(Podcast) 2019 commercial real estate industry outlook | Deloitte Insights

2019 Commercial Real Estate Industry Outlook Agility is key to winning in the digital era

10 January 2019

The commercial real estate industry thrives on risk, but it’s not always so open to change. Tanya talks to Bob O’Brien, who leads Deloitte’s global real estate sector, and Jim Berry, U.S. leader for real estate, about how new business models and competition, extensive use of technology, and changing tenant and investor expectations are redefining the commercial real estate industry.

 
“The real estate industry overall has tended to be a follower when it comes to adoption of new technologies. But when you think about the innovation that's occurring and you think about the opportunities that exist within all of the utilization of data that currently exists within real estate and how do you take that data and no longer just assemble data, but how do you really move to the next level? How do you use that data?”

—Jim Berry, Deloitte U.S. real estate leader

“When you talk about technology change, you probably need that next generation of workforce to help drive that technology change. But you also then have to attract that next generation workforce, and it's difficult to do that when we're using Baby Boomer technology versus Millennial technology. You’ve got a little bit of a chicken-and-the-egg thing here: How do you attract a workforce of the future without a digital workplace, and how do you create a digital workplace without the workforce of the future?”

—Bob O'Brien, Deloitte global real estate leader


TRANSCRIPT

TANYA OTT: I’m Tanya Ott and this is the Press Room, where today we’re talking about one of my favorite subjects: real estate.

I’m driving through the Southside neighborhood of Birmingham, Alabama. It’s a hodgepodge of restaurants and bars, retail, office buildings, apartments, and houses, some of which date back a century or so. The nearby university has big plans for the adjacent area, with lots of green space and several new buildings. There’s a sense that this part of the city is going to pop really soon. And that has real estate freaks like me stalking the neighborhood looking for good deals.

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Of course, I’m an amateur. And that’s why I was so excited to talk to two men who know the business of real estate inside and out. I’m talking about Bob O’Brien, who leads Deloitte’s global real estate sector, and Jim Berry, U.S. leader for real estate. They’re out with a new 2019 Real Estate Outlook. They surveyed more than 500 global real estate investors to find out what’s got their attention these days. What are they interested in? Where are they putting their dollars? I asked them to start by giving us the snapshot of what 2018 was like in the commercial real estate world. Jim started by noting that the year started with a little bit of uncertainty.

JIM BERRY: As you entered 2018, there was the overhang of what's going to happen with interest rates. The tax reform in the U.S. had just been passed in 2017. There was still this little bit of question mark of what would happen from that perspective. But even despite those things, there continued to be a heavy volume of transactional activity.

BOB O’BRIEN: When you take a look at the U.S. market, commercial real estate is heavily influenced by Gross Domestic Product (GDP) growth and job growth. It's been great in the U.S. across both of those in 2018. And there's a fair amount of optimism with respect to 2019 as well, kind of offsetting some of the concerns raised about interest rates. Globally, we've seen strength in Europe as a result of Europe's somewhat delayed economic recovery coming out of the global financial crisis. We've seen better fundamentals, more transaction activity, greater optimism in Europe. In the Asia-Pacific region, there continues to be great growth. It's impacted to some extent by capital flow limitations in China. But when you take a look at the other countries in Asia, [it’s] generally pretty positive from a real estate standpoint.

TANYA OTT: What are we seeing in terms of the potential of tariffs or other things like Brexit in Europe?

BOB O’BRIEN: It's a really interesting topic. A week ago we met with a group of CFOs from large real estate investment trusts and that topic came up. Thus far, these CFOs said that we haven't really seen the impact of the tariffs, but they are concerned. A reduction in global trade would have a negative impact on industrial real estate. To the extent that it causes higher prices on things, that'll have an impact on retail real estate. And the impact it has on the broader economy will impact all aspects of real estate. So that's some of where the caution comes from as we look at 2019. It’s concerned around tariffs.

JIM BERRY: The question then is also cost for construction. Construction costs right now are going up. So that's impacting some developments from a return on investment ( ROI) perspective. That's been driven by tighter labor markets, as well as certain product costs. But that tariff question on the product cost is really a concern, from a construction perspective.

TANYA OTT: There's a little bit of uncertainty out there, but investors say that they’re still going to be spending more. What's driving that?

JIM BERRY: Our surveys showed that 97 percent of the investors we surveyed are going to be increasing their allocation to real estate over the next 18 months. That's pretty impressive. I think what that points to is that real estate has achieved a certain state of maturity. If you go back several years, there was much more concern about volatility in real estate, maybe a perception of a less mature industry overall. But over the last 15 years, you've seen the continued improvement on discipline within the markets, on the overall perception of the discipline that exists. And so [now we have] a nice, steady allocation of real estate. Also, I think it points to a willingness of the investors to take a longer-term view of their returns. So [they're] willing to invest today and willing to have a little bit longer-term hold in order to achieve the returns that they're looking for on a longer-term platform.

TANYA OTT: Do you have a sense of what kind of properties they plan to invest in? Are we talking more traditional properties, or newer kinds of things?

BOB O’BRIEN: One of the things that the survey showed was that there was increasing interest in newer asset types within the commercial real estate universe. For example, increased interest in investing in data centers, healthcare and senior housing, and also in student housing. So, as the number of asset classes within institutional commercial real estate broadens, investor interest is following that.

JIM BERRY: In addition to that, Bob, there's an increased allocation, the survey shows, on mixed-use, which I think once again points to [the question of] “What's real estate going to mean and how is it going to be used?” [It’s about] looking through to the end user of real estate and linking up with them.

TANYA OTT: The guiding principle of real estate has always been location, location, location. Is that still the case in this new landscape?

JIM BERRY: Fundamentally, it is. But to that point: How is real estate going to evolve and how is it going to be used? That can change the dynamic of that question of location, location, location. An interesting point of our survey is when it points to other areas such as technology and proptechs (real estate technology), it really shows that there's going to be an increased allocation by the investors to those folks who are building, who are utilizing the real estate, who are creating a real estate that fits the dynamic of today. That gets back to mixed-use, that gets back to those that are more tied to technology. It also gets back to real estate companies who are able to embrace the changing environment around them. So, whether or not it's addressing it from a flex lease perspective or a flex space perspective—how to really create an environment that is adaptive to a company over the longer term. Investors are saying they value a company that's really trying to look forward and develop a strategy and embrace that.

TANYA OTT: Jim, I want to dive into that, because you mentioned flex lease, or flexible leases, and also flex space. Those are two of the new business models that are emerging. Tell us a little bit more about those.

JIM BERRY: Sure. In a traditional model, if you go back years ago, you basically were looking at effectively developing very long-term leases on a certain build-out, even if it was a custom build-out, that existed for a period of time. Now the models are evolving, recognizing that, as real estate use changes and the needs of the ultimate user, the tenant, are changing, there needs to be elements of flexibility that come into play. On a flex lease, you develop a mechanism so that, as the company evolves and changes and its needs evolve and change, the lease structure that's in place allows them some flexibility to move and shift and change as well. While that sounds like it could be difficult—and it is, in fact, difficult—to manage, the reality is that it can create a greater "stickiness" when you're dealing with tenants. So, to obtain and to retain tenants on a longer-term basis, you really have to start thinking about stickiness in a different way. It's no longer just locking into a long-term lease. It's really making that lease, which is long-term in nature, flexible so that it can ultimately suit the needs of that company and tenant longer-term and therefore retain that tenant longer.

TANYA OTT: And when you're talking about flexible space, you're talking about actually thinking about buildings differently and having more options on that front.

JIM BERRY: Absolutely. The design, how it's used, how the company can actually build culture around that—all of those things. There are some great models that we've seen in a lot of our different markets and I know, Bob, you've had a chance to visit some.

BOB O’BRIEN: I've had the opportunity to visit what I'll call collaborative or coworking spaces in a number of different cities over the last few months, including New York, San Francisco, London, and Tokyo. You can see the desire for flexible space. As the workforce has become more mobile, become more connected, there is a desire to effectively create experiences for employees and give them a reason to come together and work in a collaborative format. [There are] some really creative things going on out there from a flexible-space, office-space, or workplace-design standpoint, all around trying to drive collaboration.

TANYA OTT: What's something that you saw that you thought—wow, this is really innovative?

BOB O’BRIEN: One coworking space I visited had probably 20 different types of work space from library kiosks for focused work to group-working tables to old fashioned—and I mean like trading floors circa 1930s—telephone booths for placing a quick call. It was an interesting mix of what I call the old and the new, creating a variety of different spaces for people to work.

TANYA OTT: How does that work if we're looking at the interaction between the commercial real estate investor and the end user? Is this a collaborative process from the beginning of the design, or is the commercial real estate investor simply looking at building out and investing in a space that has the flexibility for someone to do what they want with it, but the end user is going to decide that?

BOB O’BRIEN: What's interesting is the owners, investors and operators—particularly of commercial office properties, but I think you can say the same about retail—have become increasingly focused on the ultimate end-user—the employee of the tenant, the shoppers at a mall—and their experience, and then working closely with the actual tenant, the company in the office space or the retailer at the mall, to help design and create space that is appealing to the end user.

TANYA OTT: You mentioned retail, and I'm really interested in this, because where I live there are some very large retail spaces that are pretty empty. But you say that doesn't have to be the case. There are creative ways to reimagine that space.

JIM BERRY: Yeah, no doubt. Retail has obviously gotten a lot of press. All of us have seen how dramatically it's changed with the use of technology. But a couple quick points on retail: First off, retail overall still has great opportunity and certainly some good returns as well. But because of the shift that's occurring, now retail becomes much more about the experience. So, to Bob's point about the ultimate end-user of the space, how do you create an experience? It's more than just shopping and it's more than just buying. It's really about an evening out, or it's how you interact with the particular space. The redesign, the repurposing of some of that is really fundamental. It’s something that's pretty exciting that's happening in some areas in retail.

JIM BERRY: You've even got some of those older spaces that might be struggling a little bit more, and one of the things we've seen is a complete repurposing of those. Creating incubator spaces, for example, for some of the proptechs or some of the new upstart companies with an idea. You can take someone and create an offering for that group as they're getting started. You know, what's some viable space today and then how do you move them throughout your platform after that.

TANYA OTT: So that might be an option for some of those shopping malls that were built out in decades past that may have some dark space right now.

JIM BERRY: You know, clearly depending on where it is and the nature of it and all that, it really is a mix. But I think the point that everyone is making is that retail is not anywhere close to dead. Retail is very vibrant in the U.S. and across the globe. It's just that people are shopping and interacting differently. The question then is how, within real estate, [can] that piece of it make sure it adds to the entire experience. It's not just the "in that moment" experience. It's really the entire retail experience.

TANYA OTT: You have mentioned the term proptech quite a bit as we've been talking the last couple of minutes. What is proptech?

JIM BERRY: Property technology. Those are the companies that are focused on delivering new solutions to real estate and real-estate-related entities. They break down into a couple of different major arenas. Some of them will be on the financial side of things, and others will be in the operational side of things, [looking at] how best to develop technologies that can enhance the business.

In our 2019 Deloitte Real Estate Outlook, one of the reasons we focused on proptech is that we see that this is a real chance for real estate, which has traditionally been behind in its adoption of technology, to find a new avenue of embracing these new, innovative companies and either collaborate with, partner with or invest in these companies as they're getting started and then utilizing that technology to give themselves a competitive advantage.

BOB O’BRIEN: There are a variety of proptech companies out there. The way we've stratified it is first around finding a property, whether it's listings or some sort of marketplace for properties or to support the brokerage community or even to view properties, whether that’s properties for acquisition or for leasing. There are proptechs out there focused on how to more efficiently build a property, how to construct a property. There are proptechs out there that help you evaluate properties and understand the potential value for them. There are proptechs out there focused on either data or equity financing of properties. There are proptechs focused on how to efficiently manage your property. And then there are what we call the asset utilization proptechs, whether that's around coworking, co-living and home sharing, event space, or even retail and industrial utilization. [There are] a number of proptechs focused on how you more efficiently utilize the underlying property assets.

TANYA OTT: When you talk to these investors, how confident do they feel that they're leveraging or understand how to leverage the technology that's out there?

JIM BERRY: Our survey results continue to point out that there is a high value being placed by the investors on the opportunities that technology brings for those companies that are willing to invest in technology. The real estate industry overall has tended to be a follower when it comes to adoption of new technologies. It's just been the standard quote for years. But when you think about the innovation that's occurring and the opportunities that exist within utilization of all the data that currently exists within real estate: How do you no longer just assemble data, but really move to the next level? How do you use that data? And as technology continues to move forward, whether it's blockchain or artificial intelligence or cognitive, how do you now embrace those technologies that already exist and all of the data that exists within a real estate company, how do you then take that to drive a more powerful decision-making process quicker?

That's the other thing I'd say that investors are really looking for. It's no longer just about data dumps. It's really about information. So how do you take the data, make it usable information, qualitative analysis to drive quicker decisions? [How do you point to or drive] the ROI - the return on investment - of the particular investment? How do you see through that investment to how you're really interacting with your tenants and the ultimate end-users to show viability of that investment on a longer term basis?

TANYA OTT: I'd like to ask both of you to make this real for our listeners and think about a use of technology that you're really excited about. Maybe it's happening already or maybe it's something you think is getting ready to pop.

BOB O’BRIEN: One of the issues around the use of technology in real estate is a lack of standardization of data, whether that’s extra data from data providers or data being generated from your own internal processes, whether that's around leasing or building operations or whatever. But I do think a combination of artificial intelligence and cognitive automation is creating opportunities to effectively standardize that data and really drive some of the predictive analytics and business intelligence that real estate investors expect out of the companies they invest in. I'm very optimistic about a real acceleration in terms of the use of technology and the value generated by technology in the real estate sector over the next five years.

TANYA OTT: Jim, how about you?

JIM BERRY: I'm broadly excited because so much of the technology is here today and [there are] some tactical things that the companies today can embrace. For example, when we talk about robotics, that's not a “Lost in Space” kind of a robot. It’s basically is taking tasks today that are very manual, very labor intensive on accumulating data and designing these robots to routinely gather and extract that data. That's here today, and it's not an expensive technology to implement. The base operation savings that a real estate company today can embrace and implement is astonishing. And that sounds fairly base level, but it really hasn't been implemented as widely as it should be.

But then you can take other aspects of the business. [For instance,] the use of drones, from a construction site, where they are utilizing it from a safety perspective. Everyone has their vest with their sensors on it and the drones are constantly flying around the construction site. Those drones will determine—is all the safety equipment in place, at the right time, being utilized properly? If not, it sends a signal. Someone can then go out and make sure that the person onsite is aware that they need to improve their safety. Then that drone [can learn] when is the higher likelihood of a safety incident, and you can go to your insurance companies and negotiate a better rate. All of this is amazingly exciting. There's just a lot of opportunity from what I call maybe the more exotic to the more routine. But to me the exciting part is much of the technology is there today and ready to be implemented.

TANYA OTT: Bob, you mentioned the immense amount of data that you can really leverage with some of this new technology. When you talked to investors, how concerned were they about data security—whether it's personal data, company data or even hackers getting into building systems and causing havoc because so much of what we do is controlled by IoT (internet of things) devices and other things like that?

BOB O’BRIEN: I think within the real estate community there is an increasing awareness of the cyber risk that's out there. In our survey we found that the investors were focused on the impact it could have on the company's reputation and the impact it could have from a financial standpoint. There have been a number of situations in the real estate industry where, through phishing or other means, companies have wire transferred money to fraudsters, effectively. And then there's also concern around personally identifiable information. That really varies by the asset type within real estate. Obviously, in residential it's more of a significant risk than it might be in office or industrial. But there is an increasing concern about the impact.

You mentioned the impact on building systems. That's one of the scarier aspects within the real estate industry, if you think about the risk of a cyberattack taking down buildings operating systems or, even worse, creating safety hazards within a building. We're finding that a number of the more sophisticated real-estate owners are looking very hard at their building systems and making sure they’re not creating exposure for the people who live and work in those buildings, or for the systems of their tenants within those buildings.

TANYA OTT: We've been talking a lot about technology and I don't want to ignore that your survey found that investors had some pretty strong thoughts on what's happening in the talent space—the kinds of people that are working in the commercial real estate world.

JIM BERRY: It was interesting to dive into the talent side of things within our survey. There was a fairly dramatic percentage that believe that the real estate industry needed to push further in the areas of talent. The dynamic of what it means to attract the best people, how that's going to happen, how you retain those, is just different today than it has been. You compete in a broader pool for that talent. You're no longer competing narrowly against folks who want to do real estate. You really are looking across all companies and what kind of experience that people are looking for as they move into the workforce or as they move through their careers. So, whether it's the millennials or the baby boomers at the other end of the spectrum who are coming closer to the end of their careers than the beginning—there's a lot of commonality. There's the aspect of creating a continuous learning environment and driving advancement and new skills, an entrepreneurial attitude which, you know, for real estate that's something that's always existed. It's that constant learning, constant evolution, moving quickly, those kinds of things.

And culture building. There continues to be a high correlation between attracting the best talent and retaining that talent on a longer term if you really are very transparent about what your culture is. Recognizing the needs of all of the talent that exists within the organization and increasing focus on diversity are all very important parts of retaining the best.

TANYA OTT: And, you say, increased focus on diversity. And I believe they specifically called out women, people of color and the LGBTQ community being represented more fully in this space.

JIM BERRY: Absolutely, and across all parts of the business, including the boards.

TANYA OTT: Right. So, you both say that real estate companies are going to have to take some risks and they're going to have to embrace change. Is that something that's traditionally been comfortable for that industry?

BOB O’BRIEN: Well, you know, embracing risk— yes. The idea of developing a property that might cost up to a billion dollars to develop and deciding to do that means you're comfortable taking on risk. So, I think the industry itself is great at taking on risk. Change, I think, is a different question. Embracing change caused by technology, embracing change in the workforce, those are things that are going to take a dedicated effort from leaders within the industry. You know, we were talking about diversity and inclusion. You certainly see a number of the leading real-estate-industry organizations and their memberships understanding that task in front of the real-estate industry and embracing it. But it'll take a while to play out. When you talk about technology change, you probably need that next generation of workforce to help drive that technology change. But you also then have to attract that next-generation workforce, and it's difficult to do that when we're using baby boomer technology versus millennial technology. One of the challenges in front of the real estate industry is you've got a little bit of a chicke- and-the-egg thing here. How do you attract a workforce of the future without a digital workplace, and how do you create a digital workplace without the workforce of the future?

TANYA OTT: So, what's the bottom line? What are the key considerations that those folks sitting in the commercial real estate C-suites need to be making?

JIM BERRY: There are several key points that came out of our 2019 Deloitte Real Estate Outlook, but I do think you start with the idea that when you look at it from the investor lens, and those 500 global investors that we surveyed, they really remain embracing of real estate. Ninety-seven percent say that they'll increase their allocation to real estate in the next 18 months. That's good. And I think that presents a platform of strength for real estate as you look forward. Now clearly there's going to be winds that have to be managed through all of that. But, at the same time, if you view it from that platform of strength and then you look at the capabilities that exist today within technology, proptechs, and some other things, it's [may be] just the right time to invest. Taking those risks, moving out beyond the typical comfort zone, recognizing and working collaboratively with your investors, with your tenants, with the ultimate end-user in the design and how all of this is going to fit together—I think there's just an enormous opportunity that exists today.

BOB O’BRIEN: Commercial real estate is a huge global industry. It has a huge impact on the overall economy. Trillions upon trillions of dollars invested are in commercial real estate. And it's a highly competitive, very distributed business. Some of the more insightful leaders within the industry recognize that there are opportunities to disrupt a multi-trillion dollar business. And I think commercial real estate leaders, whether they're leaders in the investment community or in the owning and operating community, really ought to be looking for opportunities to disrupt themselves and generate high returns by taking advantage of the changes that technology and the workforce will have on the industry. It's an exciting time. I think the next decade may be the most interesting decade in real estate ever.

TANYA OTT: Thank you so much for giving us the overview of where we are now and where you anticipate things to go in 2019. I really appreciate it.

BOB O’BRIEN: Thank you.

JIM BERRY: Thank you.

TANYA OTT: Bob O’Brien’s and Jim Berry’s 2019 Commercial Real Estate Outlook is available on Deloitte.com. Check out our website—deloitte.com/insights— for more conversations we’re having about the investment management business, capital markets, and more.

And, you can decide how you want to learn about this stuff. We’ve got this podcast, which you can listen to while working out or commuting. If you want to dive deeper, we’ve got white papers and tought leadership. We’ve got case studies and original research. Again, the website for it all is deloitte.com/insights.

You can find us on Twitter at @deloitteinsight (no S) and I’m on Twitter at @tanyaott1. I am Tanya Ott. Thanks for listening! We’ll catch you again in two weeks.

This podcast is provided by Deloitte and is intended to provide general information only. This podcast is not intended to constitute advice or services of any kind. For additional information about Deloitte, go to Deloitte.com/about…

 

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