I. Capitalization Rates-The average cap rate for 2010 for the four primary property types will be 9.5%. This is an increase from the 9% cap rate we projected in our July 15, 2009 newsletter. Some trophy properties and ones with attractive assumable debt will trade lower, in the 8% range and B & C type properties and vacant/distressed projects higher, in the 10%-12% range. Many real estate heavyweights have recently stated that cap rates will top out at 8%. We disagree, because CRE has not yet hit bottom, investors are more risk adverse and will require higher returns, there is still a lack of debt and equity capital, defaults and foreclosures are still rising and fundamentals are still deteriorating.

II. CRE Fundamentals-Property fundamentals for all property types including rent, occupancy, absorption and management will continue to deteriorate in 2010. We do not see the economy and job growth recovering and this will continue to hurt commercial real estate operations. We also predict property specific issues to continue to negatively affect the industry. Retail will see more large chain store bankruptcy’s and store closings, the office sector will be hurt by limited job growth, the apartment market will continue to weaken as potential renters move home and double up and industrial properties will remain strained as slow job growth and the difficult economy curtail global trade flows.

III. Bank Closures-The FDIC will close more than 150 banks in 2010. This is after 140 and 25 banks were closed in 2009 and 2008, respectively. Most of the bank closures will be smaller community banks that have a higher percentage of their assets in commercial real estate and SBA loans.

IV. State of California-The U.S. Government will have to bail out California either through direct loans or repayment of federal mandates. The state is currently facing a budget deficit of more than $20 billion and with the weak economy and job market; the red ink will continue to grow. The state’s budget is funded primarily through income taxes with the top rate at 9.55% plus a 1% surcharge for incomes over $1 million. With a very weak job market and many higher income earners leaving the state, it would be extremely difficult, without a bailout from the U.S. Government, to raise taxes and/or cut spending to reduce the deficit.

V. Budget Deficit-The U.S. budget deficit will again explode for fiscal year 2010 and exceed $1.5 trillion after hitting $1.4 trillion in fiscal year 2009. A weak economy, decreased tax receipts and unrelenting spending by Congress will cause the increased deficit.

VI. Oil-Oil will top over $100 per barrel in 2010. Although the U.S. economy will be sluggish at best, there will be increased demand for oil from the BRIC countries, Brazil, Russia, India and China. We also see the dollar weakening and with oil priced in dollars, the price per barrel will increase.

VII. Unemployment Rate-The unemployment rate will stay above 9% due to ineffective fiscal policies of the current administration, continued consumer and business deleveraging, uncertainty regarding new government programs, tax increases and increased regulation.

VIII. Ten Year Bond Yield-The ten year treasury bond yield currently quoted at approximately 3.70% will increase to over 5% in 2010. Bond investors will demand higher returns due to the oversupply of Treasury paper, higher inflation expectations, profligate spending in Washington, huge budget deficits, zero short term interest rates and easy Federal Reserve Monetary policy. All of these will increase inflation and hence long term bond yields in 2010.

IX. Federal Funds Rate-The Federal funds rate which is currently zero will be increased but not above 1% by the Fed in 2010. We believe that the economy will stay sluggish with high joblessness and 2010 being an election year, the Fed will make only tepid increases in the rate. The market (see VIII above), however will force long term rates higher.

X. Inflation/Gold-As stated above, inflation will rise substantially in 2010 from 2009 to at least 4.5%-5% or more as measured by the consumer price index. Profligate government spending and zero short term interest rates will cause inflation expectations to rise and eventually higher prices for goods and services. Gold will increase to over $1,500 per ounce from $1,100 per ounce as nervous investors seek gold as hard asset protection from inflation, a falling dollar and uncontrolled government spending.

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