How is technology impacting the way public real estate is used and valued? What opportunities and challenges does it create for Real Estate Investment Trusts (REITs)?
This is a presentation from September 2018, delivered by Dror as a keynote speech at the EPRA Conference in Berlin.
The full PDF is available here. And the full text of the talk is below:
Good afternoon everyone. Today, we are going to talk about technology’s impact on the value of public real estate.
Before we begin, let’s look at how technology can impact the value of companies in other industries. A little over a decade ago, two revolutionary companies went public. Since the beginning of 2005, the value of one of these companies went up more than 1,100%. That company is called Google.
The value of the second company went up nearly 1,700%. Can anyone guess which company I am talking about?
The company is Domino’s pizza.
The pizza industry has a lot of similarities to real estate. It’s an ancient industry. Reliant on manual labor. Every location has different value and preferences. It is a conservative industry, with a product that remains relatively unchanged for many years. The physical ingredients are key.
But the main reason I chose to look at pizza — is to give you hope. To show that it is possible for public companies in traditional industries to reinvent themselves and reap impressive rewards.
My name is Dror Poleg, and I am the founder of Rethinking Real Estate, a company that advises institutional real estate investors on innovation and strategy.
We work with private equity fund managers, institutional LPs — including some people in this room. We also advise venture capital funds and venture-backed technology companies that are focused on the real estate industry.
Over the next 30 minutes or so (the same time it takes to deliver a pizza), I will provide you with an overview of how technology is impacting the way public real estate is used and valued.
Then, we will look at specific opportunities and challenges this created for REITs, the changes it would require, and the barriers to those changes.
Finally, we will go over 10 things that each of the REIT managers in this room can start doing as soon as you walk out of this room.
Let’s begin. I am going to go through these different dynamics quickly. If necessary, we can delve deeper during the Q&A session.
Coworking is no longer just for kids. Or perhaps, it is just for kids, but the kids are being employed by the world’s largest companies. This means that Space as a Service is no longer about a single desk and flexible access. It is also about 2-5 year leases for companies with hundreds of employees.
Real estate spaces are becoming too complex for the tenants to manage themselves. This is most visible in retail. This is a startup called B8TA, which offers brands a retail store-as-a-service, including optimal design, well-trained staff, proprietary tools that aide the sales process, and the ability to collect data and get a better understanding of what buyers want and what works best.
The same dynamic is also starting to make its way into office and even multifamily — where tenants want a turnkey solution that integrates smart systems and employee management systems.
Part of this is due to the thickening layer of service required by office tenants. Convene is a company based here in New York. It started as a provider of events spaces, but is gradually moving towards corporate meetings and even proper workspaces. This means that (some) office spaces now compete on the quality of the food, concierge services, and a service attitude… that were previously non-existent in the mainstream office world.
Software also makes it possible to make more intensive use of existing locations. Spacious, for example, creates coworking spaces in restaurants that are otherwise closed during the day. Recharge provides access, by the minute, to hotel rooms… after last night’s guest checked out and before tonight’s guest checks in. Customers can have a nap, grab a quick shower, or….. “socialize”.
Technology also facilitates more intensive use of space through increased density. This is a Wework floor plate from Dallas, Texas… not the most dense city in the world. Wework can squeeze more people into a single floor than probably anyone else. They achieve about 50 sqft per employee, compare to 150 sqft for a typical office. They do it by using both hardware and software to create an experience and value proposition that breaks the traditional relationship between value and space.
Density and “new space” is also created in other ways. Different on-demand services now make different part of apartments and offices less necessary — the kitchen, a big fridge, storage area, washing machines.
And indeed, value is no longer just about the quantity of space, the location, and the price. Wired Score measures and certifies each building’s digital infrastructure. This is becoming an important factor in moving decisions.
Even softer aspects become more meaningful. Common, for example, is emphasizing design, community, and a focus on its customer’s specific needs. By doing so, it is able to attract tenants to new location and command higher rents than neighboring buildings. This is not a trick — the company provides actual, clear value that customers can appreciate.
And “brands” are not just there to serve real estate assets.
On the left we see a new, big real estate project. Does anyone know what it is?
It is Disney’s new Star Ware universe in Disneyland. Disney were pioneers of using real estate to deliver “immersive branded experiences”. But now this same dynamic is making its way to other types of assets.
On the right we see a new hotel in Shenzhen that was launched by MUJI. MUJI is a fashion and furniture brand. Now, they are using their style and customer relationship to create value for a real estate asset.
But real estate is no longer just about value. It’s about values. The values of the people who use the space.
A few weeks ago, WeWork announced that they will no longer serve meat in their coworking spaces.
It doesn’t matter whether you agree with it or not, or if you think it is a good or bad idea. The interesting thing here is that the operator of a space is using unique values to create a deep connection with the people who use the space.
Have you ever seen an office operator that uses culinary preferences to differentiate itself and signal its values to potential customers? When was the last time you identified with your landlord’s values? Do the employees of your tenants even know who the landlord is? Soon they will, and if you don’t decide what your brand stands for, the tenants will force their own values on you (through social media outrage, but we’ll keep that for another time).
The good news is that most brands need real estate in order to offer such experiences.
The bad news is that many of them have the power to become direct competitors of traditional real estate companies. In some way… the worst way to make money from real estate is to be a real estate company. In the past, the value of the asset determined the value the operator valuable. In the future, the values of the operator will determine the value of the asset.
But not all tenants want to join a club or a cult. They want a turnkey solution. But they also want to be able to maintain their own culture and customize the product for their needs.
Value is also detached from buildings in other new ways. Breather shows that a building’s value depends on which networks it belongs to. The company allows customers to access on-demand meeting and workspaces for an hour, a day, and even several months. A space becomes more valuable becomes it is part of a whole network.
And networks of buildings can be valuable in even more ways. Colony Northstar, one of the world’s largest real estate investment managers, recently invested in Blade, a “flying taxi company”. Blade currently has a fleet of helicopters but has its eyes on the flying car market. Flying cars need a network of roofs to land on.
But landlords don’t need to wait until cars begin to fly. 5G mobile networks, for example, require 22 times more base stations than 4G networks. That means landlords can monetize interiors, common areas, facades, and roofs in new ways.
Networks also create large quantities of data. OneMarket is a network of offline retailers and retail spaces that integrates key insights and relationships.
What is interesting here is that OneMarket was originally part of Westfield, one of the world’s largest shopping center owners. When the Lowy family sold all its shopping malls, it chose to maintain ownership of OneMarket. This means they are long on data, and may be less excited about the value of physical assets on their own.
Data also makes it possibly to make real estate markets more liquid and immediate. OpenDoor is a startups that allows you to sell you house online, within minutes (plus a few days). You log in, enter your address, receive an instant offer, and if you accept it… they send someone over to make sure all details are correct and the deal is done. This is residential, but the same capabilities are gradually making their way to commercial assets.
New companies are trying to use big data analysis to automate underwriting and to set up their own fund management business. So in a few years, you might be competing for investors with companies that have completely different DNA and strategies.
And real estate data is not just about the location, layout, or lease roll of the asset. It is moving into the buildings themselves. Buildings are getting filled with sensors, cameras, smart devices, voice activated machines, and more.
These devices will allow the operators of a physical space to extract huge amounts of personal data about their visitors, tenants, and employees.
The technologies are already available.
And they’re already making an impact.
New data sources introduce new financial, reputation, and political risks. These are just a few examples from the past year.
And data is just one part of the equation. To offer superior products and services, real estate companies are integrating different components of their value chain. Katerra, for example, handles everything from sourcing the materials, through design, to precision-construction of the actual building… and maybe one day handle the operation of the building or the collection of data on how it is used. We also see it with Wework and Convene acquiring other startups that have design, fit out, access control, and other capabilities.
The value of integration gives great advantages to players who can bring together actual buildings, technology, and operating platforms. Blackstone, for example, invested in or acquired an energy management software company, a leasing technology company, a serviced office and hospitality platform, and launched a single-family home rental and customer service platform. These gives it great advantages against competitors who only own buildings.
Other large property owners such as Brookfield and GIC are also making direct investment in real estate technology or new types of operators.
Part of the reason Blackstone is doing it, is to protect its position as a fund manager for institutional investors. If we look at Wework’s recent deal in Devonshire Square in London —the article says that Wework “paid $826”…. but Wework actually put down less than 10% of the money. The bulk of it came from Rhone and PFA, a Danish pension fund.
Pension funds historically invested in such deals through fund managers like Blackstone. Technology makes it possible for them to invest directly with operators they believe in. Tech gives them access to information — about the market and about people — that allows them to act with confidence.
On the other side of the financial world, retail investors and small developers suddenly have access to new investment product and new sources of funds.
And as flexibility becomes a main feature of office spaces, valuations are starting to become affected. When a Core asset is 40% flexible, is it still a Core asset?
The capital stack is also getting mixed up in other ways. Real estate companies are starting to invest directly into startups. They are backing up new dedicated VC funds that focus exclusively on the industry.
On the other side, traditional venture capital firms are developing an appetite for real estate technology. What is interesting is that some of them are investing in companies that use these funds to sign long-term leases or even as equity for acquisitions. This means venture money is used to secure actual assets, not just to develop technology or services.
So what does it all mean?
Technology and tech-driven changes call into question the role of real estate as an asset class with predictable cashflow and inherent value.
The value of assets is increasingly dependent their operators.
The operators of the future will differentiate themselves through technology and focus on the needs of specific customers.
Real Estate assets can be monetized in new and exciting ways.
Ok. Enough with all this drama. Let’s get practical. What can you do about all this?
Before we answer this question, let’s look at what limits REIT’s ability to change.
They are often “too” big. It takes a lot of time and effort to change the course of a large ship.
In other ways, REITs are also too small. When we see Wework raising $4b to invest in technology, hiring, branding, and expansion…. most REITs don’t have discretionary budgets to make truly bold moves or invest in anything other than buildings.
There isn’t enough pain. We all understand that the industry is changing. But things are going great at the moment… why worry or spend money on stuff that doesn’t affect us yet?
REITs are also too public. It means that every change needs to be reported and explained. Some would also say that it means management is focused on short term performance and much less on the value of assets in 5 or 10 years.
Finally, most REITs don’t have a DNA for change and adventures. This used to be a good thing. REIT are all about stability and responsibly stewardship of public capital.
But not everything is bleak. REITs also enjoy some advantages!
They have relatively centralized management structures, especially compared to private equity funds. This allows them to set clear strategies and policies that drive the whole organization.
The same technological changes that we discussed also make it difficult for small owner to complete, which create more demand for large operators with unique capabilities.
REITs are relatively liquid, meaning they can move faster than private funds, or draw new funds quickly once they have a winning strategy.
REITs can be merged, helping create scales and spread fixed investment in technology and new skills across a bigger balance sheet.
REITs owner dozens or hundreds of assets, creating networks that can be monetized in new and exciting ways.
And these large number of assets also create tonnes of data that can be used for competitive advantage or to create new revenue streams.
It’s almost lunch time. To get some inspiration, let’s go back to the pizza industry. What made Domino’s so successful?
Domino’s CEO said “Domino’s is a tech company”. What does it mean in practice?
Digitizing the whole customer journey – from how the pizza is ordered, prepared, delivered…
Rejuvenating the brand with tech in the center – make it clear to customers that you are unique
Hard tech investments, staffing with software engineers and data scientists – not just lip service, no “pizza tech vc funds”, real investment in changing their own companies
Relentless dedication to measuring results – seeing what works, what doesn’t, bringing accountability, and experimentation
Fully integrated – control over the whole experience. Why is Wework becoming a brokerage? Why does Apple not sell it’s new products on Amazon? It wants to create and control a unique experience
Start with getting the fundamentals right – use tech make sure ingredients is fresh, arrives on time, collect customer feedback, provide customer support
Organizational buy-in from the top down – it wasn’t some “associate” or some kid they brought it, it came all the way from the CEO and down
OK. So what are 10 things you can start working on as soon as you leave this room?
Get the basics right – no need to reinvent the wheel. Look at the systems you use for access control, visitor registration, elevators, air quality, light quality, noice reduction.
Consider your whole value chain – having a great building or space is not enough. How do your tenants find you? Are they having an optimal experience? What do they do in the middle of the day when they step out to eat or freshen up?
Get to know your customers – You need to get to know your customers. Customers are not just the entities that sign the lease. They are all the people who spend time in your building — visitors, employees of your tenants, anyone. They all have needs, and they all provide data that can help you create value.
Get to know your non-customers — Non-customers are people who currently use your assets, or similar assets but are not paying you. This includes people that are using Airbnb instead of your hotel, guests of your tenants, roommates who are not listed on the lease, sub-tenants of your office tenants. The behavior of each of these groups can give you a clue about where the market is going. If you understand what customers want, you can build new business around it.
Get your data in order – do you know what data is currently collected in your buildings? do you know how it is shared? Do you have a clear policy on how it is protected? Are you transparent with you customers about this policy?
Address structure & incentives – Consider what is preventing your company from making necessary investments in new capabilities and initiatives.
Leverage your network – consider how you can use different buildings to create a new offering for your customers — for example, providing them with access to a lounge in every building you own.
Consolidate – Consider opportunities to merge with or acquire other REITs. It looks like the future favors the larger players. There are exception to this. And also, being big, does not guarantee survival.
While all these changes are happening — inside and outside your company — you need to communicate with your investors and your tenants to help them understand what your plans are and how this will impact results in the short and in the long term.
And most importantly : You have to commit. If you just “give it a try”, you will give up. Technology is challenging real estate operators to reinvent themselves. This presents a massive opportunity, and a very serious challenge. You should face this challenge head on.
Thank you for your time. The PDF of this presentation, and a lot of other relevant research, is available on my web site — www.rethinking.re