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 3Q13

  1. 1. INSIGHTS TRENDS OPPORTUNITIES + + 3Q 2013
  2. 2. IN THIS ISSUE...PERFORMANCE ADVANTAGE A Message From Robert D. Duncan, Chairman and Larry P. Heard, President and Chief Executive Officer ECONOMIC OUTLOOK Is the Flight to Quality for U.S. Office Space Fading or Enduring? By Alexander (Sandy) Paul Executive Vice President Delta Associates TERRORISM COVERAGE THREATENED Federal Mandate for Insurance Firms to Offer Terrorism Coverage May Be Eliminated By Aaron F. Davis Aon Risk Services Managing Director of Aon Broking BENEFITING BEYOND REAL ESTATE Create Business Solutions with Real Estate Strategies By Michael Griffin Principal Tenant Advisory Services
  3. 3. PERFORMANCE ADVANTAGE A 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
  4. 4. ECONOMIC OUTLOOK Is the Flight to Quality for U.S. Office Space Fading or Enduring? By Alexander (Sandy) Paul Executive Vice President Delta Associates www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ During and after the recession of 2007 to 2009, tenants sought ways to reduce occupancy costs ƒƒ Densification – reducing the amount of space leased per worker ƒƒ Downsizing or eliminating private offices, or telecommuting or hoteling programs ƒƒ Smaller workspaces, shared desks and fewer employees all lead to less leased space and lower occupancy costs ƒƒ More efficient office space ƒƒ Often required a move to newer space that was better constructed ƒƒ Led to a “flight to quality” – increase in amount of Class A space absorbed compared to Class B and C space ƒƒ 2007: As economy began to weaken, Class A space secured 68 percent of all net new demand ƒƒ 2008: Figure shot up to 91 percent ƒƒ Fewer tenants seeking new space, but those that were found better deals on premium space ƒƒ 2009: All office absorption was negative, including Class A space, though top-tier assets were not hit as hard by vacating tenants
  5. 5. ECONOMIC OUTLOOK, cont. www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ 2010 to 2012: Overall demand accelerated; Class A product captured 55 to 65 percent of net absorption ƒƒ First half of 2013: Demand decelerated while the share going to Class A buildings remained in that same range, despite overall economic improvement ƒƒ 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? ƒƒ Discounted Class A rents tenants took advantage of from 2009 to 2011 are not as cheap ƒƒ 2012: Class A asking rents rising at average rate of 1.8 percent while Class B rents edging down 0.1 percent ƒƒ Tenants took Class A space off the market while rents were low, causing owners to eventually push rents higher ƒƒ 2013: Class A and B rents have increased at the same rate, 0.3 percent ƒƒ Higher-end space is no longer the bargain it was from 2009 to 2011
  6. 6. ECONOMIC OUTLOOK, cont. www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ Class A space, particularly newer product, still offers advantages of layout, energy efficiency and technological amenities most Class B and C cannot ƒƒ For that reason, we expect the flight to quality to continue, though the gap between Class A and B demand may narrow some ƒƒ Modest economic growth causing Class A rents to remain affordable in most markets with growth rates below long-term average ƒƒ Encourages tenants to seek better accommodations so they stand out to potential employees as competition for talent heats up with economy ƒƒ 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? ƒƒ Owners: Look at renovating Class B space into Class A product to compete long-term ƒƒ Owners may also look into acquiring or developing product that stands out for efficiency ƒƒ Many large tenants are willing to pay higher rent per square foot if they can lease less space ƒƒ Tenants: Take advantage of slow-growing Class A rents to lock in favorable, long-term deals ƒƒ 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
  7. 7. 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 2013 Annualized 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 Space United States | 2007 — First Half 2013 NetAbsorptioninMillionsofSF -30 -20 -10 0 10 20 30 40 50 60 70 2007 2008 2009 2010 2011 2012 2013 Annualized 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
  8. 8. 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 Space United States | 2007 — First Half 2013 AverageAskingRent $SFAnnum,FullService $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
  9. 9. ECONOMIC OUTLOOK, cont. www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES 35 40 50 55 M ar09 M ay09 July09 Sept09 Nov09 Jan10 M ar10 M ay10 July10 Sept10 Nov10 Jan11 M ar11 M ay11 July11 Sept11 Nov11 Jan12 M ar12 M ay12 July12 Sept12 Nov12 Jan13 M ar13 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 Space United States | 2007 — First Half 2013 AverageAskingRent $SFAnnum,FullService
  10. 10. TERRORISM COVERAGE THREATENED Mandate for Insurance Firms to Offer Terrorism Coverage May Be Eliminated By Aaron F. Davis Aon Risk Services Managing Director of Aon Broking www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ Government regulation requiring insurance carriers to provide terrorism coverage set to expire at year-end 2014 ƒƒ If mandate is not extended, higher insurance costs likely for many commercial property owners ƒƒ Many insurance companies will not offer the coverage if they are not required to do so ƒƒ Building owners whose lenders require terrorism insurance can expect higher premiums ƒƒ Rate increases will vary based on each building’s risk profile ƒƒ 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 ƒƒ The Terrorism Risk Insurance Act, better known as TRIA (tree’-uh), established in 2002 after World Trade Center attacks ƒƒ TRIA required insurance carriers to offer terrorism coverage, with the government guaranteeing to pay for damages above a certain amount ƒƒ TRIA renamed twice; now called the Terrorism Risk Insurance Program Reauthorization Act, or TRIPRA, but still commonly referred to as TRIA
  11. 11. TERRORISM COVERAGE, cont. www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ Pricing for terrorism coverage improved dramatically over the last decade due to federal government involvement ƒƒ TRIA created competition among insurance carriers, seeking to win business of the 80 to 90 percent of CRE owners purchasing terrorism coverage ƒƒ CRE tends to pay more for terrorism coverage than other industries, though prices are higher for natural resource companies, transportation firms and financial institutions ƒƒ Seen as higher risk because of large concentrations of value in small areas ƒƒ The majority of insurance carriers likely to discontinue terrorism coverage because they cannot predict potential losses ƒƒ Historical data shows how often earthquakes, windstorms and flooding occur, but there is no modeling for terrorism ƒƒ Terrorism is a man-made threat so it’s unknown how often it can occur ƒƒ 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
  12. 12. TERRORISM COVERAGE, cont. www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ CRE owners that renew policies this year will have TRIA coverage in place ƒƒ May have difficulty securing policies written in latter part of 2013 that extend beyond 2014 ƒƒ If TRIA not extended, property owners that are still required by lenders to carry terrorism coverage will be heavily burdened ƒƒ With smaller number of carriers offering coverage, prices will be driven up ƒƒ Same number of insureds will chase less capacity and pay more for it ƒƒ TRIA’s fate is ultimately a political decision ƒƒ U.S. Senate Banking Committee, U.S. House Financial Services Committee and White House Administration hold the keys ƒƒ Some lenders signaled support for an extension; others see TRIA as subsidy to financial industry and exposure for taxpayers ƒƒ 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 ƒƒ Most CRE owners are not aware of looming issue surrounding extension of TRIA ƒƒ 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.
  13. 13. BENEFITS BEYOND REAL ESTATE Create Business Solutions with Real Estate Strategies By Mitchell Griffin Principal Tenant Advisory Services www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES ƒƒ Astute executives should consider utilizing real estate as a business solution — a means by which to achieve overall strategic goals ƒƒ 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 ƒƒ Enough office space to accommodate both current operations and new Broadsword venture until its lease ended in 2018 ƒƒ The office was in Frisco, Texas, one of the most expensive submarkets in North Texas ƒƒ 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 ƒƒ Relocation also addressed firms’ issue of needing to hire a large number of employees ƒƒ Many of the targeted millennial employees live near firms’ new urban office
  14. 14. BENEFITS BEYOND REAL ESTATE, cont. www.transwestern.net 3Q2013 INSIGHTS + TRENDS + OPPORTUNITIES An insurance company addressed future business needs and transformed its culture ƒƒ Committed to 17,000 square feet through 2017 and needed to expand by 3,000 square feet ƒƒ Expansion space available in existing location, but not room for future growth ƒƒ 10-year deal structured in new location for an entire 26,000-square-foot floor ƒƒ 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 ƒƒ 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 ƒƒ Likewise, real estate brokers need to be able to advise clients to that end — creating business solutions with real estate strategies ƒƒ 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
  15. 15. 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 JOIN THE CONVERSATION CONVERSATION INSIGHTS TRENDS OPPORTUNITIES + + READ THE FULL VERSION LANDLORD TENANT 3Q 2013

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