The hottest real estate trend of the past decade is both coming of age and running out of steam + 5 other questions about valuations, coliving, data, and more.
It’s been a few weeks since my last piece. To make up for lost time, we’ll explore 6 big questions that touch key aspects of technology’s impact on office, retail, housing, coworking, coliving, data, privacy, network effects, valuations and more:of
- How do you opt out of a smart city?
- Is pricing space per square feet still relevant?
- Should real estate charge rent?
- Is coworking dead?
- Do network effects make portfolios more valuable?
- How does tech impact the value of individual real estate assets?
These questions are related, but feel free to skip ahead to the one(s) that interest you. As always, your thoughts or comments are welcome.
1. How do you opt out of a Smart City?
It’s hard enough to opt out of a web site that collects too much of your personal data. But what happens when your city starts doing the same? Toronto’s recent partnership with Google is a case in point, as former Blackberry CEO Jim Balsillie points out: “A privately controlled ‘smart city’ infrastructure upends traditional models of citizenship because you cannot opt out of a city or a society that practices mass surveillance.”
Google recently removed “Don’t be evil” from its code of conduct, and Dan Doctoroff, the CEO of its urban technology platform, was quite blunt when he stated the purpose of the company’s smart city initiatives: “We’re in this business to make money.” Toronto is Google’s most ambitious bet in this space, but the company already operates “information kiosks” equipped with cameras and other sensors across NYC and soon — London.
And cities are not the only places we can’t opt out of. Workplaces, schools, cars, and hospitals are also being filled with new sensors, cameras, and other data-collection devices. Check out this classroom in China for a taste of what the future might look like.
2. Is pricing space per square feet (or meters) still relevant?
As Kevin Spacey quips in The Usual Suspects, “the greatest trick the devil ever pulled was convincing the world he didn’t exist”.
In the same vein, the greatest trick that WeWork ever pulled was convincing customers to pay for “desks” and not for actual space. This allowed the coworking juggernaut to achieve unprecedented levels of density, and offer tenants an affordable way to grant their employees access to WeWork’s “community”, beer on tap, and design aesthetic.
This is not a negative development or a sleight of hand. It makes sense for goods and services to be priced based on the specific value they provide the customer. An Uber ride is not priced based (solely) on the size or make of the car. It’s priced based on the current value of what the customer wants to achieve — getting from point A to point B.
But wait, are “desks” any better than “square feet” in representing the customer’s goals? A customer is trying to complete a specific “job”. Completing it by fitting 5 employees into a smaller space is good. But completing it by using only 3 employees is even better. Looking back at Uber: Customers were enticed to pay for a temporary seat in a car instead of the whole car. But now they’re forgetting about the car and using Uber to pay for scooters, bicycles, and soon even buses.
Do you see where this is going? Real estate pricing shifted from space to seats. But it won’t stop there. “Desks” as a measure of value is just as arbitrary as “square feet”. Smart customers are already thinking about it differently. More on this soon.
The same dynamic is happening in the residential world. Coliving operators such as Common and Ollie have already shifted their pricing from “apartments” to “bedrooms”. And here too, technology makes it possible to make spaces smaller, denser but also better at serving what the customer is trying to achieve.
As the New York Times points out, companies such as Ori Systems and Bumblebee Spaces (which I advised last year) create furniture that adapts itself to people’s goals during different times of the day. The latter partnered with Starcity, an SF-based coliving operator, to deliver rooms with unique storage solutions and beds that stick to the ceiling while the customer is awake — freeing up space for other tasks.
3. Should real estate charge rent?
So rent is no longer charged per sqf/sqm. Instead, it is charged per bed or per desk or or per specific task. But should it be charged at all?
As we pointed out earlier this year, new technologies will enable real estate operators to monetize physical space in new and creative ways. The latest example comes from Rhode Island. A coffee shop near Brown University is allowing students to sip free coffee in exchange for their personal data. In lieu of payment, students tap in their names, date of birth, interests, and university majors. They then sit and sip their coffee while looking at targeted ads from various corporate partners.
While sharing your coffee shop data is still a choice, in some industries its becoming a requirement: One of the oldest life insurers in the US is now selling only “interactive policies”. These policies require customers to share health and lifestyle data on an ongoing basis, through the use of fitness trackers and other devices. Similar policies are already common in Australia and the UK.
As noted above, landlords are in a position to collect a growing amount of personal data. As customers are becoming accustomed to sharing their data in exchange for free goods or lower service costs, we expect more physical spaces to adopt creative pricing models.
As the saying goes: if you’re not paying for the product, you are the product. But real estate tenants and visitors are paying, while also being tracked. At some point, they might rebel: They’ll want privacy in the spaces they pay for and/or transparency about how their data is being used by the spaces they access for “free”.
Coworking spaces offer a great example: WeWork charges customers who use its spaces, while also making great use of these customers’ data to design new products, sell third-party services, forge brand partnerships, and raise new funds. At some point, the individuals working in these spaces might have something to say about all this.
4. Is coworking dead?
And speaking of Coworking: Is that still a thing? It looks like the hottest real estate trend of the past decade is both coming of age and running out of steam.
The Associated Press adopted the word into its stylebook, clarifying the difference between a “co-worker” within the same company and the hyphen-less “coworker” that shares a workspace with strangers. Convene, an operator of meeting, event, and private workspaces, recently launched a new white label solution to enable landlords to set up and operate their own flexible spaces.
Everybody’s “sharing space”: women, crypto enthusiasts, architects, writers, doctors, those who want to relax and those who are trying too hard. As Greg Lindsay points out, even traditional companies such as AT&T, IBM, and State Farm are setting out their own CorpWorking spaces, encouraging corporate employees to mingle with “freelancers or startups”.
But a recent Harvard study suggested that shared workspaces actually make people more guarded and less likely to interact with those around them. And a new book by productivity guru Jason Fried states that “open-plan offices are particularly bad at providing an environment for calm, creative work”.
Even WeWork, the poster child of coworking, is moving beyond its original model and focuses on corporate offerings that enable companies to move into private spaces or build out their own offices. And Breather (which I advise) recently expanded its short-term meeting and work space offering to address demand from tenants who are “graduating” from coworking and want a long-term, private space.
But while coworking hype may be at its peak, the Space-as-Service industry is still in its infancy. As it matures, it will be less about “sharing” and looking good on Instagram, and more about the basics — the elements that truly matter and help companies and individuals thrive over the long term: privacy, a unique (and not pre-packaged) culture, and solutions that are optimized for productivity and wellbeing.
5. Do Network Effects make portfolios more valuable than the assets they contain?
Last week, Brookfield and partners confirmed their intention to acquire Intu, the owner of 18 shopping centers in the UK and Spain for 2.2 billion pounds (US $2.6). Interestingly, Intu’s portfolio is valued at less than the combined value of each of the individual assets it contains.
As Green Street Advisors point out, retail portfolios were historically worth more than their constituent assets, on the assumption that malls are not transacted frequently and it takes a lot of time and money to consolidate enough of them under a single operating platform and achieve economies of scale.
As David Hatcher points out, the fact that a savvy investor like Brookfield is buying a retail portfolio might offer encouragement for other owners. But the fact that the portfolio bought at such a significant discount might send the shares of those other owners down, instead of up.
The sudden discount assigned to real estate portfolios gives rise to questions about economies of scale and network effects: Shouldn’t it be more profitable to manage a group of assets than it is to manage just one? And shouldn’t technology help portfolios become even more valuable — by leveraging data from across the portfolio to optimize marketing, spreading the costs of developing and maintaining meaningful brands, and offering tenants and shoppers benefits that are accessible in more than one location?
The answer to these question is both yes and no.
Yes, technology gives rise to network effects that make it possible to extract more value out of a portfolio of assets than from each individual assets. See, for example, how WeWork or Breather are able to take spaces in B- or C-grade buildings and extract premium rents because these spaces are brought into a global network of other spaces that customers can access.
But this dynamic is also the reason why portfolios of assets are, in many cases, becoming less valuable: The the source of value is no longer the asset itself; it is the asset’s operator. Operators who can wield proprietary technology, proprietary data, and a meaningful brand can infuse almost any asset with new value. And Brookfield is one of the few traditional operators that have been investing seriously in technology, data, and brands.
This is exactly the impetus behind Brookfield’s $2.6 billion bet: That the same assets would be worth more under its own management than they are worth under their current operator.
Also — network effects are different from traditional economies of scale. Traditional economies of scale help cut costs. Network effects mean that each new asset helps make the whole portfolio (network) more attractive to all customers.
Again, it’s easy to see how this works in the case of operators such as WeWork and Breather: When they add a new location in Berlin, their customers in New York are happy because they now have access to on-demand space in a new city. In Intu’s case, a customer in Glasgow does not care so much if the company opens a new mall in Madrid. It would be interesting to see what Brookfield can do to change this dynamic.
6. Does tech make commercial real estate assets more, or less valuable?
Innovative operators don’t just impact the value of portfolios, they also impact the value of individual assets.
A recent analysis published by Cushman & Wakefield found that “properties with high WeWork occupancies traded at capitalization rates that were higher compared to the overall market rate for similar buildings“. A separate study by Green Street Advisors also found that “property buyers required higher cap rates for offices run purely as co-working or flexible workspace, compared to those of traditionally leased offices”.
This means that investors see buildings operated under flexible models as more risky. This is not surprising. At the same time, Green Street acknowledges that flexible workspaces “can generate more than 1.5x the yield of a traditional office lease”. This means that flexible operators can draw more revenue out of a building, but this revenue is reflected in lower multiples in the building’s valuation.
As we discussed in the previous section, this makes sense: More value is extracted from the asset, but the value accrues to the operator and not to the asset itself. And so, WeWork’s valuation continues to balloon while the NOI of the assets it occupies might be trading at a discount. It also explains why more and more landlords are refusing to accept WeWork as a tenant.
Traditional office landlords need to find creative ways to cooperate with the (very few) other tech-powered operators that are more aligned with their interests. There are plenty of ways to do so, and plenty of upside left for grabs.
Retail landlords are not as lucky. A few weeks ago, I heard the CEO of one of the world’s largest shopping mall owners describe the bright future of offline retail by pointing out that “even Amazon is buying offline stores”.
It’s true. Aamazon is buying and opening physical stores. But Amazon has an existing relationship with millions of customers that it can bring into these physical stores. Amazon decides what is being sold. Amazon decides where it is being sold. Amazon made whole foods more valuable, not the other way around. It owns physical spaces, but it makes money from its online businesses.
Amazon’s physical stores are not required to perform as an individual business. They contribute to the company’s value even if they lose money based on traditional metrics. In other words, if physical retail is the loss-leader of online retail, then operators that only own physical retail spaces are due for a rude awakening: They get to compete against a trillion-dollar gorilla on the one business line in which it’s happy to lose money. It’s a bit like competing on price with Gmail (a free product) without having Google’s separate advertising business.
So, what determines the value of a real estate asset? Is it still location, location, location or is it something else? I’ll leave you with that.
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Dror Poleg is the owner of Rethinking Real Estate, a consultancy that helps institutional investors and remarkable startups make real estate assets more valuable. [Photo credit: Bench Accounting on Unsplash]