Asset & Portfolio Management Meeting Report: Is Doing Right Enough?
‚Äú We expect too much of new buildings, and too little of ourselves.‚Äù
‚Äì Jane Jacobs
For a print version, click here.¬†The way real estate is used by tenants is changing. The way real estate investments are analyzed, managed, and ultimately perceived by investors is changing. This may be a good time to reflect on more fundamental questions about how to meet a future that just happened. In April, NAREIM asset managers gathered in Nashville, Tennessee to do just that. Below are a few notes from those discussions.
Is technology disruption real‚Ä¶or will it fade away?
Some of the excitement surrounding new technologies such as autonomous cars and alternative energy may have started to dim a little as they have faced a few technical and regulatory obstacles. Doug Herzbrun of CBRE, however, reminded everyone that, ‚ÄúBad headlines or nay-sayers can‚Äôt stop technological disruption from happening, they rarely do more than delay change. We are about to experience a wave of innovation that will have far more impact on our industry and our lives ‚Äì unlike anything we‚Äôve seen up to this point.‚Äù
The technologies now entering the mainstream will require everyone to ask the question, ‚Äòwhat is real estate‚Äô. The answer to that question may be changing. According to Herzbrun, ‚ÄúAs more people accept autonomous vehicles as standard, the vehicles are likely to change how they interact with the built environment.‚Äù How long do people need to be in the office if they are able to have meetings in an autonomous car on their way to somewhere else? Are long commute times a hindrance to productivity or in an autonomous vehicle, a chance to get some work done?
As can already be seen through the expansion of ride-sharing companies like Uber, the impact of this kind of disruption can have a meaningful and complicated impact on real estate use and values. A restaurant with limited parking and no accessibility to mass transit can now attract crowds who use ride-sharing. Conversely, as the need for parking goes down, congestion may go up in areas, creating new problems for the adjacent properties. The infrastructure now in place is unlikely to effortlessly change as quickly as the new technology. ‚ÄúA system that hopes to embrace autonomous vehicles only works if the infrastructure is there with smart streets to accommodate it. Coordinated traffic lights and solutions to impediments such as construction are needed. How many cities are flush with cash to rebuild their road systems?‚Äù As exciting as the potential for autonomy is ‚Äì it does not come without challenges.
Meanwhile, 3D printing and robotics are changing the use, demand for, and location of manufacturing, distribution, and warehouse space. Herzbrun pointed out that, ‚ÄúCompanies are already pouring billions of dollars into this technology while simultaneously using lower cost materials. This could disrupt the entire supply chain; if you can produce goods on site at a ‚Äústore‚Äù, what happens to the demand for warehouses and distribution centers.‚Äù
Another potential question for developers and investors; can robotics and 3D printing reduce construction costs or even change the way buildings are developed, maintained, and used? If the replacement cost decreases meaningfully, what does that do to the value of an existing investment?
Is Retail Dead, Mostly Dead, or Just Resting?
At this point in the cycle, consumer disposable income is at record levels, but where it is spent is changing. In the third quarter of 2017, gross retail sales of food in restaurants exceeded that of grocery stores. At the same time, according to the NPD Group, US apparel sales declined 2% in 2017 from the prior year. E-Commerce apparel sales meanwhile, grew 4% to make up 21% of total apparel sales. And according to Morgan Stanley, department stores will account for just 8% of the apparel market by 2022, down from 24% in 2006.
So ‚Äì at the peak of the market, with consumers able to spend more than ever before, department stores are struggling, high-street retail occupancy levels are low, and every day it seems that another national retailer is closing their doors. Is this what disruption feels like?
How could this possibly be a good time to invest in retail? George Pandaleon, President of Inland Institutional Capital discussed a more nuanced take on retail. Grocery, for example, is not dying, but it is changing. ‚ÄúIn comparing e-commerce sales of grocery with total e-commerce sales for all retail, the distance continues to widen. This is a limited phenomenon. Though Internet based grocery is popular in urban areas, it‚Äôs only two of thirty-five of total e-commerce and it‚Äôs growing very slowly. Home grocery delivery isn‚Äôt very convenient for most people.‚Äù Plus ‚Äì on-line delivery or pick up is not profitable for the grocery stores themselves. Joseph McKeska, President and Co-Founder of Elkhorn Real Estate Partners pointed out that, ‚ÄúWe are overstored when you look at the amount of square footage we have. Big retailers such as Kroger and Walmart are turning 100,000 sq. ft stores into 40,000 sq. ft. front end retail and putting a 60,000 sq. ft. fulfillment center in back just to support click and collect. Without similar support, this creates a business model that places additional burden on labor and the economics aren‚Äôt sustainable from a grocery profitability standpoint.‚Äù
The key to reacting to disruptions like these while maintaining the value for your retail asset may be to focus on consumer experience. McKeska pointed out, ‚ÄúIt‚Äôs a great time to be a consumer because they aren‚Äôt paying for the actual cost of all of the e-commerce. Free shipping, free delivery, none of that gets passed on. Once the last mile is solved and that levels out, what percentage of the current consumer will be able to bare those costs?‚Äù
At the same time, good ‚ÄúExperiential‚Äù retail is only growing. Pandaleon pointed out that historically, ‚ÄúAll retail is experiential, and if it stops being experiential it goes away pretty quickly. It takes capital and an innovative culture to adjust to disruptions. I prefer to buy shopping centers where the grocer and the pharmacy are the only tenants selling physical merchandise. It has to be service, food, restaurants, and increasingly ‚Äì medical services. You can‚Äôt get a haircut on the internet.‚Äù If retail centers and their tenants offer a valuable and entertaining experience, if it is social, if it is special, if it provides more than a replacement sweater or box of cereal, it has a reason to be there ‚Äì and it will support rent growth.
Are retailers hurting because of the Internet, or because they aren‚Äôt providing the right experience for all those consumers flush with cash?
Enterprise Data Solutions ‚Äì Where are They?
‚ÄúWe should have one place where all users go to get data. Why doesn‚Äôt it exist yet? What‚Äôs in the way?‚Äù Asked John D‚ÄôAngelo of Deloitte Consulting. For years, meetings like this one have included exhortations to put aside the Excel spreadsheets and bespoke reporting for a more accurate, and less labor intensive approach to tracking real estate portfolios. And yet, the behavior has not changed. Investment management firms big and small still collect, track, and analyze their real estate holdings primarily through the use of individual spreadsheets.
Why is that? According to D‚ÄôAngelo, ‚ÄúIn the past, funds grew quickly, money was placed into assets and funds and left to the back office to deal with it. Accounting has their own set and analysis of the data, portfolio management has theirs, and investor relations another. The result being that everyone‚Äôs data wound up in buckets and jars around the office with no cohesion.‚Äù Meanwhile, client investors are increasingly asking for more transparency. Instead of building new systems and approaches to provide that, ‚ÄúIt has historically been easier to throw people at the problem rather than thinking differently about a solution.‚Äù
However, as Haley Donato of Continental Realty emphasized, ‚ÄúAs end users of the data, part of our job is to determine and clearly communicate the correct workflow for how the data should be collected‚Äî and WHY the data is being collected. Often times, the bulk of the data is being collected by folks who are much closer to the day-to-day operation of the real estate and may not always be exposed to the larger strategy. You need buy-in and clarity of process at all levels of the information workflow to preserve data integrity. Without that, we are just Asset Managers shuffling around incorrect or incomplete data into fancy reporting templates‚Äî no Business Intelligence platform can solve for bad front-end inputs.‚Äù
There are any number of good database solutions in the marketplace, and excellent consultants ready to help implement those systems, but it ultimately comes down to the process, the people, and the leadership of each investment management firm to make it happen. But that is ultimately true of all the change and disruption now taking place in commercial real estate. There is no magic pill anyone can take to make these challenges go away ‚Äì instead it‚Äôs time to face the issues and lead the change in ourselves and our companies. What are we waiting for?