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Is commercial real estate ready for innovation?
To an external observer, commercial real estate might appear a large, slow-moving and conservative industry. Although many industries have experienced technological disruption since the millennium, software and tech have not started 'eating the world' of commercial real estate until relatively recently. So why has it taken until the last couple of years for the word 'innovation' to become a buzzword?
Fundamentally, the structural characteristics of real estate as an asset class are sometimes not best suited to certain models of innovation and disruption, which emphasise accelerated product iteration, a focus on scalability and a 'move fast and break things' mentality. The low velocity of turnover in assets and leases, the heterogeneous nature of real estate assets and the relatively high cost of experimentation (bricks-and-mortar are harder to change than a line of code) all present obstacles to creating an environment for successful, persistent innovation.
But obstacles can be overcome. The bigger barriers to entry for innovation have been a result of the industry’s culture, which, unlike some of the more structural features of the asset class, should be more malleable. Characteristics of the commercial real estate industry that are not conducive to innovation include being generally risk-averse, a lack of alignment between real estate stakeholders and overall expectations in the industry that the future will be rigidly linear. Fundamentally, real estate is also a relatively opaque industry where connections matter and relationships involve building trust incrementally over time.
There is, of course, a clear link between the characteristics of real estate as an asset class and the characteristics of the industry itself, but these aspects of the industry’s culture are increasingly being challenged from many angles. In the last 24 months, the centre of gravity in the real estate industry has moved towards embracing innovation and engaging with start-ups, disrupters and the emerging PropTech ecosystem.
Reasons for this shift
- Disruption can happen to anyone, even in 'offline' and regulated industries. In retail, the headlines in the last year of e-commerce displacing traditional retailing models speak for themselves. In transport, Tesla and Uber are revolutionising mobility, leading the pack in making transport electric, driverless and on-demand. The proactive response of firms like GM and Ford have also provided a good example of how incumbents might react. In finance, over 80% of financial institutions now believe their business is at risk to innovators, from FinTech start-ups to bitcoin.
- The heightened presence of technology firms within real estate itself have forced the industry to pay attention. PropTech start-ups have been maturing fast, with venture capital investment rising dramatically in recent years, and larger, later rounds increasingly common. Real estate related unicorns are also starting to have a real impact on the industry and real estate fundamentals – WeWork became the largest occupier in the Central London office market last year. Moreover, Big Tech has also started to creep into areas within the industry. Google have started to make moves through Sidewalk Labs in redeveloping an area of Toronto, Amazon have now launched bricks-and-mortar stores, and Alibaba are investing heavily in offline retail, such as spending $2.9 billion for a stake in one of China’s leading hypermarket operators.
- As consumers have spent an increasing proportion of their time online, where optimising user experience (UX) is the key priority, they have started to raise their expectations for their offline UX. This is changing the nature of demand for space and challenging traditional definitions of asset classes. Retail is increasingly moving towards leisure. Offices are increasingly moving towards hospitality. Although not yet happening at dramatic pace or scale, there is already an evidenced supply side reaction to these trends, which will only accelerate.
So is commercial real estate on the cusp of technological disruption? Not quite yet, but the seeds of innovation are now firmly planted and have started to germinate. The most relevant question is not if, but when and how – and here there is no single answer. Understanding the potential consequences of technology, innovation and disruption in real estate is an ongoing, industry-wide conversation that spans from inward-looking digital transformation strategies to outward-looking re-examination of investment theses, key value prepositions and core business objectives.
There are, however, some definitive lessons that the industry as a whole could benefit from today:
- More collaboration is needed between all stakeholders across the industry, between incumbents and start-ups, investors and operators, occupiers and property managers, etc.
- An unrelenting focus on the end user and their experience of the space is crucial to maintaining relevance in tomorrow's world.
- Now being called 'the oil of the 21st century', the importance and value of data (both market and proprietary) has been historically overlooked in the industry. This is changing, fast.
- At a time when the next ten years look to be more transformative for real estate than perhaps the last fifty, maintaining a long-term, strategic perspective, and concentrating on the fundamental drivers of real estate demand is critical for successful investment strategies.