Q1 2018 Edition
© 2018 TRANSWESTERN transwestern.com
A Message from Mike Watts
Access to a qualified workforce has become increasingly important for many employers as they align their real estate strategy with overall objectives. It follows that recruitment and retention is an important consideration for landlords, investors and developers as well: To attract successful, growth-minded occupiers, those who create workplace environments must position their properties to support tenants’ recruiting efforts.
Many of today’s workers seek a lifestyle that balances work with socialization, recreation, dining, environmental stewardship, education and other objectives. Flexibility – and how it is achieved through real estate – is key to meeting many of these demands.
Work done by The Lab, Transwestern’s answer to building owners’ need to stay competitive, has proven that a closer look at amenities, space usage and branding pays off. The goal is to make decisions about the workplace easy for tenants and their employees, in part due to the quality-of-life elements incorporated into clients’ properties.
This edition of Insights digs into real estate’s potential in labor attraction and retention. Against the backdrop of a strong national economy, we explore how tenants can brand the workplace to communicate and reinforce their culture; how landlords’ creative amenities give tenants greater leverage in attracting talent; and what owners of Energy Star-certified buildings must consider to safeguard this highly sought-after certification.
We hope this glimpse into the ways real estate can support labor strategies informs your decisions in the months ahead.
Conserving energy has expanded beyond the realm of social and corporate responsibility. For many employers, sustainable practices are a necessity to attract and retain the best labor. At those firms, workers may expect their employers and workplaces to earn and display Energy Star, LEED and other certifications to demonstrate good stewardship of natural resources.
Some properties might be at risk of losing at least one of those credentials, however.
Later this year, some buildings certified under the Energy Star program likely will lose that certification after the release of updated building performance baselines. Fortunately, landlords can act now to begin improving the metrics tracked in Energy Star’s online Portfolio Manager tool and put their properties on a path to qualify for the program’s mark of approval even after the change.
Why the reset?
For most commercial properties, an Energy Star score ranging from 1 to 100 indicates how well the property compares with a sampling of thousands of buildings represented in the Commercial Buildings Energy Consumption Survey. The Energy Information Administration, which collects and analyzes energy statistics for the U.S. government, conducts the survey every four to six years. The Environmental Protection Agency (EPA) uses survey data to build statistically representative models for various building types.
When an Energy Star participant submits energy-usage performance data collected through Portfolio Manager, the EPA converts that information into a numerical Energy Star score showing how well the building performs in relation to models of its peers. Buildings that achieve a 75 or higher generally qualify for Energy Star certification as energy-efficient.
For several years, the EPA has relied on survey data collected in 2003 to calculate Energy Star scores. At the time of that survey, Energy Star was still gaining momentum on its way to becoming an industry standard for measuring and reducing energy consumption. Recently, however, the agency has been updating Portfolio Manager with survey data collected in 2012.
In the decade between the surveys, the use of Portfolio Manager mushroomed, as did the number of commercial buildings adopting various energy-conservation programs. That suggests the new data set will include a larger proportion of energy-efficient buildings. As a result, a building that achieved the Energy Star label in the past may not compare as well to buildings in the new data set, and could see its score fall due to a lower relative standing even if the property’s performance remains unchanged.
The EPA plans to publish updated scores based on the newer survey in August 2018. While there is no way to predict the change in score for a specific property, building owners should be prepared for a drop of at least five points in their Energy Star score. Buildings certified with scores of 75 to 80, therefore, are most at risk of losing certification.
What's at stake?
It’s important for property owners to remember that Energy Star scores are a mark of relative performance. Actual performance measured in Portfolio Manager is unaffected by the update in survey data.
Improvements achieved through conservation programs continue to benefit the property’s owner and occupants, and can include less-intensive electricity usage, lower utility bills, a healthier workplace that maximizes natural light, and in some cases, reductions in water consumption and waste generation. These worthwhile programs will continue to save money and improve an asset’s appeal to tenants and investors.
Owners and tenants whose downgraded scores result in the loss of Energy Star certification will lose the marketing benefits that come with this seal of approval from the EPA, potentially lowering their competitive advantage in attracting and retaining tenants. Employers who consider Energy Star a requirement for their space may look to other properties in a site search, or if they are already a tenant in the building, may let their leases expire.
In most cases, the first phase of energy conservation will have captured the low-hanging fruit of reducing weekend operations, optimizing equipment run schedules or converting some lights to fluorescent. Sustainability advisers can help landlords map out strategies to further reduce energy consumption.
Deeper cuts in power usage are more likely to require larger capital investments for items such as high-efficiency light fixtures and mechanical equipment. Yet many landlords will decide that achieving greater efficiency is worth the monetary cost. Becoming educated on the costs and benefits of improvements may now be more important than ever.
We are entering a new phase in energy conservation, where the goal may be more than a lower utility bill. Landlords and tenants are collaborating to forge a workplace that is grounded in the tenets of sustainability, and a source of employee pride.
The contract is signed, and the small group of negotiators move into the lounge to celebrate. One young professional produces a key and retrieves a bottle of bubbly from a nearby wine locker as his colleague steps behind the bar for champagne flutes. Moments later, most of the new associates are seated on barstools and bantering about their shared accomplishment, while the two senior partners take their glasses outside to stroll on the nearby putting green.
This is no country club. Welcome to the tenant wine lounge at Providence Towers, a Class A office building that Transwestern leases and manages for KBS in North Dallas. The elegant ground-floor venue opens to the lobby, an outdoor courtyard and putting green, and has provided the setting for several weddings as well as business events. The landlord provides the lounge, icemaker, glasses and other necessities; tenants can bring their own beverages or store bottles in private wine lockers.
The wine lounge is an example of how landlords are responding to increased demand for amenity-rich workplaces that help employers attract and retain talent. Many companies today must compete for skilled labor, and are making real estate decisions based on how well their leased space, the larger property and surrounding area will provide the kind of experiences that attract and retain workers.
Instead of leaving tenants to create a variety of enticing environments entirely within their leased space, property owners have joined in, converting lobbies and other common areas into welcoming, shared gathering areas.
In downtown Austin, Texas, landlord Clarion Partners added a coffee vendor and casual seating areas to the lobby in its Perry Brooks Tower as part of a recent renovation. The landlord brought in locally based Lucky Lab Coffee Co. to run the kiosk rent-free, and in the process created a refuge where tenants can recharge without leaving the building.
KBS employs a similar strategy at Fountainhead Tower in San Antonio, where it built and equipped a gourmet café just inside the 10-story tower’s entrance. The landlord adjusted the rent so the operator, Savant, can turn a profit and remain viable while catering chiefly to the building’s tenants.
Investors hunting acquisitions and developers seeking appropriate sites for construction or redevelopment projects would do well to follow the lead of major employers, which often look for neighborhoods that remain vibrant after the traditional workday is done. Like their workers, these firms gravitate to locations with proximity to services such as cleaners, health care providers, athletic clubs, recreational infrastructure, dining options and entertainment.
By bringing some of those amenities onto the property either as tenants or via third-party service providers, landlords make it easier for their occupants to win over potential new hires with the lure of a branded or unique place.
In Minneapolis, for example, Zeller Realty Group in 2017 completed a renovation of the 1.1 million-square-foot Fifth Street Towers that introduced a host of new features. The revitalized asset now offers a wellness center with napping pods; a lounge; a 5,000-square-foot deck with TVs and skyline views; a staffed exercise area with machines and weights; and a bicycle center with showers, a repair shop and space to store hundreds of bikes. The amenities are driving traffic to Fifth Street Towers and form a critical component of the property’s leasing efforts.
Distinction on any budget
Landlords can find budget-friendly opportunities to enhance and brand their buildings. One Austin landlord created a lunchtime destination on its grounds by providing food truck parking, picnic tables under a rain cover and electrical hookups outside its building. Now tenants can walk from their offices to enjoy a meal outdoors while staying out of the hot sun or rain. Coffee vendors occupy the pop-up food court in the mornings and food trucks arrive at midday, using the landlord’s power rather than running noisy generators.
In submarkets with more intensive competition for tenants and labor, property owners may consider boosting amenities with added services. For example, trainers or yoga instructors can offer programming at an existing exercise center, or for greater appeal, an underused gym can be transformed into a crossfit center or other, distinctive fitness concept run by a local operator.
Demand for amenities in and around the workplace is likely to strengthen in coming years, predicts Michael Soto, Transwestern’s Research Manager for Southern California. That’s due to competition for labor, and because some office users are coming out of spaces operated by co-working providers, many of which offer beer taps, game rooms, eateries and other attractions for their tenants’ use.
“The way many co-working operators design their spaces, and the flexibility they provide, has affected the expectations of office tenants, especially those that are growing,” he said. “Office landlords are starting to feel that influence on space demands. And in markets with concentrations of highly educated workers, competition for the best and brightest often depends on how well employers meet worker expectations.”
As skilled workers weigh employer reputations and workplace experiences when making job choices, companies are working harder to cultivate their brand as a recruiting and talent-retention tool. Given that occupancy cost is the second-largest expense after payroll at most firms, savvy employers are drawing double duty from their real estate by molding the workplace into an extension of their culture.
The best time to address workplace branding is before a site search, when the organization is free to envision elements of its ideal environment unconstrained by a particular market or floorplate, but tenants can apply the same principles to existing leased space in preparation for a reconfiguration. The key is to look beyond the office layout, identifying the cultural elements and characteristics that create social cohesion, support productivity and promote stickiness for the desired labor set.
The real estate team can use this deep understanding of the firm’s cultural needs to refine site selection. First identifying markets and submarkets with compatible social and economic characteristics, the team can investigate building or site-level ecosystems that support the company’s mission. Buildouts can add features that reinforce the firm’s identity and attract like-minded talent.
Seek first to understand…
Begin the discovery phase by exploring workforce needs.
From what labor pool is the company recruiting? Where do those workers prefer to live, and what is important to them in terms of salary, housing, recreation and community resources, including transportation options? It is often helpful to develop a cultural-fit profile for the cities under consideration, ensuring an initial smart location search reflects labor and other business drivers, while positioning the company for talent and recruitment success.
Turning to the workplace, how do employees carry out their responsibilities? Do they prefer to work in quiet seclusion, in project rooms, or in open co-working spaces? What hours do they keep? If they meet off-site, what do they like about those locations? Does the company exhibit innovation and social cohesion or is it seeking to grow those aspects of its culture?
The answers to these questions can vary considerably within the same firm. For example, Transwestern helped a national advisory firm consolidate its headquarters with a local consulting unit. Previously, the two groups had occupied separate spaces of about 100,000 square feet each, with their own budgets, goals, and dissimilar work styles.
The team developed a cohesive workplace strategy and brand for the consolidated location by identifying shared values and common goals to accomplish in designing the space, and expanding the choices available to employees as to where and how they work each day. Options include open work areas, team rooms, lounges and casual gathering spots as well as private offices and rooms for confidential calls and client meetings.
…then to be understood
Leaders can address the cultural requirements they’ve identified for current and future employees in their real estate decisions. Choices of amenities and design elements within the space can create a unique setting that conveys the organization’s message, speaking with the company’s voice to employees and potential hires.
Fabrics, artwork and materials drawn from a defined color palette form a backdrop that brands daily activities. The firm may choose to convey a sense of luxury or success with costly materials, or proclaim the group’s down-to-business attitude by emphasizing comfort and function. A culture that emphasizes creativity may opt for eclectic furniture, game areas or playful wall and floor treatments.
Amenities that reinforce culture tend to involve experiences, enriching the environment in a way that sets the company apart from competitors. Gathering places in lobbies, hallways, gardens, terraces or courtyards offer alternatives to desks and encourage social interaction. Socialization builds trust among team members and fosters idea sharing, innovation and productivity.
Shared experiences strengthen workplace culture and its effectiveness as an employee retention tool, so it is important to draw workers into the office. Cafés, kitchens with dining areas and even lounges serving beer and wine can entice employees to stay on-site for meals, meetings and socializing. Other employers may reject certain amenities, concluding they detract from a no-nonsense attitude in a company that is closely watching its balance sheet.
Bicycle racks give workers more choices in how they get to work, and will see increased use if the workplace provides showers and lockers. Demand for sports and recreational facilities may suggest the inclusion of workout facilities, perhaps offering trainers or classes. In both cases, the physical workspace communicates the company’s commitment to health and fitness.
All these elements represent opportunities to express the company’s character and values, ideally establishing an emotional connection with and among employees and visitors alike. Communicating this through real estate is a valuable way to attract talent and promote employee retention.
The U.S. economy ended the year with strong momentum, propelled by the longest-running period of job growth in the nation’s history and early signs of wage inflation. With the prospect of added business stimulus from recently adopted tax reforms, the economy and commercial real estate in particular are poised for even greater gains in 2018.
Job growth remained strong for nearly all of 2017, and this pattern held true for the closing months of the year. During the 12-month period ending November 2017, the U.S. economy added 2.1 million new jobs.
Even recently struggling sectors experienced a turnaround in job growth toward the end of the year, such as Retail Trade, which added 36,900 jobs during the 12 months ending November 2017. The 2017 holiday shopping season proved to be the strongest in seven years, with robust spending across all consumer demographics at both online and brick-and-mortar retailers. Notably, some larger brick-and-mortar retail chains, such as Walmart, Costco and Kohl’s, seem to be successfully adapting to the evolving retail market.
Despite the continued overall growth, contributions to payroll expansion from the private and public sectors headed in opposite directions through 2017. While private-sector job growth has remained consistently strong, the public sector’s share of total, annualized monthly job growth declined to a meager 1.3% in November 2017, compared with 9.4% a year earlier.
Initial unemployment claims briefly spiked by over 30,000 in the wake of hurricanes Harvey and Irma in September before continuing their long-term decline. Total jobless claims stood at 234,750 as of Dec. 9, 2017, not far from a new three-decade low. As of November 2017, the seasonally adjusted national unemployment rate stood at 4.1%, down from 4.6% a year prior.
Gross Domestic Product
After some softening in early 2017, real gross domestic product (GDP) accelerated to an annual pace of 3.3% in the third quarter — the fastest growth rate in three years. During this period, consumers continued to drive the economy forward, accounting for roughly 70% of all economic activity. Consumption fed off strong private-sector investment spending, which was in turn stimulated by profits that swelled 4.3% during the quarter. Growth in exports, and a surprising decrease in imports, also contributed to the economic expansion.
On the flip side, during the third quarter, residential and nonresidential structure investments declined by 5.1% and 6.8%, respectively. The pullbacks can be attributed to the dual natural disasters of hurricanes Harvey and Irma, which collectively inflicted losses of $121 billion in privately owned fixed assets in the Southeast, according to the U.S. Department of Commerce.
Corporate profits continue to trend upward, totaling $2.22 trillion on an annualized and seasonally adjusted basis during the third quarter of 2017. This was an increase of $92 million from the prior quarter and $114 million from the third quarter of 2016. Growth in corporate earnings has been outpacing the overall economy in recent periods as sales surge, but labor costs remain flat. Outsized growth in highly profitable industries, particularly Information Technology, has also driven the surge in profits. Looking ahead, profit growth will be muted as continued low unemployment places upward pressure on wage growth, increasing unit costs. However, a weaker U.S. dollar should boost real net income from business conducted overseas.
According to the National Association of Realtors, the annualized pace of existing home sales was 5.81 million in November 2017, up 3.8% from a year prior. The current sales pace is the fastest seen since before the national housing crash in 2007. Sales would likely be even higher if not for a severe lack of inventory. The average sale price for an existing home was $248,000 in November 2017, up 5.8% from $234,400 in November 2016.
Mortgage rates declined through much of 2017, but began trending upward in September after hitting an annual low of 3.78%. Per Freddie Mac, the average commitment rate for a 30-year, conventional, fixed-rate mortgage rose to 3.93% as of Dec. 14. We expect rates to rebound above 4% shortly as the Fed winds down its expansionary policy and raises the funds target rate.
Interest Rates and Inflation
The Federal Open Market Committee followed through on its plans for regular increases to the federal funds benchmark rate in 2017, hiking interest rates by a quarter percent at its March, June, and December meetings. In September, the Fed began the process of normalizing its balance sheets by winding down its security-purchase program. The decision to end quantitative easing is driven mainly by strong consumer spending and the tight labor market.
Consumer price inflation showed some improvement in 2017 after a lackluster 2016. According to the index, average consumer prices in October 2017 were 2.0% higher than they were a year prior, and 0.1% higher than in September 2017. The personal consumption expenditure price index, which reflects changes in consumption habits as people substitute some goods and services for others, experienced a smaller increase of 1.6% during the 12 months ending October 2017. Rebounding gasoline prices accounted for much of the inflation in 2017, increasing 10.8% over the 12-month period ending October.
After a banner year for the U.S. economy in 2017, we maintain our bullish outlook for 2018. The prolonged economic recession has clearly translated into a correspondingly extended recovery/expansion. We expect the positive economic momentum to continue, with GDP growing 2.7% in 2018.
Another trio of federal funds rate increases is likely in 2018, as the Fed becomes more confident in the strength of the economic recovery and more urgently strives to end its quantitative easing policy in advance of a future economic downturn. Long-term interest rates will rise modestly, while short-term rates will increase more substantially.
As companies expand, job growth will remain strong in 2018 but will slow from the current rate of approximately 200,000 additions per month. However, some industries will continue to see job growth strengthen in the next year, particularly Information Technology.
Consumer spending, in all facets, remains in the driver’s seat of economic growth, but business investment has also started to pick up over the last several months. Even recently depressed sectors that have been hammered by low prices and competition from overseas — including Manufacturing, Mining, and Energy — are showing signs of renewed growth. We expect these growth trends to continue in 2018. Recently enacted tax cuts will only further fuel expenditure growth in the period ahead.
The sunny prognostication carries a couple of unknowns, though. First, wage growth is considerably lagging growth in consumer spending and the rate of household savings has declined, which sets the stage for a possible deceleration or decline in future spending. On the business side, the increase in net income realized from tax savings will not necessarily translate into a matching increase in investment, hiring or wage hikes. Much of that savings may simply be passed on to shareholders.