Industrial real estate is a key component of many of the world’s largest institutional portfolios. Historically, the category was the smaller and somewhat less glamorous sibling of office, retail, and multifamily properties. The growth of online commerce and consumer demand for increasingly fast delivery windows has brought industrial properties to the fore.
In recent years, investors have been acquiring fulfillment centers and sites at a rapid clip, pushing valuation multiples (cap rates) into territories that were heretofore reserved only for other commercial assets. Demand for storage and fulfillment space is expected to grow in line with e-commerce, which still constitutes only a sixth of all retail sales in the U.S. and a little over a third in China. New product categories, most notably groceries, are also starting to shift online.
Beyond the pull of industrial, capital is also being pushed away from other assets. First and foremost, the turbulence in physical retail is driving many investors away from that category. But even in the office and multifamily categories, owners and operators increasingly face tenants that are both more volatile and more demanding. In this context, the bland façades of industrial properties shine brighter than ever: the demand is strong, the leases are long, the structures are light, and the supply is tight.
But industrial real estate is more dynamic than it seems. It is home to some of the world’s largest and most sophisticated tenants. Fast growth resulted in a more competitive labor market which, in turn, requires more attractive (and more expensive) buildings. And strong demand is fueling innovations in logistics and mobility that are set to transform supply chains. Over time, this
transformation could invalidate many of the current assumptions about supply, demand, and operating costs.
On the supply side, the biggest unknown is the impact of new ways to move goods and people. Highways and trucks liberated storage and manufacturing facilities from railheads and docks. Flying devices of various kinds have the potential to liberate them from highways, unlocking many new locations. In theory, and in some cases, drones could also enable goods to skip fulfillment centers altogether. Instead, they could fly directly from sellers and producers to buyers or to small logistics centers in the heart of cities.
Inside industrial properties, drones and other technologies already make it possible to operate multistory facilities. While this is good news for existing owners, it also means that old assumptions about the amount of land required to meet industrial demand are changing. Closer to the ground, fleets of personal cars and “freelance” delivery drivers increase delivery capacity and delivery windows. New software and hardware optimize the flow of deliveries and ensure they arrive into people’s homes.
These improvements in efficiency have the potential to reduce the space required for storage. To be clear, this does not mean that overall demand for storage will decline, but that it will not grow as fast as e-commerce sales. In other words, the nature of demand changes along with growth. The increase in delivery capacity will accelerate if and when autonomous and unmanned trucks become ubiquitous.
New transportation devices—trucks, cars, micro-devices, drones—have the potential to reduce transportation costs dramatically. This means that a higher percentage of supply chain costs could be allocated to rent. But tenants’ ability to pay higher rent will also unlock new types of assets and locations for logistical use—particularly in and next to dense urban centers. This is good news for real estate in general but it could actually lower demand for many exiting industrial assets. If office buildings are any indication, tenants prefer to pay higher rents in the city rather than save in the suburbs.
Autonomous cars have the potential to free up vast amounts of parking space. Many of these spaces are ideal for storage (and less ideal for other uses). Even before the advent of autonomous mobility, micromobility can make urban residents less reliant on cars and car ownership, leading to a similar effect on parking. The evolution of both autonomous and micromobility is difficult to predict. That, in itself, implies that the business of storing goods is far less static than many investors assume.
On the demand side, the biggest tenants are getting bigger and more sophisticated. They also show an ability to acquire and develop properties on their own. On the other hand, a long tail of small sellers and manufacturers are unable to commit to very long leases or to invest in sophisticated storage and fulfillment systems. Some production and distribution is moving out of traditional industrial spaces into smaller urban locations or even into sellers’ homes. The impact of this is not yet meaningful, but this trend is worth keeping an eye on. The emergence of new office, lodging, and housing operators teaches us that dynamics in the low end of the market can make their way to the mainstream.
The competition for labor is also driving industrial centers closer to more populated areas and existing public transport lines. It also pushes developers to make higher investments in new amenities and systems that make life better for employees. While this will continue in the near term, there are already signs that the impact of automation on the fulfillment sector will be significant. Current labor shortages are fueling innovations that might—gradually, then suddenly—make warehouses far less dependent on human employees. This, too, will require a readjustment of assumptions about ideal locations, access, and facility design.
Demand for flexibility, built-in systems, and better amenities for employees presents new opportunities for landlords. It also presents a new operational complexity and, in some cases, the need to develop solutions that cater to some tenants and not to others. One way to do so is to focus on specific niches (such as cold storage) and integrate transportation and shelving solutions. The other way is to rely on value-added resellers (VARs) who can take up space and then sublease it to smaller tenants and offer additional service. We discuss VARs at length in the Office section.
Some of the largest industrial landlords are becoming more sophisticated, investing in technology firms and in-house research, and offering tenants a comprehensive solution across a network of locations. Smaller owners will struggle to compete on their own. In the foreseeable future, this will lead to more consolidation in the space. In the longer term, we will probably see the evolution of specialized operators who barely own any assets but manage large portfolios. Such operators will be reminiscent of hotel franchises and rely on proprietary technology and a deeper integration with physical distribution networks.
Looking five years ahead, the way industrial properties are designed, operated, and valued might change more dramatically than urban office, multifamily, and even retail assets. Demand for the latter in their current locations is not going away, even if the operating models will change and some uses overlap. Meanwhile, it is not hard to imagine demand for industrial uses shifting into completely different locations and even different types of assets. That means that even if overall demand remains strong, many investors might be underestimating the risks involved in industrial real estate, and the level of expertise required to win. On the other hand, those who are investing in unique capabilities are in a position to capture more value than ever.
In the conclusion of this book, we dive more deeply into technology’s impact on real estate as an asset class and summarize the insights gleaned from retail, office, residential, lodging, and industrial properties. Specifically, we spend more time considering the consequences of all the changes described in this book and what real estate professionals can do to make the most of them.
22
It was the best of times, it was the worst of times…
This is a book about the present and the future. But while writing it, we found ourselves constantly drawn to the past, particularly to the second half of the nineteenth century. The opening line of Charles Dickens’s A Tale of Two Cities, first published in 1859, encapsulates the spirit of our own time better than anything written since. Dickens wrote during the Industrial Revolution and about the French Revolution. He described a time of rapid change when both risk and opportunity were heightened to an unusual degree.
It was a time very much like ours. Retail spaces were becoming social and experiential. People were working out of coffee shops and lobbies. It was often difficult to distinguish between apartment buildings and hotels. Streets were bustling with new transportation devices. Consumers were more educated, better informed and, at the same time, more frivolous and seemingly irrational. New companies were emerging in new industries that reached unprecedented scale.
Are we headed for a “spring of hope” or a “winter of despair”? Just like in Dickens’s time, the answer is both. There is change, which creates opportunities, and there are practical steps that can be taken to capitalize on these opportunities. The French Revolution relieved one king of his throne (and of his head), but it ultimately led to the coronation of an emperor. That emperor, Napoleon, was more powerful than any of the kings that came before him, at least for a while. In other words, the question during a time of rapid change is not whether value will be created, but rather how will value be created, and who will capture the bulk of it. Before we answer these two questions, let’s summarize the change.
Technology undermines the inherent value of real estate assets. It makes assets more dependent on their operators. It also makes these operators more dependent on specific customers and activities. As a result of this process, many of the assumptions that make real estate attractive to institutional investors are being challenged.
A building’s location is becoming less important and insufficient to define and defend its value. Humans can work remotely and many choose to do so, at least some of the time. A significant portion of commerce is shifting online, providing more people with convenient access to goods and services that previously required physical proximity. Meanwhile, technology drives a yearning toward other physical and communal experiences that have their own impact on where people to choose to live and work.
A building’s visibility is no longer restricted to the offline world. The way an asset looks online has a growing impact on its value. This is particularly true for assets that offer instant booking such as hotels, shared apartments, and short-term meeting rooms. It also applies to longer-term multifamily, office, and industrial leases. Even when end users are already inside a physical space, they often value it based on how it would look when shared with their friends and followers on social media.
Likewise, the meaning of accessibility is expanding. New ways of moving people and goods are diminishing the relative value of property along old transport routes while increasing the value of new and peripheral locations.1 For a growing number of retail, office, lodging, and industrial customers, access is no longer about a single location but about being able to move freely within a network of spaces. The ease with which physical spaces can be booked and accessed is becoming a key differentiator for many uses. Soon enough, many of the procedures we currently use to sign a lease, move into a space, or even acquire an asset will seem outdated and inadequate.
Even buildings in the best locations are expected to offer a comprehensive solution in order to draw tenants. These solutions include not only functional benefits, but also experiential and symbolic ones. This is leading to the emergence of branded operators that focus only on the needs of some customers and adapt their assets accordingly. This is already the case in most hotels, but it is becoming more common in office, multifamily, and even industrial buildings. As a result, assets, tenants, and operators are losing their fungibility and are becoming less interchangeable. In many cases, it is becoming costlier for an asset to take on a different operator, and for an operator to change its focus to a different group of tenants.
Customers are becoming more demanding and less willing or able to make long-term commitments. Offering differentiated services and flexibility will make it possible to extract more value from real estate assets. But service revenue and less traditional leases will make income less predictable and less bond-like. In a sense, many properties will no longer be assets in themselves, but will serve as inputs and components of other operating businesses. This might make buildings more valuable than ever, but it will also affect their ability to fill their current role within institutional portfolios.
As their operational intensity increases, the financial performance of office, multifamily, and industrial assets might become more correlated with other businesses in the overall economy. The performance of hotel properties, for example, is already more correlated with the overall stock market. A growing correlation with other asset classes will affect real estate’s position as an alternative asset class. Institutional allocations will have to be adjusted to reflect this change. Operators that can deliver consistent and stable results will be in high demand. This, in turn, means that owners and investors will have to share more of their buildings’ income with branded operating platforms.
Many of these operators will be new. Old habits and old relationships will fall by the wayside, unless they can deliver a return on investment that meets or beats the market. Institutional real estate capital will back or partner with companies that have the brand(s), technology, and know-how to attract and retain tenants and maximize the value of underlying real estate assets. Venture capital will continue to fund the launch of new operators that can one day attract real estate capital. Traditional lenders will initially be wary of assets with management-intensive operating models such as coliving, home-sharing, flexible office, flexible warehousing, and others. As these models become ubiquitous, lenders will look at their operators more favorably and even require their presence.
Information that was previously proprietary is now easily accessible online. Tools and capabilities that used to be exclusive to large investors are becoming commodities, available to anyone at a reasonable cost. New data sources that are controlled or aggregated by new companies are growing in importance. Old data sources are becoming more valuable in the hands of those who can utilize and analyze them to produce valuable insights. Often, that means that new competitors and service providers can use landlords’ data better than the landlords themselves.
Zoning is losing its power. New ventures are able to reach meaningful scale before regulators (and competitors) react. The boundaries between different uses are blurring, with people lodging in apartment buildings, living in hotels, working in restaurants and retail malls, and sleeping or socializing at the office. Disruption of demand for some uses (e.g. retail) creates a glut of inventory that can be repurposed for other uses. Further ahead, new mobility on land and air will likely reshape formal zoning ordinances and reshuffle the value of land.
A multitude of powers are converging to question the very idea of scarcity. In many cases, end users face an abundance of choices for where and how to work, live, shop, or store their wares. This includes new spaces as well old ones that are suddenly easier to find, easier to access, or offer more compelling services and solutions. Technology also makes it possible to use existing buildings more efficiently, making it possible for the same assets to serve a larger number of people.
We do not mean to imply that scarcity as a whole no longer matters. The supply of land and buildings is still constrained, and many markets have a shortage of different products. But technology is changing many of the assumptions about the amount of space required for a certain number of people (and goods) or for a certain level of economic activity. This, in turn, invalidates many of the most common models used to estimate future demand for real estate based on demographic and economic indicators.
As the old defenses are eroding, real estate is becoming a more competitive business. The good news is that assets can be operated to generate more value than ever before. The bad news is that they must be operated this way. Assets that aren’t will sooner or later change hands. This has always been true, but it will happen faster and leave fewer corners of the market unaffected. The new economy’s low-hanging fruits have been picked. Scores of venture capital-backed companies are now looking to transform the more physical, more challenging parts of the economy—with real estate as a primary focus. These companies are looking to optimize every process and exploit every arbitrage opportunity. Some of these venture capital-backed companies will work with existing property companies; others will take them on directly.
The competitive landscape is becoming broader and more complex for real estate investors, owners, developers, operators, and other professionals. This is true at the level of individual assets as well as for whole companies and investment portfolios. As a result, real estate is shifting from an industry governed by operational effectiveness to an industry governed by strategy. It is evolving from an industry that thrives on well-run assets to an industry that thrives on well-run businesses. Let’s see what this means in practice.
Harvard Business School’s Michael E. Porter defines operational effectiveness as “performing similar activities better than rivals”. Generally, competition in the real estate industry is still fought along operational lines.
For real estate investors, improving operational effectiveness can mean improving the accuracy and speed of acquisitions, balancing diversification across different markets and assets, or refinancing and restructuring to reduce taxes and increase return on equity. For developers, it means reducing construction costs and time. For operators, it means reducing maintenance costs, negotiating better leases with tenants, and staggering these leases in a way that keeps overall income stable.
Every investor, developer, and operator endeavors to do the above better than any of its competitors. This is not bad in itself. In fact, a high level of operational effectiveness is critical. In recent years, hundreds of PropTech start-ups have launched tools that help real estate professionals identify investment opportunities, reduce design errors and construction accidents, optimize energy management, streamline marketing and leasing, improve customer service, and more.
These tools are good, but they are good for everyone. They enable new entrants to meet or exceed the level of operational effectiveness that was previously achieved only by large and sophisticated players. And they enable existing players to become better—but better at doing the same things.
In the mid-2000s, for example, some multifamily operators started using revenue management software to optimize their pricing, lease terms, and vacancy levels. Initially, this enabled a handful of owner-operators to outperform competitors that manage similar assets (achieve “alpha”, in financial parlance). But over time, other landlords started adopting similar tools. Today, nearly all large multifamily landlords use revenue management systems, often relying on the same service providers. Revenue management is also increasingly popular among smaller landlords and is gradually becoming par for the course. As a result, multifamily operators are better in operational terms, but they are not necessarily more profitable.
Porter observed the same dynamic play out in multiple industries. Operational effectiveness usually depends on practices that are easy for competitors to emulate or acquire from third parties. Focusing only on improving operations leads companies to gradually become more similar. Such companies end up using the same tools to compete based on the same benchmarks.
As a result, “competition becomes a series of races down identical paths that no one can win”.cdxliv The only winners are the suppliers who sell the operational tools and the end users who get access to better services at a better price.
Historically, the scarce and static nature of real estate assets shielded their owners and operators from intense competition. As a result, operational effectiveness was usually enough to ensure ample and sustainable profits.2 But the new abundance and dynamism introduced by technology makes real estate more similar to other industries: Operational effectiveness is table stakes, but it is no longer sufficient in order to win. That’s where strategy comes in.
In contrast to operational effectiveness, Porter defines strategy as “performing different activities” or “performing similar activities in different ways”.cdxlv Note that Porter is not talking about simple product differentiation based on features or practices that can be easily copied. Nor is he talking about marketing positioning, which is focused on how consumers perceive a product. Instead, Porter describes five attributes that constitute a good strategy (Table 22.1). Let’s examine each of them, relying on examples from earlier chapters.
First, a good strategy delivers a unique value proposition and addresses a specific group of customers or customer needs. Common Living launched in Crown Heights, Brooklyn and offered a solution for young professionals who are unable to commit to a traditional residential lease on their own. Common provides customers a furnished room in a shared apartment, cleaning and replenishing services, a schedule of community activities, and various other support services. It does all this for a price that is on par with an unfurnished bedroom in a more desirable neighborhood. This is a unique value proposition.
Second, a good strategy is based on a unique value chain. As mentioned in the Housing and Lodging section, a value chain is a set of activities that a company performs to “design, produce, sell, deliver, and support its
Table 22.1 Michael E. Porter’s attributes of good strategy
1 Delivers a unique value proposition
2 Based on a unique value chain
3 Involving clear trade-offs
4 Relies on interdependent value activities that fit together in a unique way
5 Implemented continuously over a meaningful period products”.cdxlvi Sonder relies on a unique set of activities to compete directly with traditional hotels and serviced apartment operators. It relies mostly on existing properties that were designed for residential use, its guests check-in and access services and support via a mobile app, and its distribution was built from day one around its own branded digital platform. In comparison, a traditional hotel value chain consists of very different activities, starting with the design (and sometimes ownership) of the building, through the sales and booking process, to staffing and on-site service.
Third, a good strategy involves clear trade-offs. A trade-off means that a business must forfeit some potential customers or revenue in order to implement its strategy. WeWork spaces tend to be more open, denser, and more vibrant than those operated by traditional landlords, facility managers, or other flexible office providers such as Breather or Knotel. Among other things, WeWork customers pay to belong to the company’s community, participate in its events, and access the common areas of its locations across the world. In addition, WeWork takes a stand on social and environmental issues that resonate with its target customers—most notably, its decision to stop serving or reimbursing non-vegetarian meals.
The WeWork brand and experience are loved and admired by some customers, and are shunned, ridiculed, and even despised by others. Regardless of the company’s other challenges, this is a good sign! A clear strategy entails providing value to some customers, not trying to please everyone. As Porter famously wrote, “[t]he essence of strategy is choosing what not to do.” cdxlvii The Office Group (TOG) offers a more moderate example of the same dynamic. The company built a lifestyle brand and hospitality experience that resonates with London’s creative class. TOG’s shared and private office formats, community events, and publications are not meant to appeal to everyone, but they are incredibly appealing for a specific group of very valuable customers.
One could argue that every office building is “not for everyone”. That is true, but most buildings differ based on price or based on functional benefits such as the size and shape of their units or the physical characteristics of their common areas. WeWork provides clear and different functional, experiential, and symbolic benefits that result from its own specific activities, regardless of what building it is in. WeWork’s trade-offs fit well with the other activities of the company.
Which brings us to the fourth attribute of a good strategy: fit. The activities within a company’s value chain need to depend on one another in a way that makes the strategy difficult for competitors to copy. Common and Ollie don’t just offer tenants the option to rent bedrooms on flexible terms. Their physical product is designed to be shared by strangers. They develop unique tools to help match roommates and streamline the signing and approval of shared leases. They provide services that make it easy for roommates to get along and avoid quarrels over bills and chores. And both Common and Ollie built brands that attract customers that have specific needs that are not served well by traditional competitors. The brand and marketing channels of these two companies allow them to acquire and replace tenants at a lower cost than a traditional landlord. This, in turn, makes it easier for them to offer tenants a certain degree of flexibility.
On the surface, Common and Ollie’s strategies seem easy to copy: Any landlord can lease out apartments to roommates. But to do so profitably and at scale requires a set of interdependent activities. A traditional landlord could not adopt the same strategy without eroding its own existing advantages. Without a clear brand, it would be more costly to attract the right customers. Matching potential tenants and coordinating the signing of a single lease between several unrelated individuals would waste precious time. Brokerage, application, and other fees would make it too costly for tenants to leave before a full lease is up. In addition, the landlords’ existing tenants might not appreciate the increased activity and the real or imagined “vibe” that coliving tenants bring to a building.
Lineage Logistics offers another example of how activities fit together in a way that makes a strategy difficult to copy. The company acquires and operates industrial properties that cater to very specific uses. It conducts research and development activities that help it to reduce refrigeration costs and to optimize the organization of cold storage pallets. It develops systems that coordinate the loading and unloading process of refrigerated goods. It has partnerships with cold freight carriers that provide its tenants with flexibility that isn’t available elsewhere. The activities in Lineage’s value chain depend on one another. In less than a decade, Lineage’s strategy enabled it to become one of the world’s largest owners and operators of cold storage properties. Time will tell whether the company can continue to grow profitably.
The fifth and final attribute highlighted by Porter is continuity. As we have seen above, a good strategy requires not being everything to everyone, but foregoing certain customers and specializing in unique and interdependent activities. This means taking a risk and developing processes and products that would be costly and difficult to reverse or repurpose. For this reason, a good strategy is always a bet. It requires commitment and a long-term view. Many of the companies we used in the examples above are relatively young and have a lot left to prove. But they are trying to build differentiated businesses, and they offer solutions that fit the needs of contemporary real estate end users.
A strategy should be forged slowly and thoughtfully. Once it is selected, it should be implemented with discipline and tenacity. There will always be short-term reasons to change course. The process of selecting a strategy can involve input from many stakeholders, but the final plan should not be a compromise that keeps everyone within the organization happy. By definition, a good strategy is wholistic and consists of interdependent parts. Adding unnecessary or conflicting activities into the value chain can change the whole cost structure and muddle the value proposition to customers.
The quintessential example of strategic commitment is Amazon. For over a decade, the company has invested the proceeds from its operations in building a set of integrated capabilities that make it incredibly difficult for other companies to compete with it on price, on service, or on experience. Amazon was committed to its strategy and was willing to sustain significant and recurring losses and face criticism from investors and the media.
Commitment to a strategy should not prevent a business from continuing to evolve. In fact, it requires it to. A business must constantly seek better ways to implement its existing strategy. A business must also continue to improve its operational effectiveness because without it, strategy doesn’t matter. For example, if Common or Lineage would be subpar at performing basic maintenance or administrative tasks, the profits from their unique activities would likely be eroded by other costs.
To recap, a good strategy delivers a unique value proposition, to a specific set of customers, based on a combination of interdependent activities. Its essence is saying no to activities and opportunities that might be temporarily easy or profitable but ultimately lead to low profits or irrelevance. Every strategy is a bet that requires clarity and commitment.
All the examples above involve companies that operate real estate assets. This is in line with our broader point that assets are becoming more dependent on their operators. But it does not mean that all the “animals” within the real estate “food chain”—investors, developers, facility managers, brokers, service providers—must set up their own branded operating platforms. Nor does it mean that they should acquire or get acquired by an operating platform.
Instead, each entity needs to consider how the changes described in this book affect its position within the food chain, and what property-related activities it should focus on in order to optimize its risk-adjusted return. The answer to this question depends on each company’s capabilities, resources, capital structure, and risk appetite.
Change is not easy, and real estate companies face challenges that make it even harder. These include:
1. Mandates that only allow investments in actual physical assets;
2. Legal requirements for profits to be distributed rather than reinvested;
3. Incentive schemes that keep people within the same firm focused on the performance of specific assets but not the firm as a whole;
4. Incentive schemes that that keep partners and employees focused on the performance of the firm’s present portfolio but not its future;
5. Lack of senior management diversity in backgrounds and skills (not to mention gender and age); and
6. A general cultural aversion to new things.
With all this talk about strategy, we should also point out that most real estate companies are also far behind in terms of operational effectiveness. Many best practices and new tools are not adopted fast enough or not adopted at all.
On a positive note, real estate investors, developers, operators, and even brokers are no strangers to making bold long-term bets. It is now time to bring this audacity and conviction into new types of business activities. Before we conclude this book, here are a few bite-sized instructions on how you can begin to transform your business or career, based on the various companies and anecdotes covered in the chapters in this book. We wanted to call these the Ten Commandments—to offset the impact of the Ten Plagues—but we ended up with 15 of them.
They are:
1. Look backward. Consider the history of the assets you’re dealing with. Ask yourself: Why are they located where they are? Why are they designed this way? What are the underlying assumptions that shaped them? Have these assumptions changed? Are they about to?
2. Look sideways. The biggest impact on the way real estate assets are designed, operated, and valued will not come from within the industry or from innovations that focus on real estate. Instead, it will come from innovation in other fields that, in turn, impact the way people live, work, eat, shop, and even die. Many technologies and behaviors emerge in sectors that most real estate professionals pay little attention to such as military industries, gaming, or social media. Looking sideways also includes keeping track of how other parts of the real estate industry are changing. Lodging, retail, multifamily, office, and industrial professionals have a lot to learn from each other.
3. Consider if and how transaction costs have changed or are about to change. The current structure of industries, companies, and products is dictated by the cost of triangulation, transfer, and trust. When any of these costs change there is an opportunity to deliver value in a new way. Don’t wait until you notice that transaction costs have changed in your industry; look at new technologies and ask yourself if and how they might impact your industry.
4. Consider bundling and unbundling opportunities. Technology creates opportunities to break up or combine services and activities in new and profitable ways. Are your customers missing items or services that you can add to your offering? Are there any reasons to break up your existing company into separate entities with different investors? Is it time to become more vertically integrated in order to launch a new type of product? For example, should retail landlords integrate logistics spaces and offer tenants a more comprehensive solution? Should they step in to curate smaller brands and offer support services that were previously offered by department stores? Should office landlords launch their own coworking brands? Or should they spin off even their existing operating businesses and focus only on financial ownership? All of the above are bundling and bundling opportunities that are affected by technology. The answer is unique to each company and requires its management to think on its own.
5. Think dynamically. As you consider the future of your business and assets, don’t fall into the static analysis trap. Don’t look only at the interplay of supply and demand; consider the changing nature of demand and the changing definition of supply. Office tenants might require less space per employee or more space for activities that were previously not performed at the office. Demand for industrial space is growing, but industrial uses are also bleeding into locations that were previously used for retail or other infill sites. Some trends might plateau or even reverse course. This has always been true, but changes seem to happen faster in our interconnected world. You can’t account for all of them in advance but you can adjust the confidence level of your current models or augment them with new assumptions and analyses.
6. Consider your customers’ “jobs to be done”. No one wants “space”. Every customer is trying to achieve something. Retailers want to acquire more customers, streamline deliveries, and increase sales across different channels. Corporate tenants want to attract and retain the best people. Those people want to be healthy, to feel appreciated, and to find meaning. Or maybe they want something different altogether. Part of your job is to figure out what they are trying to achieve and what’s currently preventing them from doing so.3 Even if you “only” own the asset or are “only” a broker, you have a role to play and opportunities to capture and to miss. The more you understand your customers, the better you’ll be able to serve them.
7. Consider your customers’ journey. It’s not enough to offer a great office space, a great apartment, or a great warehouse. Customers often face pains or gaps on their way to becoming your tenants. Even if these gaps seem unrelated to your business, they provide an opening for new businesses that might ultimately become your competitors. Landlords didn’t think it was their job to match roommates, become market-makers for shorter leases, help tenants sublet underused space, or build online listings and booking sites that are pleasant to use. Each of these activities was a launchpad for new companies that now own or operate hundreds of buildings.
8. Reconsider your customers. Don’t think only about the entities that currently sign leases with you. Consider anyone who uses your assets. This could be the employees of your tenants or the people who come to visit them. It could be your tenant’s informal roommates and sub-t enants. Informal activities that happen within your building provide hints about new business opportunities that you or your partners can capitalize on.
9. Capitalize on new scarcity. As access to some things becomes abundant, other things become scarce. In our world, the things that grow in value are those that cannot be produced by technology—or those that are actually destroyed by it. There is a yearning for human interaction. For silence. For less choice. For disconnection. For being physically active. For organic material and sounds. For meaning. The built environment has a huge role to play in delivering these. And the multitude of human preferences means there’s room for plenty of new ideas and businesses to emerge. And yes, there is something melancholy about the fact that humans rely on businesses to serve many of these needs, but we’ll leave that to a separate book.
10. Double down on data and on privacy. When it comes to new scarcity, nothing seems to vanish faster than privacy. Ongoing tracking of human activity was initially an online phenomenon, but it is making its way offline. Physical spaces are being filled with new sensors, cameras, and devices that gather unprecedented amounts of data. This data is personal, and a lot of it is the property—and the responsibility—of those who own and operate physical spaces.
This creates new opportunities to make spaces more pleasant and more profitable. It also introduces a growing array of financial, reputation, and political risks. Investors, operators, and entrepreneurs need to think proactively about these issues. Over the last two years, we have been involved in ProperPrivacy.org, a nonprofit initiative to facilitate the adoption of technologies that make physical spaces safer, healthier, and more produc-tive—without undermining the dignity and trust of the people these spaces serve.
11. Seek network effects. Consider how assets and their end users can benefit from being integrated into a broader network, not just in terms of simple economies of scale but in terms of each node contributing to the value of all other nodes in the network. For example, an office building’s value proposition is increased if it also allows access to common areas and business services in other office buildings. Even if you own only one building, there might be ways for you to increase its value by integrating it into a network, possibly in partnership with other owners or operators.
12. Examine your structure and incentives. Does your current corporate structure, fund mandate, or real estate investment trust (REIT) status limit your ability to innovate and maximize the return on your assets? Are your employees or managing partners incentivized to serve the strategic interests of your organization and its long-term success? Some structural limitations are difficult or impossible to change. Understanding them clearly and discussing them openly can help you devise a strategy that works best for your organization.
13. Hire differently. Bring in people with unique backgrounds and skillsets. Empower them to make an impact on your organization. A product manager can help you improve your customer’s journey and experience. A data scientist can help you identify patterns and make better decisions. Designers of various types can help you deliver a consistent experience to your customers. A behavioral scientist can help you understand the impact of your choices on the well-being and productivity of people who spend their days or night within your assets. It has never been easier to tap into human expertise.
14. Stay informed of new technologies and business models. This is easier than you think. The best way to do so is to be part of a “scene”, to be around people who are doing (or writing about) interesting things. In every big city, there are dozens of small meet-ups and larger events each year that are worth going to. Specifically for real estate, event and content platforms such as CRETech, Unissu, Propmodo, MIPIM PropTech, and others offer great opportunities to meet interesting people and hear about new ventures, practices, and initiatives.
You don’t need to live in (or travel to) a big city in order to stay informed. Podcasts allow you to learn from the experiences of others while you are working out or commuting to work. There are multiple newsletters about real estate tech and technology in general. Spending 30 minutes a day on Twitter can help you become better informed than 99% of your competitors. You’re welcome to follow me (@drorpoleg) and discover more interesting people and companies to follow. In 2019, there is no excuse to remain uninformed!
15. Explore venture capital investments. Another great way to stay informed is to look at what start-ups are building and what venture capital investors are betting on. If you’re a big company, you can become an limited partner (LP, or passive investor) in one of the multiple venture capital funds that are focused on real estate and urban technology. Beyond the potential financial benefits, this would give you an opportunity to interact with entrepreneurs and venture investors and look at dozens or hundreds of decks a year. Each deck provides an entrepreneur’s vision of the future that is bound to inform and inspire you. If you are a smaller investor or individual, websites such as AngelList provide an opportunity to invest in start-ups on your own or alongside more experienced investors.
As we write the final pages of this book in Brooklyn, an unprecedented event is taking place on the other side of New York City. Over in Queens, the Arthur Ashe Stadium is filled to the brim. A sold-out crowd of over 23,000 men, women, and children is cheering the final game of the Fortnite World Cup. Millions more are watching the game live on YouTube and Twitch.
Fortnite is played on a computer with a keyboard and a pair of headphones. The players can barely hear the crowd and the crowd is following the game on the stadium’s multiple screens. Minutes later, the game is over. The new world champion is Kyle “Bugha” Giersdorf, a 16-year-old boy from Pottsgrove, Pennsylvania. The prize is $3 million—a little over what Novak Djokovic received for winning the Wimbledon tennis tournament a couple of weeks earlier. In total, the Fortnite World Cup gave out $30 million in prizes.
Teenage gamers epitomize the transition from the physical to the digital world. They spend hours online, chatting and playing with friends that hide behind graphic avatars and nicknames such as “Psalm”, “Ninja”, and “Twizz”. They spend their money on virtual goods and computer gear. And yet, tens of thousands of gaming enthusiasts chose to pay $50–$150 to share a physical space with other people. They paid for the opportunity to sing, clap, drink, and shop in an actual building, at the heart of one of the world’s greatest cities. They paid for a chance to experience something real, together with others.
Events of this kind are becoming increasingly common. Goldman Sachs predicts that by 2022, the global audience—spectators, not players—for online gaming will be 276 million.cdxlviii That’s about the same number of people who currently watch the National Football League (NFL), America’s most popular sports league. Dedicated arenas for multiplayer video game competitions, known as “e-sports” or “Esports” or “eSports”, are popping up all over the world. In June 2019, Simon Properties, one of the world’s largest REITs, invested $5 million in Allied Esports International, an operator of eSports venues.cdxlix
Are these the best of times or the worst of times?
The real estate industry has never been as dynamic and as open to new ideas as it is right now. The next decade provides an unprecedented opportunity for professionals to rethink everything, especially the things we take for granted. Stick around. Get involved. It’s going to be unreal.
Brooklyn, July 2019.
Peripheral, in this context, does not refer only to places outside of the urban core. It also applies to urban locations that are located off main avenues, a little farther from the subway and other public transport. In some cases, the difference can be a matter of a few hundred feet.
This is true even for hotels, where most large companies have multiple brands that compete with one another directly using mostly similar methods, offerings, and prices.
For more examples of how companies discover and cater to customers’ “jobs to be done”, see Clayton M. Christensen, Competing Against Luck: The Story of Innovation and Customer Choice (S.l.: Harpercollins Publishers, 2016).