Tech and CRE

Bringing Change to the Commercial Sector

By Paul Fiorilla on Oct 11, 2016 in Technology

Technology is destined to change the way the commercial real estate market operates, but a debate is raging as to how and how much. Will it create a sea change in the industry, or will the impact be less than transformational?

Certainly, technology has revolutionized the daily lives of most people—including the way they communicate, work, shop, eat and entertain. Yet some industry analysts contend that technological change has been slow to take root, and commercial real estate generally oper­ates as it always has.

In some sense, this is true. Commercial landlords lease the same basic property types, buy and sell based on cash flow projections, and take out mortgages. Ownership is concentrated in the hands of private companies, which tend to be zealous in guarding proprietary information. Also relatively un­disturbed are the metrics by which real estate is measured: occupancy and demand levels, price per square foot and so on.

Yet in other senses, there has been a transformation in an industry in which analysis was once performed on napkins and deals completed at country clubs. While the sector may still only be scratching the surface of its potential use of technology, there have been massive improvements in the availability of data used for underwriting. In software, that helps property owners manage assets more efficiently. In technology, that enhances access to investors.

Using Real Estate

Underlying the story of technology in real estate is the evolution in the way it impacts demand. For example, the amount of office space used per employee has continually shrunk over the past couple of decades, due to factors such as more efficient floor plans and technology that enables more people to work from home. The growth of WeWork space meets the needs of the current generation of work­ers, who are looking for flexible lease arrangements and a relaxed environment.

The story of how Internet shopping has changed retail is well known. The U.S. has more retail space per person than any other country, and shopping center owners have had to revamp their focus from shopping to creating an experi­ence and complementing online brands. Changes in retail are providing a boost to industrial real estate. Amazon and the largest brick-and-mortar retailers (such as Walmart and Target) that have large Internet presences are occupying and building tens of millions of square feet of warehouse space from which they can deliver quickly to highly popu­lated areas.

Airbnb is slowly becoming a strong competitor for the hotel industry just as hotel construction is recovering from the dip caused by the last recession. In multifamily, rather than building cookie-cutter units, apartment owners are being forced to consider amenities like co-working space, common areas for social activities and high-speed Internet access. Even Uber, which isn’t in a business related to real estate, will eventually have an impact on demand for commercial space. As fewer people drive, office buildings will need less parking, and companies will continue to retrench in urban areas close to public transportation and mass housing.

Drilling down further, there are several broad areas in which technology is developing in commercial real estate: transac­tional underwriting, property management and broadening the investor base. Let’s look at these issues.

Improved Transactional Underwriting

The most obvious way technology has advanced in com­mercial real estate is in the collection and dissemination of information. Both at the property and market level, in­formation was hard to come by years ago, but it is increas­ingly more available from both mainstream providers and new technology.

Services that provide data have been around for decades, but in recent years companies (such as Yardi Matrix) have made huge strides in both the amount of information they gather and the way it is disseminated. More sophisti­cated software enables subscribers to customize and map information in ways that go well beyond what was avail­able in the past, allowing them to delineate submarkets and correlate real estate performance with economic and demographic data. Technology has driven growth in the capital markets—one example is the creation and growth of the CMBS market, which formed in the wake of the sav­ings-and-loan crisis when traditional lenders and buyers became unwilling to transact deals. CMBS could not have grown to the level it has without modern technological systems that are used in underwriting, origination, trading and more.

What’s more, technology enhances the information-gath­ering process. Firms now use “big data” to compile loan information on commercial properties or crowdfund leasing and transaction data from brokers. The idea is that more granular and more accurate property-level infor­mation enables investors and lenders to arrive at a more accurate assessment of markets and submarkets, which in turn helps users make better investment decisions. More granular information is obviously a benefit to the market, but only time will tell whether it produces better invest­ment performance.

The data revolution remains in the “first or second inning,” according to Jim Young, co-founder & CEO of Realcomm, which advises firms on how to improve use of technology. “How many of the top 100 real estate firms have quants or data analysts that know how to use software to analyze real estate data?” Young queried. “I don’t think the industry is close to optimizing its use of analytics.”

The next level of analysis includes better understanding of how commercial real estate users arrive at decisions. Exam­ples include how consumers make purchasing decisions, or what factors help attract and retain apartment tenants. This involves using technology for such efforts as tracking cell phones to identify where shopping center visitors go and how long they linger in particular stores, or monitoring social media to gain feedback on user experiences in retail, office or apartment properties. Such methods are associated with Internet firms such as Google or Yahoo that track users’ habits with “cookies,” but such technology will increasingly be em­ployed in the real estate sector.

Property Management Efficiency

Managing properties is becoming ever more advanced due to technology, which is producing dramatic cost savings and greater efficiency for owners. Yardi was founded in the mid-1980s when Anant Yardi wrote a simple DOS software program to track tenants and rent payments, something that was not available at that time. Software moved to Win­dows-based systems and then the Internet in subsequent decades. Today, Yardi property management tools are ap­plied to some 10 million apartment units and tens of millions of square feet of commercial space.

Every aspect of a building’s operation is enhanced by tech­nology. Among applications are electronic billing, which has cut about 75% of the cost of collecting and processing rents; software that tracks financial performance and maintenance; and energy management systems that help reduce the cost of HVAC, lighting and water. “Instead of running the property with a sledgehammer, you can run it with a laser,” said Young.

Rob Teel, senior vice president of global solutions for Yardi, agrees. “As fast as advances have been, today commercial real estate managers are just scratching the surface in taking advantage of the potential in real estate technology,” he said. New build­ings are beginning to interact with technology in ways that allow even more pinpoint control. To add another dimension, commercial managers will need to see and react instantly on social media such as Instagram, Face­book, Yelp and Twitter to market properties and interact with tenants and prospective clients. And managers will be able to better track and compile data about client demo­graphics and preferences that will help them attract tenants.

Broadening the Investor Base

Another major impact of technology is that it increases access to commercial real estate for a wider spectrum of investors. Crowd­sourcing and auction firms are helping to broaden the ability to distribute real estate ownership, which historically has been dom­inated by well-heeled institutions—such as pension funds, insurance companies, REITs and sovereign wealth funds. “Real estate has been an unusually inefficient market in terms of information and distribution of capital,” says Jean-Michel “Mitch” Wasterlain, CEO of startup Capitalfund Realty, a New York-based crowdfunding platform for com­mingled real estate funds.

Commercial properties require large amounts of equity, which rules out most individuals, and unlike residential properties, require specialized management expertise to operate, maintain and lease. Individual investors have been able to participate through REITs, though the sector is rela­tively small compared to private real estate ownership. The market capitalization of equity REITs is roughly $900 billion, somewhere between 8 and 12% of the total value of all commercial real estate. REITs have drawbacks for individual investors, though. Public REITs tend to be limited to investing in Class A assets and they often perform more in sync with stocks than real estate, which limits the benefit for investors seeking diversification. Non-traded REITs charge prohibitive upfront fees (12 to 15%), which means investors rarely get promised returns, and are ex­tremely illiquid.

Crowdfunding provides individual investors with increased access to commercial properties. To participate, investors need to be “accredited,” or meet a threshold of annual in­come and net worth. The most common model to date is the dozens of firms—including Fundrise, Realty Mogul, Full­CapitalStack and RealtyShares—that are syndicating shares of development projects. To date, most of these projects are relatively small, and individual investors have to do their own analysis to weigh the pros and cons.

It’s not just individuals, though, that may benefit from im­proved access brought by technology. For example, Ten-X (formerly Auction.com) has become a leading method to trade distressed real estate, because it provides bidders with easy access to information and creates a more open process that is available to a wide range of investors. In past cycles, the sale of distressed real estate was limited to a relatively small base of value-add investors. Ten-X’s site attracts 1 mil­lion visitors monthly.

Change is Coming—Slowly

Despite the perception that real estate has been slow to im­plement use of technology, the way the market operates has evolved significantly over the past few decades. Data firms are expanding the amount of information they collect and making it more user friendly. Market players are expanding technological capabilities and using an increasing amount of information to underwrite deals, though it remains to be seen how much the extra information improves results. Crowd­funding is small as a share of the market, but it will likely gather momentum as more individuals become accredited, become better educated about the benefits of commercial real estate and look for ways to add it to portfolios.

Certainly, there is an argument to be made that implementa­tion of new technology has been slow and the industry has a great deal of untapped potential. But in the end, change will take root. Using technology will be natural to the next gener­ation of executives. And technology saves time and money, so even if for no other reason, companies will be forced to become more efficient in order to remain competitive.

Paul Fiorilla has 20 years’ experience as a researcher and writer in the commercial real estate markets. He previously spent six years as a vice president of research at Prudential Real Estate Investors in Madison, N.J., where he oversaw publishing of outlooks and thought leadership research. Before that, he covered real estate capital markets and CMBS for 12 years at Commercial Mortgage Alert.