INSIGHTS TRENDS OPPORTUNITIES - Transwestern · of 8.4 million payroll positions on a...

INSIGHTSTRENDS OPPORTUNITIES

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3Q 2014

INSIGHTSTRENDS OPPORTUNITIES

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3Q 2014 EDITION

© 2014 TRANSWESTERN transwestern.com

Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 181 offices in 40 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.

U.S RECOVERY EXPECTED TO CONTINUE A Message From Robert D. Duncan, Chairman, and Larry P. Heard, President and Chief Executive Officer

GRESB: EXPLORING THE SUSTAINABILITY BENCHMARK’S STAYING POWER By Al Skodowski Managing Senior Vice President and Director of LEED and Sustainability Services Transwestern

SMALL BUILDING IN LARGE INDUSTRIAL PARK HAS HUGE IMPACT By Jennifer Wagner Senior Vice President Ridge Development

BEYOND THE COST OF PHYSICAL SPACE: How Labor Analytics Can Drive Your Firm’s Growth By Brian McKenzie, Robert Richards and Brian Cohen Tenant Advisory Transwestern

INVESTMENT SALES VOLUME AND THE DEMAND FOR SPACE By Alexander (Sandy) Paul Executive Vice President Delta Associates

transwestern.com 3Q2014 INSIGHTS + TRENDS + OPPORTUNITIES

When 2014 comes to a close, we will have concluded the fifth year of economic recovery since the end of the Great Recession. Many may ask the question, has it really been five years? Even though it may not feel like it, that is exactly where we are in this steady, yet sometimes uneven, economic recovery.

A cornerstone of the current recovery has been investor thirst for “hard assets,” including commercial real estate. The appeal of solid current returns blended with a physical asset and its potential as a hedge against future inflation has accelerated the infusion of capital into the sector. Transwestern has worked enthusiastically and tirelessly to distinguish itself as the “go-to” source for many investors across the country. During this current economic cycle, many exceptional investment realizations have occurred, and in our view, more are on the horizon.

We as a firm have been working strategically to engineer asset turnarounds, uncover new and compelling opportunities in key growth sectors, guide our occupier clients’ space initiatives and enhance communication with our customers across the globe. These efforts have inspired our recent expansion in those strategically selected areas most responsive to the highest priority needs of our customers.

We realize economists and media outlets alike are not entirely convinced of the resilience of our domestic economy. Global political turmoil and overly aggressive monetary policies are most often cited as culprits of an imminent decline. We believe, at some point, they will be correct. At some point, we will indeed experience another economic downturn. But we do not expect that to occur any time soon. Our view is fortified by what has turned out to be irrepressible corporate financial performance, encouraging job gains across the country and robust foreign investment into domestic commercial real estate assets.

We are encouraged by what we are viewing throughout the economy in the United States. We agree with the assessment of one of our partners, Carleton Riser, president of Transwestern Development. When recently asked where we are in the current recovery cycle, he said, “I believe we are in the sixth inning of an extra-innings game.” We think he is right.

Thanks to each of you for the trust you place in Transwestern. We look forward to staying suited-up for the duration of what could be an extended ball game.

Robert D. Duncan Larry P. Heard Chairman President & CEO

U.S. RECOVERY EXPECTED TO CONTINUE DESPITE GLOBAL UNCERTAINTYA Message from Robert D. Duncan and Larry P. Heard

INVESTMENT SALES VOLUME AND THE DEMAND FOR SPACEBy Alexander (Sandy) Paul Executive Vice President Delta Associates

In 2009, the investment market for U.S. commercial real estate reached a cyclical trough, with the sales volume of office, industrial, apartment and retail properties totaling only $60.5 billion. This compares with $450.4 billion in 2007, at the peak of the last cycle. This 87 percent decline in two years reflected the unraveling of the global economy and the challenges of securing financing during a tumultuous period for the market. Those with equity were able to secure good deals at the time on quality properties that were owned by entities short on cash.

Fast-forward to 2014. During the first half of this year, the four principal types of commercial real estate have recorded $150.3 billion in U.S. sales volume. This total puts the nation on pace to nearly match last year’s annual total of $312.6 billion. While the investment sales market has not rebounded to the heights of 2007, it has rebounded strongly from the trough in 2009. Each property type is on pace to record sales volume in 2014 that is at least 300 percent higher than five years ago.

Why has volume come back? For several reasons, including improved market fundamentals. With U.S. job growth of 8.4 million payroll positions on a seasonally-adjusted basis during the past five years, there is substantially more demand for office space – the U.S. has finally rebounded to (and past) the pre-recession peak for payroll employment.


Further, more workers are in a position to create new households, gradually de-coupling from roommate situations to rent apartments. More new jobs and new households are likely to be created in the next few years, further increasing demand for office space and apartments, as well as retail goods and the distribution space that supports the retail supply chain. In short, all four major property types should benefit from increased economic activity between now and 2017 or 2018, when the expansion cycle is likely to wind down.

Yet, there are concerns in many metro markets about too much new office and residential development that give investors pause and place downward pressure on the investment sales market. In addition, changes in how we work and live – from densification of the office environment (a reduction in the square feet leased per worker) to online shopping (which has increased the need for distribution space) – are factors in how investors view the commercial markets.

Of note, the sales volume during the first half of 2014 put this year on pace to come up 4 percent shy of last year’s total. Each property type is on pace for less value

to trade hands in 2014 than in 2013 – from 1 percent to 9 percent less than a year ago. Are investors finding better value elsewhere?

Some of this disparity is simply statistical anomaly. With the fourth quarter often the strongest of the year, annualizing first half totals is not a perfect representation of how the year actually will finish. We could increase our forecast for 2014 to account for this, but using prior fourth quarters as a model would not necessarily be more predictive, given the many variables in forecasting both economic growth and the demand for real assets. Beyond statistical matters, though, investors are seeking yield and having to go to second-and third-tier markets to find it. Naturally, the aggregate value of the properties sold in secondary and tertiary markets will not match that of properties sold in core markets. Of note, at the national level, pricing generally continued to rise during the first half of 2014, with some variation by product type.

What action steps do the recent trends in investment sales volume suggest for owners and tenants of commercial real estate?

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2009 2010 2011 2012 2013 2014*

U.S. COMMERCIAL REAL ESTATE SALES VOLUME (IN BILLIONS)

OFFICE +483%

APARTMENT +409%

RETAIL +317%

INDUSTRIAL +342%

Source: Real Capital Analytics, graphic by Delta Associates; August 2014. *YTD through June, annualized.

2009 – 2014

“ALL FOUR MAJOR PROPERTY TYPES SHOULD BENEFIT FROM

INCREASED ECONOMIC ACTIVITY BETWEEN NOW

AND 2017 OR 2018.”


ACTION STEPS FOR OWNERS

While sales volume may not continue to rise at its recent pace, values are likely to continue increasing over the next few years due to job creation and overall economic growth. Owners of commercial real estate should consult with their advisors to develop or refine efforts to maximize occupancy during the expansion cycle. If interest rates rise over the next few years, as many pundits predict, the number of potential buyers for each asset may decline. Therefore, planning an exit strategy today is wise. On the other hand, if inflation increases, which also is expected by many economists, then holding commercial real estate would make sense, as it is regarded as a good inflation hedge. Further, real estate may be a better alternative to stocks, as the peak of the bull market may not be far away. Bonds have little appeal in a market of rising interest rates. In sum, owners should assess their alternative investment options and their thinking on interest rates and inflation and then plan accordingly.

ACTION STEPS FOR TENANTS

Tenants should be aware that as properties change hands over the next few years, they may have an opportunity to extend or renegotiate their lease terms with a new owner. Office tenants that have significant new requirements – rare in today’s market – may be able to use their leverage to lock in lower rents. This is especially true in situations where a new owner’s goal is to increase occupancy and then sell the property.

Alexander (Sandy) Paul [email protected] 703.299.6373

BEYOND THE COST OF PHYSICAL SPACE: How Labor Analytics Can Drive Your Firm’s Growth

When many companies consider relocating, they focus primarily on how much the new office space will cost. And rightly so, since real estate expenses are typically the second-largest operating cost behind employee costs for most corporations. However, a real estate decision is so much more than picking the right building on the right block. It’s an operational decision that can be transformative, helping the company elevate business performance to the next level by capitalizing on top talent.

THE CASE FOR LABOR ANALYTICS

C-level executives are increasingly focused on labor analytics as a major factor in creating optimal real estate solutions for their organizations. For companies that understand the value of this approach, the lead driver in a relocation decision is determining which location will position the firm to recruit from the labor pool it needs to be successful today, as well as 10 years down the road. Sometimes that requires implementing creative workplace strategies or paying more for office space to accomplish corporate goals. Companies that are looking to achieve

“break out” performance will consider the overall value of a location (access to human capital, partners, customer base, etc.), rather than just focus on selecting the lowest cost option.

Analyzing how accessible a potential site is from a firm’s existing employees is important, but it’s just the beginning of a more detailed labor analytics process. Skilled labor analytics specialists delve much deeper into a company’s business functions to evaluate all relevant factors. They examine a client’s industry and labor needs of the various functional divisions within the company. They determine what skill sets future employees must possess and from which industries they could be recruited. They perform comprehensive studies on where the desired employees live and where they currently work. That data is evaluated in conjunction with the standard real estate metrics of submarket, size and price per square foot.

Failure to thoroughly study the labor pool can result in higher overall costs. For example, leaders of a call center hired our team to advise them after completing a less than perfect relocation. Call center executives were pleased with the fantastic deal they got on their building – until they finished the move and found they couldn’t keep the call center staffed. They realized quickly that no space is good if you can’t find and retain the right people to work in it. The average cost of attrition of a typical frontline employee is 40 percent of their annual compensation, according to a study by Corporate Executive Board, a business advisory firm. Attrition-related costs are extensive, including

Brian McKenzie Partner, Tenant Advisory Transwestern

Robert Richards Partner, Tenant Advisory Transwestern

Brian Cohen Senior Vice President, Tenant Advisory Transwestern

expenses associated with in-house or outsourced recruiting, training new employees, lost productivity and other factors. In short, a site selection decision that results in high turnover can be very costly.

Take the following example (see chart) of a contact center operation that saved $10.00 per square foot in rent expense versus a more costly, better located submarket. Unfortunately, the suboptimal nature of the location contributed to a high 60 percent annual attrition rate. The annual cost of attrition far outpaced any real estate cost savings, resulting in the company paying a premium of $1.7 million per year. In addition to overall cost savings, forward-looking companies examine the ability to recruit the right employees as a way to improve business performance, work on “top line” growth and more aggressively pursue market opportunities.

SEEING THE BIGGER PICTURE

Labor analytics specialists are not in the brick and mortar business. They’re in the people business. They often work directly with a client’s CEO, operations executives and human resource leaders, discussing which skill sets are required to take the company to the next level. Well-conceived location decisions strike an optimal balance between supporting a company’s strategic vision and selecting a path that is financially responsible.

Simply put, executives who incorporate labor analytics in real estate decisions are best equipped to make decisions that position their companies for success. They know that an office relocation is more than a change of address. It’s an investment that can help the company deliver on its strategic and operational goals in the short term and for many years to come.

Brian [email protected]

Robert [email protected]

Brian [email protected]


CONTACT CENTER LOCATION EXAMPLE

Putting Cost Structure Components in Perspective

SUBOPTIMAL LOCATION

OPTIMAL LOCATION

REAL ESTATE COSTS

Square Feet 50,000 SF 50,000 SF

Gross Rent/SF $15.00 $25.00

Total Annual Cost of Real Estate $750,000 $1,250,000

EMPLOYEE ATTRITION COSTS

Employees 400 400

Average Annual Compensation $35,000 $35,000

Cost of Attrition (% of Emp. Compensation)

40% 40%

Cost of Attrition/Emp. $14,000 $14,000

Annual Attrition Rate 60% 20%

Annual Attrition 240 Emps 80 Emps

Total Annual Cost of Attrition $3,360,000 $1,120,000

Annual Real Estate Cost $750,000 $1,250,000

Annual HR Attrition Cost $3,360,000 $1,120,000

Total Real Estate + Attrition Cost $4,110,000 $2,370,000

SAVINGS AT OPTIMAL LOCATION $1,740,000

GRESB: EXPLORING THE SUSTAINABILITY BENCHMARK’S STAYING POWER By Al Skodowski Managing Senior Vice President and Director of LEED and Sustainability Services Transwestern

To sustainability-minded real estate owners and investors, ENERGY STAR® ratings and LEED® certifications are important metrics for evaluating operations and acquisition targets. They effectively gauge the energy efficiency of a single asset, and Transwestern utilizes both programs throughout its portfolio. But what if an investor wants a broader picture of sustainability performance for an entire portfolio, an owner’s corporate practices or a management company’s operations? A relatively new sustainability ranking system created in response to requests for such data is gaining some traction after being embraced by some large real estate organizations.

Formed five years ago, Amsterdam-based Global Real Estate Sustainability Benchmark (GRESB) states its annual survey data is being utilized by more than 100 institutional investors, fund managers and property companies managing $6.1 trillion in global assets. GRESB participants include such prominent organizations as Bentall Kennedy, BNP Paribas Real Estate, Brookfield Office Properties, Cornerstone Real Estate Advisors, Principal Real Estate Investors, Prologis Inc., TIAA-CREF and USAA Real Estate Co. A total of 637 property companies and private equity real estate funds responsible for 56,000 global assets participated in the 2014 GRESB Report, which was released in early September. The report is available at gresb.com.

ENERGY STAR and LEED aren’t going anywhere, but it can be challenging to determine which new sustainability-related benchmarking programs will have staying power. When making a decision on whether to participate in a new ranking system, real estate owners and investment funds must thoroughly examine the program’s cost and value proposition. Taking into consideration the buy-in from some leading real estate institutions, it might be time to give


GRESB an in-depth look. As a property management provider, Transwestern is knowledgeable on the reporting process and prepared to support owners that want to participate in GRESB.

GRESB (pronounced GREZ-bee) produces a ranking that measures building metrics on energy, water and waste; portfolio-wide performance; and corporate sustainability practices of real estate owners and investment funds. GRESB collates information on sustainable practices and social responsibility of investment advisors and corporations, an informational piece that’s missing from other programs. Findings can elevate the profile of a property or portfolio for sustainable-minded investors and assist owners in determining the potential lifespan of an asset or group of assets. GRESB collects data during the second quarter of each year for a report that aims to be the global industry standard for assessment of the environmental, social and governance performance of real estate portfolios. The benchmark is aligned with other global reporting organizations such as the Global Reporting Initiative (GRI), the Principles for Responsible Investment (PRI) and the Dow Jones Sustainabilty Index (DJSI), according to GRESB. The GRESB benchmark enables participants to measure the sustainable impact of their own portfolios and share that data with the capital markets. Large investment funds and other capital sources have begun to request GRESB benchmarking data as an additional metric when determining where to deploy capital. Transwestern has been the recipient of several of these requests.

GRESB has been criticized by some owners for adjusting its metrics over time, but the program appears to be building momentum within the real estate industry.

GRESB Executive Director Nils Kok stated in an April 16, 2014 blog post that the organization is looking forward to increasing the transparency of the real estate sector. He acknowledged that GRESB may be a new idea for some green building professionals, but “it was established in response to the demand for sustainability data from investors in property companies (REITs) and private equity real estate funds.” TIAA- CREF, a stalwart in sustainable property operations, recently became a GRESB member. “Joining GRESB will allow us to expand our benchmarking initiatives to a broader scope of socially responsible investment activities and offer us the means to track and achieve even greater results,” stated TIAA-CREF Senior Director Nicholas Stolatis on GRESB’s website.

GRESB data demonstrating how assets have been maintained could someday increase the properties’ attractiveness and value when they come to market. Institutional investors and capital sources are beginning to put reporting systems in place to hold building owners and investment advisors to a higher level of sustainable accountability. If GRESB’s adoption rate increases, owners may be required to provide a more in-depth explanation of building and portfolio-wide performance. Ultimately, owners will decide for themselves whether to participate in GRESB. It might be worth remembering that not so long ago, the industry did not recognize the value proposition of LEED.

Al [email protected]

"ULTIMATELY, OWNERS WILL DECIDE FOR THEMSELVES WHETHER TO PARTICIPATE IN GRESB."

SMALL BUILDING IN LARGE INDUSTRIAL PARK HAS HUGE IMPACTBy Jennifer Wagner Senior Vice President Ridge Development

Much is written about the development of mammoth industrial facilities and the effect they have on their given markets. But sometimes it’s the smallest development that can have the largest impact. Such is the case with a 50,000-square-foot refrigerated facility just outside Chicago. The industrial building is 700 feet long by 70 feet wide − an odd shape, indeed − but the opportunity therein is apparent more than 2,000 miles away. The facility is leased by National Logistics and Cold Storage (NLCS) and used by the TransCold Express

− the first refrigerated boxcar unit train connecting the Midwest and West Coast in more than half a century. The service has the potential to change how refrigerated goods, as well as many other products, are transported across the country.

Operated by McKay TransCold, the TransCold Express runs bi-directionally between Wilmington, Illinois, and Selma, California. The 30 refrigerated boxcars run on BNSF Railway transporting products such as meat, eggs, cheese, butter, finished goods and dairy creamers from the Midwest to California and backhauling vegetables, fruit, cheese and butter from California. Refrigerated boxcars line up on one side of the industrial building, trucks pull up to the opposite side and goods are transferred from one side to the other. The warehouse’s design is perfect for the task. Meanwhile, TransCold Express gives produce growers and meat and dairy producers a valuable link to all U.S. destinations and the opportunity to distribute products more cost-effectively. The railroad option saves 5 to 25 percent over the cost of trucking and is more environmentally friendly. The hub-to-hub service takes four days, the same amount of time it takes the same trip by truck. But one boxcar holds the same volume as four trucks, making it four times more fuel efficient. Since the TransCold Express service began in June 2014, one 30-car train has traveled


both directions each week. The westbound cars are approximately 95 percent full and the eastbound cars are approximately 75 percent full, according to Jason Spafford, McKay TransCold’s vice president of business development.

TransCold Express usage has ramped up fairly quickly, but it took years to reach this point. The NLCS building used by the refrigerated boxcars was designed and developed by Ridge Development, the industrial arm of Transwestern Development Co. It is located in the RidgePort Logistics Center, a 1,500-acre intermodal park being developed by Ridge Development. NLCS and McKay TransCold selected RidgePort Logistics Center, in part, because they project TransCold Express customers will want to establish ancillary facilities nearby. With room for 14 million square feet of industrial, warehousing and logistics buildings, RidgePort rail-served industrial park met that important criteria. The new park, which is located three miles from the BNSF Logistics Park-Chicago in Elwood, Illinois, provides economic incentive packages to qualified park residents, has an enterprise zone designation and qualifies for a foreign trade zone designation. RidgePort has attracted users both small and large–earlier this year, Michelin announced it will occupy a 1.7 million-square-foot build-to-suit upon its completion in July 2015.

Developing a 50,000-square-foot building is straightforward enough, but creating the infrastructure required by this particular facility, and the industrial park

“SOMETIMES IT’S THE SMALLEST DEVELOPMENT

THAT CAN HAVE THE LARGEST IMPACT.”

as a whole, made it a complex undertaking. It involved finding the best location based on logistics patterns, multiple parties making large investments in the project, negotiating special services with the railroad, fulfilling track requirements, securing economic and government incentives to offset construction costs and executing a multi-phased development plan. The 1,500-acre project site originally sat in an unincorporated area. The developer worked to have its acreage annexed by the city of Wilmington and simultaneously secured intermodal tax increment financing to fund construction of the project.

RidgePort’s potential impact mirrors that of the NLCS building and TransCold Express, though on a much larger scale. Since the 1,500-acre intermodal development is located at the crossroads of north/south and east/west trade routes, it has the potential to change logistics channels in the U.S. Well-located industrial parks that provide flexibility in transportation and development options stand to have a greater impact beyond their borders.

Jennifer [email protected] 312.257.2891

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