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Insights + Trends + Opportunities 3Q13

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Insights + Trends + Opportunities is a quarterly publication by Transwestern. Each issue contains a message from Transwestern leadership, and economic outlook by Transwestern's research affiliate, Delta Associates, and a tenant and landlord article on various topics. In this issue, we take a look at how real estate strategies can create business solutions. Through two examples, we show how going above and beyond for our clients accomplishes much more than finding suitable space. Additionally for this issue, we have partnered with Aon to delve into the issue of terrorism coverage. The federal mandate that requires insurance firms to offer the coverage is set to expire at the end of 2014, which could increase premiums for many commercial property owners.
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INSIGHTS TRENDS OPPORTUNITIES + + 3Q 2013
Transcript
Page 1: Insights + Trends + Opportunities 3Q13

INSIGHTSTRENDS OPPORTUNITIES

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3Q 2013

Page 2: Insights + Trends + Opportunities 3Q13

IN THIS ISSUE...PERFORMANCE ADVANTAGEA Message From Robert D. Duncan, Chairman andLarry P. Heard, President and Chief Executive Officer

ECONOMIC OUTLOOKIs the Flight to Quality for U.S. Office Space Fading or Enduring?By Alexander (Sandy) PaulExecutive Vice PresidentDelta Associates

TERRORISM COVERAGE THREATENEDFederal Mandate for Insurance Firms to Offer Terrorism Coverage May Be EliminatedBy Aaron F. DavisAon Risk ServicesManaging Director of Aon Broking

BENEFITING BEYOND REAL ESTATECreate Business Solutions with Real Estate StrategiesBy Michael GriffinPrincipalTenant Advisory Services

Page 3: Insights + Trends + Opportunities 3Q13

PERFORMANCE ADVANTAGEA Message from Robert D. Duncan and Larry P. Heard

We are delighted to present to you, our valued client, our latest edition of Insights, a real-time, hands-on, grass-roots look at trends we see in the real estate markets. In this rapidly changing, highly competitive marketplace, every dollar and every hour counts. Through our “boots on the ground” local market knowledge and our diversified competencies, Transwestern is uniquely capable of arming you with valuable information that will improve your decision making.

As Transwestern celebrates its 35th anniversary this year, we take this opportunity to offer our heartfelt thanks for the business relationship we enjoy with you. Your support and confidence, your constructive feedback and valuable insights, and your quest for excellence has been the foundation of our success. We want to reciprocate by committing to you that we will strive each day to exceed your expectations, to be a thought-leader in our industry and to be your Performance Advantage in Real Estate.

Warmest personal regards,

Robert D. Duncan Larry P. Heard

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

Page 4: Insights + Trends + Opportunities 3Q13

ECONOMIC OUTLOOKIs the Flight to Quality for U.S. Office Space Fading or Enduring?By Alexander (Sandy) PaulExecutive Vice PresidentDelta Associates

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

During and after the recession of 2007 to 2009, tenants sought ways to reduce occupancy costs

Densification – reducing the amount of space leased per worker

Downsizing or eliminating private offices, or telecommuting or hoteling programs

Smaller workspaces, shared desks and fewer employees all lead to less leased space and lower occupancy costs

More efficient office space

Often required a move to newer space that was better constructed

Led to a “flight to quality” – increase in amount of Class A space absorbed compared to Class B and C space

2007: As economy began to weaken, Class A space secured 68 percent of all net new demand

2008: Figure shot up to 91 percent

Fewer tenants seeking new space, but those that were found better deals on premium space

2009: All office absorption was negative, including Class A space, though top-tier assets were not hit as hard by vacating tenants

Page 5: Insights + Trends + Opportunities 3Q13

ECONOMIC OUTLOOK, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

2010 to 2012: Overall demand accelerated; Class A product captured 55 to 65 percent of net absorption

First half of 2013: Demand decelerated while the share going to Class A buildings remained in that same range, despite overall economic improvement

GDP growth from 0.1 percent on an annualized basis during 4Q12 to 1.1 percent in 1Q13 and 1.7 percent in 2Q13

Is the plateauing of Class A share of absorption the new normal, or might the flight to quality continue? And if the flight to quality is tapering, why might that be? Discounted Class A rents tenants took advantage of from 2009 to 2011 are not as cheap

2012: Class A asking rents rising at average rate of 1.8 percent while Class B rents edging down 0.1 percent

Tenants took Class A space off the market while rents were low, causing owners to eventually push rents higher

2013: Class A and B rents have increased at the same rate, 0.3 percent

Higher-end space is no longer the bargain it was from 2009 to 2011

Page 6: Insights + Trends + Opportunities 3Q13

ECONOMIC OUTLOOK, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

Class A space, particularly newer product, still offers advantages of layout, energy efficiency and technological amenities most Class B and C cannot

For that reason, we expect the flight to quality to continue, though the gap between Class A and B demand may narrow some

Modest economic growth causing Class A rents to remain affordable in most markets with growth rates below long-term average

Encourages tenants to seek better accommodations so they stand out to potential employees as competition for talent heats up with economy

More efficient space today will allow for long-term cost savings

What can owners and tenants do at this pivot point in the real estate cycle? Owners: Look at renovating Class B space into Class A product to compete long-term

Owners may also look into acquiring or developing product that stands out for efficiency

Many large tenants are willing to pay higher rent per square foot if they can lease less space

Tenants: Take advantage of slow-growing Class A rents to lock in favorable, long-term deals

Consider using leverage of modest pullback in net new office demand to secure concessions on higher-quality space

We expect the flight to quality to continue, though the gap between Class A and B demand may narrow some

Page 7: Insights + Trends + Opportunities 3Q13

ECONOMIC OUTLOOK, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

-30

-20

-10

0

10

20

30

40

50

60

70

2007 2008 2009 2010 2011 2012 2013Annualized

68%

34%

-2%

91%

39%

-30%N/A

N/A

N/A

62%

36%

1%

57%

39%

4%

63%

36%

1%

56%

37%

7%

Class A Class B Class C

Percentages reflect share of total U.S. office absorption

Source: CoStar, Delta Associates; August 2013.Note: Percentages may not total 100 percent due to rounding. Shares for 2009 are not available because U.S. total absorption was negative.

Net Absorption of Office SpaceUnited States | 2007 — First Half 2013

Net A

bsor

ptio

n in

Mill

ions

of S

F

-30

-20

-10

0

10

20

30

40

50

60

70

2007 2008 2009 2010 2011 2012 2013Annualized

68%

34%

-2%

91%

39%

-30%N/A

N/A

N/A

62%

36%

1%

57%

39%

4%

63%

36%

1%

56%

37%

7%

Class A Class B Class C

Percentages reflect share of total U.S. office absorption

Page 8: Insights + Trends + Opportunities 3Q13

ECONOMIC OUTLOOK, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

$26

$27

$28

$29

$30

2007 2008 2009 2010 2011 2012 2013*

1.1%

-5.8%

-1.6%-0.4%

1.8% 0.3%

Percentages reflect year-over-year rent change

Source: CoStar, Delta Associates; August 2013.*Average rent as of mid-year 2013; percentage change from year-end 2012 through mid-year 2013.

Average Rents for Class A Office SpaceUnited States | 2007 — First Half 2013

Aver

age

Aski

ng R

ent

$\SF

\Ann

um, F

ull S

ervic

e

$26

$27

$28

$29

$30

2007 2008 2009 2010 2011 2012 2013*

1.1%

-5.8%

-1.6%-0.4%

1.8% 0.3%

Percentages reflect year-over-year rent change

Page 9: Insights + Trends + Opportunities 3Q13

ECONOMIC OUTLOOK, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

35

40

50

55

Mar 09May 09

July 09Sept 09

Nov 09Jan 10

Mar 10May 10

July 10Sept 10

Nov 10Jan 11

Mar 11May 11

July 11Sept 11

Nov 11Jan 12

Mar 12May 12

July 12Sept 12

Nov 12Jan 13

Mar 13

45

Source: CoStar, Delta Associates; August 2013.*Average rent as of mid-year 2013; percentage change from year-end 2012 through mid-year 2013.

Average Rents for Class B Office SpaceUnited States | 2007 — First Half 2013

Aver

age

Aski

ng R

ent

$\SF

\Ann

um, F

ull S

ervic

e

Page 10: Insights + Trends + Opportunities 3Q13

TERRORISM COVERAGE THREATENEDMandate for Insurance Firms to Offer Terrorism Coverage May Be EliminatedBy Aaron F. DavisAon Risk ServicesManaging Director of Aon Broking

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

Government regulation requiring insurance carriers to provide terrorism coverage set to expire at year-end 2014

If mandate is not extended, higher insurance costs likely for many commercial property owners

Many insurance companies will not offer the coverage if they are not required to do so

Building owners whose lenders require terrorism insurance can expect higher premiums

Rate increases will vary based on each building’s risk profile

Annual increase could be as low as 10 percent or skyrocket above 100 for buildings in high-density, high-risk metropolitan areas like New York City

The Terrorism Risk Insurance Act, better known as TRIA (tree’-uh), established in 2002 after World Trade Center attacks

TRIA required insurance carriers to offer terrorism coverage, with the government guaranteeing to pay for damages above a certain amount

TRIA renamed twice; now called the Terrorism Risk Insurance Program Reauthorization Act, or TRIPRA, but still commonly referred to as TRIA

Page 11: Insights + Trends + Opportunities 3Q13

TERRORISM COVERAGE, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

Pricing for terrorism coverage improved dramatically over the last decade due to federal government involvement

TRIA created competition among insurance carriers, seeking to win business of the 80 to 90 percent of CRE owners purchasing terrorism coverage

CRE tends to pay more for terrorism coverage than other industries, though prices are higher for natural resource companies, transportation firms and financial institutions

Seen as higher risk because of large concentrations of value in small areas

The majority of insurance carriers likely to discontinue terrorism coverage because they cannot predict potential losses

Historical data shows how often earthquakes, windstorms and flooding occur, but there is no modeling for terrorism

Terrorism is a man-made threat so it’s unknown how often it can occur

Concerns rating agencies, like Standard & Poor’s and Fitch Ratings, that gauge the ability of insurance carriers to pay claims

Historical data shows how often earthquakes, windstorms and flooding occur, but there is no modeling for terrorism

Page 12: Insights + Trends + Opportunities 3Q13

TERRORISM COVERAGE, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

CRE owners that renew policies this year will have TRIA coverage in place

May have difficulty securing policies written in latter part of 2013 that extend beyond 2014

If TRIA not extended, property owners that are still required by lenders to carry terrorism coverage will be heavily burdened

With smaller number of carriers offering coverage, prices will be driven up

Same number of insureds will chase less capacity and pay more for it

TRIA’s fate is ultimately a political decision

U.S. Senate Banking Committee, U.S. House Financial Services Committee and White House Administration hold the keys

Some lenders signaled support for an extension; others see TRIA as subsidy to financial industry and exposure for taxpayers

Geography plays crucial role — terrorism perceived to be less of a threat in the South than the Northeast, and therefore not perceived as a national risk

Most CRE owners are not aware of looming issue surrounding extension of TRIA

Initially, only affects the reinsurance behind carrier’s policy, but if TRIA is eliminated, CRE owners will become very aware of the issue when it comes time to renew terrorism coverage

Copyright © 2013 Aon plc. This article is provided for general informational purposes only and is not intended to provide individualized business or legal advice. Should you have any questions regarding how the subject matter of this alert may impact you, please contact your Aon team member or other appropriate advisor.

Page 13: Insights + Trends + Opportunities 3Q13

BENEFITS BEYOND REAL ESTATECreate Business Solutions with Real Estate StrategiesBy Mitchell GriffinPrincipalTenant Advisory Services

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

Astute executives should consider utilizing real estate as a business solution — a means by which to achieve overall strategic goals

Real estate brokers implementing advanced methodology serve as business consultants who just so happen to work in real estate

EFA Processing needed to raise $2 million for its new start-up company, Broadsword Student Advantage Enough office space to accommodate both current operations and new Broadsword venture

until its lease ended in 2018

The office was in Frisco, Texas, one of the most expensive submarkets in North Texas

By subleasing space at a discounted rate, firms were able to move both operations to Dallas’ more affordable Addison submarket, netting $650,000 in savings

Relocation also addressed firms’ issue of needing to hire a large number of employees

Many of the targeted millennial employees live near firms’ new urban office

Page 14: Insights + Trends + Opportunities 3Q13

BENEFITS BEYOND REAL ESTATE, cont.

www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES

An insurance company addressed future business needs and transformed its culture Committed to 17,000 square feet through 2017 and needed to expand by 3,000 square feet

Expansion space available in existing location, but not room for future growth

10-year deal structured in new location for an entire 26,000-square-foot floor

Ownership agreed to let tenant pay for a fraction of newly occupied space for a period, then pay in full for remainder of the term when additional space is actually needed

Deal will save $250,000 and permits tenant to vacate patched-together office environment and create space that will be more “Starbucks” rather than “Dilberville.”

Companies should recognize that real estate is an avenue to accomplish business goals Likewise, real estate brokers need to be able to advise clients to that

end — creating business solutions with real estate strategies

It takes time and creativity to accomplish this, but tenants should expect this level of service from their real estate representatives

It takes time and creativity to accomplish this, but tenants should expect this level of service from their real estate representatives

Page 15: Insights + Trends + Opportunities 3Q13

Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, development, research and sustainability. The fully integrated enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. Transwestern facilitates better decision-making for clients by combining penetrating local market intelligence and macro-market research through its affiliate, Delta Associates. Transwestern has 33 U.S. offices and assists clients through more than 180 offices in 36 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.

© 2013 TRANSWESTERN

www.transwestern.net

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