Consumers of Space
With the world in flux, at what feels like a very brief pause in an extremely long race, we find ourselves at an inflection point. Dire economic data such as a staggering -31.7% contraction in U.S. Q2 GDP, unemployment stubbornly hovering around 8.4%, over 75 corporate bankruptcies in the last 3 months alone according to Bloomberg and Transunion reporting 25% of all consumer credit products including credit cards, mortgages, auto loans and personal loans in hardship programs, suggests an arduous road ahead. Leaders will use this disruption as a catalyst for change, like a trusty scythe to carve a path ahead of the curve.
As we reimagine what’s possible and recalibrate what can be achieved, there is one driving force that allows for this potential, data. It has the ability to change business models, push industry boundaries and create new market structures. Modern analytics are essential right now as business’s recover, reset and start anew after disruption. Data is the solution needed to address the most prescient changes brought on by COVID such as the abrupt shift in how people work, how customers behave, how supply chains function and a complete redefinition of what constitutes business performance.
When considering the use of data and how it correlates to performance, Amazon quickly comes to mind. Now clearly a tech company has a far different business model than real estate, however consider the following. The company has a sustainable competitive advantage, through the use of data it understands consumer behaviors, markets at a hyperlocal level and beats its competitors in every CPC (customer purchase criteria) including price, delivery/execution and reliable service. Amazon harnesses its capabilities by winning and keeping its customers. Lastly, it stays ahead of the curve with trends and technology with the goal of maximizing efficiency and the customer experience. Bringing this back to real estate, the next generation of firms will use infrastructure and digital solutions to create unique, personalized experiences that foster meaningful interactions, collaboration and productivity. They’ll force strategic change by diversifying sources of revenue and utilizing advanced analytics as a tool to drive decisions.
With $151 billion raised in 2019 for real estate assets across approximately 295 funds, according to Preqin, compared to $148 billion raised in 2018 across 486 funds, the amount of dry powder and fund sizes are larger than ever. Yet one can not help but think, that’s $319 billion estimated by Preqin as of the end of 2019, in addition to anything raised in 2020 thus far to be deployed across strategies with long held assumptions and bureaucratic hierarchies that have entrenched interests, inherently clouding the decision making process. Doing what you’ve always done rings loudly in these old halls of power, where intuition and retrospective data is heavily relied upon. But the real opportunity exists in the place the world rarely looks.
Today’s competitive landscape, the stewards of all this dry powder, have significant headwinds that could hinder their ability to anticipate and adapt to the changing environment.
REITS are required to distribute 90% of their taxable income. While implementing cost cutting initiatives, they must still adhere to compliance regs, striking a balance between meeting distribution requirements, maintaining assets and conserving enough cash to absorb economic adversities. The CARES Act does not address some of the unique concerns that REIT’s have. While rental payments and loan payments are delayed, REITS may still be in a position of accruing income without receiving the funds necessary to pay out to shareholders. Asset values may fall in relative terms, affecting asset tests, putting the REITs tax-advantaged status at risk. REITs will also be challenged to raise additional capital due to their depressed stock prices.
Existing real estate funds are focused on under-performing assets within the portfolio, falling revenues, increasing operational expenses brought on by COVID, over zealous rent growth assumptions, over levered assets, lack of digitization, occupancy issues, lack of team diversity and a heavy reliance on debt service arb, masking other risk factors.
Developers face a plethora of challenges including massive construction delays, labor shortages, construction loans coming due at inopportune times simultaneously as liquidity dries up for future construction financing, permitting delays and regulatory changes, all of which have contributed to a -12% contraction in construction starts through 1H20 YoY for resi alone, a 5 year low, after peaking in 2018. Moreover, anything being recently delivered or on the horizon will require additional capital and repositioning to bring the asset to the post-COVID market.
Pension Funds will be slow to deploy capital as they mitigate risk in other parts of their portfolios while struggling to maintain monthly distributions and adhering to new internal governances.
Insurance companies are focused on several global crisis’ at play such as climate, COVID, a collapse of biodiversity and social unrest. Outflows are tied to actuarial tables many standard deviations away from today’s norm.
International capital itching to take advantage of extremely low hedging and financing costs will face significant obstacles to transact in a post-COVID environment due to social distancing and quarantine requirements, travel restrictions and their inability to properly due diligence assets in a finite amount of time. Additionally, ongoing issues with tax leakage and the expectation to protect the equity investment of their respective countries despite historically low cap rates will hinder their ability to bid competitively.
Local buyers, unsophisticated in nature and typically risk adverse, will have difficulties or opt out all together to adopt and adhere to the new market and regulatory environment.
What remains are the new entrants, those with a clean slate, a fresh view and those with the fortitude to create and innovate. Managers who are asking what is the lesson? What long held beliefs and assumptions do I need to explicitly reset to achieve what I’m trying to achieve? The world can not go back to the way it was. Not because of the pandemic, but because what the lockdown has done in changing behaviors. The future of real estate is not delivering 4 walls. Real estate companies will need to create spaces and experiences that match how people want to work, live, shop, learn and interact. The ability to successfully navigate these waters will be predicated on how well a company addresses the immediate challenges and how well they understand the consumers of space.
