This article was sponsored by Yardi. It appeared in the Technology Special Report alongside the December/January 2019 issue of PERE magazine.
When property prices hit their nadir in 2010, an investor could buy and hold an asset and reasonably expect attractive returns. Indeed, the investment market has enjoyed an extraordinary expansion lasting most of a decade. Needless to say, investors should not be preparing to fight the last war.
Though investment volume has fluctuated over the past couple of years, prices overall show little sign of retreating. It is virtually impossible to buy an asset at the top of the market cycle, sell it in three to five years and expect to realize a large ROI. Investors cannot merely sit on properties acquired at peak prices and expect values to improve; and neither can they bank, literally or figuratively, on acquisition cap rates to deliver big paydays at disposition. Today’s conditions call for a much different strategy.
So how will satisfactory returns be achieved? The answer, it seems to us, is clear. Active management is the only plausible strategy. The most reliable way to drive attractive returns is to improve operational performance. Increasing revenue, decreasing expenses and reducing risk is the recipe for improved building value and greater returns. And that raises another question: What is the right recipe for improving operational performance? We live in what a recent article in the Harvard Business Review called “the age of continuous connection.” We contend that connectivity will be the key to achieving peak property performance in the next downturn, no matter when it arrives or how drastic it may be. In order to enhance performance at the rapid-fire pace of today’s business, connectivity in real time with all stakeholders, from ownership and management to occupants and vendors, is essential.
Riding the cycles
In some respects, today’s market outlook is bifurcated. Real estate market conditions suggest a strong forward-looking picture, as the investment market demonstrates surprising staying power. As CBRE reported recently, commercial real estate investment volume increased 3.4 percent year-on-year during the second quarter to $121.5 billion, the second-highest tally for the second quarter since 2015.
Sector performance varied considerably: the office sector registered a 30.5 percent year-on-year increase for the quarter; multifamily volume gained 20.6 percent; and industrial, retail and hotel assets all showed slight declines.
While broadly positive, these figures also suggest cause for concern. It appears that many investors, if not most, are still buying at the top of the market, even as growth slows and a recession could be on the horizon. That should raise alarm bells. Will returns still be acceptable to investors? If not, fund managers will face dissatisfied clients. Trade tensions and geopolitical volatility could also threaten consumer and business confidence, swinging the pendulum from cautious optimism toward full-fledged caution.
With that in mind, we are advising preparedness. As worries about an economic downturn mount, investors should begin turning their attention to building performance. Maximizing revenue, controlling expenses and mitigating risk are always priorities; in a stagnant or recessionary market, those activities take on new urgency. Without active management, fund managers and their clients cannot expect returns to meet expectations.
That said, much has changed in the decade since the beginning of the Great Recession. Investors and fund managers have the benefit of a new generation of tools that can enhance operational efficiency and boost property income. Whenever the next market downturn does arrive, those that have already put new strategies in place today, while adhering to fundamentals that are still basically sound, will give themselves a leg up.
The recipe for value
As every asset manager knows, even modest reductions in operating expenses and increases in income quickly add up. We consider a typical 250,000-square-foot office building in a major market that generates $10 million in annual revenue. Suppose that maintenance, repair and operations expenses total $1.2 million; a reduction of just 5 percent would add $60,000 to the bottom line. Assuming $900,000 in annual energy expenses, a 10 percent decrease in utility costs would save $90,000. Then turn to the property’s revenue side and target marketing strategy.
Improving the analysis in several areas – accurately comparing deals to market conditions, the property’s leasing history and its budget pro formas – could conservatively be estimated to increase revenue by 1 percent. That translates to an additional $100,000 in income. Even if no other improvements are made, addressing these three areas alone would boost the property’s value by $5 million. Such results go a long way toward achieving investor expectations.
Every aspect of ownership provides opportunities to improve asset performance. Part of an effective acquisition strategy calls for ensuring that pricing is in line with the market for comparable assets. Closing deals in a timely manner is crucial as well. During operations, a variety of tactics can improve performance; controlling utility costs is a particularly fruitful exercise. Construction projects, too, deserve attention, since most properties require an upgrade upon acquisition. In all these areas and more, the common thread is connectivity. Tools that help project teams to hit milestones, stay on budget and raise red flags will reduce the risks of cost overruns and enhance asset values.
Achieving these operational improvements is challenging, but investors and fund managers have an huge advantage compared to their counterparts only a decade ago. A new generation of technology helps achieve vital connections: between fund managers and the client’s investment principals, between joint venture partners, and among internal departments.
Across the board, using technology platforms to their full capacity is the linchpin of productivity. Everyone involved in the deal or project pipeline must have ample real-time data in order to make informed decisions. That includes asset investors and owners, managers, internal and external brokers, system vendors and tenants. Today, it also means the building itself.
For investors, this carries numerous implications. First, managing the deal pipeline. By using tools to work on the portfolio, the asset manager can make sure the price is right. For instance, one can assess local demographic and business trends in a way that properly reflects the market’s dynamic performance. The investor can avoid getting locked into long-term rents that exceed market value.
Moreover, fund managers and advisors can conduct virtual conversations in real time. That is more effective than tracking communication through a conventional email chain and, in turn, helps investors and their representatives efficiently circulate vital information.
Business-to-business connectivity harks back to an earlier generation of enterprise relationship management tools. Today, however, B2B connectivity is real-time and cloud-based. Tools like portals allow vendors to log into a common, shared system to make bids, submit invoices and check project status.
Business-to-customer communication has also made great leaps forward, allowing tenants and investors to join the thread. Modern tech encourages us to log into the same system and share a conversation. Consider the potential of an online chat, or what may be the most exciting trend – the emergence of the business-to-property power of the Internet of Things (IoT) to communicate a building’s operational status, and eventually to diagnose and communicate problems.
Smart building tools can enable multifamily property teams to control access remotely and schedule self-guided tours for prospective residents without tying up the time of a staff member. On the commercial side, an operator can enhance the profitability of a co-working space by installing a smart door lock that controls access to a conference room.
Gaining an edge
As property value appreciation slows, investors that take full advantage of the available tools will gain an edge. In any part of the cycle, and especially when a downturn slows growth, maximizing net operating income requires stepped-up attention to operating expenses. For commercial owners, investing in energy retrofits trims expenses and directly benefits the bottom line. Picking low-hanging fruit, such as installing high-efficiency light bulbs and regularly fine-tuning systems through active commissioning, is now standard practice.
Trailblazing tools like real-time energy management and monitoring the meter reduce operating costs. Leveraging IoT for smart thermostats that adjust the building climate by time of day and occupancy are proven to monitor the property’s temperature, and can be controlled at the portfolio level from a single location. Our own campus in Santa Barbara, California, shows the power of connectivity in managing energy expenditures. A continuous connection from business to property reads utility kilowatt-hours every 15 seconds, comparing them to benchmark usage and utility invoices. It then gathers valuable data from the utility invoices for benchmark comparison, audit and sustainability reporting. The system controls thermostats, office zones and the HVAC plant for reduced energy usage and better comfort. These steps have reduced energy costs by more than 30 percent and lowered energy consumption by 25 percent. Results at the Yardi campus may be exceptional, but even more modest savings are substantial; in our experience, a 10 percent reduction is typical.
The gee-whiz days of technological capability are far from over. A steady stream of exciting concepts and applications will boost connectivity still further. Such products and systems are aids to continual communication, whether business-to-business, business-to-customer or business-to-property. But keep an eye on the last of the three. As use of the IoT expands, along with its connection to big data on building operations, even greater advantages will accrue to performance and, by extension, to tenant and resident satisfaction. We’re already starting to see those results. There is much more ahead in the way of automating decisions and recommending preemptive solutions. Stay tuned.
Tech in action
Five ways it can enhance a portfolio’s performance
A large institutional fund manager and Yardi client recently implemented tools in these key areas:
Opening real-time communication between brokers and asset managers, and improving net effective rents.
Streamlining budgeting and identifying potential cost overruns.
Providing accuracy in revenue growth projections.
Offering precision maintenance of building equipment to reduce costs and improve tenant satisfaction.
For improved sustainability reporting for benchmarking and identification of underperforming assets.
Multiple benefits accrued to Yardi’s client as a result of these enhancements, not the least of which were the reduction of forecast time from an annual to a monthly basis, the ability to close better deals faster and improved control of construction projects. Ultimately, the resulting increase in revenues and the lower expenses added up to higher asset values.