Brick-and-mortar goes SaaS
Päivitetty: 18o kesä 2019
By Ilkka Tomperi
After reading Antony Slumbers’ recent article Real estate and technical denial ¹ one cannot avoid starting to seriously think about the unavoidable tectonic forces affecting the real estate industry sooner than most of us are realising. Real estate – or real assets – is one of the most profound asset classes to investors. Real estate allocations typically range around 10 percent of the total portfolio. Real estate is added to the investment portfolio to provide diversification from equity and fixed income investments. It is also seen as a natural, albeit not perfect, hedge of inflation.
Traditionally, real estate investors have avoided operational risk whether that comes through management agreements in hotels or other formats. Fixed-term indexed leases have been the preferred route and the longer the leases the better. Times are changing and so are companies. The average age of stock exchange listed companies has decreased significantly over the past decades. Technological evolution, M&A and other reasons have shortened the lifespan and stability of businesses. The average age of an S&P 500 company is now under 20 years, down from 60 years in the 1950s, according to Credit Suisse ². Thus, binding your company economically to inflexible agreements that potentially are also significant financial liabilities is getting less common.
“Offices are seldom so unique that there would not be a comparable equally functional or even better alternative around the corner.”
Strategic retail, logistics and hotel locations can be irreplaceable and thus still examples of real estate, where long leases can make sense also to the tenant and contribute positively to their valuation. Offices are seldom so unique that there would not be a comparable equally functional or even better alternative around the corner. Small and mid-sized office occupiers are moving around quite flexibly and frequently already, larger occupiers tend to be stickier. Still, even the biggest companies do occasionally require flexibility to smoothly scale up and down the space they are occupying. No wonder that providers of modern and flexible office space allowing short leases are growing rapidly across the globe.
Key questions to traditional real estate investors arising from this rapid development are worth to be included to your next strategy session: (i) what part of the value chain you want to be part of; (ii) are you ready to go into the services and operational business and what are the alternatives; and (iii) are the technical and data related aspects of your business allowing the transformation from the good old brick-and-mortar to value adding service business.
(i) Pure traditional real estate investors own the real assets – the physical space – supporting the activities from various business operations to living. Leasing entire buildings or large areas of your offices to co-working operations is a decent alternative to leasing the space to the traditional end-occupier. It’s easy and the cash flow is typically seemingly secure and stable. The flipside is a business risk that follows a single tenanted building and leaving part of the upside to the operator who in practice is taking a cheaper per square meter lease on a “wholesale” basis with a long contract and plans to collect a premium rent to lease the space in smaller parcels on short term or flexible contracts to end-users. Alternatives to the property owner to gain on this development could be to agree a turnover based lease contract with the middleman sharing the business risk with them but also allowing the property owner to share part of the upside or to run the operational side itself. Going into more flexible leasing would require attention to branding, marketing, services, IT platform and many other aspects not traditionally associated that strongly with real estate investing. For sure, sticking to good old bricks and mortar may still allow you to pay the bills for some more years to come – but for how long and how the traditional real estate investing will evolve?
(ii) Co-operation and risk sharing with existing players might be the easiest option, but an increasing number of real estate investors are also attracted to develop their own operational models and brands. These could still run on white label software and hired service providers. The ultimate option would be to set up your own operating business with related staffing. Since this does not come without costs, the key is scalability. For sure, this makes more sense for the larger property owners and is already happening.
(iii) Technology can be the great enabler, but it is also a big unknown to many real estate investors. Most property players do not have significant inhouse knowledge or team to handle data or IT-related matters not to mention development projects. A lot of real estate related financial and operational data is born but not much of that is either efficiently stored in a data warehouse that would allow efficient use of the data, or even if the data would be available, it is not efficiently utilised to maximise the performance of the real estate operations. So, there are only few players in our industry who can consider to be at the forefront of the utilisation of modern technology across their portfolios in an efficient way. Likewise, it is easy to agree to Antony Slumbers’ warning that the tech industry will learn real estate faster than real estate is learning tech.
So where are we today? I am quite confident that most real estate investors have realised the unavoidable. But realising what is happening and the speed of adapting to that are two different things. Old fashioned real estate folks still feel more comfortable to negotiate traditional leases and stick to the modus operandi they have applied for decades. At best, projects to enhance the use of real estate related data are progressing and systems allowing smooth data analytics and use of financial, operational and client data is becoming more efficient. At the same time, the growth of co-working lead by the relative newcomers, like WeWork, and followed by an increasing number of local and regional operators is conquering the office markets city by city – and block by block. That development itself is a proof that established market positions are not guarantee of anything. In retail, the adaption of e-commerce and the growing share of millennials that require speedy deliveries of their purchases are having a significant effect on the logistics chains and logistics properties and the role different retail units play.
“I am quite confident that most real estate investors have realised the unavoidable. But realising what is happening and the speed of adapting to that are two different things.”
The growth of the coworking and flexible office space is visible also in the Nordics. Technopolis Oyj, a Finnish shared office space expert, has started to switch from a business park owner and operator to renting space for its UMA coworking concept. Swedish Castellum AB (publ) has decided to develop its own unique concept, and to offer more versatile office-space solutions to existing and future customers utilising a digital platform. At Varma, we have been developing a coworking brand of our own – VarmaWorks. The ramp up is finally starting across our portfolio to allow our small and large customers to solve their office needs in an increasingly flexible manner. Smaller, satellite units are also included in shopping centres and places where people may need office space occasionally.
Wider utilisation of AI is still some years ahead but practical applications that help processes to become quicker and more accurate are reality. Applications of AI that allow human beings to focus on where they are best can save a lot of time. In real estate, we need to get our data in order, switch from Excel and manual copy pasting to flexible modern IT-systems, start utilising also our client data and get service minded. It’s not too late, but the SaaS model is already here. Offices as a Service or Space as a Service sounds much more appealing to many potential occupiers than negotiating heavy lease contracts, working with interior designers and investing into office furniture and infrastructure just realising a couple of moments after the completion that the contracted space does no more suit your needs. Still, I am sure that there is also life beyond pure Space as a Service world and agile, service minded, real estate owners – also the more traditional ones – will have their role to play in the market in the future.
1 Real estate and technological denial, Antony Slumbers (27 July 2018) available online via https://www.linkedin.com/pulse/real-estate-technological-denial-antony-slumbers/
Ilkka Tomperi spoke at the REWORK The Future Office Summit October 24, 2018 in Helsinki.
Check out this years event at: https://www.tulevaisuudentoimisto.fi/summit