Successful office investments in disruptive times

Last week I gave a short presentation at the VIP Europe Conference of IREI in Amsterdam about the impact of innovation, technology and sustainability on office investments in the Netherlands.

In this blog I want to share the main content my presentation in a more aggregated way. My key message is: Technology and sustainability have a positive impact on institutional office investments. Institutional investors should mainly focus on providing flexibility to facilitate and adopt new technologies providing the most desirable office space with high social profitability, environmental profitability and economic profitability.

Currently the pace of technology development and innovation is occurring at an exponential rate. @AntonySlumbers showed at the conference that the development of technology driven innovations currently exceedds the expectations of Moore’s Law.

The impact of #BigTech, #FinTech and #PropTech innovations are increasingly visible in the real estate market. Looking at the retail markets where online shopping is redefining the sector, where logistics is using technology to increase value in the supply chain and in the office markets there is an invasion of technology to increase the flexibility, efficiency, productivity and well being of the workplace. Looking at the amount of capital that is being raised by the tech-companies, it is to be expected that the relative traditional real estate is up for disruption.

Sustainability and innovation

Sustainability developments and innovation are becoming more important in the real estate markets as in all products and services markets. However the rate of diffusion is still relatively slow (see my recent blog about Successful Sustainability).

The future impact of sustainability on real estate investments is expected to increase due to the visible effects of climate change, government regulation, tenant and user demand, benchmarking on sustainability performance and also by opportunities driven by technology.

Investment opportunities and threats for offices

To examine the outlook for institutional office investments, I have used in my presentation four perspectives:

1.      Location perspective

2.      Asset perspective

3.      Tenant perspective

4.      Ownership perspective

Location perspective: we have learned our lesson!

After many years of office investments with volatile swings of returns due to “boom-bust” developments, the global financial crisis (2007-2008) made a more sustainable way of office development possible. This new way of office development very much coincides with the views of how sustainable cities should look like. Future proof office locations are “well connected” by either knowledge in business districts, where knowledge can be shared and co-created. Also these locations are well connected through infrastructure (nearby public transport and other forms of transport) but also having a high walkability score to services and other points of interest.

What can be a potential disruptor for the institutional office investor? In my opinion offices will fulfill a need for companies and workers. Working at home and flexible working on remote locations will be part of how people are working. However offices in central business districts will remain. Even in the case where there are only driverless cars, this will not necessarily impact the central business districts.

Asset perspective: invasion of technology has a positive impact

The invasion of technology that can be used in relation to everything that is related to the asset is perhaps the most visible development today. This technology is intended to increase the performance of sustainability (e.g. energy efficiency, lowering waste), flexibility of use, productivity and well being of office workers. These are all factors that can increase the performance of an office building and in most cases risks can better be controlled.

From an office investment perspective, there is in my opinion no need for a single investor to invest in all these technologies. Investors should however invest in flexibility to implement the necessary technologies by suppliers, tenants or users.

Investments in the office buildings that are related to the resilience of the asset related to climate change or sustainability (regulations) can be worthwhile. This can be both from a risk perspective as well as from a performance perspective. Timing these kind of investments is essential. For example creating a green roof at the time when the roof covering needs replacement.

Tenant perspective: offices investments are still business-to-business

There is proof that offices need to be more flexible for office users. This does not mean that the traditional lease or rental contract remains a business-to-business contract. The providers of the flexible office spaces such as WeWork and Spaces, do enter into a long term rental contract with the owners. There is the possibility that these flexible office space providers could become big enough to have decisive bargaining power over the investor or could even be a competitor to the investor. However there is a distinct business in my opinion for a real estate investor than an operator of flexible offices.

Ownership perspective: too early to say?

The ownership of office buildings in the central business districts in the major cities across the globe will be institutional investors like pension funds, insurance companies or specialized real estate investment companies who pool capital from multiple smaller investors. There are two developments that are interesting to watch. First is the implementation of blockchain technology. This could make it possible to disrupt the ownership structure and the traditional relationship between the owner, tenant and other stakeholders. Although blockchain is making progress, it is not to be expected that this technology will impact the ownership structure. The technology still has a long way to go, including the compliance to government regulations and the adoption of behavior of the relevant stakeholders.

The second interesting development is related to the upcoming of the circular economy. Circularity is something that is not well known by international institutional investors. After my presentation I’ve had a lot of questions about it. Especially because the Dutch government has indicated that buildings should be “circular” in 2050. It is possible that parts of an office building are owned by the original supplier. This could make buildings less transparent as to who is responsible for what part of the building. Technology (e.g. Blockchain) can probably solve practical issues when circularity really takes the form of co-ownership.

Re-assessing volatility and returns for the medium term

To summarize the developments related to innovation, technology and sustainability, I would like to say that office buildings in central business districts are becoming more efficient, productive, flexible and healthy. For an institutional investor this is good news. Good reason to expect a better return with a lower risk profile compared to historic figures.

Norbert Bol

Literature

Original post on Linked In: Norbert Bol (25 February 2019), Successful office investments in disruptive times.

Cover photo by Joe in DC on Foter.com / CC BY-NC-ND

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