Our Stuff is Shrinking: What Will Happen to Our Real Estate?

Posted on June 4, 2012 in Viewpoints by admin

In 1965, the co-founder of Intel, Gordon Moore, described in a paper what he had observed as a doubling in the number of components that could be fit onto an integrated circuit every year since their invention in 1958.  That observation has become a rule of thumb for the entire computer industry, now described as “Moore’s Law” where processing speed and memory capacity double every 18 months or so.  This exponential growth over the last 40 plus years has transformed our lives in remarkable ways.  Computers in the 1950’s filled entire rooms but could only perform simple calculations.  Computers that fit in a pocket today can make any number of complex calculations plus make phone calls, send messages, carry complete personal collections of books and records, and even play movies.

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In other words, sitting in most people’s pockets today are computers, libraries, telephones, record collections, movie theatres, and file cabinets. Thousands of pounds and cubic feet of stuff now fit into a device that measures 4.5 inches by 2.3 inches and weighs less than 5 ounces.  This tremendous shrinkage of the physical world has made it possible now to work, live and play anywhere and to access information and entertainment from anywhere.  If the exponential “Moore’s Law” growth continues for the following 5, 10 even 20 years, the shrinkage of our material world will be unlike anything we can currently imagine.

But what happens when the things people use, collect and enjoy no longer take up as much physical space? Does it change what we do with the space, how we value it, and where we want it to be? The implications of Moore’s Law are only starting to be felt by the commercial real estate industry, but investors, operators and users of space are already seeing meaningful impacts on their business that prompt them to challenge many assumptions about growth, obsolescence and value.

Change in Office Space

How much space people use for work is not constant.  In an article published by RICS, (Revolutionizing Office Demand:  Investor be Prepared, 2.24.2011), American companies in the 1970’s allotted 500 to 700 square feet per employee for the typical office.  Today’s average is approximately 200 square feet.  According to Peter Miscovich, Managing Director at Jones Lang LaSalle, that allocation could shrink to 50 square feet in the next few years.  Most leasing brokers point to a reduction of space requirements from all their tenants, but most interesting and most indicative is the 20-30% decrease of office space required by the most dominant users of high quality downtown office space – law firms.

What’s driving this?  Ty Spearing, managing director of LaSalle Investment Management, puts it most succinctly, “Law libraries have become extinct.  Document management and eletronic archiving have lessend the large storage requirements.  According to Konstantino Armiros, partner at Arnstein & Lehr, “There is more emphasis on technology rather than space in the modern law office.  Thanks to databases, mobile phones and cloud based servers accessible from anywhere we produce less paper and require less support.  As an example, the partner to secretary ratio has reduced from 2 to 1 to 5 to 1 today.”  A downtown high quality office is still essential to today’s lawyer, but they aren’t living in their office anymore.  As Mr. Armiros describes it, “not so long ago, we all spent countless hours, seven days a week, in our offices – now we work from anywhere as the desk has been replaced by the device.  We still need to be a cab ride away from the courts and clients, but we don’t have to be there all the time.”

The shrinkage of space requirements per person doesn’t mean that office buildings are going away, but it strongly influences what kinds of buildings will be more successful than others.  As Doug Kintzle, Managing Director at Principal Global Investors, explains, “There has been a cultural shift to open office configurations and collaboration, which requires less space per person.”  The need for collaboration suggests that centrally located office buildings, close to solid transportation, will have an advantage – even over less expensive space in less central locations. With less square footage requirements, companies will also be able to spend more on a per square foot basis for better quality buildings and locations closer to clients, vendors and employees. As Ed Glaeser, Harvard Economic Professor and author of The Triumph of the City”, describes it, “Knowldege has become more important than space.”

Change in Living Space

While office space has been steadily shrinking in the last few decades, living space has been increasing.  In 1950, according to U.S. census data, the average American had 292 of square feet of personal living space.  In 2006, that number was closer to 900 square feet.  That growth in space per person has come about from a combination of smaller average family sizes and larger homes and apartments built in the last few decades.  However, that growth in space may be more of a historical anomaly than is generally understood.  With inexpensive transportation from affordable private cars and fuel, the sprawl of US housing to more and more distant suburbs allowed for an inexpensive expansion of living space.

The desire for more collaboration and proximity to others has increased and for the first time in the history of the auto, young people are driving less. According to a report by Kiplinger, (Generation Y Giving Cars a Pass, – 9.14.2010) motorists aged 21 to 30 now account for 14% of miles driven, down from 21% in 1995.  The other interesting aspect to young people’s lives today versus 20 years ago is the amount of square feet they require.  The typical young person of the 1970’s, 80’s or 90’s might have taken up a third of their living space with milk crates filled with books and records. Today, it all fits into a pocket.

And it isn’t just young people that are shrinking their stuff.  Americans of all ages have spent the last ten years substituting digital music files for records and downloadable books for the traditional bound books of the last century.  As reported in the New York Times last year (“E-Books Outsell Print Books at Amazon” New York Times, 5.19.2011), “Since April 1, Amazon sold 105 books for its Kindle e-reader for every 100 hardcover and paperback books, including books without Kindle versions and excluding free e-books.”  According to last Year’s  BookStats, an annual statistical survey of raw sales revenue and unit data provided by nearly 2,000 publishers, E-books made up 13.6% of revenue from adult fiction in 2010.  With a little calculation, it’s possible to estimate that 114 e-books were sold in 2010 versus a total of 724 million books.  If one determines the average book dimensions to be 8x6x2 or 96 cubic inches – that means that in one year 6.3 million cubic feet of space was no longer needed for books.  Essentially, 114 million pounds of new books were translated into electrons that take up almost no space at all.

There are also reasons to believe that today’s young people will be renting far longer than their parents did.  They have the largest college debt load in history – averaging over $20,000 per student.  They also face a very different labor market from their parents: a fifth of them will likely be self-employed following the trend for all employers to offer more and more short-term contracts.  Renting may make economic sense, not just when they are beginning their careers, but for many more years to come.  Since the end of World War II, the trend was for more and more young families to purchase a home in the suburbs, leaving rental apartments to young singles.  Based on the economics today combined with a reluctance to drive and a cultural proclivity for proximity to others, that trend may shift towards more people renting throughout their lives.

According to Jim Smith, Managing Principal at Kensington Realty, “The demand for exurban, far out suburban housing is declining for both single family and multi-family.  This is likely due to Generation Y’s preference for urban areas.  Commuting expenses are excessive and likely to get higher.  At the same time, Generation Y prefers apartments with less space, good transportation access and substantial common area amenities such as cyber cafés, fitness centers, and common meeting areas.  There is now new apartment construction with lower average unit sizes and even units that are in the 300 square feet range in the mix.  The depth of demand for the smaller units is still unclear.” It is clear, however, that less space may be acceptable for a younger person looking for affordable housing close to where they work and play.

According to research conducted by Christopher Leinberger, a professor at the George Washington University School of Business, (Now Coveted:  A Walkable, Convenient Place, New York Times – 5.27.2012) the value of more urban areas may be strengthening while the values of more distant, car based suburbs (with larger houses) appear to be weakening.  “Our research shows that real estate values increase as neighborhoods became more walkable, where everyday needs, including working, can be met by walking, transit or biking. There is a five-step ‘ladder’ of walkability, from least to most walkable. On average, each step up the walkability ladder adds $9 per square foot to annual office rents, $7 per square foot to retail rents, more than $300 per month to apartment rents and nearly $82 per square foot to home values.

As a neighborhood moves up each step of the five-step walkability ladder, the average household income of those who live there increases some $10,000. People who live in more walkable places tend to earn more, but they also tend to pay a higher percentage of their income for housing.”

Doug Kintzle of Principal Global Investors observed that, “tenants are definitely accepting smaller units.  20 years ago, most people looked for an extra bedroom to serve as their home office with room for a desk, computer and files, etc.  now this office is carried around in a laptop and people are fine hanging out at the local coffee shop equipped with free wi-fi, to work on the computer.”

The way we live has changed as much as the way we work – and the location and size of the spaces we live in are already changing.  Exactly how that will impact the future of location, configuration and value of the apartments and homes we live in is still uncertain.

Change in Retail

Just as the ubiquitous smart phones and mobile computers have changed our work and home lives, the sellers of those devices are changing the rules about how we buy them as well.  E-Commerce and downloading of products with no physical presence – such as music, books, movies and computer applications have created a level of sales density retail has never seen before.  According to RetailSails reporting on retailers, Apple retail stores sell more than $6,000 per square foot of space every year – double the amount of their closest competitor, Tiffany & Company.  The average for regional shopping malls is only $341 per square foot.  That means that Apple has figured out a way to sell seventeen times more per every square foot than anyone else.  How do they do that?

To start with, they are an incredibly successful manufacturer of the one item everyone now must have:  an iPhone.  But it isn’t just because of their blockbuster gadget.  Apple has also engineered a retail environment that sells at least as much knowledge and entertainment as they do hardware – if not more.  They have created a compact marketplace of knowledge, of ideas, and of a few very powerful, very small products.  Less stuff, but more value.

While e-commerce continues to grow at 14% a year (source:  IMRG CapGemini e-Retail Sales Index), retailers are experimenting more and more with hybrids of on-line and in-store sales strategies that use less space to deliver more.  The nature of the successful retail space is not unlike that of successful residential space: located in high-density areas, close to as many people as possible, and of a higher quality design.  Ty Spearing of LaSalle Investment Management points out that, “E-commerce and social networking have changed the retail landscape, and it continues to change rapidly.  While more electronic transactions will reduce the overall need for retail space in non-strategic locations, we believe there will always be a need for space in strategic locations.  At the same time, distribution and warehousing facilities will see increasing demand due to those electronic transactions.”

The accelerating growth of e-commerce suggests that physical retail spaces have a different purpose now than before.  Instead of being a distribution outlet for products to consumers, they are becoming marketing ventures that provide education, service and an immediate experience of the value of their products.  Shopping is now focused on the entertainment of consumers more than the fulfillment of product and the need for large warehouse shopping experiences are diminishing.  Doug Kintzle of Principal Global Investors believes that, “successful retailers will offer the ease of the Internet for ordering products from home but maintain a storefornt for customer service, returns and display of products.  We are already seeing smaller demand for larger spaces.”

It’s imporant to understand, however, that retail is changing, just like office and residential space, but it is not going away.  Occupancy rates are actually going up nationwide, with the best quality shopping districts and malls able to charge rents comparable to those before the economic recession.  George Pandaleon, President of Inland Institutional Capital Partners, explains that, “Any reports of retail’s demise because of technology are greatly exaggerated.  People continue to need brick and mortar stores to meet their needs…even Internet centric retailers like Amazon and Ebay have opened physical stores to have a physical presence and better serve their customers.  Retail has always been a continuous process of creative destruction.  The successful retailers will be those who can better adapt to and develop processes and technology to grow their sales.  There were no Apple Stores a decade ago.  As one retailer fades, another one grows.  Dematerialization certainly seems to be taking place, but it will not eliminate the need for real estate but properties and how we use them will have to adapt.”

Less Stuff Means A Brave New World for Commercial Real Estate

George Carlin, the late comedian, once said, “That’s all you need in life, a little place for your stuff. That’s all your house is: a place to keep your stuff. If you didn’t have so much stuff, you wouldn’t need a house. You could just walk around all the time.”  Is it possible that by shrinking our stuff, we may be freeing ourselves to live, work, and play in places that are more attuned to our needs?  Will we become more free to simply “walk around all the time”?  If so, it is likely that people will have less and less tolerance for real estate that doesn’t provide for their needs and less willing to trade volume for location and quality.  Commercial real estate investors are already starting to see small but important changes in the behaviors of tenants that suggest a need for a strategic shift.  Simply providing inexpensive storage for a growing mountain of stuff will be more challenging to execute than it has been in the past.

What will happen in a world dominated by the exponential shrinkage of material goods made possible by Moore’s Law?  Perhaps there will be less stuff and better real estate.