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Q3 2018 Edition

A Message from Chip Clarke

Cover Story
Elements of Healing
Justin Brasell

Making Space for Maker Tech
Edward Del Beccaro

Opportunity in the Yield Curve
Robert Murphy

Contrary Economic Currents
Jonathan Chambers


Transwestern is a privately held real estate firm of collaborative entrepreneurs who deliver a higher level of personalized service – the Transwestern Experience. Specializing in Agency Leasing, Tenant Advisory, Capital Markets, Asset Services and Research, our fully integrated global enterprise adds value for investors, owners and occupiers of all commercial property types. We leverage market insights and operational expertise from members of the Transwestern family of companies specializing in development, real estate investment management and research. Based in Houston, Transwestern has 35 U.S. offices and assists clients through more than 211 offices in 36 countries as part of a strategic alliance with BNP Paribas Real Estate. Experience Extraordinary and @Transwestern.

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A Message from
Chip Clarke

What does it mean to be a full-service commercial real estate organization? At Transwestern, that term has many dimensions. Across the United States, we are fortifying our service offerings in Agency Leasing, Tenant Advisory, Capital Markets, Asset Services and Research. Geographically, we represent clients coast to coast from 35 U.S. offices, and globally as part of a strategic alliance with BNP Paribas Real Estate.

Looking through the lens of the larger Transwestern organization, we provide thought leadership, market insights and operational expertise in development and real estate investment management. Through advisory groups dedicated to specific product types or industry sectors, Transwestern teams follow nuanced market trends, collaborate across service lines, and create new ways for real estate to enhance our clients’ long-term success. This edition of Insights explores leading-edge opportunities in real estate subsectors and in property markets attracting specific industries.

"These stories highlight the depth of expertise Transwestern cultivates and deploys throughout the industry."

Our article on innovative design for medical office buildings reflects the insights and expertise of our healthcare advisory group, which is one of the largest dedicated real estate teams serving that industry. We also explore advanced manufacturing and the strategic role these industrial users play in many supply chains. And we highlight a timely opportunity to refinance short-term debt with long-term financing, thanks to the flattening yield curve. Finally, we share a perspective on the national economy from Delta Associates, our research consulting affiliate.

These stories highlight the depth of expertise Transwestern cultivates and deploys throughout the industry. We offer these insights to enhance your real estate strategy and suggest new roads of opportunity we might travel together.

Warm regards,

Chip Clarke
President, Americas
How real estate design can improve the patient experience

Justin Brasell
Executive Vice President
Healthcare Advisory Services
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Innovative healthcare spaces are setting new standards in patient satisfaction and retention, invigorating a medical-office-building sector that has fallen largely out of sync with emerging service models.

Change is in order because American healthcare is exponentially more consumer-driven than it was just five years ago. As in retail, consumers expect on-demand service and prompt attention from healthcare providers, in a pleasant setting that offers convenient access and parking. These are some of the reasons that young adults are more likely to visit the nearest urgent care center for treatment than to select a primary care provider, to whom they return each time they require medical attention.

To help physician practices, clinics and healthcare system tenants compete for patients, owners of medical office buildings can provide spaces that give tenants a needed edge. Their shared goals include providing distinctive environments that enhance the patient experience while boosting efficiency to help control cost.

What follows are design elements that can create a welcoming, patient-friendly environment that promotes healing as well as efficiency. Many offer the added benefits of strengthening employee retention, enhancing efficiency and eliminating excess square footage, lowering overall rent and utility costs.

"A practice can minimize its space requirements without compromising patient comfort or an efficient working environment."

Streamline reception

End waiting-room drudgery by removing the bulky front desk and providing a speedy check-in. Give patients the option to fill out insurance and patient forms online before their visit, and introduce a digital sign-in system, such as a tablet computer mounted just inside the entry. Although not yet in widespread use, wearable technology can simplify registration by automatically identifying a returning patient, alerting the staff of their arrival and verifying insurance coverage with providers.

Shrink the waiting room

With streamlined reception, many practices will find a large waiting room unnecessary. A few seats will accommodate new arrivals for check-in before they are directed to an examination room to await their doctor. Eliminating hundreds of square feet of waiting room space from the lease can yield a profound savings in occupancy costs.

Harvest natural light

Taking a cue from modern office design, large windows and furniture angled to capture optimal views can reduce stress and promote a sense of well-being. The effect is as beneficial to caregivers as it is to patients and can aid employee retention. Additional access to natural light can include walking trails around the building’s exterior, even in an urban setting. A cool color palette and soothing, interesting artwork also help to create a welcoming and peaceful environment that eases distress.

Invest in better examination rooms

We advise clients to revisit the conventional exam room layout. Alternative designs can more comfortably accommodate a loved one accompanying the patient and allow more relaxed physician-to-patient interaction. The standing physician looming over an examination table can intimidate some patients, so many doctors select furniture and designs that foster eye-to-eye conversations. Tablet computers remove the barrier that a laptop computer or monitor can impose between physician and patient.

"With streamlined reception, many practices will find a large waiting room unnecessary."

Arrange space strategically

Today’s healthcare realities require higher patient throughput, but doctors can maximize their time with patients by locating their personal offices nearer exam rooms. A pod arrangement of three to four exam rooms, surrounding a work area shared by the practitioner and their staff, fosters collaboration, reduces physician-to-exam-room time, and enables a nurse to monitor several exam rooms simultaneously. By designing examination rooms and staff areas around the dimensions of preselected furniture and fixtures, a practice can minimize its space requirements without compromising patient comfort or an efficient working environment.

The healthcare industry is adopting technology and practices to accommodate today’s rising patient expectations for service and a personal connection with physicians and other caregivers. Commercial real estate must catch up to these changes. From the parking layout to building design, in the overall structure and in individual tenant spaces, medical office buildings must promote wellness, use natural light and increase the natural movement of patients through the space. When owners and tenants succeed, they will deliver a seamless, more pleasant patient experience.

Insight into a Changing Healthcare Industry

Innovative medical-office design strategies attempt to better address today’s shifting expectations from patients and caregivers. Some of these motivating trends in the healthcare industry include the need to leverage technology, drive down costs and improve the patient experience to achieve better outcomes.

Transwestern identifies these and other themes in The Convergence of Healthcare Delivery in the U.S., a report it co-authored with IMEG Corp., which summarizes responses of healthcare thought leaders from 24 healthcare-related organizations to critical questions facing the industry.

The report provides viewpoints that can help real estate professionals and other third parties deliver products and services to caregiver clients that ultimately improve the patient experience.

To learn more, view or download the full report at

Justin Brasell
Justin Brasell

Edward Del Beccaro
Senior Managing Director
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In small industrial spaces across the country, advanced manufacturers or “maker-tech” firms are merging design, fabrication, small-batch production and other activities to offer turnkey research and development services.

Sharing characteristics of hacker or maker culture, these companies may employ engineers, scientists, skilled tradespeople, production line operators and other specialists in a single, highly flexible, technologically advanced industrial facility. The uses each firm brings together vary widely, but collaboration across disciplines is a defining characteristic of this growing niche.

Maker-tech facilities seldom occupy more than 10,000 square feet, but their services are essential to some industries. Indeed, relatively small advanced manufacturers have played a vital role in the development of electric sports cars, military-grade drones, consumer electronics and other cutting-edge products over the past decade.

Advanced Manufacturing:
The Other Mixed Use

An array of uses occurring within the former Sun Chemical building in San Leandro, Calif., epitomizes the diverse activity common to maker-tech space.

Tenants include Atlantic Specialty Coffee, which makes decaffeinated green coffee and tests coffee samples in a laboratory setting for an international clientele; component painting company Reliable Powder Coating; and Sun Chemical, a high-end printing firm that once occupied the entire building but has compressed its footprint by incorporating advancements in printing technology.

The current landlord purchased the building in 2002. Transwestern helped plan and complete upgrades to meet new users’ requirements. Property enhancements included a new fire alarm system, elevators, re-graded parking lot, landscaping and lobby.

Greater speed to market

In many industries, the time-tested model of rolling out a product, collecting user feedback and introducing improvements in the next year’s model has become too slow and cumbersome to retain a company’s market share. The faster a manufacturer can incorporate improvements, the better its chances of capturing sales while the iron is hot.

For example, when a manufacturer of limited-production automobiles wants to improve a part such as a motor bracket, it may turn to a nearby maker-tech firm for assistance. The automaker will probably select a provider within a half-day’s drive of its assembly plant to minimize transportation time.

"Advanced manufacturers have played a vital role in the development of cutting-edge products over the past decade."

After receiving specifications for the existing bracket and desired modifications via a high-speed data connection, the smaller shop will work out a new design with the client’s engineers. Using a form of 3D printing, the supplier may mock up a plastic version of the bracket and have it delivered to the client on the same day.

Once the automaker confirms the design fits its requirements, a metal fabrication shop – which may be at the same facility that produced the plastic version – can machine a prototype of the bracket out of steel, aluminum or even an advanced composite, again using same-day delivery to send it to the customer for testing. The same producer can make follow-up adjustments and transmit the final design and a sample to a small-batch manufacturer. Alternatively, it may produce the new parts in volume on its own flexible manufacturing line.

Thus, multidisciplinary industrial providers can speed the innovation process to deliver a final product in a matter of weeks or even days. Even if the end goal is mass production at a dedicated manufacturing site, a dynamic maker-tech shop can reduce the time required to begin production. Compare that to the months that were once required to ship designs and prototypes to distant or overseas manufacturers, design and outfit production lines, make and then ship a final product.

Site selection

Reflecting their role as problem solvers for larger organizations, maker-tech firms may form clusters or ecosystems around a major employer, such as an automaker, or around a regionally dominant industry, such as oil and gas. As in the above example, most will locate within a four-hour drive of suppliers, clients or prospective clients. Most will also require easy highway access and an airport within a one-hour drive.

Advanced manufacturers require access to a diverse labor pool, continually replenished by area universities and trade schools. As a result, maker tech flourishes in communities with existing brain clusters serving the targeted industry. These hubs exist in only a handful of major U.S. markets, with examples including the San Francisco Bay area, Boston, New York and Atlanta.

Buildings must offer a robust shell and excellent power and gas service. Advanced manufacturers are unlikely to choose low-cost locations off the beaten path, because the disadvantages of accessing a remote facility will outweigh any benefits to be gained from below-market rent.

Maker Tech in the Making

"Multidisciplinary industrial providers can speed the innovation process to deliver a final product in a matter of weeks or even days."

Standard ethernet broadband access may be inadequate for firms that need to rapidly transmit massive design files and supporting data. For those users, properties with access to dark fiber may offer a solution. Dark fiber is unused fiberoptic cabling that many telecommunications providers now install alongside their lines for future use, which can sometimes be leased or purchased for exclusive use as part of a fast and secure wide area network. At a minimum, maker-tech firms will seek the highest commercially available bandwidth to the site.

Building out a space for an advanced manufacturer may cost $50 to $100 per square foot, compared to about $20 per square foot for more traditional manufacturing. This reflects the variety of activities required, which can range from computer-aided design in an office setting to welding and machining in the next room or a building nearby. The use may require advanced heating and cooling, specialized fire suppression or elaborate plumbing.

A few progressive municipalities have recognized the importance of maker-tech space and established advanced zoning rules to accommodate non-traditional combinations of activities. Zoning may become less of a concern as more communities recognize the vital role that maker tech plays in product development and manufacturing.

Edward Del Beccaro
Edward Del Beccaro

Robert Murphy
Vice President
Structured Finance
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Commercial real estate investors concerned about the effect of rising interest rates on their floating-rate debt may find a welcome hedge opportunity in the flattened yield curve, although that window may be closing.

The yield curve is the relationship between the annual return rates across maturities on debt instruments, chiefly U.S. Treasury bonds, which also serve as benchmarks for interest rates.

A normal, sloping yield curve reflects a premium or additional yield to compensate investors for incurring the added risk of holding a bond for a longer term. During the curve observable during the past 10 years or so, the spread premium between two- and 10-year Treasury yields was roughly 150 to 200 basis points.

A flattening yield curve describes a tightening yield spread. Historically, when the curve inverted and long-term bond yields fell below those on the short end of the spectrum, economic recession followed.

"Pricing for new, long-term, fixed-rate debt may be similar to the floating rates borrowers are currently paying."

In 2018, the Federal Reserve has been raising rates about 0.25 percent each quarter to slow the economy and deter inflation. The two-year Treasury yield hit 2.673 percent on July 25, its highest point in a decade. Recent fluctuations in the 10-year Treasury have been relatively slight, however. That yield stood at 2.977 percent on July 25, or 30 basis points over the two-year. The spread hasn’t been this tight since the yield curve inverted in the summer of 2007.

However, it is worth noting that several economists – including Federal Reserve Chairman Jerome Powell and Ben Bernanke, the former chair – have suggested that the yield curve has grown distorted and unreliable as a forecasting tool.

Those obfuscating factors include central bank manipulation at both ends of the yield curve: In addition to adjusting the fed funds overnight lending rate as a benchmark for short-term lending, the Federal Reserve and other central banks are winding down programs of quantitative easing or buying massive quantities of long-term government bonds, which reduced supply and raised prices, thereby lowering yields.

A similar effect is occurring today as worries over geopolitical events including escalating trade disputes drive investors to the security of government bonds, exerting downward pressure on long-term yields even as the Fed nudges up short-term rates.

An appealing proposition

Perhaps the most compelling aspect to the current yield curve is the opportunity it has created for commercial real estate borrowers to refinance into longer-term debt. This is particularly appealing to floating-rate borrowers concerned about further rate hikes by the Fed.

Until the beginning of this year, the lower interest rates made short-term commercial mortgage debt more attractive than longer-term debt.

For example, four years ago, strong applicants with cash-flowing properties could borrow floating-rate, non-recourse, senior debt at about 2.75 percent (the 30-day LIBOR rate plus 250 basis points), or they could lock in 10-year, non-recourse senior debt costing about 100 basis points more at 3.75 percent (the 10-year Treasury rate plus 175 basis points). LIBOR is a popular benchmark for setting short-term and floating lending rates.

Savvy long-term investors recognized the savings potential of this 100-basis-point delta and borrowed short-term debt, with the intent of refinancing into longer-term debt later if they anticipated rates were going to rise. Given that the Federal Reserve began hiking rates in earnest last year, these investors did very well utilizing this arbitrage strategy.

Now floating-rate borrowers are using the flatter yield curve as a hedge against further Fed rate hikes. Given that the spread between the 10-year and two-year Treasurys is roughly 30 basis points, pricing for new, long-term, fixed-rate debt may be similar to the floating rates borrowers are currently paying.

For example, a floating-rate loan originated two years ago with an initial interest rate of 3.0 percent would reflect a coupon of 4.6 percent today. Life companies, a popular source of long-term debt for commercial real estate, can presently offer mortgage rates between 4.25 and 4.75 percent, with loans earmarked for commercial mortgage-backed securities (CMBS) priced slightly higher, between 4.75 and 5.25 percent.

If short-term rates were frozen at today’s levels, a borrower’s preference for fixed or floating-rate debt could be decided by a flip of the coin. The probability of rising interest rates in the months and years ahead, however, provides another reason to convert short-term debt to long-term, and adds a degree of urgency.

The real estate community has benefited from historically low interest rates during this expansion cycle. Smart investors have leveraged the yield curve the past few years to maximize returns.

Now that we have entered the higher-rate environment we’d hoped to avoid, investors can leverage the yield curve for defensive positions. This temporary flatness allows floating-rate borrowers to take rising interest rate risk off the table by refinancing into long-term, fixed debt at a potentially nominal expense.

But don’t wait too long. The window may soon close, because loans with terms of 10 years or longer are becoming more expensive. For one thing, commercial real estate debt is highly correlated to corporate bonds, and those yields have been rising this summer. Additionally, many life insurers, which are an important source of real estate financing, have nearly reached their annual production goals and can afford to demand higher rates on future deals.

Robert Murphy
Robert Murphy

Jonathan Chambers
Vice President
Delta Associates
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This summer has offered a mixed bag of economic trends and indicators, most pointing to continued growth, but some suggesting an approaching end to the current business cycle.

U.S. gross domestic product (GDP) surged to 4.1% in the second quarter with a heavy boost from net exports, which was a vast improvement from the comparatively lackluster 2.2% growth in the first quarter. The surge in economic output, growing corporate profits, robust consumer spending, and continually tightening labor market reinforce the notion that the economic recovery has plenty of runway remaining.

Contrarily, the deepening trade dispute with China remains a major downside risk, and the Trump administration has seesawed on introducing tariffs on goods imported from Europe, as well. With corresponding tariffs on U.S. exports threatened in retaliation, it has become increasingly difficult to determine what policies will be implemented.

Further, many economists are growing wary of an impending recession as late-cycle indicators begin to emerge, most notably the flattening yield curve. An inverted yield curve (when two-year Treasury yields exceed those on 10-year Treasury securities) has accurately predicted economic downturns seven times since 1970. (For more, read the yield curve feature in this issue.)

Office Investment Sales

Before drawing conclusions about the outlook, let’s take a deeper look at the various economic indicators.

Growth and trade concerns

Consumer expenditure growth rebounded from a five-year low of 0.5% in the first quarter to a more robust 4.0% in the second, reclaiming the role of lead generator of economic growth. Other GDP components saw higher percentage growth, however. Most notable was exports, which saw a sharp uptick of 9.3% thanks to a temporary flood of soybean exports to China in advance of recently introduced tariffs. Domestic fixed investment also continued to grow markedly in the second quarter at a rate of 7.3%, although this was weaker than the 11.5% rate in the first quarter.

American tariffs on $34 billion of Chinese goods came into effect on July 6, with China imposing a similar amount of retaliatory tariffs. More significant are pending U.S. tariffs (now increased to 25%) on $200 billion worth of Chinese goods, which China has already countered with threatened tariffs on $60 billion of U.S. imports. It remains to be seen how far each side is willing to go and the negative effects the dispute will have on the domestic and global economies, but most business leaders agree that neither nation benefits from the dispute.

Labor market

The story remains largely unchanged in the labor market for the second quarter of 2018. Employment growth remains vigorous, albeit less so than this past winter, when monthly, seasonally adjusted job additions surged past the 300,000 mark. The most recent monthly figure for job growth was 157,000 in July 2018. Over the 12 months ended July, the U.S. economy added 2.4 million new jobs for a monthly average of just over 200,000.

The private sector continues to account for nearly all job growth. During the 12 months ended July, private employers in the U.S. created 2.4 million net new positions, while the public sector shrank by 3,000.

"There is some concern that upside is diminishing as rising interest rates and labor costs cut into margins."

The Trump administration has been following through on prior campaign promises to reduce the size of the federal government through attrition. Since the beginning of President Trump’s term, the decline in 12-month federal job growth has been relatively consistent, dropping from a high of 45,000 for the 12-month period ended January 2017 to an 8,000-job contraction for the 12-month period ended July 2018. State employment has been on a similar trend, with 12-month job additions falling from a post-recession high of 85,000 at February 2017 to 14,000 as of July 2018.

After a steady decline last year, the national unemployment rate (seasonally adjusted) leveled out over the past few months. As of July 2018, the jobless rate stood at 3.9%, down from 4.3% in July 2017.

Payroll Job Growth
Unemployment Rate
Payroll Job Growth

Average hourly earnings climbed 2.7% between May 2017 and May 2018, according to the Bureau of Labor Statistics. Annualized wage growth has climbed marginally in 2018 to nearly 3%, which is a significant improvement from a couple of years ago but still below expectations given the exceptionally low unemployment level.

Corporate profits

Corporate profits totaled $2.18 trillion (annualized and seasonally adjusted) during the first quarter of 2018. This was a $27 billion increase from the prior quarter. Corporate earnings have continuously beat analysts’ estimates quarter after quarter as sales surged, but labor costs remain flat. The recently passed corporate tax cuts have further stimulated profits.

U.S. Corporate Pre-Tax Profits

We expect profit growth to flatten when wage growth picks up, although anticipated increases in productivity will help offset higher labor costs.

Housing market

The pace of home sales across the U.S. slowed somewhat toward the middle of the year. According to the National Association of Realtors, the annualized pace of existing home sales was 5.38 million in June 2018, down from 5.50 million in June 2017, and was 5.9% off the post-recession peak of 5.72 million recorded in November 2017.

U.S. Existing Home Sales vs. Sale Price

While higher interest rates are certainly a factor in the slowdown, a pronounced lack of supply seems to be the biggest culprit. This is confirmed by the opposing trend in existing home prices which averaged $314,900 in June 2018, 3.8% higher than a year ago and a new post-recession high.

After climbing by over 50 basis points during the first quarter, mortgage rates calmed slightly in the second quarter. As of the end of July, the average commitment rate for a 30-year, conventional, fixed-rate mortgage stood at 4.5%.

Interest rates and inflation

As expected, the Federal Open Market Committee raised the federal funds benchmark rate another quarter-percent at its June meeting, pushing the target to 2.0%. The June rate increase followed an equivalent hike in March.

Selected U.S. Government Interest Rates

Although we previously anticipated just three interest rate hikes in 2018, the Fed recently deemed a fourth increase likely in light of robust economic growth, and with the surge in GDP this seems to be a near certainty. However, an additional three increases planned in 2019 has investors on edge, considering recent trade friction and a flattening yield curve.

"Consumer price inflation continued to climb during the second quarter of 2018."

Consumer price inflation, which is usually inversely related to interest rates, continued to climb during the second quarter of 2018. According to the CPI-U index, average consumer prices in June 2018 were 2.9% higher than they were a year prior—the largest 12-month increase since February 2012. The personal consumption expenditure price index, which takes into account changes in consumption habits as people substitute some goods and services for others, increased 2.2% during the 12 months ended June 2018.

U.S. Inflation and Personal Consumption Expenditure Index

The upward trend in energy prices steepened further in the second quarter, fueling significant overall price inflation. Gasoline prices increased sharply by 24.3% over the 12 months ended June 2018.

All things considered, we believe that there is remaining ‘gas in the tank’ for the economy and that a recession is unlikely in 2018, notwithstanding any major shocks. We project annual real GDP growth to be 2.8% for the 2018 calendar year—10 basis points higher than our previous projection.

Jonathan Chambers
Jonathan Chambers

Delta Associates