20/20 Investor Summit Report: Walking into an Unknown
With all the changes afoot in politics, the economy, demographics, technology, and capital, the future seems more and more unknown every day. And yet, investment managers today are asked by their clients to go forward into an uncertain future by putting capital to work, finding opportunities and navigating risk.
How does one do that? What is the prudent way to walk through a door into the unknown? This is a challenging time for everyone – and the thought leaders (or as NAREIM Chair Peter DiCorpo referred to them, “The best and the brightest”) that gathered in Chicago this May to discuss changes in the investor landscape had plenty of collective reflection to do.
Two questions in particular were considered: How can we best prepare investment operating platforms for the unknown, and how can we best manage the risks that come with it?
The door to the unknown is definitely ajar. Now things get interesting.
How do we work this?
John D’Angelo of RealFoundations pointed out, “We see changes under our feet that we haven’t seen for 10 years at least.” These changes prompt all investors to shift strategy, find new opportunities and mitigate new risks. As firms approach the unknown, there is an imperative to understand precisely how one’s own platform actually works. “A solid strategy without a solid operating model is just ineffective. The stuff at the bottom is important.”
Do investment managers really understand the details of how their firms work? D’Angelo recommended that everyone take some concerted effort to understand their “functional operating model – or in other words, the work that it takes to be in business”.
So how can leaders better understand their “functional operating model”? According to D’Angelo, leadership teams should go through an annual assessment of all the tasks that are completed by their firm. For example, what are the discreet tasks that are executed by employees to perform due-diligence on a potential investment? What are the tasks involved with making a credit decision? What does your firm do around reporting? Once mapped out, the next step is to determine who does the tasks, and how their performance is overseen, measured and controlled.
Crucial to a clear understanding of functional operations is real-time, comprehensive data on assets and operations. Yet, how many firms can confidently say they have a full grasp of this? Information and data is a more and more important determinant of future success for any investment manager, not only because it contributes to better efficiency, accuracy, investing decisions, and operating decisions, but also because investors are demanding more transparency.
And the era when investment managers could rely on individual spreadsheets, individual knowledge, and careful hand-crafting of reporting seems to be coming to an end. That means we have some work to do. As D’Angelo pointed out, “We don’t have anywhere near ‘big data’. Instead, real estate is all about ‘dark data’.” As investors are exposed more and more to the transparency, efficiency, and insights provided by data from other financial asset classes, real estate’s ‘dark data’ has become less and less sufficient.
D’Angelo recommends that every firm does a deep dive into their ‘Information Model’, where they clearly lay out what information is collected, how it is gathered, where it goes, how is it used, and how it is governed. Surprisingly, one of the important tasks for every firm is to define what their information metrics are. “If you asked everyone on your team to write down how they calculate net operating income, you would be surprised to see how different their answers are.” How can anyone feel comfortable about their operating model when there are multiple ways to calculate the same metric?
This isn’t an easy process to undertake, but it is essential. “A decade ago, you did everything yourself, but now there are multiple parties collecting, analyzing and acting upon data, we can no longer improvise how this is managed.”
And we can no longer assume that these changes are a long way off. Bill Gates wrote in his book The Road Ahead, “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don’t let yourself be lulled into inaction.”
That was written over 20 years ago.
Alan James of Real Page told a story about his recent business trip to Denver. Once the meeting was over, he secured an Uber back to the airport. After riding for a while, he began to notice that the car was no longer on the freeway – in fact, they were travelling on a gravel road. How could that be? “The driver was using a mapping application that gave him instructions to avoid an accident on the freeway. Unfortunately, the new route took us not to the airport, but to an access road for the surrounding oil wells. The Data was wrong.”
Fortunately, for once, James’ flight was delayed and the driver was able to get him to the real airport in time. But why was the flight delayed? The airline had just deployed a new data system, and couldn’t determine if one of their passengers was actually on the plane. After struggling with their database for a while, “an attendant walked down the aisles with paper and pencil asking everyone, ‘are you Vanessa?’”
The Data was wrong.
According to James, “Everything around us is not only dependent on data, but on its accuracy and timeliness. And the success of any enterprise in the future is tied to its ability to organize data in a way that leads to right action.” When the data is right, when it can be seen and understood by anyone – it is astonishing how much the game changes. New businesses like Amazon, Uber, and Google can disrupt entire industries simply because the information is available to everyone and their decisions can be made in a fraction of the time it once took.
That’s what institutional investors really want when they ask for “more data”. They want to be able to make real estate investing as transparent as investing in the stock market – or even as simple as comparing prices on a book bought from Amazon. We have to collect, aggregate, assemble, deliver, and empower all the stakeholders to use our data.
Getting there isn’t easy. James warned, “Be careful of the data swamp. It needs to be clean and relatable to everyone.” The days of a private and silo-ed sets of real estate data being enough are long gone.
But, according to Diane Vrkic, CEO of Waypoint, “If you arm yourself with better performance analytics, you will thrive.” According to Vrkic, “Real estate companies are, at heart, information companies.” Investment firms are making decisions and acting upon them based on whatever data can be gathered. The industry regularly chides itself for not moving too much farther beyond the Excel spreadsheet and subjective, aggregated, and unreliable data such as recent lease and sales transactions – but perhaps that is about to change. For the first time several new data and software solutions are being developed by real estate people for real estate. After decades of investment management firms running a fragmented process defined by distributed teams, multiple funds, multiple partners, and multiple accounting systems, a few solutions are emerging.
Vrkic’s company analyzes performance data for over 2.0 billion square feet of commercial real estate. That data not only helps to improve the management of individual assets, but offers real time insights on performance, value, and investment opportunities. Where does this potentially end up? What would happen if you could have real time updates of portfolio performance on your phone? What if investment decisions could be improved with real-time and granular asset performance?
According to Matt Macri, a Senior Executive with VTS, “all real estate assets are sitting on a pile of data.” And much of that data revolves around the tenant. It is becoming more and more apparent that the commercial real estate business model could be radically improved if we had a better knowledge of what tenants were doing. At the same time, according to Andrew Flint, head of business development at VTS, “tenants today have more power than ever before because they have access to a huge amount of information on you and your building.” More and more, the job of building owners is to fathom the data created by assets and tenants.
Who is the ideal tenant for a particular space? What do they need, what are their challenges, and how does your space, your amenities and your building culture help them succeed? Flint pointed out that we should all, “take customer success seriously.” If you gather, measure, and analyze the data generated by them, you will be able to turn insight into action.
Gathering a high level of customer data has become commonplace for other industries. Amazon probably knows more about you than you do. Data analytics at Google, Uber, Apple, and even Nordstrom’s are building businesses and strengthening customer relationships. It’s time for real estate to get on board.
What if the information we use to do our jobs was better?
Chris Happ, the CEO of Goby asked another question, “Is real estate ready to consume better data?” The answer to that question may very well be, “not yet.” Happ’s company started out as a building consultant – but as they transformed into a software and data company, they had to change their operations and their team in order to understand, trust, and act on what the new data was telling them to do. Scores of data scientists became part of their team, and the conclusions they came to – though not based in a lifetime in real estate, but rather a lifetime in data – have transformed Goby’s strategy and operations. “We have to accept the outcomes of data – which can be surprisingly difficult to do.” The way we always did things before might not work anymore.
The biggest change may very well be that you need less time and/or people to get things done. Happ talked about the Chicago Food Depository, a massive non-for-profit charitable food distribution organization as an example. When Starbucks pledged to donate all of their extra food from their 164 Chicago area stores, the leadership team had to figure out how to get all that food to their central warehouse. Instead of hiring more people and more trucks, they were able to analyze and find their most efficient strategy – in this case, they found that by understanding their existing routes, actual store donations, and ultimate food demand that they could avoid increasing their fixed cost base by making their routes more efficient and augmenting their existing fleet with UBER outside of peak hours.
So what would happen to real estate investment management firms if they could use better data to create, for example, 40% efficiency improvements? According to D’Angelo, “We spend 25-40% of our time just normalizing the data we have before even thinking about it. How could we reinvest that 40% of productivity earned through better data?”
This was a thought-provoking question for the room. Jason Kern, CEO of the Americas for LaSalle Investment Management pointed out, “The obvious answer is to take those currently involved in data gathering and shift them to analytics – but that would mean that we have to reinvest in training that helps us all make better decisions based on that data and analysis.”
Howard Fields, Senior Vice President at Inland Institutional Capital pointed out that, “we could develop new product lines.” And Peter Borzak, CEO of Pine Tree pointed out, “we could spend more time with our partners.”
As everyone started to wrestle with what they would do with all that extra time, D’Angelo pointed out “if you haven’t thought about higher value activities yet, it’s really hard to get people to do so. People complain about not having enough time to get to those activities, but they won’t take the steps to make that time. This will take real leadership.”
Creating efficiency through data and technology forces everyone to ask, “how do we do what we do?” and as more tasks are replaced by smart data gathering and analysis, the real estate industry will have to think through what real estate professionals should be doing with their time.
Efficiency or Profit? It depends on how you look at it.
Matt Ganser, Vice President of Engineering at Carbon Lighthouse announced, “Your buildings are worth more than you think they are. To us, real estate assets look a lot like oil and gas assets, where the best companies have learned how to extract the most value out of a given piece of property.”
Brenden Millstein, Carbon Lighthouse CEO added that, “Like oil industry ‘energy reserves,’ tapping ‘efficiency reserves’ in buildings provides a huge edge and creates real value. If you look at building energy efficiency opportunities there are billions of dollars in value from wasted energy that can be harvested.”
But tapping those reserves is not a simple task. Efficiency is scattered across multiple building systems and processes – single point solutions like swapping out old lighting fixtures, replacing a chiller, updating a roof system, or changing management practices can require major capital expenditures and take time to produce a positive return. Creating significant value from efficiency requires vast amounts of original data to uncover and continuously correct hidden inefficiencies in existing, interconnected building systems. Being able to accurately calculate the financial return from a building’s efficiency reserves is critical, because the wrong decision can cost more money than it harvests from the reserves.
But that’s just like the oil industry, where expert businesses have emerged specifically to identify and efficiently harvest reserves for their clients. Real estate needs the same kind of help – and like oil, it needs to look at efficiency less as a cost savings than a value creation. Sustainability and efficiency can be viewed as prospecting for value. In a tight market priced near to perfection, these efficiency reserves can be the difference that creates alpha.
According to Jeff Adler, Vice President at Yardi, “Right now technology is ripping through the existing order of things in commercial real estate. It’s essential that investors understand what they are and actively manage the risks and opportunities in these technologies.” The era when the value and the operations of commercial real estate was largely untouched by changes in technology may very well be over.
Data, artificial intelligence, and the internet of things – technologies created, used, and disseminated by companies such as Google, Amazon, Uber and others – are already changing the way things are done in our business. Just as they are disrupting other industries by driving out costs and building new efficiencies, they are now impacting us in ways that are exciting and perhaps frightening. What are the points of friction in our business? What processes and people can we do without if we have access to good data, intelligence, and automation? Adler declared, “Data is the new oil, and just like crude oil, it has to be mined and refined to be useful.” New technologies are creating an environment where our buildings can produce tremendous amounts of data on operations, on people, on risk, and on value.
At the same time, artificial intelligence and data has already changed transportation in our cities – and changed the value of buildings in those cities through ride sharing services like Uber. What happens when ride sharing becomes autonomous – and therefore cheaper than taking a bus? What happens when shipping and trucking can happen without drivers? The traditional value drivers of proximity to public transit and a plethora of free parking may become less of a given.
Energy is another area to pay close attention to. Solar power is now cheaper on average than conventional forms of electricity provided by utilities. As more consumers switch over to solar power generated on their rooftops, stored in batteries, and shared through smaller collective grids, the cost for utility provided power will only rise, in some cases dramatically. In some regions of the country, not having a solar power strategy for your assets could be a very risky omission.
High paying blue collar work is fast disappearing and a middle-class income is difficult to find without higher-level skills. According to Adler, “Our society has failed to provide the education needed for everyone to succeed. That is an opportunity for commercial real estate to create positive externalities.” How can a real estate asset make a difference? Can an office project provide space for coding classes for inner city students? Can affordable housing options and new work opportunities be part of a master plan? “What is real estate doing to solve the problem?” The imperative is there for this problem to be solved, because the same economic forces that change our population’s ability to earn a living also impacts the supply/demand and the value of real estate.
After numerous discussions on process, data and data transformation it was abundantly clear that there is a shift in how we might be able to work as investment managers. Howard Fields pointed out, “It’s not that long ago since real estate was done on the back of the proverbial envelope. What we do now is vastly different, but the future can change again, and quickly.”
Ed Casal, Chief Executive for Global Real Estate at Aviva Investors pointed out, “We are analytical people that know what good looks like but don’t always have any data to support it. We need to transform the culture of the front office to use this data, to embrace it. We have met the enemy, and the enemy is us.” Real estate investment managers need to significantly change their approach to data, and make it an integral part of their lives in ways that real estate never has before.
What is capital doing, and what should we do about it?
According to Lucy Fletcher, a Managing Director of JLL’s Global Capital Markets Group, the world of institutional commercial real estate investing is becoming more global all the time. “Global assets under management have grown by 17% on average annually since 2010” – but it is still very much focused on the “western world.” “If you combine institutional property markets in Europe and the US, you have accounted for 85% of global assets under management. Asia, of course, is growing every year, but the scale is entirely different.” This, and the continued relative strength and lower risk environment domestically, contribute to an environment where 14% of all acquisitions in the US are by non-US investors.
Some changes in the last year that are notable: As expected at this point in the cycle, more capital has moved to secondary markets. Middle Eastern investments are decreasing. Asian capital is growing – with South Korea, Singapore, Hong Kong, China and Japan now representing 64.2% of all non-US capital. Interestingly, family office investments in real estate are growing faster (95%) than any other investor class.
The capital environment is becoming more global, more complex, and just plain more. According to Fletcher, “We anticipate that the US will be driven by foreign capital flows for the next 5 to 10 years.”
What do investment managers need to do about it? Adjust to new investors, new rules, and new structures. According to Wendy Gallegos, a Partner at Mayer Brown, “Our managers are telling us that the fund structures used for many years are not fully aligned with what is needed now.” AFMD requirements in Europe are challenging capital raisers with a rising bar of compliance requirements while US FIRPTA requirements continue to create complexity. “We are creating more non-REIT structures for non-US investors such as a blocker structure using an LLC rather than a REIT – although this means it will be taxed at a corporate rate, and there are some complications, but it allows for far more flexibility – which in many cases is a meaningful advantage.”
Meanwhile, high net worth involvement, family offices, and more involvement with defined contribution plans mean that how investment managers structure themselves and their procedures have to be re-examined very carefully.
For example, how confident can someone be about reporting the “value” of assets under management? Historically, most institutional investors have understood that as a non-liquid asset class, commercial real estate values are, by definition, an estimate until the property is sold. But what happens in a fund that provides “daily valuations” when an investor feels that you are under or overvaluing assets? To illustrate this point, John Kjelstrom, a Director at Chatham Financial asked the ominous question, “How many times have you sold a property for significantly more or less than its appraisal value?”
An unexpected windfall at point of sale could actually become a problem.
Kjelstrom pointed out, “the appraisal companies are not currently built to deliver daily valuations. Annual appraisals work fine, but quarterly, monthly, and daily? It just doesn’t work yet.” But it can get there. Just like predicting the weather, the more data we analyze, the better we can “predict” the value of an asset More than looking at a few data points, we need to create more comprehensive models drawing on rental, sales, and human activity data.
How can investment managers better manage our risk?
In an environment of secular shift and disruptive change, the management of risk only becomes more important. As Amos Rogers III, Managing Director at State Street, pointed out, “Risk is a key business criteria for all of us.” His colleague, Ada Chu, head of risk and compliance for State Street Alternative Investment Solutions, added, “This is a challenging time of change, but every change is an opportunity.” In State Street’s case, the opportunity to meaningfully manage risk lays with the front line employees. “After four years on the trading desk I realized that risk is inherent to what traders do every day. That’s why we focused our risk management process on employees. Do you want to know where the skeletons are buried? Talk to your most junior person. They always know.”
According to Chu, everyone at State Street is involved with risk management, from top to bottom. “Just saying ‘the risk guys do that’ is an antiquated way of thinking.” Instead, through intensive discussions, open forums, testing, and mini-audits performed throughout the year, everyone is part of a much larger risk management culture.
A holistic risk management culture should be built in an environment where everyone can speak openly – and readily admit mistakes without fear of punishment. A mistake that’s known can be solved so much more quickly and inexpensively than a mistake that is hidden. As challenging as that may be, companies that adopt such policies not only manage risk better, they quite often perform better than their peers – as every employee can better participate in the entire mission of a firm if they are able to speak openly, honestly, and with a questioning mindset.
Having “all hands on deck” is even more important when it comes to a growing area of risk for everyone, cyber security. Greg Kratofil, Chair of tech transactions and data privacy at Polsinelli noted for the group that Warren Buffet expressed this year his belief that cyber-attacks are “the number one problem for mankind.” As more and more cyber-attacks are reported every quarter, it has become apparent that commercial real estate is becoming a big target. Whether it’s fraudulent wire-transfer schemes, hacking of customer information, or even hacking of HVAC systems and holding whole buildings ransom, cyber security has become a very real risk concern.
According to Kratofil, regulations in this area continue to change, and there is a meaningful legal and compliance burden around this issue. In 2016, the SEC fined Morgan Stanley $1 million for failing to protect their customer data – but with Jay Clayton the new chair of the SEC, there’s reason to believe that we may see less action. Meanwhile the FTC, the most active organization around cyber security, has fined many groups that don’t have adequate protection in place. Maureen Ohlhausen, the new active chair, has dissented on recent enforcement actions and has expressed a belief that the FTC shouldn’t go after companies if there is only potential injury to others.
So there may be more clarity from both these agencies in the coming year, and perhaps less action in general. But the state and local governments may pick up more of the enforcement duties, leading to a more complex patchwork of laws across the US. Meanwhile, in the EU there is likely to be a lot more enforcement and firms are encouraged to review the applicability of the EU G-DPR requirements going in effect in May 2018.
When it comes to protecting your companies, Kratofil recommends three things in particular to keep in mind:
1. “Know where your data is. Have a data map that will allow you to move, secure, or delete old data.”
2. “Have an incident response plan with clear policies and procedures. Don’t put it into a drawer once you’ve made it, however. Practice runs and ‘fire drills’ should become a regular part of your company’s schedule.”
3. “Pay special attention to how you manage your vendors. Two-thirds of all breaches occur through a vendor. Make sure you understand their cyber practices and have a clear contractual understanding of how your data is accessed, used, and protected.”
Just as Ada Chu pointed out regarding risk management, cyber risk management needs to happen throughout your company – every employee, no matter how junior or senior, has numerous opportunities to click on a malicious hyperlink, share a pass code, leave a laptop unprotected, install a vulnerable building system, or assume that a partner is asking for a wire transfer right away – and in the process open up your company to an attack.
Whether considering new technology or new risks, it is appropriate for everyone to feel a bit uneasy. As John D’Angelo at one point commented, “in the next few years, we are not headed for business as usual, capital is behaving differently, data is changing things, and risk is only greater.” Everyone is learning new skills, and new approaches – but the challenge to learning is that it always involves stumbling. Mistakes, by necessity, will be made. Everyone will occasionally look awkward or even foolish in the process. The key here may be to simply admit it – we don’t know exactly how this all works – and then try again.
There is so much to learn right now. It might be more important at the moment to be honest than to be right.
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