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INSIGHTSTRENDS OPPORTUNITIES
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3Q 2013
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
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
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
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
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
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
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
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
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
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
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.
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
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
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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3Q 2013