Rethinking Real Estate

Photo of Wanamaker's Department Store courtesy of the U.S. Library of Congress

Gridium: Hello everyone and welcome to this conversation with Dror Poleg, author of the book Rethinking Real Estate and Co-Chair of the Urban Land Institute’s Technology and Innovation Council in New York.

Today we’ll be discussing his new book on how technology is changing the way humans work, live, eat, shop and travel.

My name is Millen and I’m with Gridium. Buildings use our software for data-driven sustainability.

It’s quite exciting to have Dror join us today—our first guest author with a new book about to hit the shelves. On the first page of Rethinking Real Estate, Dror states it plainly that “no asset is safe”. That’s certainly one way to sum it up! Dror, it’s thanks to Twitter that we’re connected and it’s great to have you join us on the podcast today.

Dror:   Hi Millen. Great to be here and thank you for making this effort to pronounce my name properly. You’re already in the 95th percentile! 

Gridium: The real estate industry includes scores of different people in different roles. Why did you write this book and for whom?

Dror:   So, I wrote this book first and foremost for myself.

I’ve always been interested in multiple things such as history and technology and sociology and finance. And being inside real estate, an industry which I spent almost two decades in, although I never planned to become a real estate person, I keep trying to find interesting ways to make work exciting for myself. I’ve done that since forever, but over the past few years I realized that many of those things that interested me are suddenly becoming very, very important for everyone else in this industry.

So, everyone suddenly needs to understand technology and they need to think about sociology and demographics a little more deeply and in a more dynamic way than in the past. And history and finance are suddenly becoming much more interesting and important for people to understand—both for people inside the industry and also for a lot of entrepreneurs and people that are coming from outside that suddenly need to understand how real estate works and to have it explained to them in a way that makes sense.

Looking at all this, I figured that someone needs to write a guide to provide this needed context ,the missing pieces for professionals within the industry, and to provide some guidance and some background for people from outside of the industry who are coming into it in order to disrupt it or improve it.

Gridium: Dror, we’ve just been through Black Friday and Cyber Monday, and those two heavy retail days just followed the shuttering of Barney’s. Should we be surprised by the shuttering of Barney’s?

Dror:   I’ve lived next to two different Barney’s stores: one in Chelsea, here in New York City, and the other one in Brooklyn Heights. And to be honest, I was always surprised that they’re still in business. The stores always looked empty to me. The merchandise looked out of touch with the people who actually walked by the store, both in terms of pricing and in terms of the style. So, I was surprised that they lasted so long and I think it’s generally good news that things that don’t work are freeing up space for newer things that might work a little better.

Gridium: I believe you’ve got some thoughts connecting what we’ve learned on Cyber Monday and Black Friday to what the future of a department store might look like. What do you think that might be?

Dror:   What we saw this year, and it’s a trend that’s been going on for at least 10 years now—20 probably—is that more and more money was spent on Black Friday and Cyber Monday, but more and more of it was spent online.

And this year it was extra pronounced. Walking around New York City, you really felt the subdued atmosphere in the streets; you didn’t see people going crazy inside stores and standing in line. So, money was being spent but it wasn’t visible in the physical world.

One of the things I dive into in the book in the retail chapter is the history of department stores and how much they’ve changed—and not for the better—over the past 150 years. In the 19th century, the department store was really a cultural center; it was, in a way, the most exciting place in the city: A place to see new things, to experience almost like a museum—to see stuff that is not even for sale and that might not be for sale for another decade or two. But to go there and see it, whether it is a new technology like the television or it’s an airplane that crossed the Atlantic.

All of these things were presented in department stores and people would go there in order to experience them. And the department stores themselves often felt like visiting a home of a very wealthy family or visiting a lounge or a salon. A place where you want to spend time or you’re being served; where you feel like there’s a certain atmosphere that attracts you into it. And they also offered some things that are suddenly coming back into fashion such as free delivery and free returns and all sorts of new financing options that were not available elsewhere.

Even culturally, department stores were usually on the cutting edge and introduced all sorts of new activities and behaviors that were not common anywhere else. So, for example, in London, I think the first bathroom that is dedicated for women and was designed for them and that was safe and nice and clean was introduced in a department store. In Japan, the first place where you could come in and keep your shoes on and not have to take off your shoes in a local business was a department store.

A lot of things that were considered faux pas or issues that other businesses or other institutions didn’t care about, the department stores were actually innovating for — because they were so in touch with their customers. This is something that they’ve lost over the last 100 years.

Gridium: We should talk about the tremendous amount of potential—well, not potential, but the dry powder in the proptech venture space. What does some of your research show is the trend there?

Dror:   We’ve seen over the past few years about 15 billion dollars or so going into real estate technology companies or proptech companies.

There’s different ways to define it which means there are different ways to measure it, but it’s somewhere between 5 to 20 billion. In any case, it’s a lot of money and I think we’re just going to see more and more of it. Maybe not necessarily flowing as venture capital, but flowing as capital in all sorts of structures and strategies…because the real estate industry is one of the last  bastions of the old world.

People have invested in software companies and transformed media and other industries that lent themselves to digital disruption much more easily. But today, investors are looking to spend money on industries that have growth potential and that can absorb a lot of money; they find themselves looking at real estate among only a handful of industries that both need a lot of help and can absorb a lot of capital, and have companies within them that can actually deploy huge amounts of capital.

These companies can deploy capital in very risky ways (e.g. WeWork), but they at least promise the hope of faster growth and better returns than what you get if you put your money in the bank or even in the stock market over the long term.

Gridium: WeWork has stumbled. Do you think this tells us something about the proptech space? Or what about it might we learn from that?

Dror:   I think WeWork is good news for the proptech space, one way or another. Their presence and their earlier large funding rounds are the ones that really jolted some of the largest landlords to start acting and to start investing in proptech and to start thinking about innovation.

It hasn’t been so long ago that most of these landlords, even two or three years ago, were in complete denial about the fact that anything is changing and that anything needs to be done.

Gridium: Right.

Dror:   And so seeing WeWork grow and seeing WeWork get so much capital, definitely made them understand that “Okay, this is not just a little trend. This is not a gimmick. Something real is happening and there’s a lot of money behind it that is money that comes from outside industry in order to take away our lunch”. And in that sense it’s good.

Obviously, it would’ve been better if WeWork were completely successful and they would have IPOd and it could’ve completed the proptech ecosystem because then we would have another giant that can actually acquire smaller companies and support them. It’s just one of the things that I think are missing today in proptech, but for better or worse, I don’t think anyone doubts that the industry is now being transformed.

So even if WeWork fails to be the one reaping most of the benefits from that transformation, I don’t think any landlord thinks anymore that “business as usual” can still work. And again, not long ago, most of these landlords were still able to convince themselves that they can just stick to what they know.

Gridium: Let’s talk about that. What is the role of active management in real estate? How has that been changing and why?

Dror:   Real estate for many investors and many types of assets used to be a relatively passive type of investment.

It’s something that is almost like a fixed income product: you buy an asset and if it’s in a good location and you take care of it reasonably well, you generate a stable coupon every year. You get 5% or 6% of what you paid for it and it’s enough that you have the money to acquire it and you bring in a manager such as CBRE or Cushman & Wakefield or JLL and the manager does a great job and the building works.

Today, what we’re starting to see in office buildings—which are really the quintessential real estate assets because they’re so stable, because they’re so boring, very vanilla, they’re one-size-fits-all. They have a floorplan that kind of looks the same, it doesn’t matter who you are.

So, these assets are becoming more and more like a hotel or a retail project. They need many more hospitality services. The tenants themselves are starting to ask for more flexibility. They’re asking for more service. The tenants starting to choose a building based on all sorts of different characteristics that can only be attractive to certain customers but are very unattractive to other customers—which is something that is common in hotels and WeWork is an example of it as well.

WeWork for half of the world looks like a joke and terrible and annoying and stupid, and for the other half it’s like the best thing that ever happened to them because no one ever served them this well before. And that’s the opposite of what an office building used to be. So, it used to be something that was just like okay for everyone. Very stable. Not flexible. Ten-year leases from large companies that have great credit.

Suddenly, it’s becoming this extremely dynamic thing. This branded thing requiring trade-offs and pissing off certain people. And that’s something that many owners are just not ready to deal with, but they actually don’t want to deal with it ‘cause when they went into real estate investment to begin with, they went into it assuming that it’s a certain type of product, and now it’s becoming something a little different.
It’s becoming more like investing in an operating businesses, which could be a great business, but has a different risk profile; it has much more volatile income and it would require a lot more love and attention over time.

Gridium: Dror, it was fun to read about the industry’s “ten plagues” as you called them, in the advanced copy of the book. What are they and can you give us an example?

Dror:   The ten plagues mentioned in the book basically list the ten things that have defined and defended the value of real estate assets and the owners and operators of these assets, and how technology is now undermining and redefining each of these attributes.

Starting from the meaning of location to visibility to accessibility to how easy it is to access capital or information for people that are coming to compete with existing landlords. All of these things are being redefined by technology. So, if we want to use an obvious example, let’s say that I wanted to build a department store 50 years ago in the center of the city.

I would go and see that there was a subway line there—or that a subway line was coming because 20-years in advance I could know that it was being planned. Once the subway is built, I start to build my department store on the piece of land that I bought, and all of the people that come to that part of the city now have to go through my department store because they come out of that subway station. So, that was a very static, very predictable environment.

It was difficult enough to operate then. It took a lot of money. It took a lot of work and it involved a lot of risk for all sorts of reasons. But today, if we look at that situation of the department store: so first, a lot of the customers don’t really shop in the physical world anymore. So that’s one thing that is obvious.

Second, people start to move around using ride sharing apps, for example, people that used to rely on public transport, or using micro-mobility things such a scooters or eBikes or all sorts of other new devices. So, it’s becoming much harder for me to predict how people move around and to force them into my specific location.

And it’s also a bit of a bummer for me because I paid to be on top of a subway station, assuming that this is the main way for people to move around in the foreseeable future and suddenly they start moving around in different ways.

The third thing that is happening is that when I bought this piece of land, I looked at the zoning plan for the area and I made a simple supply and demand calculation and figured out how much other retail supply is going to be there and then figured out how big my project should be. But suddenly we’re seeing that technology is enabling all sorts of businesses to sell goods without being in a specific retail area. Or selling goods from stores that are much more experiential on the one hand, or from places that are actually just storage facilities for the distribution of goods on the other.

Both of these types of “stores” compete with me and both of them are not traditional retail spaces and don’t require the things that a good competitor would’ve required ten years ago. So, I could’ve looked at a site and said, “Oh, you know, yeah… maybe someone will build retail here,” but it wouldn’t matter to me. And suddenly, it becomes a competitor of mine.

And this is just in retail, where it’s the most obvious. But we’re starting to see it in office as well, for all sorts of reasons. So again, people can work remotely. People need to move around, even when they are in the office. They need access to all sorts of different kinds of things in order to be happy and productive. They’re expecting all sorts of amenities, such as healthcare or childcare or other things in the neighborhood itself that weren’t important 30 or 40 years ago.

The ten plagues basically means that the environment itself is becoming much more dynamic and that the owner of the asset or operator of the asset needs to be much more creative and much more proactive in order to extract value out of it. So, it’s not enough to just own it and kind of take care of it reasonably well; you have to operate it like an operating business—like a Starbucks or like a McDonald’s or like a hotel.

Gridium: What about this is changing—what role does a building owner’s strategy for the site have to do with it?

Dror:   Real estate is basically now transitioning from an industry governed by operational effectiveness to an industry governed by strategy.

Both of these terms come from the work of Michael Porter, a Harvard Business School professor, kind of the godfather or strategy and strategic thinking. Operational effectiveness means that you have an asset and you have to manage it better than the next person, which is what real estate is and used to be…but not for long.

Meaning, I buy a building. If I can manage it better than the other person that was there before, I’m going to make a little more money and my net operating income will be a little higher and then I can sell it for a higher price to the next buyer.

Now, in this sense, operational effectiveness means, you know, keeping the systems running well, leasing it a little faster, employing maybe half a person less than the other person. It means doing the same things as everyone else, but doing them better. So a lot of very marginal improvements and some of them even involving technology, but involving technology in a way that everyone else can copy.

So, let’s say, I’m installing a property management system or revenue management system and all sorts of things that everyone else cannot do as soon as I do them, but they will all hear about it in a year or two and then they’ll all do the same. Then I’ll have to go and come up with something new. So all of that, I mean, it’s no laughing matter. It’s difficult enough and there’s only a few great companies that can do it very, very well. But unfortunately, that’s not enough anymore.

Because the environment is becoming so dynamic, because there’s so much money flowing in and funding all these new competitors, because the tenants themselves are becoming much more demanding with much higher expectations and at the same time, they’ve become much more fickle and much more easy to leave and move around, suddenly landlords have to think strategically.

And strategically means—Michael Porter again. So, he defines a good strategy with five key attributes. #1, it has to deliver a unique value proposition. A unique value proposition means don’t just offer me what the same building next door is offering, but offer me something that is specific to my needs. So, going back to something like at WeWork, it’s not for everyone, but for the people that it is for, it’s a wonderful solution.

And the same goes for some co-living companies. Even in the industrial market, you know, companies that specialize in different types of logistics or in cold storage, or other categories like senior housing or student housing. Very specific products that serve a very specific customer.

The second attribute that Porter refers to is that delivering this value proposition has to rely on a unique value chain. Now what he means by “value chain” is a set of activities that the company is doing that is unique. So again, unlike today, where I just want to lease a little faster or clean the bathrooms a little faster or maintain the elevator a little better, in the future you’re expected to actually do different things.

And different things might mean, for example, to do branding. To provide services that the other building is not providing. To use technology that is proprietary—or to use off-the-shelf stuff in a way that others are not using. To create partnerships with other brands or service providers that create experiences that are not available anywhere else.

The third attribute that Porter identifies is that a good strategy must involve clear trade-offs—meaning not trying to be everything for everyone, but actually deciding what you are and what you aren’t and being willing to piss some people off and to take some risk and to be committed to that path.

And #4, a good strategy depends on interdependent value activities. Interdependent means that let’s say, we talk about Common which is a co-living company, for example. So, they have a great brand and a great digital presence, allowing people to find apartments and look at them and experience them online before they even visit them offline and sometimes even allowing them to actually lease the apartment without visiting it.

The activity of building that great digital product is interdependent with the fact that Common’s physical activities include getting buildings in neighborhoods that are a little out of the way, that are shared, that at least in the beginning were in older buildings. So, a building that would have been very difficult to lease under the normal process, when they’re intermingled with that digital product, it makes each of them better. Activities are interdependent: the building itself wouldn’t be as valuable without Common’s digital layer. And there’s many other examples of this.

And the fifth attribute that Porter identifies is that a strategy is something that has to be implemented continuously over a meaningful period. So, not just to keep trying different things. Not to change your tune based on the tenant that just happened to walk in the door… the strategy has to rely on choosing who your customers are, focusing on their needs, then building your whole model and your whole value chain based on how to be the best at serving that specific customer.

Gridium: I should’ve warned you about this, but I didn’t. I want to know your thoughts on the potential impact from Autonomous Vehicles. Certainly, it’s early days, but still do you think AVs will make cities and urban centers in metropolitan areas more dense or less dense?

Dror:   First, I think the most interesting thing about this question is that nobody knows the answer, which is a dynamic situation that real estate hasn’t faced in a long, long time.

You know, trains have been with us for a few hundred years. The car has been around for over 100 years and really a mainstream thing for about 70 years. And suddenly, we’re facing a new type of mobility that we really don’t know what impact it will have, but there’s no doubt that it will have a very, very deep impact.

In terms of my thinking, I think flying things will probably have a bigger impact on cities over the next 10, 20 years than autonomous vehicles. The autonomous vehicles that will have a big impact will be those that move things, not people. And even those that move people, they’ll be interesting because they will start moving all sorts of people that don’t currently move—whether it is children or older people.

So, people assume that we will have less cars on the road and not need parking and need less roads, I doubt if that will be the case.

In terms of densification, I think that centers of cities will become more walkable and will start actually limiting where cars can and cannot go. That’s an interesting trend that will impact the evolution of cities. And in terms of the big, big, big picture, I generally think we’ll see centers becoming more dense, more walkable, more governed by humans and things that don’t involve cars.

And then we’ll see at the farther periphery, areas that are becoming more popular because they offer all sorts of other lifestyle benefits that the city doesn’t offer.: access to nature or clean air or a lot of space. A  lot of the suburbs in between might actually suffer because they might have a lot of the downsides of a city without the benefits that, some of these farther areas include which touches into a different thing that is happening now as well which is that the more digital we are and the more we’re connected by technology, the more we yearn for and learn to value the things that cannot be reproduced by technology.

So, things like nature, fresh air, water, the presence of other people and a lot of that is not what the current first suburban strip of large cities is good at providing.

Gridium: Since we’re sitting here in December, when I would normally at this point in the conversation ask what you think is next, let me phrase that differently today. Which would be: in December of 2020, what do you think we would be looking back on in 2020? What do you think will have happened in the next year?

Dror:   Oh we’ll say, “Woah! That Airbnb IPO thing was even worse than that WeWork thing.” (Laughs)

Gridium: Really?

Dror:   I mean, I don’t know but I think Airbnb might have an interesting bumpy ride this year. I hope they figure it out. I struggle to see how they can maintain their 35 billion-dollar valuation at this point, but they still have time to pull a few rabbits out of the hat. So I’ll give them the benefit of the doubt.

Gridium: Okay.

Dror:   Second, if there will be a slowdown in the office market, I think we will find ourselves at the end of this crisis with an office market that is much more flexible, much more branded, much more serviced than the one we currently have.

But that will probably take a few years to play itself out. I’m not sure if December 2020 will be the time for it. And what I hope that we will see is the emergence of a few new ways to finance a lot of the innovation in real estate ‘cause so far, most of these companies—and WeWork is the prime example—have relied on venture capital.

And I think for most of the activities that they conduct, venture capital is not the correct source of funding. And startups will have to figure out a new stack that involves some venture capital for the technology and maybe some thin layer of operation and branding, but then a lot of other types of capital to help them buy a building or even lease a building. But using money that is not so expensive and does not require such fast growth as the money that comes from venture investors. Figuring out the kind of proptech or space-as-a-service capital stack is an interesting challenge, and this year I think WeWork will have to make some progress on coming up with solutions. And I hope they come up with something that could help the rest of the industry.

Gridium: Well, this has been great Dror. I really appreciate you taking the time today and I know our audience will find your thoughts quite interesting. I’ll be sure to link to your book in the show notes, and yeah… thanks again for chatting.

Dror:   Thank you for having me Millen, I enjoyed it.

About Millen Paschich

Millen began his career at Cambridge Associates, trained in finance at SMU, and has an MBA from UCLA. Talk to him about bicycling, business, and green chile burritos.

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