Combatting Inflation with Technology
After more than a decade of sustained growth, many experts are warning that the economy is approaching a recession. Some even argue that the recession is already here. Either way, the rapid increase in inflation over the past year and subsequent interest rate hikes by the Federal Reserve has changed the landscape that the commercial real estate industry has enjoyed for 12+ years.
In addition to interest rate hikes and the ebb and flow of macroeconomic cycles, emerging trends in the technology space are contributing to the volatile situation. Chief among them is the continuation of technology-enabled hybrid work environments. Many employees who exclusively worked from company-owned space before the COVID-19 pandemic are demanding the option to continue working entirely from home or an option that includes a mix of in-office and remote work. In the face of a tight labor market, employers have had little choice but to offer hybrid or full work-from-home options or else risk losing workers to those that do.
Nearly 60 percent of respondents to a McKinsey survey of 25,000 Americans reported that they had the option to work from home at least one day a week, and 87 percent of those chose to exercise that option.
The reduced demand for office space has and will continue to drive concerns about vacancy in the asset type. Interestingly, the opposite has been the case in the residential space, with the Federal Reserve Bank of San Francisco attributing 60 percent of U.S. housing price growth and rent increases to remote work, presumably tracking the increased time workers spend at home.
Another trend in the tech space is a slowing of venture capital (VC) flow into tech startups. VC funding dropped 23 percent from Q1 to Q2 of 2022, with Seed and Series A companies taking the biggest hit. This trend is expected to continue, with prominent startup accelerator Y Combinator advising companies planning to raise capital in the next six to 12 months, “We recommend you change your plan.” Industry experts blame a combination of the changes in monetary policy discussed above and lackluster returns on the glut of funding to the industry in 2021.
On the contrary, according to the Center for Real Estate Technology & Innovation (CRETI), VC money has been increasingly directed at PropTech startups. According to CRETI’s PropTech Venture Capital Report for H1 of 2022, “Venture capital investments in private real estate technology companies outperformed the global venture capital market. In H1 2022, $13.1 billion was invested in real estate technology companies, including commercial, construction, residential, industrial, and other real estate sectors.”
One reason investors are eager to back PropTech ventures is that the CRE space stands to benefit greatly from technology in a period of economic downturn. By recognizing the value of PropTech and using it effectively, owners can maximize value, mitigate risk, and emerge from uncertain economic conditions stronger than ever.
Technology Investments Improve Tenant Experience and Increase Value
In the immediate future, CRE investors can expect properties to trade less often and at higher cap rates. In areas and asset classes with a projected decline in potential tenant pool, keeping existing tenants and competing to replace those that leave are imperative. The most recommended approach is to drive towards an improved tenant experience.
According to Deloitte, “Leaders should adopt a Real Estate-as-a-Service (REaaS) approach, which combines strategy, technology, and data to deliver digital and physical services—not just space—to tenants and users.” In most cases, as the acronym implies, technology is the answer to successfully implementing this strategy by enhancing their property and including new, value-add services.
As with most strategic plans in CRE, industry subsectors vary in how they prioritize the services offered by owners. Residential occupants rank energy efficiency as their top priority, whereas the hospitality sector sees the most benefit in integrated mobile apps that increase and improve touchpoints with guests. Retail tenants want more configurable spaces, but office occupants are more interested in automated, integrated conference room scheduling.
Unfortunately, according to Deloitte’s 2022 Commercial Real Estate Outlook, 80 percent of CRE firms are still heavily reliant on legacy systems that are ill-equipped to integrate with those advanced technologies. The same survey found that most respondents in the industry ranked their top priority for investment over the next 12 to 18 months as upgrading their existing assets to improve their value proposition. Replacing or at least reducing the dependency on those legacy systems will be key for those investors trying to bridge the gap.
Business Intelligence
It is always important for owners to understand how their assets are performing, but it becomes particularly crucial in times of economic downturn to ensure that the assets in their portfolio are running at maximum effectiveness. This starts with understanding the key metrics that show the performance of an asset type and the benchmarks of how those indicators should be measured. Strategy is just the first step, though. Data is the fuel of the business intelligence (BI) engine. Telemetry from internet of things (IoT) devices, specialty third-party data providers like foot traffic trackers, and data aggregators can all contribute to an owner’s toolkit for BI. One particularly critical function of BI tooling is to understand a portfolio’s rollover risk. In times of economic downturn, there is an increased likelihood that a tenant may lose the ability to meet their lease obligations. Tenant rollover analysis models vary by asset type, size, location, etc. Likewise, they can be used with a variety of tools, from a simple spreadsheet to sophisticated data models and BI applications.
However an investor comes to find a tenant at risk of rollover, it gives the owner the option to be proactive with the situation. Depending on market dynamics, it may be advantageous to restructure lease terms rather than source a new tenant. The CRE market is heading for a dramatic change after more than a decade of sustained growth. This is largely due to broad macroeconomic trends, but major shifts in the technology space are contributing, such as reduced demand for office space due to hybrid work environments and a concentration of venture capital in the PropTech space. This shift to PropTech-focused capital investment implies that the market sees value in implementing real estate as a service (REaaS) tech as a mitigating factor against the market forces changing the CRE space. Improving tenant experience with technology focused on particular asset types is anticipated to be a major factor in retaining existing occupants and attracting new ones.
Advanced business intelligence and analytics will also be a significant factor in retaining tenants by providing investors with the insights they need to proactively identify rollover risks and analyze mutually beneficial adjustments to lease agreements.
