Aug 19, 2022
The Future of Real Estate
August 2022 New concepts in real estate
Chris Heron and Wim Froon
Introduction
‘Businesses that can reimagine real estate can prove to be highly profitable. Last year there was $267 billion (sic) of aggregate public and private enterprise value in real estate technology companies. Airbnb has been valued higher than all hotel companies at $30 billion. The largest public owner of office buildings in the U.S., Boston Properties, has been valued significantly lower than WeWork ($19 billion against $30 billion). Real estate companies can learn from this model and reimagine opportunities ahead. The future of space lies in the clever servicing of it — not, it would seem, its ownership. To thrive in the future, I believe companies would be wise to learn to monetize space. Physical assets do not need to be purchased in these models, making them highly scalable and capital efficient.’ [1]
Summary
James Moore wrote in a 1993 Harvard Business Review article:
‘Successful businesses are those that evolve rapidly and effectively. Yet innovative businesses can’t evolve in a vacuum. They must attract resources of all sorts, drawing in capital, partners, suppliers, and customers to create cooperative networks. I suggest that a company be viewed not as a member of a single industry but as part of a business ecosystem that crosses a variety of industries. In a business ecosystem, companies co-evolve capabilities around an innovation: They work cooperatively and competitively to support new products, satisfy customer needs, and eventually incorporate the next round of innovations.’ [2]
The innovation is PropTech and the drivers it creates in the property market, which are radically altering the way that the supply and demand sides of the real estate market work.
The changes have started with the concepts of ‘space as a service SAAS and REAS (real estate as a service).
The changes affect the way real estate is used as an asset by users, suppliers, and investors.
First Driver:
Our lives post-pandemic will not be the same again. The blurring of the boundaries between the time we spend working and how we work have been thrown into sharp relief by the pandemic.
People have been working remotely, with many from both the employer and employee sides wanting to continue with remote work. This will alter the way we need to use the space we live in and render many commercial spaces redundant. Debts have been created by commercial tenants and as much as 40% of commercial real estate is empty in large cities. The retail and commercial spaces are being ‘repurposed’ as hybrid work live spaces and luxury fully serviced apartments.
Second Driver:
The move from asset ownership to asset usage, or the desire to have a liquid asset, is evident in the younger generations and businesses such as Uber, Air B&B, We Work, Buzzcar, and other shared economy models.
Younger generations are increasingly seeing their lives as a set of experiences and are less concerned with ownership and more with usage and flexibility. The Air B&B concept suits post-millennials who rent property rather than buy, hire cars rather than buy and change the way they live quickly.
They must do this because the speed of hyper-change is so fast that jobs can come and go.
They are living in the gig economy and working and living together, essentially sharing experiences in other words.
The sharing concept is alien to the older generations but not to the new. We already see younger people sharing ownership, sharing space, and living in larger cooperative groups.
They seem to be hardwired to share and cooperate. This predilection will alter the way property is used.
Third Driver:
We all understand that technology has been used very effectively during the pandemic period. We do not need to meet to work together, to do deals and, even to buy houses or acquire learning. The future will be virtual not physical.
The connectivity and mobile data access to the internet, faster processors and cloud data storage combined with these new habits developed during our quarantine periods have radically altered the way we work, shop and, socialise. Public drinking in Japan is radically reduced, online shopping is outstripping purchases in conventional retail outlets and holiday and transport have been reduced by 50% plus.
There is a move towards more sustainable and healthy living in the countryside and co-living and co-ownership continue to grow!
Fourth Driver:
The growing cost of property ownership and the lack of continuous employment and financial employment data make it impossible for many to buy.
Fifth Driver:
There are new innovative and frictionless supply chains powered by blockchain, which eliminate middlemen and complex information systems sector ecosystems. They are cheaper, more efficient, automated, transparent, and more secure.
Sixth Driver:
Lastly, the growing relevance and importance of the currency of Bitcoin is controversial but real, and cryptocurrencies are being adopted by many countries to break free from the control of the US Dollar. Cryptocurrency is part of the new ecosystem business model and highly relevant to the future of the real estate market.
These drivers will combine with changing social values to alter the way we see and use property.
To summarise.
• More people will work from home.
• Fewer people will own property.
• There will be less property finance as we know it.
• Businesses will not need as much commercial space.
• There will be fewer shops.
• The design of property will be more holistic.
• People will seek to live in communities for work and leisure.
• People will own fewer things.
• Property supply chain will be automated.
• Technology will enable different industry supply chain practices.
How will this Impact Real Estate and Finance?
• The concept of space as a service is becoming accepted.
• The design of property is changing.
• The way it is sold has changed and will evolve further.
• The way that the supply chain works is changing.
• The way real estate is used is changing.
• The structure of financial investment in property is changing.
• Finance and financial investment in property assets are changing.
• We are seeing the rise of crowd ownership and funding models.
• Tokenisation and cryptocurrency are adding liquidity.
Property Use
New systems for rental and purchase will need to be created to manage these changes. The transaction costs will be reduced through automated supply chains and space as a service will take over. The integration of all elements of the supply chain, sales, compliance, legal, design, components, building and finance will reduce the friction in transactions.
Assets will need to be tokenised to be able to cope with this and current laws and financial controls will become largely obsolete, requiring them to change.
The design of the property will need to be lifecycle-purposed and design-orientated. The boxes we live in will no longer be empty spaces but designed for modular use, depending on the time of the day and your age. Walls will move, space will be repurposed, and a small footprint will be transformed according to the time of day.
There will be communities in the sky where you will work, shop, live, meet, exercise and be entertained. There will be shops, communal hot-desking spaces, bars and cafes, cycle and, jogging tracks on the roofs and gyms in the basements.
Maybe we will even see different age groups supporting each other for practical purposes like proxy families.
Property Finance
Real estate is a historically proven safe and profitable asset. As a result, the property industry globally is valued at $217 trillion, 25% of which ($54 trillion) is in commercial real estate.
However, this asset has one key issue:
It is not liquid.
Investors trying to sell assets often face a liquidity discount, with a liquidity premium estimated at 20%. This suggests about $44 trillion is locked up by inefficiencies in the marketplace — almost four times the value of all the gold ever mined.
The illiquidity discount on global commercial real estate is therefore about 60–80 times the aggregate value of the current cryptocurrency market.
Some existing models try to address this, such as time-share, REITS, and fractional sales. But none of these has been mainstreamed due to their high costs of compliance, administration, and marketing.
Construction also continues to require large amounts of capital, which is traditionally financed by equity and debt (the annual estimate is $10 trillion). This financing is still largely controlled by intermediaries, such as special financing, Private Equity firms, and banks.
As markets become more liquid and faster than ever, the whole industry has a problem and the investment economics applied is too slow and inflexible.
Additionally, the increasing attraction towards cryptocurrencies by governments, banks and younger investors is seen as a potential threat to the industry. It is its saving grace!
Breaking down assets to a fraction of their whole value enables more investors to become involved and to trade at any time more fluidly and cheaply.
To deal with this liquidity the market will need to re-evaluate its supply chain and compliance.
There are already a few examples of tokenisation and using cryptocurrency and blockchain, but the use cases are rare, and none have been commonly adopted.
The solution to reduced costs and more liquid assets is blockchain and tokenisation. The trusted distributed ledger can move information quickly in a trusted way so a transaction for sale or rental can be done on a smartphone in minutes. With online banking technology, we see the first signs of a process, that originally took weeks, is now being done in a few minutes.
This will happen with property transactions. It will not be necessary to search a database as the information about property titles will be digitised. The UK, Sweden and India are already working on central title databases in the blockchain. With finance online and smart contracts authorising your legal transactions by linking to title and financial data, complex transactions can be done very quickly.
The tokenisation of property assets splits the title and value of a property into tokens. These tokens can be bought, sold, or even exchanged as an alternative currency. Combined with small contracts, blocks and transactions, a whole ecosystem starts to form where data, compliance, buyer, seller, and finance can be in one system.
Deloitte estimate that the effect of liquidity release on the property market would be more than 20% of market value, which equates to 44 trillion dollars. [1]
The financial outcomes of the increased liquidity and lower costs are far more reaching than the changes in property ownership and automated transactions.
When the market ecosystem is changed in this way, it has a domino effect on the whole financial system and the way we all pay in and invest in it.
If you imagine the life cycle of a person once they leave education: they get a job; start to make money; move out from home; rent or buy property; save money; have children; downsize and use their investments and pension funds to fund their non-working lives.
In the new blurred business models with cryptocurrency, the tokens issued and bought by individuals could be used for all these purposes.
We would not need financial advisors and pension funds anymore, and we can decide on a month-to-month basis how many tokens we invest according to excess cash flow or earnings.
If we want to use property, we simply convert some tokens and, if we have an excess of earnings, we can invest in more property assets. It is no secret that the bulk of financial investments is in property, but we have a huge chain of middlemen that increases the complexity, causes barriers to entry for smaller buyers and produces a lot of wealth for a small percentage of people.
Of course, there will be many job casualties in banking, finance, financial service industries and the property sector. But the good news is that the changes in other supply chains in other sectors are producing a greater demand for different types of jobs with new skills, which are not being catered for.
The skills gap is known as one of our biggest problems and the individual challenges will be to learn new skills as fast as possible to take up these new positions.
So, the loss in one sector creates opportunities elsewhere.
Crowd Ownership
The final stage in this homogenisation of buying, selling, investing, increased liquidity and tokenisation with blockchain results in reduced costs. The changes these factors bring will be even more unimaginable than space as a service.
Investing in your pension fund and being able to convert your property assets at the touch of a button will open the market to a huge expansion.
But crowd ownership has arrived. When you buy a product you might buy a fraction of the stocks in a company, and businesses will feel more secure in having closer relationships with you and understanding your buying patterns better. You are more inclined to buy a product if you are part of the company and, even in current shareholder offers, there are discounts for product usage for the shareholders.
Businesses are currently financed by equity investment, whether they are small or large.
This is done either by individuals or large institutions holding your funds as pensions or other financial institutions through stock markets.
Businesses depend on this finance to expand, grow, and change.
On the other hand, they also depend on the loyalty of their customers who buy the products. There is a big focus on the relationship between customers and producers. This relationship is becoming closer and closer as brands draw customers into ecosystems.
The best small step I can imagine is that you can link the customer purchase to the ownership of stocks in a company. You could disintermediate the need for finance and many links in the distribution and supply chain. This would be mutually beneficial as the customer is benefiting by profit share and reduced costs, while the company is benefitting by reduced costs and increased margins.
The blurring of identities in the supply chain is seen being renters, owners, and investors all at the same time. Large institutional investors and B2c investors can be mixed into one business model due to platform technology.
Platforms
Platforms bring together supply chains with great efficiencies, automation, security, and cost savings.
This enables less friction and ultimately a greater marketplace. However, there are always casualties as the parts of the supply chain which add the least value are eliminated by the automated chain.
In the property industry, there is often a complex arrangement of investors, multiple sales agent channels and complex supply chains.
As we approach choppy financial waters, and a potential recession property investment will be under pressure of difficult lending criteria and fast-increasing interest rates. The cost of materials is also under pressure as prices and quality control due to tightening environmental criteria increase costs.
Margins are diminishing and traditional business models are no longer valid or as profitable as they were.
A side issue which is widely accepted by expert commentators is the rise of crypto or virtual assets both on the metaverse and the crypto markets. Virtual assets are cheaper and easier to access, convenient to manage and easy to liquidate. They have therefore more liquidity as opposed to the illiquid property marketplace with its physical assets.
In short, many people feel that the real estate market has to become more liquid.
Deloitte’s summary for 2022 is
‘Sustainable properties are often key to a better tenant experience; building partnerships to provide new offerings to tenants can also enable real estate-as-a-service (ReaS). Over three-fourths of respondents say their companies will likely expand partnerships with or invest in PropTech, which could help firms deploy the ReaS delivery model.
Sustainable properties are often key to a better tenant experience; building partnerships to provide new offerings to tenants can also enable real estate as a service (ReaS). Over three-fourths of respondents say their companies will likely expand partnerships with or invest in PropTech, which could help firms deploy the ReaS delivery model.
Sustainable properties are often key to a better tenant experience; building partnerships to provide new offerings to tenants can also enable real estate as a service (ReaS). Over three-fourths of respondents say their companies will likely expand partnerships with or invest in PropTechs, which could help firms deploy the ReaS (SAAS)delivery, model.
Conclusion
We know that change is happening 3,000 times faster in the current Industrial Revolution than it did in the First Industrial Revolution.
We understand the power of cloud data, increasingly powerful processors, and the connectivity of the Internet.
For many people blockchain is still a mystery, but it is already seeping into our established systems and altering the way our information is flowing. 40% of adults in the USA hold Bitcoin!
We are seeing the start of smart contracts and cryptocurrency as alternative finance to banks and central banking systems. Another widely predicted financial market crash will accelerate the progress of these changes. The macro factors in play are:
• Tokenisation of assets
• Defi platforms
• Blockchain and cryptocurrencies
• Inflation and property price increases
• Pressure on finance to keep pace with increasing property values
• The change to renewable fuels and the consequent undermining of the US dollar as a global currency
• Central banks and large investors using the liquidity of crypto assets to move funds from existing fiat funds
• Chinese adoption of cryptocurrencies
We think we are seeing the beginning of a disruption now.
The COVID-19 pandemic has changed a lot of things for everybody and will change many things about our established processes and ideas.
If we get a financial recession combined with a pandemic driver above, change in social mores is will see the financial industry restructured.
Appendix
[1] https://www.forbes.com/sites/forbescoachescouncil/2019/01/30/what-space-as-a-service-could-mean-for-the-future-of-real-estate/?sh=4c8d44dddb4b
[2] https://www2.deloitte.com/us/en/insights/focus/business-trends/2015/business-ecosystems-come-of-age-business-trends.html#endnote-4
[1] Deloitte
