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Beware the Disruptor

By_L2A3182 Gunnar Branson CEO, NAREIM There has been a recent abundance of examples that graphically demonstrate what happens when disruptive technologies and business models are introduced to an industry.  Every year, billions of dollars in revenue are taken away by competitors that weren’t considered a credible threat – until they were. Could the bookstore giants of the 1980’s know that a little e-commerce business called Amazon would take everything away? In 2000, when American print-based newspapers enjoyed a record $65.8 Billion in advertising sales, did they believe that by the end of the decade, they would only share $17.5 Billion in advertising?  Did Sony Music predict that they would lose half their business to a computer company by 2010? Today, Uber is threatening the entire taxi business without owning a fleet of cars or employing drivers, Airbnb is eating away at the hospitality business without owning a single hotel, and Facebook, the world’s most popular media company is taking viewers away from all other media without creating any content of their own. In each of these and many other cases, it isn’t established competitors that threaten to destroy incumbents, but outsiders.  Motorola, Nokia, and Blackberry didn’t lose to each other – instead, they lost to Apple, a company that wasn’t even in the phone business until 2007 when they introduced the iPhone.  Circuit City didn’t lose to Best Buy, any more than Borders lost to Barnes & Noble or Tower Records to Virgin Megastores. When considering competition, it is prudent to consider all the companies in your space, consider their strengths and weaknesses, and then align strategy to compete against them.   But is that enough?  In most examples of disruptions, the incumbents were very competitive in their space, enjoyed dominant market share, and considered their importance and position unassailable, until an outsider changed the rules of engagement. Of course, the real estate investment management business is different from consumer driven businesses like entertainment, media and taxicabs.  How could an outside disruptor take away something as sophisticated and specialized as institutional real estate investing?  After all, this is an industry defined by long-term relationships, deep real estate experience, extensive checks and balances, and limited sources of capital.  An algorithm can’t raise capital or execute an investment strategy…or can it? For the sake of argument, imagine what would happen if a non-financial, non-real estate firm decided to enter real estate investing.  What would happen if a compulsive disruptor like Apple, with over $200 Billion in cash burning a hole in their corporate coffers started to take a closer look? Likely, they would perceive vulnerability in the value proposition currently offered by investment management firms. Institutional investors, although perhaps satisfied by the risk-adjusted returns they currently enjoy through some of the best investment teams in real estate, are clearly interested in something more: more transparency and more control, while wanting a bit less: less fees and less time between commitment and investment.  Although investment advisors have done very well for institutions over the past few decades, real estate investing, as it exists today is by no means a perfect fit.  Disruptors are always attracted to markets where there is a clear disconnect between customer desires and industry offerings.  It is unlikely that Uber would have been so quickly adapted by millions of taxi customers if their needs had been fully met by the incumbents. Investment management firms emerged in real estate to solve for a fundamental disconnect between the demands of real estate investing and the needs of institutional investors.  In order to acquire, improve, and benefit from commercial real estate, any investor needs ready access to very large and very patient pools of capital.  Waiting weeks or months to aggregate that capital when a transaction becomes available is not feasible.  Institutional capital, meanwhile, does not usually have the capability or bandwidth to efficiently acquire and manage real estate.  By raising large pools of discretionary capital, a bridge is created through investment advisory firms to access real estate investments. However, this is a somewhat awkward bridge between two very different worlds. The factors that currently make this difficult look much like the kinds of challenges disruptors like to solve.  With a determined focus on providing real-time data, more investor control, and faster velocity of both capital raising and investing, a new, data-enabled investment platform would be very attractive to institutional investors. A company like Apple might view a typical two-year fund-raising process as something that could be dramatically changed.  If they developed an electronic syndication or “crowd funding” process similar to what Realty Mogul, FundRise, Peer Realty, or Cadre Real Estate use – it might be possible to raise the capital needed for any given acquisition in a few hours or days.  If ready access to capital doesn’t require large amounts of “dry powder”, why have a fund at all?  The management cost to maintain a platform that raises capital this way could theoretically be far less, along with the time and cost of dormant capital, while providing the institutional investor with far more transparency and control. It would not be easy to create this kind of disruptive platform.  The depth, breadth, and accuracy of real-time data required to roll up from the asset level to the ultimate investors would be considerable. Although electronic syndication platforms are beginning to emerge, they are still far from any real critical mass, and meanwhile there are legitimate concerns around control, confidentiality, and potential for fraud.  Legal and regulatory issues present considerable challenges, as do the fiduciary requirements of institutions – but they are not impossible to surmount.  It might be too difficult, risky, or time consuming for a successful real estate investment advisor to want to create such a platform, but that is precisely why an outside company with deep pockets, technical know-how, and a strong brand reputation might find this interesting. There have been periodic discussions about an alternative to the current model for real estate investment management since the beginning of this sector, and so far, the big disruption has not happened.  Real Estate Investment Trusts were supposed to take over everything once upon a time, and though they have grown considerably in the last twenty years, they have not replaced private investing.  New electronic schemes for exchanges or clearing houses have been experimented with over the years, but no leader has emerged yet.  Crowd-funding is intriguing but still small.  Perhaps algorithms cannot replace the work of investment advisors.  Perhaps our existing processes and technology will only change gradually. Or perhaps not.  Change can take forever to start, but when it does, it can happen so quickly that it takes everyone, especially the incumbents and experts, by surprise.  Are we paying enough attention to the disruptors? Can we adapt to change when it comes?  As difficult as it may be to create the digital institutional investment platform of the future, once it is built, the market is likely to change rapidly.  Just as Apple iTunes took away over half of the $38 Billion music business in less than ten years, if institutional investors were able to easily and less expensively allocate their funds to real estate through a digital platform, how long would it take for investors to abandon the co-mingled funds of today? This hypothetical platform of the future will likely still need investment and real estate professionals to find great assets, figure out how and where to create value, operate them and effectively sell them at the end of the term – but it does pose some very serious questions about how our businesses might evolve in the years to come:
  • How could an investment management firm optimize operations around asset-by-asset funding?
  • How more efficient can we make operations (and therefore how much can we lower costs to investors) with a new capital raising model?
  • How would the communications with investors change?
  • Does a new capital raising structure allow for different, more flexible, or specialized investment theses?
Whether we lead the change, or have the change imposed upon us by an outside disruptor, this is the time to begin asking, and perhaps answer a few of these questions. _L2A8575
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