If I had to summarise the future of real estate in one word, I’d use the following acronym: REAAS for “Real Estate as a Service”. Long gone are the days where real estate investors could simply invest their capital and wait for the checks to come in; in order to be competitive in today’s marketplace, capital must get comfortable with otherwise foreign concepts such as sales, managing social media, handling suppliers, cleaning contracts, catering, staff and all the other things normally reserved to hotel operators. In essence, our industry can longer be content with offering space, but it must also provide the service – the convenience – that comes along with it.
We can see this phenomenon taking place across all asset classes within real estate. In office, it’s the proliferation of Coworking spaces; in industrial it’s last mile logistics, dark kitchens and supermarkets; in housing it’s the appearance of co-living, corporate housing and serviced apartments. What is the common thread cutting across the emergence of all these new asset classes? Service, propelled by the advent of technology, and with service comes a whole set of expectations and key drivers about what constitutes good real estate.
This trend has impacted every sector in the real estate industry, from office to housing and everything in between, so real estate investors must consider not only the return on and of their capital stemming from the yield and capital appreciation of the assets they acquire but also the efficiency and profitability of the businesses they create. This is not a mere anecdote but a complete paradigm shift in how we think, value and trade real estate.
We can see this phenomenon taking place across all asset classes within real estate. In office, it’s the proliferation of Coworking spaces; in industrial it’s last mile logistics, dark kitchens and supermarkets; in housing it’s the appearance of co-living, corporate housing and serviced apartments. What is the common thread cutting across the emergence of all these new asset classes? Service, propelled by the advent of technology, and with service comes a whole set of expectations and key drivers about what constitutes good real estate.
This trend has impacted every sector in the real estate industry, from office to housing and everything in between, so real estate investors must consider not only the return on and of their capital stemming from the yield and capital appreciation of the assets they acquire but also the efficiency and profitability of the businesses they create. This is not a mere anecdote but a complete paradigm shift in how we think, value and trade real estate.
The Impact on Real Estate Valuations
The advent of REAAS is changing the paradigm of how real estate is valued. If service is becoming a core competency in real estate and an integral part of the investment process, does the value of an asset increase by virtue of improved operational performance? To put it a different way, how do you separate the business from the building when they are one and the same? No longer is it adequate to estimate market rents, cap the end year NOI and discount the cash flows at a predetermined rate. Let’s say you are in the business of managing corporate rentals; your income statement will now take into consideration cost of sales, staff on and off site, allocation for central costs, the costs associated with supplies, cleaning and laundry, repairs and maintenance, and FF&E, in addition to other traditional real estate costs such as tax, insurance and utilities. Now, whereas traditional valuation methods would require you to estimate market rates for rentals, taxes, utilities and insurance, you now have to consider your scale and ability to negotiate large supply contracts with vendors, the capability of your own sales platform, the training of your staff, possible economies of scale for operating large assets, etc These savings can have a large impact on the bottom line and therefore the increased value of assets by virtue of these operational efficiencies can translate into millions in capital valuations through the multiplier effect of exit yields. The point is that bigger and more efficient operators will drive higher valuations. Conservative investors applying more traditional “market rate” methods will be priced out of the market by forward looking investors that have assimilated that operations and assets are inseparable and go hand in hand. The end result is that businesses and assets will be bought together.
The advent of REAAS is changing the paradigm of how real estate is valued. If service is becoming a core competency in real estate and an integral part of the investment process, does the value of an asset increase by virtue of improved operational performance? To put it a different way, how do you separate the business from the building when they are one and the same? No longer is it adequate to estimate market rents, cap the end year NOI and discount the cash flows at a predetermined rate. Let’s say you are in the business of managing corporate rentals; your income statement will now take into consideration cost of sales, staff on and off site, allocation for central costs, the costs associated with supplies, cleaning and laundry, repairs and maintenance, and FF&E, in addition to other traditional real estate costs such as tax, insurance and utilities. Now, whereas traditional valuation methods would require you to estimate market rates for rentals, taxes, utilities and insurance, you now have to consider your scale and ability to negotiate large supply contracts with vendors, the capability of your own sales platform, the training of your staff, possible economies of scale for operating large assets, etc These savings can have a large impact on the bottom line and therefore the increased value of assets by virtue of these operational efficiencies can translate into millions in capital valuations through the multiplier effect of exit yields. The point is that bigger and more efficient operators will drive higher valuations. Conservative investors applying more traditional “market rate” methods will be priced out of the market by forward looking investors that have assimilated that operations and assets are inseparable and go hand in hand. The end result is that businesses and assets will be bought together.
Different Assets Equal Different Business Models
The amount of capital required for an investment is traditionally a filtering parameter in the investment decision and every fund has a sweet spot; whether it is between €10m and €20m, up to €100m or close to €1 Billion, funds tend to filter their acquisition targets by the size of the capital required, but these ranges tended to be wide and flexible. Any investor would quickly drop the €10m floor for the right opportunity. When service, and the operations required to perform them are taken into consideration, the size and configuration of assets become an even more important factor. A student housing operator may have tailored its operations to provide a very specific and targeted student experience with a programmed number of cleanings per room, catering service, service from staff members and entertainment. All these factors are integrally related to the size and configuration of the asset itself. Three full time staff members at reception plus one manager may be an adequate setup for a three hundred bed student housing concern, but do you need double the staff for a six hundred bed operation? Instead of experimenting, the prospective owner/operator may hedge its bets and stick to its proven concept. In contrast, a low-cost student housing operator may offer very little in service and can get away with no on-site reception, little cleaning and no catering; the low fixed costs associated with these operations allow an owner operator to go with small assets of, say, 100 beds or less. In fact, such an operator may be at odds with larger assets because of the possible loss of control stemming from the reduced oversight associated with having no staff on site. Again, the operations and the assets go hand in hand. What may work for a given owner/operator may not fit the bill for the next. This goes back to the earlier point that operations and assets are inseparable and are therefore likely to go hand in hand, developed, acquired and traded in unison.
The amount of capital required for an investment is traditionally a filtering parameter in the investment decision and every fund has a sweet spot; whether it is between €10m and €20m, up to €100m or close to €1 Billion, funds tend to filter their acquisition targets by the size of the capital required, but these ranges tended to be wide and flexible. Any investor would quickly drop the €10m floor for the right opportunity. When service, and the operations required to perform them are taken into consideration, the size and configuration of assets become an even more important factor. A student housing operator may have tailored its operations to provide a very specific and targeted student experience with a programmed number of cleanings per room, catering service, service from staff members and entertainment. All these factors are integrally related to the size and configuration of the asset itself. Three full time staff members at reception plus one manager may be an adequate setup for a three hundred bed student housing concern, but do you need double the staff for a six hundred bed operation? Instead of experimenting, the prospective owner/operator may hedge its bets and stick to its proven concept. In contrast, a low-cost student housing operator may offer very little in service and can get away with no on-site reception, little cleaning and no catering; the low fixed costs associated with these operations allow an owner operator to go with small assets of, say, 100 beds or less. In fact, such an operator may be at odds with larger assets because of the possible loss of control stemming from the reduced oversight associated with having no staff on site. Again, the operations and the assets go hand in hand. What may work for a given owner/operator may not fit the bill for the next. This goes back to the earlier point that operations and assets are inseparable and are therefore likely to go hand in hand, developed, acquired and traded in unison.
Conclusion
The ground is shifting for us real estate people and the industry is becoming more complex. Not only do we have to make informed bets on factors such as the market rate for rental rates, construction costs and yield compression but we must now become conversant with terminology normally associated with sales, marketing and operations.
The ground is shifting for us real estate people and the industry is becoming more complex. Not only do we have to make informed bets on factors such as the market rate for rental rates, construction costs and yield compression but we must now become conversant with terminology normally associated with sales, marketing and operations.