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Q4 2019 Edition

A Message from Larry P. Heard

Cover Story
In Demand
Career Opportunities for Property Services Engineers
Katie Sakach

Homogenize Industrial Real Estate Portfolios to Maximize Returns
Collin Comer and Scott Fitzgerald

Weighing Healthcare’s Certificate-of-Need Laws
Steve Hall

Haves and Have-Nots of the U.S. Economy
Jonathan Chambers


The Transwestern enterprise comprises diversified real estate services, investment management and development companies. The privately held, fully integrated organization leverages competencies in office, industrial, retail, multifamily and healthcare to add value for investors, owners and occupiers of real estate. Experience Extraordinary at and @Transwestern

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A Message from
Larry P. Heard

At some point, people will be correct in predicting the next downturn. Until then, we remain on course with action-oriented strategic planning for our Commercial Services, Investment Management and Development companies. That said, part of our planning has well-considered defensive measures woven into our activities, anticipating that this slow and (reasonably) steady expansion will sooner or later come to a halt.

We are also working closely with our clients and investors to funnel an abundance of data and analytics into actionable strategies. The goal is to increase the speed and enhance the certainty of investment-related decisions.

In this edition of Insights, our experts also discuss demographic-driven recruiting initiatives in the asset services sector, why pension plans are increasing their allocations to real estate, evolving regulatory effects on healthcare real estate and a research piece contrasting a domestic market enjoying some expansion against a backdrop of sluggish global market performance.

We regularly provide these insights to support your real estate investment decision-making and to become a more valuable resource to you, today and for many years into the future. Thank you for your support.

Larry P. Heard
Chief Executive Officer

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Katie Sakach
Managing Director
Asset Services

With time running out for the commercial real estate industry to address a looming exodus of building engineers entering retirement, Transwestern is laying groundwork to recruit, train and retain the team members who will manage and operate its properties in the years ahead.

Demographers have long warned that baby boomers, born between 1946 and 1964, will disrupt an array of industries as they exit the workforce. Commercial property management is already experiencing the beginnings of what will become an ongoing, critical shortfall of talent as large numbers of facility management professionals retire, according to a series of reports by the International Facility Management Association and Royal Institute of Chartered Surveyors.

How did we get here?

After World War II, high school vocational classes, apprenticeships and trade schools introduced legions of Americans to careers in engineering and skilled trades such as carpentry and welding. By 1980, however, these traditional occupations had begun to lose favor among students as college admissions mushroomed. Trade school enrollment has begun to recover since 2000, but boomers still hold the lion’s share of the blue-collar jobs that are essential to operating commercial properties.

Research by Able Services for BOMA International shows that nearly a third of property management personnel will reach retirement age by 2027, with an even larger segment reaching that point just a few years later. While that trend siphons off much of the industry’s most experienced labor, job creation in real estate and property management is on track to grow twice as fast as the overall economy through 2026, according to the Bureau of Labor Statistics.

At a time when unemployment is already at a 20-year low, the property management sector will soon have more open jobs and fewer seasoned professionals to fill them. What’s more, the industry is at risk of losing the vast institutional knowledge that boomers will take with them into retirement.

A Majority of Building Engineers are Near Retirement

Facing the challenge

Like many firms in the property management space, Transwestern in the past hired a combination of experienced building engineers and newer entrants to the industry who would require supervision and training before taking on progressively greater responsibilities. A system of on-the-job study by shadowing more experienced team members served the company well for decades, but has become impracticable for several reasons:

For one, teaching by example takes many years and is a luxury the property management industry can no longer afford. And two, if all the property engineers reaching retirement age in the next decade indeed retire, there may not be enough experienced team members remaining to train new hires. Add in the need for team members to master an accelerating inflow of new building technology, and the need for a rigorous continuing-education program becomes apparent.

Transwestern is attacking the problem on dual fronts, intensifying recruiting efforts and focusing on the development of a comprehensive internal training program for its Asset Services group. It expects these measures to not only secure the company’s competitiveness in the years ahead, but to also help the industry by raising the awareness among students and recent graduates of the careers available in building services.

Effective hiring begins with a job profile that clearly represents requirements. Oftentimes, individuals who have just finished high school, college or military service may be unaware that their abilities apply to property management and building operations.

For example, many recently discharged military veterans have learned to service mechanical and electrical systems or work with automation software like those used in a modern office building. Such experience can produce prime candidates for building engineering jobs. Navy veterans may be particularly suited, because naval vessels share many operational features with commercial buildings. Another highly qualified audience for this job track is HVAC program graduates.

Not simply a job, but a career

Longer term, the property management industry must develop a robust talent pipeline and demonstrate that there is considerable opportunity for advancement in an exciting sector of the economy that continues to evolve with building trends, technological advances and workplace preferences. This requires educating educators about the strong, longterm career prospects in property operations so that they are equipped to convey that information to students.

“Job creation in real estate and property management is on track to grow twice as fast as the overall economy through 2026.”

Retaining talent will also be critical in the years to come, and investment in human capital is one of the factors that keeps team members informed and engaged. At Transwestern, for example, our Asset Services group reviews each team member’s skill set at points throughout the year and helps to identify additional training needed for career growth. We pair highly motivated team members with mentors to assist in their advancement.

Training for building engineers can span inhouse courses on building systems, proprietary software, client accounting, customer service, sustainability and energy management best practices, as well as certification programs offered through industry organizations or other specialty groups. In our union markets, we take full advantage of continuing education and safety programs for members. All these opportunities enable team members to develop their capabilities and learn new ways to add value for clients, enhancing their own earning potential in the process.

Building engineers are in high demand in many markets, with earning potential that rivals some positions requiring a four-year degree. And amid growing awareness that a college education can also saddle graduates with debt for much of their working life, students training to become building engineers and to fill other property management roles will find many opportunities for tuition assistance and employer-provided training that will help launch their careers on a sound financial footing.

Katie Sakach
Katie Sakach
Industrial article

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Collin Comer
Senior Managing Director
Transwestern Investment Group
Scott Fitzgerald
Executive Managing Director
Transwestern Investment Group

As many investors will attest, few industrial portfolios available today will entirely dovetail with a buyer’s needs. Real Capital Analytics data shows approximately 70% of industrial asset sales are one-off transactions, creating a fundamental mismatch between those offerings and the volume of capital that seeks large-scale placement in the sector.

This dynamic provides an opportunity for investors with properly positioned portfolios to achieve premium pricing. But to better appreciate that opportunity, it helps to understand the reasons for the incompatibility between buyer and seller requirements, one of which stems from the way fundraising has evolved since the Great Recession.

Larger funds, fewer managers

Targeting higher returns and lower volatility, pension plans have increased allocations to commercial real estate over the last 10 years. In the wake of the 2007-2008 global financial crisis, pensions consolidated external manager relationships to reduce expenses and demands on internal staff, with best-in-class managers benefitting from broader mandates. By 2013, more than 450 closed-end private real estate funds were targeting new commitments, according to Preqin, with 40% seeking capital for the first time.

“Annual portfolio and entity-level transactions are up 279% since 2012.”

Aiming to avoid the risk of investing with new management teams, pensions have opted to commit allocations to existing external managers, resulting in larger allocations to fewer managers. By 2016, the 10 largest funds secured 36% of the total capital raised, according to Preqin. The average fund size in 2016 was $500 million, with many managers raising multibillion-dollar closed-end funds in record time.

The average investment in an industrial property is approximately $12 million, according to Real Capital Analytics. That amount is half the average value of office transactions and poses a challenge for some investors seeking to increase industrial exposure.

The larger funds that have emerged in recent years need large transactions to fully deploy their committed capital because the alternative – targeting smaller transactions – would require additional resources and staffing levels, elevating investment-execution risk while increasing cost and inefficiency.

Instead of engaging in one-off transactions, many larger firms have concentrated on gaining industrial asset exposure by pursuing portfolios and entity-level transactions. By 2018, annual portfolio and entity-level transactions for industrial properties totaled $45.6 billion, up more than 279% from $12.0 billion in 2012, per Real Capital Analytics.

Portfolio premium

Industrial market fundamentals are strong, with demand outpacing supply in most of the major markets. E-commerce tenants continue to drive demand for warehouse and distribution space, vacancy rates are at cycle-lows and rents are increasing. Investor demand for these assets has grown, and some large investment funds, which generally have the lowest cost of capital, will pay more for a large, multitenant, geographically diverse portfolio of similar vintage.

Lenders have increased their appetite for industrial as well. Although they remain cautious, debt providers have rewarded investors financing large, diverse portfolios with lower credit spreads and higher leverage ratios than can be achieved in alternative property types or lower mortgage balances. This trend produced liquidity that has enhanced larger portfolio transactions. Currently, demand from large investment funds can combine with enhanced liquidity to create a significant premium for a portfolio trade over a single-asset trade.

However, not all portfolios will trade the same. Industrial portfolio sales are highly dependent on the proper mix of assets and locations.

“A portfolio with similar assets in logistically related markets of comparable vintage will attract significant investor attention.”

For example, offering a portfolio that includes both high-throughput logistics assets as well as flex assets that are chiefly finished out as offices will limit investor interest because of the mismatch between investment strategies. The investor that focuses on the logistics assets will not want to invest in the flex assets and vice versa. This leads to a breakup of the portfolio into multiple transactions where the assets are allocated according to the proper strategy.

Homogeneous portfolio strategy

Conversely, a portfolio with similar assets in logistically related markets of comparable vintage will attract significant investor attention, given the uniform strategy that can fit within an investor’s defined investment profile. A homogeneous portfolio of sufficient scale will garner the portfolio premium.

Transwestern Investment Group (TIG®) achieved premium pricing on a recent industrial portfolio sale by catering to the market’s largest buyers, aggregating smaller acquisitions into a sizable industrial portfolio in TSP Value and Income Fund I, which delivered a net 17% internal rate of return to investors after fees, expenses and carried interest. The firm is continuing with the same strategy on its second and larger fund, combining narrow acquisition criteria with a value-add program.

As an experienced owner and operator, TIG acquired assets it could enhance through efficient operations. In addition to making needed capital improvements, TIG renewed tenants on long-term leases, reconfigured spaces to fill vacancies and maximized net operating income (NOI). Adding value is the principal strategy to reach targeted returns, and Fund I boosted NOI by almost 20% over an average weighted hold of 3.5 years.

Throughout the investment period for both funds, the team was laying groundwork to substantially outperform when monetizing those assets. The key to outperformance was aggregating a product that could participate in the significant transformation stemming from the proliferation of e-commerce, sized to garner the attention of the market’s largest buyers.

TSP Value and Income Funds I and II

Transwestern Investment Group’s industrial investments in both TSP Value and Income Funds I and II have positioned TIG to be a low-cost provider of functional, infill warehouse space.

The asset class already offers an attractive yield and has a strong tailwind as the growth of omnichannel retailing and e-commerce drive demand for fulfillment and distribution centers. TIG’s portfolio aggregation strategy provides multimarket diversity with highly functional bulk warehouses containing a low ratio of office space in infill locations suited for order fulfilment and last-mile delivery to urban populations.

The firm drew upon its lengthy experience as an owner and operator to increase value, improving each asset’s net operating income through leasing, improvements and efficient operations. Fund I boosted NOI by almost 20% over an average weighted hold of 3.5 years.

Fund I’s 3.5 million-square-foot portfolio – including 21 logistics facilities in Illinois, Ohio, Indiana and Kentucky – provided a highly sought-after product type that met the size and quality requirements of the market’s largest buyers. The portfolio was 91% occupied when it sold to an overseas institutional buyer whose low cost of capital gave the seller a premium on the fund’s residual cap rate, boosting the net internal rate of return to 17%.

Fund II is using the same strategy at twice the scale, buying assets that coalesce to capture demand for large transactions. By midsummer 2019, Value and Income Fund II had approximately 4 million square feet in committed industrial acquisitions.

Collin Comer
Collin Comer
Scott Fitzgerald
Scott Fitzgerald

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Steve Hall
Senior Managing Director
Healthcare Advisory Services

In all but a dozen U.S. states, proposals to develop or expand a hospital, clinic, outpatient surgery center or similar project must obtain a state agency’s certification that the local community needs the infrastructure or services to be provided there. In those markets, a certificate of need (CON) is a make-or-break component of any healthcare real estate development large enough to be regulated.

“In some markets, a certificate of need (CON) is a make-or-break component of any healthcare real estate development.”

While CON statutes vary, all began with a goal of containing healthcare cost inflation by avoiding overbuilding in a community’s medical resources. This longstanding assumption argues that a hospital with too many empty beds will likely increase patient fees and other pricing to cover its overhead. Similarly, if two imaging centers open to serve a patient population that is only large enough to support one imaging center, neither facility may be able to attract enough patients to cover its capital and operating costs without raising prices.

States often weigh the opinions of existing providers in determining the need for proposed facilities. Critics argue that this practice stifles competition that could force existing providers to operate more efficiently, which would ultimately reduce patient costs.

Most states have or had CON laws in place, but some have tempered or abandoned those regulations to take varying degrees of a free-market approach to healthcare development. The ranks of states in each camp continue to change, so any healthcare professional or organization contemplating a relocation, expansion or launch of a healthcare business should investigate local need certification requirements early.

CON considerations

Even when a state health authority denies an application for a new need certification, there may be other options available, says Andrew King, president and founder of Acumen Healthcare, a Georgia-based developer and manager of ambulatory surgery centers in 20 states.

“As CON reform proposals gain support in many states, changing laws may soon open new opportunities in healthcare development.”

One route may be to purchase or merge with an existing entity that already holds a certificate. With a valid CON, the combined entity may then be able to relocate or develop a facility without incurring a new review, provided the firm will continue to serve the same patient base covered in its certification.

And as CON reform proposals gain support in states including Alaska, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Vermont and Washington, changing laws may soon open new opportunities in healthcare development.

Georgia administers one of the nation’s most stringent need certification programs, for example, but recently eased some of those regulations. Its reforms in 2019 freed private cancer treatment centers to add beds without going through the CON application process. Georgia also raised the thresholds on capital expenditures a provider can make before triggering CON review from $2.5 million to $10 million for a healthcare facility, and from $1 million to $3 million for diagnostic equipment.

Also in 2019, Florida repealed need certification requirements for general hospitals, tertiary hospital services such as those provided by oncology centers or psychiatric facilities, and complex medical rehabilitation beds; similar requirements for the state’s specialty hospitals will end in July 2021.

Need certification requirements can be a source of confusion and frustration, particularly if CON-related challenges surface after a project has already absorbed substantial time and capital. Because failure to obtain this precious document can derail even a well-funded and otherwise sound business plan, need certification should take precedence over many other planning aspects for a healthcare project.

A review of needs-based project review

The concept of linking hospital and clinic development to a community’s healthcare needs is nothing new. For roughly 30 years after World War II, the federal government required communities to provide population and per capita income data to demonstrate their need for new hospital beds funded with loans or grants under the Hospital Survey and Construction Act of 1946. Better known as the Hill-Burton Act, the program had helped fund construction of nearly a third of the nation’s hospitals before lawmakers rolled it into the National Health Planning and Resources Development Act of 1974.

Nearly all of today’s certificate of need (CON) statutes trace their impetus to this 1974 measure. At the time, Congress found that “the massive infusion of federal funds into the existing healthcare system” was contributing to inflationary pricing.

Believing better planning would help states and communities to match medical facility development with patient needs, Congress directed all states to establish CON guidelines. The programs were to charge a state health planning agency with vetting proposed capital expenditures for new institutional health services, which could range from building a hospital to expanding a clinic or adding high-tech devices. The state agency would review each plan and choose whether to certify it as needed and therefore free to proceed.

Most states adopted CON laws as a result. New York had a decade’s head start, having asserted its authority to determine need for proposed hospital or skilled nursing project development in 1964. Louisiana is the only state that didn’t enact some form of CON legislation.

The federal government severed funding associated with CON review in 1987. Since then, several states have modified or repealed their CON rules, and organizations are pressuring lawmakers in other states to revisit their statutes. While most changes have tended toward deregulation, Indiana bucked that trend on July 1 this year when it enacted a new CON program, 20 years after removing a similar law from its books.

Steve Hall
Steve Hall

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Jonathan Chambers
Vice President
Delta Associates

The post-recession recovery period has brought growth and prosperity to many parts of the nation, but other areas and industries have been left behind. Rural communities and small towns, where 20% of Americans reside, as a group have yet to reach pre-recession employment levels, while the nation’s major metropolitan areas have enjoyed the bulk of economic growth.

“It’s no surprise that major cities have been most prosperous in the recovery.”

Sectors that have led employment growth since the beginning of the recession mirror the top three categories in recent jobs reports: Education/health, leisure/hospitality and professional/business services each added over 3 million jobs between November 2007 and August 2019. The combined 12.5 million positions these rapidly expanding sectors added surpasses the 12.1 million net total employment growth over the same period. These sectors account for approximately 23% of economic output, up from 21% prior to the recession.

At the other end of the spectrum are five sectors that have contracted through the recession and recovery: State/local government, manufacturing, retail trade, information and wholesale trade have shed a combined 2.5 million jobs and currently account for just 40% of economic output, down from 43% in 2007. A third cluster have stagnated since the recession with positive, but weak, job growth and an unchanged gross domestic product (GDP) share of approximately 35%. This group includes transportation/utilities, other services, financial activities, construction/mining and the federal government.

Given these trends, it’s no surprise that major cities have been most prosperous in the recovery. Education/health, leisure/hospitality and professional/business services employment has always clustered in densely populated urban areas with high concentrations of well-educated residents, historical and cultural resources, and educational and healthcare institutions. Rural areas and mid-sized cities historically depend on trade, transportation, manufacturing, local government and mining jobs—sectors which are currently contracting or stagnating.

Expansions and Contractions

Measuring the gap

Between 2010 and 2018, the nation’s 30 most populous metropolitan areas grew their headcounts by 8.1%, approximately twice the national pace. Since the start of the recession, those top-30 markets increased their job base by 8.7%, compared to 5.8% for the rest of the country. GDP grew 36.3% in the top 30 versus 29.2% in the rest of the U.S. between 2007 and 2017. The nation’s major activity centers outperformed the rest of the country in virtually every meaningful economic metric.

“The nation’s 30 most populous metropolitan areas grew their headcounts by 8.1%, approximately twice the national pace.”

Performance has been uneven among these growth centers, however. Metro areas in the Sun Belt and West have generally outperformed urban areas in the Northeast and Midwest.

The Lone Star State has done especially well, with the rapidly growing Austin area dominating in every category and Dallas/Fort Worth, San Antonio and Houston consistently appearing near the top in each metric. Other major growth centers include Denver, Seattle and Charlotte, North Carolina.

Notably, top performers in one measure do not necessarily perform as well in others, given each region’s distinct demographic makeup and economic structure. For instance, Pittsburgh was the only top-30 metro area to record negative population growth since 2010 but has seen its GDP rise a solid 41% since the onset of the recession. Conversely, Southwest retiree magnets Phoenix and Las Vegas have outpaced most other metro areas in population growth but place near the back of the pack in economic expansion.

The tech surge

Tech and gig economy firms have been a boon for metro areas and remain highly sought after. There is probably no better example of the high value placed on these employers than last year’s competition for e-commerce giant Amazon’s HQ2 campus. A total of 238 jurisdictions in the U.S. and Canada offered billions of dollars in tax breaks, subsidies, infrastructure improvements and other incentives to win the 50,000 planned jobs. Of the 20 finalists, 16 were unsurprisingly from the 30 largest metro areas.

“Pittsburgh was the only top-30 metro area to record negative population growth since 2010 but has seen its GDP rise a solid 41% since the onset of the recession.”

Even with the tech industry’s solid growth propelling the economy forward, there are concerns over the long-term viability of many startups that are burning through cash and have yet to generate a profit – the unfolding WeWork IPO saga being the most prominent example. Few of these firms have experienced an economic downturn, fueling fears of a wave of tech insolvencies in the next down cycle. If that were to occur, it could hammer the nation’s large metro areas, as the dot-com bust jolted the West Coast in 2000.

Recovery in the 30 largest metropolitan areas

Indicators ‘slowing and going’ into 2020

U.S. economic growth continued to slow over the summer. Trailing 12-month employment growth totaled 2.06 million new positions in August, more than a half million short of the 2.61 million jobs added over the year ending August 2018. In 2018, monthly job growth averaged 223,000 workers, but aside from an exceptionally strong January performance, job gains in 2019 haven’t approached 2018’s average monthly pace.

Payroll job growth

The national unemployment rate held steady at 3.7% for June, July and August and was nearly unchanged in September and October at 3.5% and 3.6%, respectively. September marked a 50-year low, equal to the rate in December 1969.

Real GDP growth declined to 2.0% during the second quarter of 2019. This was 100 basis points lower than the rate of expansion in the first quarter and the slowest since the first quarter of 2017. A drawdown in business investment, trade and manufacturing are the main culprits behind the deceleration and can all be directly linked to the Trump administration’s trade war with China. Private domestic investment and net exports decreased sharply from the previous quarter, by 6.3% and 5.7%, respectively. Strong growth in personal consumption (4.6%) once again buoyed the economy, as it repeatedly has done since the recession; had it not, growth would have been significantly weaker.

Public sector hiring over the year ending August was led by local and federal governments, with 68,000 and 50,000 net additions, respectively. The latter was in the midst of a nationwide hiring campaign in advance of the 2020 census, however; the vast majority of these positions were temporary, evidenced by a 17,000-job decline in federal employment in October. The education/health, professional/business services and leisure/hospitality trio continue to lead private-sector job growth, accounting for 1.33 million net additions over the year ending August 2019.

The manufacturing sector added well over 100,000 new positions during the same period, but the outlook for the sector is grim. The Institute for Supply Management’s purchasing managers index fell below 50% in August through October, indicating a contraction in the sector. Notably, the September figure of 47.8% was the lowest reading since the end of the Great Recession.

Jonathan Chambers
Jonathan Chambers

Delta Associates