in 2008. We concur with this estimate, given the credit market problems, recent job growth trends, and the unstable situation in the Middle East. We believe that 2009 will be a better year for the U.S. economy. The long-term average growth rate for real GDP is approximately 3% per annum.

The key factors affecting national economic performance in 2008 are likely to be oil prices, the credit market, and the housing market. As always, the possibility exists that a terrorist event could jolt economic progress.

National Payroll Job Growth Summary

U.S. payroll job growth remains healthy, adding 1.8 million positions in 2007 on an average annual basis. Those gains represent a growth rate of 1.3%. The pace of job growth slowed in 2007; in 2006, nearly 2.5 million net new payroll jobs were created, as shown below:

Job Change % Change

2007 1,800,000 1.3%

2006 2,478,000 1.9%

2005 2,273,000 1.7%

2004 1,433,000 1.1%

2003 -357,000 -0.3%

2002 -1,485,000 -1.1%

2001 40,000 0.0%

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Job Change Job Change

Metro Area # % Metro Area # %

New York 80,000 0.9% Denver-Boulder 24,000 1.7%

LA Basin Austin 22,500 3.0%

Riverside/San Bernardino/Ontario 39,600 3.1% Orlando 22,500 2.0%

Los Angeles/Long Beach/Glendale 30,400 0.7% Oklahoma City 21,400 3.7%

Orange County (Santa Ana/Anaheim/Irvine) (2,200) -0.1% St. Louis 20,800 1.5%

Subtotal LA Basin 67,800 1.0% Baltimore 16,300 1.2%

Dallas/Ft. Worth 63,500 2.2% Raleigh-Durham 16,200 2.1%

Houston 58,800 2.4% San Antonio 15,500 1.9%

Atlanta 52,500 2.2% Charlotte 15,400 1.8%

Seattle 44,400 2.6% New Orleans 15,200 3.1%

Chicago 42,800 0.9% Portland (OR) 14,600 1.4%

Washington, DC 40,400 1.3% San Diego 13,300 1.0%

Phoenix 32,000 1.6% Tampa-St. Pete 12,400 0.9%

San Francisco Bay Area Kansas City 11,400 1.1%

San Francisco/San Mateo/Redwood City 14,400 1.5% Indianapolis 10,200 1.1%

San Jose/Sunnyvale/Santa Clara 11,700 1.3% Las Vegas 10,100 1.1%

Oakland/Fremont/Hayward 3,700 0.3% Memphis 8,500 1.3%

Subtotal Bay Area 29,800 1.0% Jacksonville 7,600 1.2%

Philadelphia 28,800 1.0% Sacramento 5,600 0.6%

Salt Lake City 27,500 4.4% Minneapolis-St. Paul 4,700 0.3%

Boston (Metropolitan NECTA) 26,500 1.1% Nashville 4,300 0.6%

South Florida Pittsburgh 3,000 0.3%

Miami/Miami Beach/Kendall 11,900 1.1% Cincinnati 3,000 0.3%

West Palm Beach/Boca Raton 8,800 1.5% Columbus (OH) 2,700 0.3%

Fort Lauderdale 5,700 0.7% Cleveland 1,800 0.2%

Subtotal South Florida 26,400 1.1% Detroit (Detroit/Warren/Livonia) (33,300) -1.7%

12-Month Payroll Employment Change Through November 2007


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THE WASHINGTON AREA ECONOMY

As the Current Cycle Winds Down, Region Remains ResilientPrepared with the invaluable assistance of Dr. Stephen Fuller

Economic performance in the Washington metro area appears to have peaked in this cycle in 2004. In 2007, we can characterize the region’s economic performance as sturdy, as new jobs continue to be created and the metro area relishes a low unemployment rate. But job creation is now running at or slightly below the 15-year average of 45,000 per annum. Overall, the Washington area economy continues to expand, but at a slower pace than experienced in the past four years.

Year-End 2007 Economic Highlights

n Payroll Employment: 3.0 million at November 2007.n Job Growth: 40,400 during the 12 months ending November 2007, compared to 49,900 in 2006.n Unemployment Rate: 3.0% at November 2007, unchanged from one year ago.n Coincident Index: 119.5 at October 2007, down from 120.0 one year ago.n Leading Index: 108.3 at October 2007, down from 110.0 one year ago.n Inflation: prices increased 4.5% during the 12 months ending November 2007. n Housing Prices: declined 0.3% in the 12 months ending September 2007, compared to rising 6.3% in 2006.

Job Growth

With 3.0 million payroll employment jobs, the Washington metro area ranks the fourth largest job base among metro areas, behind New York, the LA Basin and Chicago.

Payroll employment increased 40,400 in the Washington metro area over the 12 months ending November 2007 – an average pace of about 3,400 jobs per month.

Compared to other metro areas, the Washington metro area is seventh for job growth – migrating to the middle of the pack, while other markets caught up.

THE

WASHINGTON AREAECONOMY

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The Washington metro area experienced a 1.4% rate of job growth over the past 12 months, compared to 1.1% nationally.

Northern Virginia created 54% of these jobs while Suburban Maryland created 24% and the District the balance.

The ascent of New York, LA, Dallas, and Houston as superior job creators to Washington is not unexpected in the mature part of the business cycle. They are either larger (New York and LA) or faster growing (Dallas and Houston). And their Core Industries serve them well during more robust periods of national economic conditions, compared to Washington’s Core Industries which serve it well during weaker periods of national economic performance.

Job Growth by Sector

The service-providing sector accounted for 95% of the job growth in the Washington metro area during the 12 months ending November 2007. The goods-producing sector accounted for the remaining 5%.

The top three sectors leading job growth in the metro area over the past 12 months are Professional and Business Services, Retail Trade, and Leisure and Hospitality.

The Professional and Business Services sector gained 18,900 jobs during the last 12 months, just above the 15-year average of 18,800.

The Retail Trade sector gained 5,400 new jobs in the past 12 months, well ahead of the 15-year average, as consumers have a high level of disposable income in the metro area.

The Leisure and Hospitality sector gained 4,600 new jobs in the previous 12 months, 7.0% above the 15-year average of 4,300.

Payroll Job Growth Washington Metro Area | 1981 Through November 2007

Payroll Job Growth Large Metro Areas | 12 Months Ending November 2007

Trends in Employment by Major SectorWashington MSA (In 000’s of Payroll Jobs)


Nov. 2006 Nov. 2007 12-Mo. Growth 15-Yr. Avg.

Prof./Bus. Svs. 673.2 692.1 18.9 18.8

Retail Trade 278.4 283.8 5.4 1.0

Leisure/Hosp. 248.6 253.2 4.6 4.3

Other 175.4 178.9 3.5 3.9

Government 648.6 650.8 2.2 3.7

Constr./Mining 192.8 195.0 2.2 3.3

Financial 161.6 163.8 2.2 1.5

Edu./Health 325.1 326.9 1.8 7.6

Whole. Trade 70.1 70.3 0.2 0.2

Transport/Util. 64.8 64.8 0.0 0.3

Manufacturing 63.0 62.8 -0.2 -0.6

Information 98.4 98.0 -0.4 1.0

Total 3000.0 3040.4 40.4 45.0

*12 months ending in November 2007 Note: Data restated since 2000 consistent with redefinition of metro area in March 2005 Source: Bureau of Labor Statistics, Delta Associates; January 2008


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Unemployment Rate

The Washington area unemployment rate was 3.0% at November 2007, unchanged from one year ago. Today’s unemployment rate is below the average unemployment rate of the 1990s, which was 3.9%.

The Washington metro area holds the lowest unemployment among large metro areas and compares favorably to the national rate of 4.7% in November 2007.

Coincident and Leading Indices

The Washington Coincident Index, which represents the current state of the metropolitan area economy, was 119.5 in October 2007 – which is 110 basis points below the 10-year average. The current index is slightly lower than 120.0 one year ago.

The Washington Leading Index, which forecasts area economic performance over the next 18 months, is 108.3 at October 2007, which is 210 basis points below the 10-year average. In addition, the current index is below 110.0 achieved one year ago, which suggests the regional economy will continue its cyclical cool-down.

Consumer Price Index

Overall inflation in the Washington/Baltimore region increased from 3.6% during the 12 months of 2006 to 4.5% during the 12 months ending November 2007. The sharp increase is attributed to rising prices in energy and transportation.

Unemployment RatesLarge Metro Areas | November 2006 vs. November 2007


Leading IndexWashington MSA | October 2006 - October 2007

Source: GMU Center for Regional Analysis; January 2008

Coincident IndexWashington MSA | October 2006 - October 2007


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Housing PricesHouse prices declined 0.3% in the Washington metro area during the 12 months ending September 2007 according to the Office of Federal Housing Enterprise Oversight (OFHEO). Although demand for housing has slowed, we expect demand to pick up pace in 2009. Increased demand and a decline in construction in 2008 will stabilize pricing, leading to an uptick in sales activity, with improvement in market conditions appearing in 2009.

Region’s Core IndustriesThe Washington area’s gross regional product (GRP) was $356.3 billion in 2006, an increase of 7.5% compared to 2005.

Approximately one-third of the GRP was generated by the Federal govern-ment – the region’s most important Core Industry. A Core Industry is one that imports capital and exports a good or service. Total Federal spending in the Washington metro area was up in 2006 to $116.5 billion, a 4.0% increase from 2005.

Federal procurement increased by 4.0% in 2006, after increasing by only 2.5% in 2005. Although procurement spending in the metro area remains solid, spending growth has eased significantly, after growing by 19.0% in 2004 and 16.9% in 2003. As procure-ment spending growth eases, so does job growth, given that roughly 7,000 new jobs are created per $1 billion in additional Federal contract spending (graph on following page).

Percent Change in House PricesWashington MSA | 2000 - 2007

Note: 2005 figures are actuals; 2006 figures are estimates. Procurement figures do not include US Postal Service and FAA purchases Source: Dr. Stephen Fuller, Delta Associates; January 2008

2005 2006

$ %GRP $ %GRP

GRP in Billions

Total Federal $s $112.0 33.8% $116.5 32.7%

Portion Procurement $52.4 15.8% $54.5 15.3%

Technology $51.2 15.4% $54.3 15.2%

Building Industry $20.3 6.1% $21.4 6.0%

Int’l Business $17.3 5.2% $17.8 5.0%

Hospitality $7.2 2.2% $7.4 2.1%

Other $123.5 37.3% $138.9 39.0%

Total GRP $331.5 100.0% $356.3 100.0%

Core Sectors of the EconomyWashington Metro Area

Consumer Price Index (CPI)Washington/Baltimore Region | 1998 - 2007

*12 months ending in November 2007 Source: US Commerce Department, Delta Associates; January 2008

*12 months ending in September 2007 Source: Office of Federal Housing Enterprise Oversight; January 2008

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Baby Boomers’ Impact on the Job Market

Baby Boomers, born between 1946 and 1964, are currently 43 to 62 years of age. This cohort currently makes up almost half of the workforce in the Washington metro area. As this segment of the population ages closer to retirement, its participation in the labor force is expected to decline.

The U.S. population in 2012 will have more people in the age 55 to 65 bracket and fewer in the 35 to 45 bracket, according to the Census Bureau. According to the Council of Economic Advisors, this decline will lead to a shortage of experienced workers and wages are likely to be under pressure – adding to inflation.

In a metro area already with a chronically low unemployment rate, how will Washington fare during this period?

Funding Tourism

National Harbor is expected to open the Gaylord Convention Center, the first phase of its $2 billion mixed-use project, to attendees in the Spring of 2008. As the mixed-use development progresses – with all the bells and whistles to make it a destination spot – other locales in the metro area might feel the pinch.

The City of Alexandria recently approved $1.3 million in funds for promoting tourism. Alexandria, located directly across the river from National Harbor, is devising a marketing plan that will attract visitors from National Harbor. According to the Washington Business Journal, the marketing campaign will include brochures, videos and ad placement. In addition, other upgrades will be made, including a trolley service that runs on King Street.

The District, with a new convention center, might lose some business to National Harbor, as convention attendance is projected to flatten or decline over the next few years, according to the Washington Business Journal. Tourism officials are prepared to ask the city for $10 million per year through 2011, which will fund a new marketing campaign.

Foreclosures Impact County Budgets

The Credit Crunch has transformed into an increase in foreclosures throughout the nation. Although faring better than most metro areas, foreclosures were up to 79 for every 10,000 Washington area households at the 3rd quarter, up from 11 one year ago, according to the Center for Regional Analysis.

As the housing market ebbs from its peak performance of a few years ago, local county officials are seeing the impact on county budgets, as several counties have relied on the real estate tax to add significant revenue to their bottom line.

Rate of ForeclosuresWashington Metro Area | November 30, 2007


Jurisdiction Foreclosures/10,000 Units

Prince William 262

Loudoun 219

Prince George’s 127

Montgomery 53

Fairfax 34

Alexandria 34

Arlington 27

District 22

Federal Procurement SpendingWashington Metro Area

Source: Dr. Stephen Fuller, Delta Associates; January 2008

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For example, Fairfax County projects a shortfall of roughly $220 million, Montgomery County projects a $61 million loss, and Prince William County estimates a $51 million shortfall, according to the Washington Business Journal. The District’s transfer and recordation revenue is projected to decline to $309 million in 2009, from $330 in 2006. Prince George’s County projects a decline to $165.9 million in 2009, from $221.8 million in 2007.

Although county budgets will feel the pinch of the housing slowdown in the near-term, we expect conditions to firm faster in the Washington area than in other metro areas. We expect that consistent demand and a decline in construction will stabilize pricing and market conditions by 2009.

Washington Area Outlook

We expect the Washington metro area economy to progress in 2008 at a modest pace. Although growth has slowed compared to the past four years, we predict conditions will remain sturdy during the next two years.

The Professional and Business Services sector should continue to lead job growth, as government contractors and law firms spur growth in this sector. If the 2008 election favors Democrats, procurement spending could shift from Northern Virginia’s defense contractors to Suburban Maryland’s health contractors.

In consultation with Dr. Stephen Fuller of George Mason University, we project that 43,400 new payroll jobs will have been created in the Washington area in 2007, once the numbers are finalized in March. Job growth will edge down in 2008 to 37,600 and rise to 39,000 in 2009.

Payroll Job GrowthWashington Metro Area | 1999 - 2009

Note: Data restated since 2000 consistent with redefinition of metro area in March 2005 Source: Dr. Stephen Fuller, Delta Associates; January 2008

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THE WASHINGTON AREA OFFICE MARKET

Ranking Well Nationally; Office Market Cools as Capital Continues to Flow at Record Levels Although the region is in a cool-down, it continues to rank among the strongest office markets in the nation. The metro area ranked 5th in lowest overall vacancy and 2nd in absorption among metros at year-end.

THE

WASHINGTON AREAOFFICE MARKET

Office Vacancy RatesSelected Metro Areas | Year-End 2007

Net Absorption of Office SpaceSelected Metro Areas | 2007

Source (for both): CoStar, Delta Associates; January 2008

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The Washington metro area office market continued its cool down from its peak in 2004 – absorption edged down to 5.4 million SF while vacancy ticked up to 9.1%. Rents on average moved up 2.2% metro wide.

Net Absorption: Resilient But Below Average

Net absorption of office space totaled 5.4 million SF in 2007, compared to 6.8 million SF in 2006 and the long-term average of 8.1 million SF per annum.

Northern Virginia experienced higher absorption levels compared to the District and Suburban Maryland due to several pre-leased deliveries and stronger gross leasing activity during 2007. However, each substate area remains below its long-term absorption average.

Sublease space increased by 472,000 SF in 2007, compared to a decrease of 526,000 SF in 2006. Sublease space currently represents just 1.1% of standing inventory.

Net absorption of Class A space totaled 4.8 million SF, which accounts for 89% of the total absorption for all class types. In 2006, Class A absorption totaled 7.8 million SF.

2007 Market Highlights

n Net absorption: 5.4 million SF, compared to 6.8 million SF in 2006 and a long-term average of 8.1 million SF.

n Overall vacancy rate: 9.1%, up from 8.5% one year ago. n Direct vacancy rate: 8.0%, up from 7.5% one year ago. n Pipeline (U/C and U/R): 20.6 million SF, up from 16.8 million SF a year ago. n Pipeline pre-lease rate: 28%, compared to 35% a year ago.n Rents: Increased 2.2%. n Investment sales: $13.7 billion, inclusive of two portfolio sales and two com-

pany sales, compared to $13.8 billion in 2006. Average sale price: $369/SF.

Net Absorption of Office SpaceWashington Metro Area | 2007


Net Absorption of Office SpaceWashington Metro Area | 1980 - 2007


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Office Leasing Activity by SectorWashington Metro Area | 2003 - 2007

* Legal, Financial, Business Services ** Preliminary figure subject to re-benchmarking in Q1 2009 Source: CoStar, Delta Associates; January 2008

Gross Leasing ActivityWashington Metro Area | 2000 - 2007

* Preliminary figure subject to re-benchmarking in Q1 2009 Note: Data updated each quarter Source: CoStar, Delta Associates; January 2008

Gross Leasing: Below Average

Gross leasing activity totaled 28.0 million SF during 2007. Northern Virginia captured 46% of the lease deals inked during the year in the Washington metro area. The District accounted for 32% and Suburban Maryland accounted for 22%.

For historical perspective, the accompanying chart reflects the distribution of activity by type of tenant from 2003-2007.

There are 797 buildings with contiguous blocks of available space that are 10,000 SF or greater, compared to 769 available blocks one year ago. 49% of the total blocks are located in Northern Virginia.

The largest block of available space is 1.4 million SF at Constitution Center, the former Department of Transportation headquarters. This space is currently under renovation and is expected to deliver by Spring 2010.

Net Absorption of Office Space and Change in Sublease Space2006 vs. 2007 (000s of SF)


Direct Space Net Absorption

Sublease Space Absorbed or Returned

2006 2007 2006 2007

Market

NOVA 3,875 3,155 450 (260)

Sub MD 240 920 (55) (194)

District 2,695 1,296 131 (18)

Total 6,810 5,371 526 (472)

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Source: CoStar, Delta Associates; January 2008

December 2006 December 2007

Vacancy Rate

Direct 7.5% 8.0%

Sublet 1.0% 1.1%

Vacant Space (Millions of SF)

Direct 27.0 29.9

Sublet 3.7 4.2

Vacancy Rates and Vacant Space (All Classes) Washington Metro Area | December 2006 vs. December 2007

Buildings with Contiguous Blocks of Available SpaceWashington Metro Area | December 2007

Note: Includes buildings under construction or renovation Source: Delta Associates’ analysis of CoStar data; January 2008

Direct Office Vacancy RateWashington Metro Area | 1980 - 2007


The chart at left depicts the breakdown of contiguous available space by block size.

Vacancy Rate: Edged Up Over the Year

The Washington area’s overall vacancy rate was 9.1% at year-end 2007, up from 8.5% one year ago.

The Washington metro area direct vacancy rate was 8.0% at December 2007, up from 7.5% one year ago.

The sublease vacancy rate increased 10 basis points in 2007, compared to declining 20 basis points in 2006.

The Washington area overall Class A vacancy rate was 10.1% at year-end 2007, up from 8.6% one year ago. The Washington area direct Class A vacancy rate is 8.7% at December 2007.

Construction: Up in 2007

There is 20.6 million SF of office space under construction or renovation in the Washington metro area at December 2007, up from 16.8 million SF one year ago.

With high construction and operating costs, coupled with easing demand and increased credit difficulty, we expect construction levels to ease in 2008.

28% of the space under construction is pre-leased at December 2007, down from 35% a year ago.

Since 2004 pre-lease rates on recent deliveries in the Washington metro area have declined. Projects set to deliver during 2008 and 2009/2010 are 23% and 34% pre-leased, respectively. These pre-lease rates are subpar, given the 10-year average pre-lease rate is 55%.

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Office Space Under Construction Washington Metro Area (Millions of SF)

Substate Area December 2005 December 2006 December 2007

NOVA 8.2 9.5 8.0

Sub MD 1.7 2.7 3.3

District 7.8 4.6 9.3

Total 17.7 16.8 20.6

Construction StartsWashington Metro Area | 2004 - 2007

Source (All charts on this page): CoStar, Delta Associates; January 2008

Leasing on Recent Deliveries and Projects U/C or U/RWashington Metro Area | 2004 - 2010

Note: Recent deliveries are based on % leased upon delivery

Construction began on 15.7 million SF in 2007, compared to 14.7 million SF in 2006.

Groundbreakings edged up in the metro area during 2007, primarily due to several renovation projects starting in the District. The most notable renovation project is 1.4 million SF at Constitution Center.

Approximately 9.9 million SF of office space, including renovations, delivered in the Washington metro area in 2007, compared to 13.4 million SF in 2006.

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Projects that delivered during 2007 came online at 36% pre-leased, compared to 2006 projects delivering at 59% leased.

Supply vs. Demand: Vacancy to Continue to Edge Up

We expect demand to remain healthy during 2008, but given the amount of space under construction, vacancy is very likely to rise over the next two years:

n From 9.1% today to approximately 11.3% by December 2009.

We expect vacancy to rise in each substate area, particularly in the District, as construction levels remain high relative to demand, as indicated in the following chart.

Office Space DeliveriesWashington Metro Area | 1980 - 2007

Note: Delivery totals include renovations Source: CoStar, Delta Associates; January 2008

Office Space Demand and DeliveriesWashington Metro Area | 24 Months Ending December 2009


However, we believe that the vacancy rate will be slightly greater outside the Beltway, as demand is lighter compared to inside the Beltway.

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n The overall vacancy rate inside the Beltway is projected to rise to 10.0% over the next 24 months, from 7.2% today.

n We expect overall vacancy to rise to 13.0% outside the Beltway by December 2009, from 11.5% today.

Rents: Rising

The average effective office rent increased 2.2% in the Washington metro area during 2007, compared to rising 2.7% in 2006.

n Rent growth was 3.8% for submarkets located inside the Beltway.

n But rents flattened to 0.4% growth for outside the Beltway submarkets.

n Better buildings in better submarkets outperformed these regional averages.

We anticipate rents will slow or stabilize inside the Beltway in 2008, as the spread above the Rent Equilibrium Zone in this submarket will be slight.

Rents may stall or edge down during 2008 outside the Beltway, as we project vacancy to rise 300 basis points above the top of the zone in this part of the metro area.

Investment Sales: Match Record Volume of 2006

2007 sales volume totaled $13.7 billion, compared to $13.8 billion in 2006. The 2007 sales volume included four significant transactions, the Starco and Columbia Equity Trust portfolio sales and the Equity Office Properties and Republic Property Trust company sales, which added $4.3 billion to the sales volume.

The 2006 total included three large transactions, the Mark Winkler portfolio sale and CarrAmerica and

Office Space Demand and DeliveriesWashington Metro Area | 24 Months Ending December 2009


Overall Vacancy Rate vs. Effective Rent ChangeWashington Metro Area | 1995 - 2007


Comparative Investment Sales VolumeOffice Buildings | 2000 - 2007

Source: CoStar, Real Capital Analytics, Delta Associates; January 2008

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Trizec company sales. These major transactions have been taking a larger share of the market. With changes in credit market conditions, we do not expect this trend to continue into 2008.

Sales prices averaged $369/SF in the Washington area for 2007 transactions, inclusive of company and portfolio sales. For all of 2006, sales prices averaged $319/SF.

The average cap rate for office assets in the Washington metro area is 6.1%, with the District achieving an average cap rate 5.4%. Cap rates are showing signs of increasing and we believe will continue this trend in 2008, due to shifts in:

n The cost of debtn Asset re-allocationsn Risk premium spreads

Investment Returns Are High But Below National Levels For the First Time in a Decade

Total returns (cash flow plus appreciation) realized in the Washington office market were 15.44% for the 12 months ending September 2007. This compares to the national rate of 22.78%, which continues to rise gradually.

National returns are ahead of Washington returns for the first time in a decade, as demand for Washington metro area assets skyrocketed over the past two years, causing property values to increase and returns to ease.

We expect the Washington area to remain among the premier investment markets in the nation in 2008, although returns from other markets are closing the gap as market fundamentals in those cities improve relative to Washington. Income returns should

Return vs. Pricing - Core Office AssetsWashington Metro Area | 1985 - 3rd Quarter 2007

Source: NCREIF, Delta Associates; January 2008

Metro Area 12-Month Total Return at 3rd Quarter 20071

Boston 45.34%

New York 40.43%

Houston 28.38%

Los Angeles 27.52%

San Francisco 25.72%

National Average 22.78%

Denver 19.27%

Phoenix 19.06%

Chicago 17.31%

Washington 15.44%

Wash. Suburbs 15.58%

Wash. CBD 15.22%

Atlanta 11.93%

Dallas 11.43%

1 NCREIF compiles return based on its members’ $108.2 billion office porfolios The index includes both current income and capital appreciation returnsSource: Delta Associates, based on data in NCREIF’s 3rd Quarter 2007 Real Estate Performance Report

NCREIF Return Index1

Office Properties

remain strong, but capital appreciation is likely to plateau with current pricing already at elevated levels.

Land Sales: Exceed 2006

We recorded seven notable land sales in the metro area, totaling $371 million in 2007, which exceeds the $342 million achieved in 2006.

With easing demand and shifting market conditions, land sales are likely to ease in 2008. Although transactions picked up in 2007, developers could hold these parcels for development in the next cycle.

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The Washington Area Office Market Outlook

The Washington metro area office market is healthy but cooling from its peak of 2004.

For 2008 we see demand below the long-term average, vacancy edging up, and rent growth modest.

Although demand should remain steady, we expect it will not be able to keep pace with the level of available space due to robust construction activity. Construction levels should ease over the 12 months, as rising construction costs and lackluster rent growth make new development harder to justify.

Regardless, the Washington area office market remains a top performing market in the nation even under softer conditions.

Market Outlook:

n Overall Vacancy: Expected to increase from 9.1% to 11.3% by December 2009. n Leasing Activity: Should remain healthy in 2008, but off pace compared to

prior years. n Construction: Each substate area should experience a decline in new

construction, with the exception of renovations. n Rents: Expected to stabilize in 2008. n Investment Sales: Activity should remain solid, but off the peak of the past

two years.

The key to success in this asset class in 2008 and beyond is to avoid debt, improve operations at existing assets, and select investment and development opportunities that have one or more of these characteristics:

n Transportation-favoredn Close-inn Tenant-drivenn Medical-relatedn In a submarket with a low pipelinen Low land cost basis

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THE

WASHINGTON/BALTIMOREFLEX/INDUSTRIAL MARKET

sect

ion

54

THE WASHINGTON/BALTIMORE FLEX/INDUSTRIAL MARKET

Strong Performance Characterizes This Asset Class

The Washington/Baltimore flex/industrial market turned in a strong performance in 2007. Net absorption was above-average, construction eased, and rents increased 2.8%. And prospects are good for continued sturdy performance in 2008.

2007 Market Highlights

n Net absorption: 6.6 million SF, compared to 4.3 million SF in 2006 and 5.4 million SF 10-year average.

n Overall vacancy rate: 9.5%, down from 9.8% one year ago. n Direct vacancy rate: 8.8%, down from 9.3% a year ago.n Under construction: 6.4 million SF, down from 10.1 million SF one year ago.n 24% of the space under construction is pre-leased, compared to 21% a year

ago.n Rents: Up an average of 2.8%.n Investment sales: $1.5 billion, compared to $1.9 billion in 2006. Average sales

price: $80/SF.

THE

WASHINGTON/ BALTIMOREFLEX/INDUSTRIAL MARKET

Largest U.S. Flex/Industrial MarketsYear-End 2007


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National Context

The Washington/Baltimore flex/industrial market, at 334 million SF, is a mid-scale market where the primary function is regional distribution and accommodation of R&D and low-cost office uses. With the exception of some older product in the Baltimore area, there is little manufacturing in this region.

As shown in the accompanying graph, the Washington/Baltimore region’s overall vacancy rate, at 9.5%, is just above the national average of 8.4%.

Net Absorption: Strong

Flex/industrial net absorption totaled 6.6 million SF in the Washington/Baltimore region during 2007, compared to 4.3 million SF during 2006. The 2007 absorption level exceeded the 10-year annual absorption average of 5.4 million SF per annum.

The 2007 absorption total was boosted by pre-leased deliveries and healthy gross leasing activity.

Sublease space increased by 481,000 SF during 2007, compared to increasing by 158,000 SF in all of 2006. Sublease space represents only 0.7% of the standing inventory – not material enough to impact rents.

Flex/warehouse and bulk warehouse space accounted for the majority of the region’s total net absorption during 2007. Although assisted by pre-leased deliveries, healthy leasing activity played a notable role as well in boosting absorption for these property types.

Net absorption of newer space (built after 1987) totaled 6.2 million SF during 2007, compared to 5.1 million SF during 2006. For newer space, the Washington metro area absorbed 3.0 million SF and the Baltimore metro area absorbed 3.2 million SF.

Location of Flex/Industrial Inventory and AbsorptionWashington/Baltimore Region | 2007


Inventory at 12/2007(Millions of SF)

Net Absorption (000s of SF)

Direct Space Including Sublet

Metro SF % SF % SF %

Washington 169.3 51% 3,396 51% 3,315 54%

Baltimore 164.9 49% 3,236 49% 2,836 46%

Total 334.2 100% 6,632 100% 6,151 100%

Flex/Industrial Vacancy RatesSelect Metro Areas | Year-End 2007


Flex/Industrial Net AbsorptionWashington/Baltimore Region | 1997 - 2007


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Type of Flex/Industrial Inventory and AbsorptionWashington/Baltimore Region | 2007


Inventory at 12/2007(Millions of SF)

Net Absorption2007

Type of Space SF % SF

Bulk Warehouse 103.3 31% 2,670,000

Flex/Warehouse 197.7 59% 3,268,000

Flex/R&D 33.2 10% 694,000

Total Flex/Industrial 334.2 100% 6,632,000

Gross Leasing Activity: Healthy

Leasing activity in the Washington/Baltimore region totaled 21.5 million SF during 2007. The Baltimore metro area accounted for 58% of the total SF leased in the region during the past six months. Washington accounted for the balance of 42%.

Bulk warehouse space accounted for 43% of the total SF leased in the region during 2007. Flex/warehouse accounted for 41% and flex/R&D accounted for 16%.

There are 751 buildings with contiguous blocks of available space over 10,000 SF in the Washington/Baltimore region. The largest block of space is 1.2 million SF located at 2800 Eastern Boulevard in the Baltimore County East submarket.

Gross Leasing ActivityWashington/Baltimore Region | 2000 - 2007

* Preliminary figure subject to re-benchmarking in Q1 2009 Note: Data updated each quarter Source: CoStar, Delta Associates; January 2008

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Percent of Total SF Leased by Product TypeWashington/Baltimore Region | 2007


Buildings with Contiguous Blocks of Available SpaceWashington/Baltimore Region | December 2007

Note: Includes buildings under construction or renovation Source: CoStar, Delta Associates; January 2008

Vacancy Rate: Down

The region’s overall flex/industrial vacancy rate ticked down to 9.5% at year-end 2007, from 9.8% one year ago. The Washington area’s overall vacancy rate is 120 basis points lower than the Baltimore area’s rate.

The region’s direct flex/industrial vacancy rate was 8.8% at December 2007, down 9.3% one year ago.

The region’s overall vacancy rate for newer product (built since 1987) ticked down to 10.8% at year-end 2007, from 11.7% one year ago. The region’s direct vacancy rate for newer product is 10.1%, down from 11.0% a year ago.

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Direct Flex/Industrial Vacancy RatesWashington/Baltimore Region | All Space at:

Market Year-End 1996 Year-End 2000 Year-End 2007

Wash/Balt Region 12.3% 7.3% 8.8%

Wash/Balt Subs. 10.4% 6.1% 8.9%

Balt/Wash Corr. 10.8% 7.5% 7.7%

Wash. Metro Area 10.5% 6.2% 8.3%

Balt. Metro Area 14.5% 8.4% 9.3%

Flex/Industrial Vacancy RateWashington/Baltimore Region | 1998 - 2007

Construction: Declined During 2007

The amount of flex/industrial space under construction in the region is 6.3 million SF at year-end 2007, down from 10.1 million SF one year ago.

Space under construction is 24% pre-leased at December 2007, up from 21% one year ago. The Washington area’s pre-lease rate is 45%, compared to the Baltimore area’s at 7%

Construction starts eased notably during 2007. Groundbreakings totaled 5.8 million SF during the past 12 months, compared to 11.9 million SF in all of 2006. The Dulles Corridor and Baltimore County West submarkets were the leaders in starts during the year.

6.4 million SF of flex/industrial space delivered in the region during 2007, compared to 6.5 million SF in 2006.

31% of the space delivered during the year was leased upon delivery, compared to 32% during 2006.

Supply vs. Demand: Vacancy to Edge Up

The regional flex/industrial vacancy rate likely will tick up to 10.2% by year-end 2008, from 9.5% today. Washington is likely to see a rate of 9.4% and Baltimore a rate of 11.1%.

Rents: Up 2.8% During 2007

Flex/industrial rents in the Washington/Baltimore region increased 2.8% during 2007, the same rate of increase experienced in 2006.

Rents for flex/warehouse space and flex/R&D space increased at a higher rate, where vacancy remained low, compared to bulk warehouse space.

Leasing on Recent Deliveries and Projects U/C or U/RWashington/Baltimore Region | 2004 - 2008

Note: Recent deliveries are based on % leased upon delivery Source (All charts on this page): CoStar, Delta Associates; January 2008

Flex/Industrial Space Under Construction and Pre-LeasedYear-End 2006 and Year-End 2007 (Millions of SF)

Metro AreaAt 12/2006 At 12/2007

SF U/C % Pre-leased SF U/C % Pre-leased

Washington 3.7 40% 2.8 44%

Baltimore 6.4 10% 3.5 7%

Regional Total 10.1 21% 6.3 24%

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Flex/Industrial Space Deliveries and Pre-LeasingWashington/Baltimore Region | 2007

Metro Area Millions of SF Delivered % Pre-leased

Washington 3.4 36.2%

Baltimore 3.0 25.5%

Regional Total 6.4 31.1%


Projected Year-End 2008 Vacancy RatesWashington/Baltimore Region Flex/Industrial Market (Millions of SF)

Washington Metro

Baltimore Metro

Regional Total

Inventory

Inventory at 12/07 169.3 164.9 334.2

Pipeline Thru 12/081 4.2 4.7 8.9

Inventory at 12/08 173.5 169.6 343.1

Supply2 vs. Demand

Vacant Space at 12/07 15.1 16.6 31.7

New Supply Thru 12/08 4.2 4.7 8.8

Avail. Space at 12/08 19.2 21.3 40.5

Demand Thru 12/08 3.0 2.4 5.4

Vacant Space at 12/08 16.2 18.9 35.1

Vacancy Rate2

Vacancy at 12/07 8.9% 10.1% 9.5%

Vacancy at 12/08 9.4% 11.1% 10.2%

1 Pipeline equals buildings under construction and those planned that may deliver by year-end 2008 2 Includes sublet space Source: CoStar, Delta Associates; January 2008

Rent Growth by Product TypeWashington/Baltimore Region | 2007

Submarket% Change

December 2006 to December 2007

Bulk Warehouse 1.9%

Flex/Warehouse 2.9%

Flex/R&D 3.1%


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Flex/industrial rents should continue to rise at a moderate pace during 2008, as tenants continue to seek space. Given the amount under construction and easing demand, we expect rents to rise 1.5% to 2.5% over the next 12 months.

Investment Sales: Strong

Flex/industrial investment sales volume totaled $1.5 billion in the Washington/Baltimore region during 2007, compared to $1.9 billion in 2006. There were a handful of multiple building deals during the year, which boosted the sales volume.

Sales prices averaged $80/SF during 2007, down slightly from $88/SF achieved during 2006. A handful of deals lowered the average sales price. For example, Landover Centre II in Suburban Maryland sold for $11.3 million ($55.15/SF) and 2800 Eastern Boulevard sold for $37.5 million ($19.56/SF) in Suburban Baltimore.

We expect investment sales activity to remain solid during 2008, as property performance remains healthy. Investors will likely remain interested in the Washington/Baltimore flex/industrial market, given its long-term, stable nature. However, the Credit Crunch is likely to filter leveraged buyers from the market and reduce the number of bidders for each available asset.

Land Sales: Solid

Flex/industrial land sales volume totaled $149.7 million in the Washington/Baltimore region during 2007, compared to $167.6 million in 2006. The average price per land SF was $8.16, or $355,497 per acre.

The most notable land sale during 2007 was 47.4 acres at 44901 Russell Branch Parkway in the Dulles Corridor purchased by Visa USA for $19.8 million. The buyer is planning a flex/industrial park, called Russell Branch Parkway Industrial Park.

The Washington/Baltimore Regional Flex/Industrial Outlook

The Washington/Baltimore flex/industrial market should remain healthy during 2008. We expect leasing activity for flex/industrial space to remain strong, but off the peak levels experienced during the robust part of the cycle.

Market Outlook:

Overall, strong population and economic growth will continue to fuel steady expansion of the flex/industrial market in the Washington/Baltimore region in the period ahead.

n Overall Vacancy: Given modest pre-lease rates on pipeline projects, we project overall vacancy will rise to 10.2% by year-end 2008.

n Leasing Activity: Should remain healthy in 2008, but off pace compared to prior years.

n Rents: Regardless, rents should increase 1.5% to 2.5% over the next 12 months, as market conditions remain favorable.

n Investment Sales: Although we expect investment sales volume to remain healthy, the Credit Crunch could withdraw some capital from this market.

The key to success in this asset class in 2008 and beyond is to avoid debt, improve operations at existing assets, and select investment and development opportunities that have one or more of the following characteristics:

n Transportation-favored, like ports, airports and Interstates – near Dulles Airport or the Port of Baltimore

n Submarkets with a low development pipeline – I/95 and I/395 in Northern Virginia or Montgomery County in Suburban Maryland

n Low land basisn Tenant-driven

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THE

WASHINGTON AREAAPARTMENT MARKET

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64

THE WASHINGTON AREA APARTMENT MARKET

Sturdy Market Performance, Even As Pipeline Balloons

The Washington metro area continues to be one of the better apartment markets in the nation due to:

1. A sturdy job market.

2. A transient work force that has produced a large pool of Class-A renters by choice.

3. A stalled condo market that has turned would-be condo purchasers into renters.

4. An expensive for-sale market that has turned cash-strapped buyers into renters.

However, this otherwise solid market began to show stress in the 4th quarter of 2006 that continued through 2007 due to:

n “Shadow rentals” from a cooling housing marketn Condominium developers reverting to rentalsn A ballooning pipeline of supplyn A moderating jobs market

National Context

The Washington metro area is the 3rd largest apartment market in the U.S., next to New York and Los Angeles.

At 3.7% stabilized vacancy, Washington enjoys the 3rd lowest vacancy rate in the U.S. – behind only NY and LA. While this is 80 basis points higher than last year, most of the increase is due to Class B apartment performance, which is stressed by the shadow rental market and condo rentals.

Net Absorption during 2007, at 5,042 units, was 1st in the U.S. and the highest we have seen since 3rd quarter 2006. Absorption at new projects held steady at 17 units per project per month – and this is particularly noteworthy as the number of projects marketing doubled since 2006.

THE

WASHINGTON AREAAPARTMENT MARKET

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Largest Apartment Markets2007

Note: Excludes NYC and includes only those units in projects of 20 or more units Source: Delta Associates; January 2008

Lowest Apartment Vacancy Rates Among Major Metro AreasYear-End 2007

1/ The largest 71 apartment markets in the U.S. | * 2nd Quarter data except for Washington, Baltimore, and Philadelphia are as of 4th Quarter 2007 Source: REIS and Delta Associates; January 2008

Other Year-End 2007 Highlights

Rent increases for all investment grade product dipped below the long-term average of 4.4% per annum – to 1.8% since December 2006. Class A rents grew by 1.3% during 2007, compared to 4.0% at year-end 2006.

n Quality, high-rise product inside the Beltway increased 2.5% while Class A gardens outside the Beltway grew just 0.8%.

n Even high-rise within the Beltway was sensitive to pipeline: the District, with four projects in lease up, experienced rent growth of 4.3%, while Alexandria, with seven projects leasing up, registered just 0.5% growth.

Concessions at Class A projects continued to move higher, to 4.8% of face rent, compared to year-end 2006, which was 2.4% of face rent. The 1st quarter of 2007 was the first time the market had witnessed an increase in four years.

Pipeline. After a long decline in the early-2000s, the 36-month pipeline of on-coming apartment product declined to 18,000 units by 2005. That was a critically low supply. Since then, it has ballooned to 36,951 units in December 2007, largely driven by the reversion of condominium projects.

Concessions

Concessions doubled for all Class A projects, from 2.4% to 4.8% during 2007. The increase was most pronounced in Northern Virginia, where Class A rent growth was 0.6% as a result of the increase in concessions. Concessions also markedly increased in Suburban Maryland and in the District.

Annual Net Absorption of Class A ApartmentsMajor Apartment Markets | 12 Months Ending December 2007*

1/ The largest 71 apartment markets in the U.S. | * Wash = 12 Months Ending 12/07; Others 6/07 Source: REIS and Delta Associates; January 2008

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Concessions for all Class A properties (that is, those filling up as well as those replacing turnover) averaged 4.8% metro-wide at year-end 2007 – and are back up to where they were at the end of 2004 (see table at right).

Concessions for projects currently filling up, and not yet stabilized, are indicated in the table at right.

The rates are up in response to the increased number of projects currently in lease up – 41 compared to 20 at year-end 2006.

Pipeline

The pipeline grew significantly in response to the recent robust performance of the apartment market and because of developers reprogramming condo projects in light of the slowing condominium market. The pipeline continued to grow during 2007, particularly in Northern Virginia.

The District’s 36-month pipeline of projects grew to 7,126 units as of December 2007 – a large jump from earlier in the year. This figure includes only those units that we believe are probable to move forward as planned. Currently, vacancies remain low – down slightly to 3.1% from 3.2% one year ago – and rent growth is the strongest in the region at 4.3% per annum. However, with over 1,700 units expected to deliver in 2008, occupancy rates will be under pressure.

Northern Virginia’s 36-month pipeline grew to 17,120 units. As a result, we expect supply to exceed anticipated demand through 2008 and into 2009, and vacancy is likely to edge up.

As the pipeline continued to grow over the past 21 months, rents slowed or retreated slightly. For example, during 2007 rents were:

Pipeline Activity Since 1997Washington Region (Units Likely to Deliver In Next 36 Months*)

*Assumes attrition factor Source: Delta Associates; January 2008

n Up 0.8% for all investment grade units.n Down 0.3% for Class A garden apartments.n Up 2.3% for Class A high-rise apartments.

Positive rent growth in the Vienna garden apartment submarket, amid overall negative garden rent growth, is a testament to the value of limited pipeline volume (no new projects have delivered in the submarket since 2004) combined with Metro access.

* Includes those filling up as well as those replacing turnover Source: Delta Associates; January 2008

Year-End 2004 Year-End 2005 Year-End 2006 Year-End 2007

No. VA 3.9% 2.6% 2.7% 5.8%

Sub. MD 5.8% 2.4% 2.1% 3.4%

District 5.9% 2.4% 2.7% 3.3%

Metro-Wide 4.7% 2.5% 2.4% 4.8%

Concessions for All Class A Properties*Washington Metro Area


Year-End 2004 Year-End 2005 Year-End 2006 Year-End 2007

No. VA 5.0% 3.8% 6.0% 9.5%

Sub. MD 8.7% 3.8% 6.0% 8.4%

District 9.3% 2.7% 5.4% 7.9%

Metro-Wide 6.5% 3.7% 5.9% 9.0%

Concessions for Unstabilized Class A PropertiesWashington Metro Area

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Net Apartment Unit Absorption for Class A and Class B UnitsWashington Metro Area


Suburban Maryland’s pipeline grew to over 12,700 units by year-end 2007. Approximately, 2,800 units are expected to deliver in the market during 2008, outpacing demand. Rents for both Class A and B product have grown, however, in part due to unexpected strong demand. Rent growth during 2007:

n Up 2.9% for all investment grade units.n Up 2.1% for Class A garden apartments.n Up 0.6% for Class A high-rise apartments.

Absorption

The Washington area’s apartment absorption bounced back from a soft performance earlier in 2007.

Absorption has been consistently strong at 4,300 to 6,500 units per annum over the past 12 years. However, absorption during the first three quarters of 2007 had been curtailed because of a soft housing market in which frustrated sellers put their listings up for rent, thereby siphoning off apartment demand. This created a “shadow market” of rental units.

Net absorption declined precipitously during the final quarter of 2006, slipping further and remaining low through the 3rd quarter of 2007. Given continued sturdy job growth and overall demand, we believe this decline can be largely attributed to two factors:

1. The cooling of the overall housing market and subsequent rental of housing units of all types that are slow to sell.

2. The large number of “shadow” market condominium rentals investors placed on the market in the latter half of 2006 and first half of 2007.

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A Word About Our Definition of Vacancy Rate

We sometimes hear from apartment developers and managers that their portfolio vacancy rate is 200 to 400 basis points higher than the numbers we report, which places them under unfair investor scrutiny. As a result, we thought it appropriate to describe here our term “vacancy.”

When we conduct our quarterly surveys, we obtain information on “units available to lease” – that is, physical vacancy. Obtaining the information this way, of course, may produce several important differences from “vacancy” as reported in your financial statements. Simply stated, the difference can be characterized as:

Delta’s Definition:Available units to lease

Operating Statement Vacancy:Economic vacancy

Our definition (available units) may therefore be understated compared to yours (economically vacant) by our exclusion of units occupied by non-paying tenants (which we cannot know), and of units not available for lease, such as employee units and model apartments. We estimate that this adds about 100 to 150 basis points to your definition of vacancy, as compared to ours. Our vacancy rate may also be understated, compared to yours, by our exclusion of what at present are economically vacant, on-notice units for which a lease to occupy in the future has been signed (hence, they are not currently available to lease). We estimate that this potentially adds another 150 to 200 basis points to your definition of vacancy, as compared to ours.

These conditions seem to have eased in the 4th quarter, as 12-month absorption rebounded to over 3,200 units. We think these conditions will continue to ease in 2008, thereby positively impacting apartment absorption during the first half of 2008.

A testament to the strength of the apartment market: Absorption pace per project remained steady during 2007 at 17 units monthly, even as the number of projects in active lease-up increased markedly from 20 to 41.

Absorption Pace Per Project Per MonthWashington Metro Area (Projects in Initial Lease-Up)


Equilibrium Shift?

Stabilized vacancy rates increased during 2007, even as rents for Class A product continued to edge up slowly. This recent pattern may represent an emerging paradigm shift for the Washington market. A new equilibrium level for vacancy may be developing, as operators experience continued rent growth at vacancy levels previously determined to be “too high” for this market. Additional observation of this phenomenon is warranted.

Effective Rental Rate and Vacancy RateWashington Metro Area | All Types and Classes of Apartments


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section 6 | 69

Supply/Demand and Rent Projections

We expect stabilized vacancy rates in Northern Virginia, Suburban Maryland and The District to edge above 5%.

We believe that supply will outpace demand at the metro level through 2010. As a result, we expect the region-wide vacancy rate for stabilized Class A apartment properties to edge up to 5.3% over the next three years. While that level will remain lower than the national average, it will be the highest we have seen in the Washington metro area since the early 1990s.

Rents will likely continue to edge up during this period, but below the long-term average of 4.4% per annum.

Better projects in stronger submarkets can vastly outperform these averages.

Washington Investment Sales: Another Record-Setting Year 2007 has surpassed prior record-setting years. In 2006 , as Delta’s Year-End Apartment Report went to press in late December, we had identified 15 Class A building sales (most of them gardens), consisting of $1.19 billion of multifamily Class A building sales volume.

During 2007, we noted $1.69 billion of multifamily Class A building sales closed (comprising 12 garden apartments and 8 high-rises).

The average per-unit prices for 2007 sales ran higher than 2006: 14% higher for garden units (at nearly $250,000) and 15% higher for high-rises (at $400,000).

Class A Apartment Vacancy RateWashington Metro Area | 2000 - 2010


Class A Apartment Rent Growth Per YearWashington Metro Area | 1998 - 2010


Demand and Supply Projections: Class A Apartment MarketWashington Metro Area | 12/07 - 12/10

% = Stabilized Vacancy Rate at 12/2010 Estimated Stabilized Vacancy Rate at 12/2010: 5.3% Region-Wide Source: Delta Associates; January 2008

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Having officially closed in October, the largest transaction of the year is the sale of Archstone-Smith’s entire portfolio to Tishman-Speyer. This REIT buyout, which includes numerous Washington metro properties, is valued at approximately $22 billion.

The explanation for these high volumes and prices?

1. What is a better alternative investment vehicle, either within the real estate sector or even across other asset classes?

2. Strong prospects of improved operating performance as rents continue to edge up, yielding even better net income.

3. The prospect of increasing long-term interest rates suggests a “closing window of opportunity” to purchase the higher-performing assets with capital as reasonably priced as it is currently.

So now, evidently, is the time to buy. And the Washington Metro is, evidently, the place to buy:

n The regional economy is among the strongest in the country, and son Low vacancies and continued rent growth drive market performance to among

best-in-nation levels, and son Total returns are higher here.

But the recent Credit Crunch appears to be re-pricing all forms of risk – real estate included. It is too soon to know the implications for apartment pricing, but most observers believe cap rates have reached their cyclical low and price increases will now be earned the old fashioned way – by performance enhancement. We believe the apartment segment is a winner in the turmoil that follows this Credit Crunch – with home ownership rates edging down from their cyclical high of 70%. If that is the case, demand for this product type should remain strong. So also should demand for this asset class.

Key Question in Washington Area

How will the cooling housing market (and moderating condominium market in particular with its potential of reversions – condo projects reverting to a rental program) affect the apartment market? In the short term, the confluence of a tepid condominium market and the delivery of investor units to the “shadow” market continue to impact net absorption. Sturdy job growth is still attracting people to the region, but the increasing number of condominium rentals is siphoning off a sizable portion of overall demand. However, as a countervailing force, the recent Credit Crunch is making apartments a more viable housing option for many. More stringent lending policies, coupled with continued high for-sale housing costs in the region, point to more optimistic expectations for the Washington apartment market.

Longer term, we must continue to closely monitor the large pipeline of condominium product. As condominium demand has moderated, apartment supply has increased as developers have surveyed their changing fortunes and have altered their development programs. This phenomenon began in the 2nd quarter of 2006, and while abating from its peak in the 4th quarter of 2006, its cumulative affect is having a sizeable impact on the apartment development pipeline.

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section 6 | 71

During the 3rd quarter of 2007, 16 condominium projects were cancelled, totaling 3,681 units. In the 4th quarter of 2007, 18 projects were cancelled, totaling 4,367 units. Of those changing course, 13 projects with 3,840 units, were added to the Class A development pipeline. Over the last two years nearly 21,000 condominium units have been reprogrammed and added to the Class A apartment pipeline.

While the overall number of altered projects is small when compared to the overall supply of nearly 500,000 apartment units in the Washington region, these project switches from condominium are beginning to impact the projected supply/demand balance through 2010 and beyond. This certainly bears watching during 2008 as the condo market settles out.

A corollary question: What about the “shadow” market of rental units that individual condo owners will put on the market as they take delivery over the next 24 months? In the 1st quarter of 2007, the market began to feel the impact of these units. Nearly 12,000 condominium units have delivered since mid-year 2006. If estimates hold true that up to 1/3 of them were purchased as investor units, this sudden “delivery” of nearly 4,000 units to a cool condominium market may have added nearly as many available “rental” units to the Washington metro area.

While the existing “shadow” rentals do not compete as effectively due to a lack of mass marketing and professional management, their sheer number will continue to impact the market. While the shadow market can not compete with apartments in terms of marketing budgets because they are individually-owned, they compete on price, as investors seek to obtain at least some cash flow from tenant rentals, to cover an investor’s mortgage. Therefore, their impact on the B market, which has more comparable amenities, has been even more dramatic. However, these units have become a countervailing force to dampen demand somewhat for the “institutional-grade” Class A rental market as well. Their impact, as well as that of other non traditional rentals, should dissipate over time, as the countervailing forces of more exacting lending policies and continued high for-sale prices drive more people to rent rather than own.

Market Outlook: The Path Forward

In this phase of the real estate cycle, the successful investor/developer will use cash to:

Invest in repositioning existing under-performing assets and developing new projects with superior design features at premier sites within submarkets that maintain a supply/demand balance where better than market average rent increases can be expected.

Superior design features: As the mixed-use moniker becomes more prevalent at projects across the region, what was once seen as a niche is increasingly common. Merely adding 1st floor retail to an otherwise common project will yield diminishing differentiation in this market. We feel creative approaches to place-making, partnered with bold design, and designing for niches is essential – niches such as student housing, seniors housing, mid-market housing in some locations and up-market housing at others.

Superior locations: Not just transit access, but those submarkets with superior supply/demand fundamentals are keys to success in the period ahead. And by our analysis there are many submarkets with good supply/demand fundamentals that warrant attention and development in the period ahead.

Demographically-driven solutions: Seniors housing, student housing, are two such niches warranting attention at the right location.

Low land cost basis: A pipe dream? Perhaps a necessity to compete in the period ahead.

Condo Development Pipeline RemovalsWashington Metro Area | Through Year-End 2007

* Previous quarter’s totals are aggregate removals from the condo pipeline Source: Delta Associates; January 2008

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THE WASHINGTON AREA CONDOMINIUM MARKET

Prices Are Steady; Pipeline Continues to Decline, but Not as Rapidly as Sales Velocity

It is hard to believe if you read the popular press, but new condo unit prices are steady.

However, sales velocity is way down in the second half of 2007 compared to the first half. Little wonder:

n The August Credit Crunch removed at least one-third of the buyers due to the end of exotic mortgages and loans to investors. Jumbo loans became much more expensive – so many high end buyers are on the sidelines too.

n Demand is off its peak, as job growth, while still near the region’s long-term average, is lower than it has been since 2002.

n Consumer confidence is at its lowest level since Hurricane Katrina. Consumers simply are not in the mood to buy.

n And then there is the buyer conundrum: Interest rates and prices are not rising, so what is the hurry in making a decision?

Even though the inventory of condominiums continues to decline, the main driver behind the reduction has more to do with project cancellations and less to do with contract sales.

Year-End 2007 Highlights

n Volume. Way down in the second half of the year: (defined as net binding contracts written with security deposits up) 3,905 units were sold in 2007 – about the same as in 2003.

n Concessions. Surprisingly, concessions are down in 2007 by 90 basis points from 2006 – to 3.7% of the purchase price.

n Pipeline. Down 6,601 units during 2007 – 27% – to 17,607 unsold condominium units that are actively marketing in the metro area at year end 2007. More importantly, there now is 4.5 years’ worth of inventory of product on the market at current rates of sales velocity. History tells us that at 2.5 to 3.0 years and below, prices move up smartly. Some submarkets are there, but as a whole, the metro has some “cure time” ahead of it.

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n Prices. Condo prices held steady in 2007, as viewed by two different sources of data. Resale prices during the past 12 months were down by only one percent. Same-store new condo prices (after concessions) were up by about one-half a percent metro-wide.

n Sales pace. Contract cancellations continue to have an impact on net sales pace. As projects get closer to delivering, buyers get second thoughts about going through with closing on their units. In today’s environment, a good sales pace per project is 3 to 5 units per month.

New (and Conversion) Unit Sales by Jurisdiction2007

*Binding contracts executed Source: Delta Associates; January 2008

Jurisdiction Group # of Units Sold*

Prince William/Loudoun 1,092

District of Columbia 996

Prince George’s 719

Montgomery 505

Fairfax/Falls Church 250

Anne Arundel/Howard 173

Arlington/Alexandria 170

Metro Total 3,905

New Condominium Sales TrendWashington Metro Area | 2002 - 2007


Effective Prices Holding Steady; Concessions Down From a Year Ago

During the past twelve months, re-sale prices have declined in the District and Northern Virginia. In Loudoun and Prince William County, the price decline was in the double-digits. In Suburban Maryland, prices continue to appreciate.

Same-store new condo sale prices edged up slightly from a year ago, due to fewer concessions being offered. The District showed the most strength as prices increased there by 2.6%. However, annual average price change since 2004 shows a decline metro-wide of 1.2%. The most severe price decline in the past three years has been in Prince William and Loudoun Counties, where prices have gone down on average by 3.7% each year. On the other end of the spectrum, in Prince George’s County, prices have increased by 7.1% per annum.

Sales Activity Declines Further

The August Credit Crunch slowed sales velocity in the latter part of 2007. For the year, there were 3,905 units sold in the metro area. The local condo submarkets with the lowest and highest average prices per SF (Prince William/Loudoun and the District, respectively) had the most condo sales in 2007.

As in prior quarters, select submarkets had more contract cancellations than contract sales. This was the case in Arlington/Alexandria, Fairfax/Falls Church, and Anne Arundel/ Howard. While two years ago there were more than 4,000 contract sales in Arlington/ Alexandria, due to multiple quarters of contract cancellations, there were only 170 sales in 2007 – the least of any jurisdiction in the metro area.

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THE WASHINGTON AREA CONDOMINIUM MARKET

Note: “Same store” sales Source: Delta Associates; January 2008

Sub-State Area Price Change Before Concessions Price Change After Concessions

Suburban MD 1.1% 0.9%

Northern VA -1.8% -0.5%

The District 1.6% 2.6%

Metro Average -0.5% 0.4%

New Condominium Price Change 2006 - 2007

New Condominium Prices Per SF* Washington Metro Area | Year-End 2007

* Reflects prices of condo projects currently selling, so averages should not be compared from quarter to quarter since locations of projects change each quarter Source: Delta Associates; January 2008

Concession rates declined in the District and Northern Virginia. While Suburban Maryland was the only sub-state area to see an increase in the concession rate, the increase was only slight in nature. High-priced jurisdictions such as the District and Arlington/Alexandria currently offer the lowest concession percentage.

Pipeline Declines Further

The number of unsold condominium units in projects currently marketing now stands at 17,607. Of this total, 14,243 units are under construction or delivered, with the balance not under construction but actively marketing. In addition, there are 13,386 units planned with sales likely to begin within the next 36 months.

The currently marketing pipeline has been declining since early 2006. Condo availability has dropped by 32% metro-wide since the peak in March 2006. The most dramatic decline in condo availability since December 2006 occurred in Fairfax/Falls Church, where inventory has dropped by 56%. The only jurisdiction to see an increase in condo product during the past 12 months is Anne Arundel/Howard.

Condos are being removed from the pipeline for the following reasons: (1) Switched back to rental; (2) Unconverted back to a rental project after sales began; (3) Reprogrammed their initial condo project plans to a for-rent regime; or (4) Cancelled plans altogether.

Even though there were about 3,900 new condo sales in 2007, condo availability declined by almost 6,600 units during the same time period. At least 2,700 unsold units were removed from the actively marketing condo pipeline in 2007 due to cancellations or reversions back to the apartment market. On the following page is a graph showing the trend of condo units removed from the development pipeline.

Source: MRIS, Delta Associates; January 2008

Median Price Increase

Sub-State Area 2006 11/06 – 11/07


Northern VA -0.3% -6.2%

The District -5.6% -1.4%

Metro Average -0.1% -0.9%

Median Condominium Resale Prices Percentage Increase in 2006 and 12 Months Ending 11/07


Concessions as a Percentage of Average Sales Price by Sub-State AreaYear-End 2006 And Year-End 2007

% of Sales Price

Sub-State Area YE 2006 YE 2007


Northern VA 5.4% 4.1%

The District 3.5% 2.5%

Metro Average 4.6% 3.7%

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Sales Pace

Not many new projects have been introduced to the market in the past few months. The average monthly sales pace for projects that sold out during the past two years is six units. Here are some examples of sales pace among the few new entrants to the market:

n In October 2007, The Cohen Companies began sales at Velocity – Phase I, the first condominium project to begin sales at the Capitol Riverfront (a.k.a. Ballpark) neighborhood in the District. Since then, 18 units out of 200 have sold at prices averaging $458/SF.

n Fleet Street Condominium, the second building to start sales at Peterson’s National Harbor project in Prince George’s County, began sales in November 2007. In the first four weeks, 93 out of 163 units sold, averaging $500/SF.

Washington Condo Market Outlook: The Path Forward

The Washington metro area currently has an inventory of 17,607 units to sell, which means it will take about 4.5 years to sell these units at current rates of sales velocity. The only two jurisdictions that are currently below the metro average are the District (3.3 years) and Prince George’s County (2.2 years). Arlington, Fairfax, and Alexandria are close.

We believe price traction will start to occur by late 2008 or early 2009 as the inventory-to-sales ratio gets closer to the 2.5- to 3.0-year range in select jurisdictions.

We believe sales will track in the 4,000 – 4,500 units range in 2008.

During this time in the cycle, we find the more successful developers are

36-Month Condominium Market PipelineWashington Metro Area | 2006 - 2007


Condominium Development Pipeline RemovalsWashington Metro Area | Through Year-End 2007

* Previous quarter’s totals are aggregate removals from the condo pipeline Source: Delta Associates; January 2008

being highly selective when targeting new projects. Opportunities exist for builders to invest in niches (both geographic and product-type):

n The move-up market is tough right now – there is a home to sell before the buyer can settle.

n The first-time buyer market could be lucrative – no home to sell, and generally priced not needing a jumbo mortgage.

n Boutique buildings for the empty-nester market may also be an alternative. But location is critical here.

n Developing in close-in submarkets to take advantage of better pipeline conditions and transit options/existing infrastructure could also prove to be successful.

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THE WASHINGTON AREA RETAIL MARKET

Superior Occupancy and Rent Performance Driven by High Household Income; Sturdy Job Growth and Continuing Under-Development of Product

The Washington metro area retail market remained a strong performer in 2007. In fact, it continues its long run since the early 1990s due to solid employment growth, high disposable incomes, and an under-developed pipeline of activity. While all categories of retail are benefiting from these conditions, the focus here is on the 52.1 million SF, 299 grocery-anchored neighborhood centers:

n Vacancy declined to a chronically low level of 2.28% at year-end 2007.n Rents increased at 3.9% in 2007, after escalating 5.7% in the prior year.

Jobs and Income Drive Demand

The retail market in the Washington metro area derives its success from job creation and above-average income. Over the next three years, job growth is projected to remain healthy, with the local economy creating on average 40,000 jobs per annum.

As jobs continue to expand in the metro area, retail employment is expected to keep pace. Retail hiring increased by 5,400 positions in the 12 months ending November 2007.

The above-average income of Washington metro area residents supports a vibrant retail market. By 2012, the Washington metro area’s average household income is projected to be $110,300, compared to $73,700 nationally.

Incomes in the Washington metro area grew by 21.5% from 2000 to 2007, compared to 17.8% nationally. Compensation in the metro area has risen at a faster pace compared to other areas, as high-level positions are difficult to fill with qualified candidates due to a low unemployment rate; this has prompted companies to use high salaries as a lure.

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Retail Inventory: Not Enough

The Washington metro area has over 116.0 million SF of retail space, inclusive of all types of retail, in just over 1,000 shopping centers. Northern Virginia is home to 52% of the total metro retail inventory.

With such high income and rapid growth the metro area should have more retail space per capita than it does – just 21.3 SF per capita. This compares to the national average of 20.0 SF per capita.

Although over 12.3 million SF of retail inventory has been added to the metro area since the year 2000, the area remains underserved as the growing population continues to demand retail services, particularly in the District of Columbia where there is just 7.8 SF of retail space per capita. There are significant opportunities for development of retail space inside the Beltway to serve an underserved population and outside the Beltway to serve the leading edges of our growing metro area.

The Washington shopping center landscape is aging, as just over half of the shopping centers are over 25 years old, while only 16% are aged ten years or less. There are significant opportunities for renovation of the region’s aging stock of retail space.

Prince George’s County takes the lead, as 64% of its total retail inventory is aged 26 years or older. Of note, most jurisdictions in the metro area have over 50% of their retail inventory in this age range.

Retail EmploymentWashington Metro Area

*Employment total at November 2007; change reflects growth during the 12 months ending November 2007 Note: 2005 and 2006 have been re-benchmarked by the Bureau of Labor Statistics Source: Bureau of Labor Statistics; January 2008

Year Retail Employment Change

2001 255,200 (1,700)

2002 255,900 700

2003 256,600 700

2004 263,500 6,900

2005 268,500 5,000

2006 269,900 1,400

2007* 283,800 5,400

Retail Space per CapitaSelect U.S. Metro Markets | 2007

Source: CoStar, U.S. Census, Delta Associates; January 2008

Retail Space per CapitaWashington Metro Area | 2007


Average Household Income

Source: Claritas Inc., Delta Associates; January 2008

Jurisdiction 2000 (Actual) 2007 (Est.) 2012 (Proj.)

Washington Metro Area $80,600 $97,900 $110,300

U.S. $56,600 $66,700 $73,700

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Shopping Center Age DistributionWashington Metro Area | 2007 (Share of Centers)


Shopping Centers Aged 26 Years or OlderWashington Metro Area | 2007

Source: CoStar, Shopping Center Directory, Claritas, Delta Associates; January 2008

Grocery-Anchored Shopping Center Market Conditions

Of the total retail inventory in the Washington metro area, 52.1 million SF is located in 299 grocery-anchored shopping centers, which is almost half of the total retail inventory in the metro area.

Given the demand for groceries at all points of the economic cycle, grocery-anchored shopping centers maintain the greatest stability compared to other retail property types. Therefore, our analysis in this report is focused on grocery-anchored shopping centers.

There are 16 notable grocery-anchored shopping centers, totaling just over 4.5 million SF, under construction in the metro area at year-end 2007. Four of the 16 projects are creating shopping centers around existing grocery stores. Given the economic viability of grocery-anchored shopping centers, we believe this trend will continue.

We perform an annual survey of these grocery-anchored shopping center owners, and tabulate vacancy and rent data.

Metro-wide vacancy remained chronically low at year-end 2007 at 2.28%, down slightly from 2.31% from one year ago. The year-end 2007 vacancy rate is 98 basis points lower than the long-term average vacancy rate of 3.26%.

Each jurisdiction in the Washington metro area has a low vacancy rate. However, Arlington County, District of Columbia, and Montgomery County lead the pack, as each area has vacancy below 2.0%.

Grocery-Anchored Shopping CentersWashington Metro Area | 2007 (Millions of Square Feet)

Note: Estimate Source: CoStar, U.S. Census, Delta Associates; January 2008

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Grocery-Anchored Shoppings Centers Under Construction Washington Metro Area | Year-End 2007

1/ Using existing Wegmans as an anchor. 2/ Relocating from existing store at Congressional Plaza. 3/ Using existing Giant Food as an anchor. Source: CoStar, Washington Business Journal; January 2008

Shopping Center RBA Anchor

Brandywine Crossing 730,000 Safeway

Potomac Town Center 700,000 Wegmans

Dulles Landing 700,000 Super Wal-Mart

The Shops at Stonewall 317,000 Wegmans

Wisconsin Place 305,000 Whole Foods

Dulles 28 Centre 300,000 Wegmans 1

White Flint Crossing 230,000 Whole Foods 2

Bristow Shopping Center 200,000 Harris Teeter

Metropolitan Shops 170,000 Giant Food 3

Village Ctr @ Belmont Greene 166,000 Bloom

Virginia Gateway 165,000 Giant Food 3

Ashland Square 163,000 TBA

Moorefield Marketplace 151,000 Harris Teeter

Urbana Village Center 94,000 TBA

Calverton Shopping Center 70,000 Giant Food

Kingsbrook Crossing 9,000 Giant Food 3

Total: 4,470,000

Grocery-Anchored Shopping Center Vacancy RatesWashington Metro Area | 1999 - 2007


Rental rates at grocery-anchored centers increased 3.9% in 2007, after rising by 5.7% in 2006. Metro-wide average rents were $33.16/SF at year-end 2007, up from $31.91/SF 12 months earlier.

Grocery Store Wars

Food retailers in the Washington metro area experienced $9.8 billion sales volume in 2007, a 1.8% increase from 2006 based on average per store sales volume. The top three volume producers were Giant Food, Safeway, and Shoppers Food Warehouse.

In 2007, the per store average sales volume for all grocers in the Washington metro area was $22.5 million. Wegmans surpassed all other food retailers, with a $79.1 million per store average. Selling a vast selection of prepared dishes and offering both organic and commercial food in an open-air market format has lured shoppers to Wegmans, a unique marketing concept that other grocers are starting to mimic.

Sales increased by 15.5% in 2007 for Food Lion. This growth comes after its transformation of existing Food Lion stores into Bloom and Bottom Dollar stores. Food Lion converted 40 stores into Bloom Stores, a high-end alternative, and eight stores to Bottom Dollar, a discount alternative, as the company attempts to broaden its scope to capture a wider spectrum of shoppers. Harris Teeter experienced an 11.5% sales growth, as this brand is opening several new locations around the metro area.

To keep up with the competition, Giant Food plans to remodel or replace 100 stores over the next three years, under the campaign “project refresh.” Since 2004 sales at Giant Food have declined 4.8% in the Washington metro area,

as consumers shifted attention to organic/specialty grocers. Safeway and Food Lion, direct competitors to Giant Food, have already changed formats to appeal to consumers. However, Giant Food stalled until recently, and now plans to upgrade the product section to a fresh market concept for produce, in addition to replacing flooring and lighting.

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Grocery-Anchored Shopping Center Vacancy RatesWashington Metro Area | Year-End 2007


Jurisdiction Vacancy

Arlington County, VA 0.35%

Washington, DC 0.47%

Montgomery County, MD 1.55%

Fairfax County, VA 1.97%

Loudoun County, VA 2.15%

City of Alexandria, VA 2.80%

Prince George’s County, MD 2.93%

Prince William County, VA 3.82%

Grocery-Anchored Shopping Center Asking RentsWashington Metro Area | 1999 - 2007


Total Grocery Sales Volume – Top ThreeWashington Metro Area | 2007

Source: Food World, Delta Associates; January 2008

Jurisdiction Sales (in Millions) Percent of Total Market Volume

Giant Food $3,106 32%

Safeway $2,193 22%

Shoppers $1,258 13%

Average per Store Grocery Sales Volume – Top FiveWashington Metro Area | 2007

Store Sales (in Millions)

Wegmans $79.05

Costco $48.84

BJ’S Wholesale $36.23

Shoppers $32.24

Sam’s Club $30.45


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Total Grocery Sales Growth – Top FiveWashington Metro Area | 2007

Store Sales Increase

Food Lion 15.5%

Harris Teeter 11.5%

Whole Foods 10.7%

Target 6.8%

Trader Joe's 6.2%


Organic/specialty stores experienced strong sales growth in 2006, outpacing traditional stores by 460 basis points. However, in 2007, traditional grocers outpaced organic/specialty stores by 130 basis points. A possible explanation could be that traditional grocers have increased the amount of organic and specialty items in their stores in order to compete with organic/specialty stores. This, coupled with an easing economy, has lured shoppers to the traditional grocer.

With super center/club stores and traditional markets capturing customers wanting organic food at affordable prices, the organic/specialty niche is feeling the pressure. In June 2007, the Federal Trade Commission (FTC) attempted to block Whole Foods from purchasing Wild Oats, another natural and organic grocery chain. The FTC felt the merger would reduce options and raise prices for consumers. Although Whole Foods’ total sales have increased each year, the rate of growth has slowed since 2004. According to financial press releases, in the 12 months ending September 2007, Whole Foods states that sales increased 13.2%, compared to 22.8% in 2004.

Whole Foods is typically priced higher than the traditional grocery store. The company attributes the slow growth in sales to a slowing economy and soft housing market, which has turned some consumers away from their higher-end groceries. In addition, Whole Foods argued that traditional grocers have increased competition by offering similar food selection and store formats. Whole Foods plans to double its sales to $12 billion a year by 2010. The company estimates that merging with Wild Oats and closing certain locations will increase revenues by up to 90%.

Whole Foods ultimately won and purchased Wild Oats for $565 million. This battle shows the strong influence of the consumer dollar, as we generate two-thirds of the economy with our spending power. In addition, it proves how competitive the food industry is and how fast it has evolved.

Whole Foods Sales GrowthUnited States | 2002- 2007

*12 months ending 3rd Quarter 2007 Source: Whole Foods, Delta Associates; January 2008

Average per Store Sales Volume – By TypeWashington Metro Area | 2006 vs. 2007

Note: Includes only grocery stores with $2 million or more in sales Source: Food World, Delta Associates; January 2008

Type 2007 Growth 2006 Growth

Super Center/Club 1.6% 4.7%

Organic/Specialty 0.6% 5.4%

Traditional 1.9% 0.8%

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Retail Growth in the Outer Suburbs

Population and income growth soared over the past seven years for Loudoun, Prince William, and Frederick Counties – the outer suburbs. As housing prices increased at a fast pace in the early part of the decade, these jurisdictions experienced a growing population of people migrating to the outer suburbs in search of affordable housing. As people migrated, retail, housing, and office development followed.

The amount of retail space has grown 18% since 2000 in the outer suburbs. Comparatively, the number of housing units increased 38%. Office space grew 128%.

Office development increased notably over the past seven years, particularly in Loudoun and Prince William County, and demand is currently having a difficult time keeping pace. Office vacancy reacted and rose in both jurisdictions to over 13% at year-end 2007, from 6% in 2000, due to a surge in groundbreakings. Rents are now starting to tick down.

Comparatively, the amount of retail space has been slow to climb in the outer suburbs, however. Retail vacancy remains chronically low at 3.2% in the outer suburbs, with asking rents climbing 11.5% over the past year.

Given the population is projected to rise 18% in the outer suburbs by 2012, additional retail space is needed to meet the demand.

Population and Income GrowthWashington Metro Area | 2000 - 2007

Source: Claritas, Delta Associates; January 2008

County Population Income

Loudoun, VA 63.5% 95.8%

Prince William, VA 29.3% 63.6%

Frederick, MD 16.0% 47.7%

Washington Metro Area 11.9% 36.7%

Commercial and Residential GrowthFrederick, Loudoun, Prince William | 2000 - 2007


Grocery-Anchored Shopping Center PurchasesWashington Suburbs | 1999 - 2007

* Includes large portfolio sale by CalPERS Note: Excludes sales of regional malls and power centers; excludes properties under contract Source: Real Capital Analytics, CoStar, Delta Associates; January 2008

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Grocery-Anchored Shopping CenterInvestment Sales

Investment purchases of shopping centers in the Washington metro area suburbs totaled $429 million on 16 notable transactions in 2007.

The investment worthiness of grocery-anchored shopping centers increased to fourth place, from seventh place in 2006, according to our annual Market Maker survey. With a score of 6.2 on a 10-point scale, this product type remains attractive.

Cap rates are starting to rise for all product types. However, according to our survey, grocery-anchored shopping centers experienced the lowest cap rate increase – just 10 basis points. With demand for assets easing, return expectations for Shopping Centers increased by 77 basis points in 2007.

NCREIF Returns for Retail Properties

According to NCREIF’s Washington area retail data, the average total investment return for the 12 months ending in September 2007 was 14.79%, exceeding the national average of 12.95%. Washington’s strong market fundamentals and high disposable income have positioned local returns ahead of the national average, and those of most other metro areas.

Retail investment returns are leveling off from the growth experienced in recent years, as the economy is transitioning. Regardless, returns remain solid. Given this market’s growing population and rising disposable income, it remains underserved from a retail perspective.

Retail Total Investment ReturnsWashington Metro vs. U.S. | 2003 - 2007

* 12 months ending September 2007 Source: NCREIF, Delta Associates; January 2008

NCREIF Return Index1 – Retail PropertiesSelect Metro Areas

1/ NCREIF compiles return based on its members’ $64.0 billion retail portfolios The index includes both current income and capital appreciation returns Source: Delta Associates, based on data in NCREIF’s 3rd Quarter 2007 Real Estate Performance Report; January 2008

Metro Area 12-Month Total Return at 3rd Quarter 20071

Chicago 16.22%

Washington 14.79%

Phoenix 14.57%

Minneapolis 13.71%

National Average 12.95%

Dallas 12.91%

Los Angeles 10.75%

Atlanta 8.60%

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Retail Outlook: The Path Forward

The Washington metro area retail market is robust, as the area remains underserved and residents have high disposable incomes.

Given the health of the metro area’s retail market, vacancy rates should remain low and rents continue to climb through 2008 and beyond for most retail types.

Although the economy continues to transition off the robust peak of the economic cycle, we expect retail vacancy to remain low and rents to continue to rise at grocery-anchored shopping centers in particular. Investment sales volume is expected to remain robust even if off its peak of 2005 - 2007, as the Washington metro area is a premier retail market with strong property performance.

In this phase of the real estate cycle, we believe our more successful clients will use cash to:

n Invest in repositioning existing, older centers, especially in closer-in submarkets.n Develop new life-style, mixed-use centers, especially accompanied by the

anchors of transportation and employment assets. n Develop grocery anchored neighborhood centers in the District and on the

leading edge of our growing metro area.n Tend to performance enhancement of existing quality assets.

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CAPITAL MARKETS ANDINVESTMENT TRENDS

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CAPITAL MARKETS AND INVESTMENT TRENDS

Record-Setting Volume, Again; All Eyes on Cap Rates as the Credit Crunch Hits

Investment sales in commercial real estate again broke records in 2007.

Real estate remained in favor despite a Credit Crunch that drove most leveraged buyers from the market. Elevated prices and some upward movement in cap rates did not seem to dissuade buyers, as a volatile stock market and soft bond market did not offer much competition. Both domestic and foreign investors who sought to capitalize on U.S. economic growth found real estate to be the best bet from a risk-reward perspective. When the pace of that growth slowed, the weak dollar helped foreign investors take even greater advantage, especially after the August Credit Crunch caused highly-leveraged buyers to withdraw from the market.

Of note, in 2007, investors sought office assets, pushing the national total to $218.4 billion, an increase of 48.9% from 2006. Other product types also experienced gains.

CAPITAL MARKETS ANDINVESTMENT TRENDS

National Investment Sales of Office Buildings2001 - 2007


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The Washington Metro: Favored Investment

The Washington metro area remains among the world’s top investment markets for real estate. Office building sales in 2007 in the Washington area reached a total volume of $10.0 billion, excluding whole-company sales. Including those sales, the total was $13.7 billion – on par with the 2006 total.

Returns are more predictable in Washington than in most other metro areas, leading to a flood of capital entering the market. Because office prices escalated so much over the last several years, returns no longer exceed the national average for that product type. For apartments and retail, however, returns continue to exceed the national average.

Due to solid total returns and a strong underlying regional economy, office building sales in the Washington area outpaced other major U.S. markets in 2007. For example, even though the LA office market remains strong, Washington’s stability attracted more investment dollars.

Investors searched for opportunities in every product type in Washington in 2007, with office and multifamily assets attracting the most interest. Total volume for all the product types was $14.8 billion in 2007, up modestly from the $14.6 billion of asset value that changed hands in 2006.

Sales volume slowed in the latter portion of the year following the Credit Crunch. Evidence suggests that cap rates edged up 25 to 65 basis points.

Total Investment Returns: Core Commercial Real EstateWashington Metro vs U.S. | 12 Months Ending September 2007

Source: NCREIF, Delta Associates; January 2008

Comparative Investment Sales Volume: Office BuildingsSelected Metro Areas | 2000 - 2007

Note: Excludes whole-company transactions Source: Real Capital Analytics, Delta Associates; January 2008

Investment SalesWashington Metro Area | 1999 - 2007

Source: Real Capital Analytics, CoStar COMPS, Delta Associates; January 2008

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Cap Rates

Washington area office cap rates declined in 2007, at least until the late Summer or early Fall. The impact of the Credit Crunch appears to be that there has been a slight increase in cap rates used by buyers to shop for assets. We anticipate cap rates will edge up in 2008 as the rate of capital flows slows. The Credit Crunch has pulled highly-leveraged buyers from the market, reducing competition for available assets. As a result, rapid price escalation is likely off the table for 2008. Price appreciation in 2008 and beyond will be earned the old fashioned way – by asset performance enhancement.

Cap Rates for Core Office AssetsWashington Metro Area | 2002 Through 2007


Basis Point Change in Cap RatesBy Product Type

Source: Annual survey by Delta Associates, conducted October 2007, of the region’s leading commercial real estate players

Product Type Basis Point Change in Cap Rate 10/06-10/07

Hotels 66

Apartments 34

Office 16

Industrial/Distribution 14

Shopping Centers 10

Value Increases

Strong demand, declining cap rates and improving fundamentals pushed sale prices to new heights in 2007, although conditions moderated late in the year. Average office sale prices rose 15.7% in the Washington metro area in 2007, after rising 3.9% in 2006. Sales of Washington area office assets averaged $369/SF in 2007.

Similar price increases were realized in 2007 for other asset classes.

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Investment Outlook

In 2008, we expect investment dollars to continue to flow into commercial real estate in the Washington area, but at a reduced volume as compared to 2005 to 2007. While it is unlikely that 2008 will bring a record-setting performance, sales volume should remain above average for 2008.

We expect cap rates to edge up in 2008, but prices should continue to rise modestly on improving property performance. Vacancy should remain low enough in most key submarkets for owners to push rents higher, keeping those assets desirable to investors.

Average Office Sales PricesSelected Metro Areas | 2007


Cap Rates In Use At Year-End 2007 By Those Looking To Acquire Assets

Note: Buyer’s cap rate, based on prior 12 months NOI, before reserves Source: Annual survey by Delta Associates, conducted October 2007, of the region’s leading commercial real estate players

Product Type All RespondentsDevelopers of This

Property Type

Apts.: High-Rise – Class A 5.62% 5.64%

Apts.: Suburban Garden – Class A 5.85% 5.85%

Apts.: Suburban Garden – Class B 6.29% 6.29%

Shop. Ctr.: Groc. Anchor – Class A 6.48% 6.43%

Office: CBD – Class B 6.55% 6.55%

Office: Suburban – Class A 6.64% 6.65%

Office: CBD – Class A 6.90% 5.90%

Industrial/Distribution: Class A 6.90% 6.80%

Office: Suburban – Class B 7.19% 7.21%

Hotels: Suburban – Class A 7.62% 7.64%

TRENDSETTERAWARD RECIPIENT

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TRENDSETTER AWARD RECIPIENT

Each year, Transwestern and its research affiliate, Delta Associates, honor an individual, or individuals, who have made a noteworthy contribution to the commercial real estate industry as a whole, and to the Washington metropolitan area in particular. This year our honoree is Oliver T. Carr, III, President and Chief Executive Officer of Carr Properties.

2008 TrendSetter of the Year

Oliver T. Carr, III President and Chief Executive Officer, Carr Properties

For over 100 years, the Carr name has been associated with Washington, DC real estate. Since founding Carr Capital in 1994 and serving as Chairman, CEO and President of the successor publicly traded firm, Columbia Equity Trust, Oliver Carr, III has established his own reputation for investment acumen and creating value for his partners and investors. In engineering a merger with an institutional investment fund to take Columbia Equity REIT private, he capitalized on two of the most significant trends impacting our industry: the expanding flow of capital into real estate and the growing influence of private equity.

Now, as the head of privately held Carr Properties, with a $1 billion commercial real estate portfolio and significant resources available for new investment and development, Oliver Carr, III has once again elevated the Carr brand to the forefront of Washington’s commercial real estate industry. For his distinguished record of accomplishment and continuing market leadership, we are very pleased to honor Oliver T. Carr, III as our 2008 TrendSetter of the Year.

TRENDSETTERAWARD RECIPIENT

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Past TrendSetter Award Recipients

Milton Peterson2006 TrendSetter of the YearChairmanThe Peterson Companies

F. Joseph Moravec2005 Public SectorTrendSetter of the YearCommissionerGSA Public Buildings Service

John E. (Chip) Akridge2005 Private SectorTrendSetter of the YearChairmanAkridge Real Estate Services

Douglas M. Duncan2003 Public SectorTrendSetter of the YearCounty ExecutiveMontgomery County

Clayton F. Foulger2004 Private SectorTrendSetter of the YearPrincipal and Vice PresidentFoulger-Pratt Companies

Bryant F. Foulger2004 Private SectorTrendSetter of the YearPrincipal and Vice PresidentFoulger-Pratt Companies

Congressman Tom Davis2004 Public SectorTrendSetter of the Year11th District of VirginiaU.S. House of Representatives

R. William Hard2003 Private SectorTrendSetter of the YearExecutive Vice President and Principal-In-Charge, LCOR

Anthony A. Williams2002 Public SectorTrendSetter of the YearMayor District of Columbia

Robert Gladstone2002 Private SectorTrendSetter of the YearChairmanQuadrangle Development

Thomas M. Garbutt2001 InstitutionalTrendSetter of the YearManaging DirectorTIAA-CREF

Michael J. Darby2001 EntrepreneurialTrendSetter of the YearPrincipalMonument Realty, LLC

Jeffrey T. Neal2001 EntrepreneurialTrendSetter of the YearPrincipalMonument Realty, LLC

Ray D’Ardenne2000 TrendSetter of the YearChief Operating OfficerLend Lease Real Estate Investments

Daniel T. McCaffery1999 TrendSetter of the YearPresidentCCR McCaffery Developments

Robert E. Burke1998 TrendSetter of the YearExecutive Vice President, OperationsBoston Properties

Raymond A. Ritchey1998 TrendSetter of the YearExecutive Vice President, Head of the Washington, D.C. Office & National Director ofAcquisitions and DevelopmentBoston Properties

Andrew Florance2007 Public CompanyTrendSetter of the YearFounder, Director,President & CEOCoStar Group, Inc.

Benjamin Jacobs2007 Private CompanyTrendSetter of the YearManaging PartnerThe JBG Companies

Michael Glosserman2007 Private CompanyTrendSetter of the YearManaging PartnerThe JBG Companies

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A STATE OF THE MARKET OVERVIEW AND FORECAST REPORT

2007 Market Maker Survey Participants

Delta Associates thanks all of its 2007 Market Maker survey participants, among whom are the following:

Advance Realty Group LCOR

AIMCO Lincoln Investment Management

Apollo Real Estate Advisors Manekin Corporation

Bernstein Management Corp. Meridian Group

Boston Capital Merritt Properties

Bozzuto Group Metro Management Services

Brandywine Realty Trust Mid-City Finance Corporation

Broad Street Ventures Northwestern Mutual Life

Buchanan Partners Penrose Group

Chesapeake Real Estate Group Potomac Investment Properties

Donohoe Companies, Inc. Prudential Real Estate Investors

DRI Partners PS Business Parks

Eastdil - Wells Fargo Quadrangle Development Corporation

Elm Street Development Rappaport Companies

Fairfield Residential Roadside Development

First Centrum Corporation Sidewalk Development Advisors

Gables Residential Spaulding & Slye Colliers

General Investment & Development Transwestern

GMU Institute of Public Policy Union Realty Partners, Inc.

Green Light Retail Real Estate Services Uniwest Jefferson

Holliday Fenogilo Fowler Van Metre Management Company

John Akridge Companies Velsor Properties

John B. Levy & Co. Wells Fargo Bank

Johns Hopkins University

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Documents

Delta Associates Trend Lines 2008