2015/16 - NAREIM Year in Review
At the¬†NAREIM Asset & Portfolio Management Meeting in April, we were fortunate to speak with Paul Meadows, the CEO of Atlanta Beltline Inc. Over the last few years, his group has transformed some of the most troubled, overlooked and discounted neighborhoods in the City of Atlanta by taking 22 miles of abandoned railroad tracks that circle downtown and turning them into multi-use trails and parks. The project has recreated an entire area into a thriving urban neighborhood. If you haven‚Äôt visited Atlanta recently, you owe it to yourself to spend an hour exploring some of the completed trail. It is remarkable what they‚Äôve accomplished in such a short amount of time.
This is a unique place. No carbon copy of suburban spaces planted into a city ‚Äì instead there is a genuine sense of ‚Äúlocality‚Äù. Although thriving and new, it still has the layers that generations of residents have built up over a century of living and working in the area.
Paul said something very interesting, ‚ÄúYou have to build for the people who live there.‚Äù Difficult to disagree, and yet, too often developers focus on the people they want to move in ‚Äì and in the process, lose what makes a place valuable. Is the real estate industry building for the people who already live in places like Detroit, Philadelphia, or Baltimore? Or are too many investors too quick to transplant a shiny and homogenized suburban fa√ßade into the city? Do the office buildings in our portfolios serve the actual needs of office users, or are they simply the most efficient way to stack up square feet? Is a traditional shopping center delivering everything retailers actually want or need in a space?
Expand that question out even further ‚Äì are investment managers always building the optimal investment program for investors and helping them deliver to their constituencies? Do they have true transparency to the performance of assets? As our investors and their priorities change, are they getting precisely what they need now and into the future?
Are the talented people inside investment management firms getting what they need? Are the policies and processes for assessing, investing, managing, and reporting working the way they should? Is leadership building a culture for the people that live here and will live here long after they are gone?
Throughout the last year, it has been difficult to avoid facing this reality: Demand is changing, sometimes faster than we can understand or respond to. People want something different from the buildings they live, work and play in.
Capital desires more transparency, more control, and more efficiency. Rising leaders within the real estate profession also need something different than their predecessors.
There is quite a bit to talk about.
REAL ESTATE DEMAND CHANGES
At the Fall Executive Officers meeting last year, NAREIM members were able to tour a fascinating real estate disruptor, ShopWithMe and meet its CEO, Jonathan Jenkins. Set up in a plaza in downtown Chicago on Michigan Avenue was their mobile shop designed by Girogio Borruso and made up of modular units. Extremely portable and changeable, it spent two weeks in Chicago housing two different clothing retailers, TOMS¬Æ and Raven + Lily.
Despite its small footprint, the store itself felt spacious, thanks to its smart design and a translucent ceiling material that bathed the space with natural sun light. A ‚Äúpixel wall‚Äù made up of small moveable screens took up one wall, where changing light and graphics could switch from one retailer to another in an instant. The pixel wall was able to reconfigure itself as different kinds of shelves to hold different merchandise.
Despite all the technology on display, the truly provocative notion was this: If a luxury store can be set up anywhere in a day, and taken down just as quickly, what happens to the existing real estate environment? Is this an opportunity to activate and test locations? Can this augment or replace existing retail?
What about co-working? Some savvy owners of underused office space have found that there is strong demand for temporary or shared office space from startup and professional businesses, but what happens if that demand continues to expand. How secure is the gold standard of 20 year leases on large floor plates to the biggest companies?
And then there is Air BnB. They sell more room nights than any other hotel operator. Is that a threat to existing hotels? Or is it an opportunity for multi-family operators with un-leased units?
Industrial space demand is changing as well. Mike Brennan of Brennan Investments spoke in detail during our 20/20 Investor Summit about a ‚Äúthird Industrial revolution‚Äù focused on mass customization of machines. According to Brennan, ‚ÄúThe third industrial revolution is here already. Advanced robotic manufacturing and 3D printing now allow for meaningful scale. Out of our 180 industrial tenants, there isn‚Äôt one that isn‚Äôt automating.‚Äù And most significantly, they are looking for more space in urban environments in order to be close to markets and the very few highly skilled workers they need. Are we ready for a change in industrial demand, or are we assuming the model of off-shore mass manufacturing and container traffic through Long Beach and other ports will grow indefinitely?
There are significant desire lines emerging in the use of commercial real estate. Office, retail, multi-family, hotels, and industrial tenants are looking for something different. Large numbers of people and a growing number of businesses are adapting existing buildings, leases, and businesses to suit their desire for shared, temporary, and customized space. Like all powerful desire lines, the investors who can adapt to the new demand profile will have a path to growth. Those who can‚Äôt adapt may face fewer opportunities.
Investors want more control. Every new action taken by a large pension plan focuses on two things: Cutting costs and increasing governance. The LP‚Äôs and their constituents are taking an ever-closer look at the costs of investing. Edgar Alvarado of Allstate Investments mentioned at our December Capital Raising Meeting that ‚ÄúCalPERS disclosed to the public what they paid in fees for the first time. Now to us, this is not news, but it looks like a lot of money to the general public. Vanguard has been beating this drum for 30 years: fees matter.‚Äù
At the same time, the continued drive for control has meant that separate accounts still dominate late into this recovery, and demand for transparency is only increasing. According to Alvarado, ‚ÄúWhen I started out in this industry ¬†30 years ago it was a totally private environment, but the current transparency in public stocks and financial markets is where I see our sector going.‚Äù
It isn‚Äôt just the market that is demanding more, the SEC wants transparency: brutal, painful, and time consuming transparency. They will not rest until all investment managers deliver it. The past year has been a time of aggressive auditing of NARIEM member firms ‚Äì making clear to everyone that our level of disclosure to investors must increase and conflicts of interest will not be tolerated.
According to Eva Carman of Ropes & Gray, a frequent speaker at our meetings this year, ‚Äúthe SEC is digging, and they are finding lots of stuff.‚Äù Carman told us that the SEC essentially asks two questions of companies they are investigating.
- Is there a conflict of interest? ‚ÄúI‚Äôve never seen examiners answer this question no,‚Äù Carman noted.
- Was the conflict disclosed? ‚ÄúMost of the time, it‚Äôs not. Not sufficiently anyway. I‚Äôve only ever seen a couple companies come out of this OK. It‚Äôs not because there are so many nefarious people out there, it‚Äôs because the SEC doesn‚Äôt accept industry standard practices.‚Äù
Moving to a more transparent industry standard is not easy, but the SEC insists we do. Disclose everything. Let your investors know the details and the process. Make sure they know what they are paying for and why.
Good enough is no longer good enough.
Meanwhile the drum beat of alternative sources of capital such as crowd funding or on-line syndication continues. At several of our meetings, we heard from groups like Realty Mogul and Peer Realty who are making more and more headway as on-line capital raisers ‚Äì and a few NAREIM members are beginning to experiment with it. This is still early in the evolution of on-line capital raising, and it will not come without difficulty, both practical and regulatory, but so far it is not going away. Will how we raise capital fundamentally change? It might have to.
THE CHANGE IN HUMAN CAPITAL
There has been no shortage of discussion in the last several years about Millennials entering the workforce and Baby Boomers retiring, but NAREIM members wondered aloud if we might be missing the point. Is it possible that the most salient difference between generations is their age and where they might be in their life‚Äînot so much culture or technology use? And is it possible that the generations are more alike than they are different?
At our HR meeting Gail Silver of Walton Street Capital and Mesa West Capital pointed out, ‚ÄúThere seem to be quite a few older workers not interested in retiring‚Äîbut rather living a working life not unlike younger people who demand more flexibility in how and when they are in the office.‚Äù Vicki Maskell of AEW Capital Management did not disagree, ‚ÄúActually, flexibility is one of those things that everyone is seeking. It‚Äôs not just Millennials anymore.‚Äù In other words, Millennials may be teaching their elders how better to balance life with work.
According to Debbie Brin of LaSalle Investment Management, no matter what stage of life, ‚ÄúThere is a common desire that everyone shares; to be known, to be respected. How we might describe that may be different at different times, but all human beings need to be recognized.‚Äù
The generational discussion then, may be operating from a flawed premise. Instead of listening to people, understanding where they are and what they need, we may be too quick to brand people with generational labels.
But whether you give a generation a label or not, it is clear that there is a need to build leadership skills. Christine Nicholl of Heitman asked, ‚ÄúAre we spending enough time grooming the next generation of leaders? Our leadership has multiple decades of experience and perspective‚Äîhow are we passing that on?‚Äù
That question was asked by many executives at our meetings. This is a complex challenge that will continue for many years to come. How do we develop the best leadership for real estate investment management today and for years to come?
Change is happening in every part of the industry, and it continues to challenge managers to be the very best leaders, to listen, to explore new ideas and to question every assumption. Leaders within the NAREIM community have not held back as they have worked to learn and understand what forces are impacting their businesses today and in the future. It has been a privilege to question and to learn with you, and I look forward to our continued discussions in the year ahead.
-- Gunnar Branson, President of NAREIM