A Blog by Jonathan Low


Oct 1, 2018

Why Tech Is Causing Commercial Real Estate To Peak But Not Residential

Homes have gotten more expensive, but venture capitalists view it as a major industry which has not yet optimized the potential for tech.

Commercial - retail, office and warehouse - are all impacted by tech trends like ecommerce, open plans and logistics/delivery, which is leading to inefficiencies in anticipated usage. JL

Larry Light reports in CIO magazine; Erin Griffith reports in the New York Times:

Working remotely hasn’t dented demand for office space. A shift is underway to open plans. New supply has led to an uptick in office vacancy rates. VCs casting about for the next area to be infused with software and data have homed in on real estate because parts of the industry — like pricing, mortgages and building management — have been slow to adopt software that could make business more efficient.Last year, real estate tech start-ups raised $3.4 billion in funding. Industrial, thanks to online delivery, (is) sturdiest. Retail, beset by e-commerce, most vulnerable.
CIO Commercial real estate, which has romped during the economic recovery, now may be at or near its peak, and set to wind down.

“Growth is slowing, and we are at the late stages of the cycle,” said Renee Csuhran, managing director for real estate and community lending at Huntington National Bank.
For sure, the single-family housing market is anemic, as home prices become less affordable and fewer dwellings are built. On the commercial front—office, industrial, retail, and apartments—signs of a coming slowdown are just starting to appear.
Rising interest rates, over-building, and an expected recession (the betting now is for a 2020 downturn) threaten to end the party. As always, the strength of the US economy is the most potent determining factor for commercial property. Whenever a recession erupts, real estate dips or, depending on the sector, outright tanks. Long-term, commercial property makes sense as an asset class: Businesses always will need roofs over their heads.
For investors, the trick is parsing out the best sectors to be in. Some have better staying power than others, for reasons ranging from demographics to technological change. Industrial, thanks to the expansion of online delivery, may have the sturdiest ability to withstand an economic downturn. Retail, beset by e-commerce-driven changes, is the area most vulnerable.
Across the real estate spectrum, returns today, while strong, are on the brink of decelerating, according to PGIM Real Estate, an arm of Prudential Financial. The firm estimates that commercial property returns will rise to 10.7% this year, from 10.5% in 2017, but then fall as low as 4.8% over the next several years.
Meanwhile, the rate of growth has slipped for commercial real estate loans, which now total $1.4 trillion in the US. New lending growth, by the reckoning of BankRegData, topped out at $32 billion in 2015’s last quarter and has added just $11 billion in this year’s first period. The inflow of foreign capital focused on American real estate has slowed 25% since late 2016.
A look at prospects in the major commercial sectors, which in most cases shows a solid base at present, finds a lot of pluses, but some worrisome minuses starting to appear:
Office. Performance continues to shine here. A Cushman & Wakefield report notes “steady leasing volumes, healthy absorption, and rising asking rents” in the second quarter. The highest rents are on the coasts, particularly in New York’s Midtown and San Francisco. Construction of new buildings is robust, with 18 million square feet completed in the second period, up from 10 million in the previous quarter.
While a trend has developed toward working remotely, that hasn’t dented corporate demand for office space. An even greater shift is underway to open plans, where separate offices and even cubicles give way to long tables that allow employees to interact more frequently. “Companies value collaboration,” said Fred Stoops, head of real estate at Vident Financial, pointing to the enormous open-plan buildings that Facebook uses.
All the new supply has led to an uptick in office vacancy rates, rising nationally to 13.4% most recently from 13.2% the year before. This is hardly alarming at the moment: The historical average is 14.7%.
Nevertheless, a troubling aspect is the large number of buildings that are being erected on spec—meaning, without tenants already signed up. Once the recession hits, owners of these vacant structures will have a big problem. “That’s frightening,” said Jonathan Lewis, partner and co-founder at JLJ Capital, which makes real estate loans.
Industrial. A true powerhouse. Only a sliver of the new inventory is from manufacturing, which has slowly rebounded in the aftermath of the Great Recession. The bulk of the buildout is in warehouses, a.k.a., distribution centers, which service the explosion of online product purchases. The surge in home deliveries, begun by Amazon, has been further fueled by Walmart, Target, and scads of other merchandisers.
Absorption of industrial real estate—that is, new leased-out space—totaled 6.41 million square feet in the second quarter, a 4.9% increase from the year-before period, Cushman & Wakefield figures indicate. The vacancy rate is falling, now at 5%. In some of the hottest markets, like Los Angeles, Jacksonville, Florida, and central New Jersey, the rate is 3% or lower.
But this can only go so far. Rental growth, up 7.2% recently, will begin to ebb next year, Cushman & Wakefield forecasts.
Retail. Here’s where the biggest troubles are. Absorption is minimal, and thus new construction is, also. Vacancies are just above 10%, little improved from the recession. Rent hikes are a measly 2%. The suffering is the most acute at old-school department stores like Sears and J.C. Penney, which have struggled to re-connect with customers.
Developers built too many malls. Hundreds of them are dead. In the 1990s, the US had 1,500 malls. Today: 1,100. A quarter of these are at risk of closing over the next five years, Credit Suisse estimates.
As a result, some mall owners are scrambling to convert empty department stores, which once were anchor tenants, to alternate uses, such as hotels or restaurants. Others retailers, such as Walmart, are experimenting with valet parking and using stores as pickup sites for online orders.
The malls that killed off many a Main Street shopping district are themselves the victims of changing tastes. The iconic teen film of 1982, “Fast Times at Ridgemont High,” was set in the Sherman Oaks Galleria, where the kids would hang out. They’re not there nowadays.
Apartments. Demographics loom large in the multi-family segment, as apartments are known. Millennials are less inclined than previous generations in their 20s to purchase homes.
For one thing, they can’t afford to buy. Many have crushing student debt and until recently suffered from a lack of well-paying jobs, plus mortgage lenders have become more restrictive. “They are renters by need,” said Phil Andrews, head of real estate equity at Aegon Asset Management, adding that more baby boomers, giving up their houses now that they’re empty nesters, are turning to apartments, too.
After a rapid amount of building earlier this decade, the pace has slackened off. Vacancy rates are low at around 5%. Cushman & Wakefield projects that vacancies will inch up, though still remain low.
“Everything looks good now,” Vident’s Stoops said of commercial real estate in general. “But it depends on the broader economy.” And once that tilts downward, commercial property inevitably will follow.

New York Times
Opendoor, a start-up that flips homes, attracted attention in June when it announced it had raised $325 million from a long list of venture capitalists. The financing valued the four-year-old company at more than $2 billion.
That was only an appetizer. Three months later, Opendoor has more than doubled its cash pile. On Thursday, the company said it had gotten a $400 million investment from SoftBank’s Vision Fund. The valuation for Opendoor remains the same.
The so-called mega-round for Opendoor was not the Vision Fund’s only major real estate-related deal on Thursday. The firm also co-led a $400 million investment in the high-end brokerage Compass that valued the company at $4.4 billion.
The hauls are part of a race by investors to pour money into technology for real estate, or what Silicon Valley now calls proptech.

Having watched tech start-ups upend old-line industries like taxis and hotels, venture capitalists are casting about for the next area to be infused with software and data. Many have homed in on real estate as a big opportunity because parts of the industry — like pricing, mortgages and building management — have been slow to adopt software that could make business more efficient.
Last year, real estate tech start-ups raised $3.4 billion in funding, a fivefold increase from 2013, according to the start-up data provider CB Insights. One firm, Fifth Wall Ventures, is entirely dedicated to proptech.
“Tech is starting to make inroads to becoming adopted, and it’s opening the eyes of investors,” said Jeffrey Housenbold, a managing director at SoftBank’s Vision Fund.
Until recently, the biggest tech innovations to hit the residential real estate market have come from listing sites like Zillow and Redfin. But the start-ups in the new wave are tackling a wide range of areas — appraisals, building management, financing, co-working, co-living, building amenities and empty retail space.
The Vision Fund, one of the most aggressive investors in real estate tech start-ups, has written large checks to Katerra, a construction company; WeWork, an office rental company; Lemonade, a home insurance start-up; and Oyo Rooms, a hotel company in India.
Mr. Housenbold said SoftBank’s deep pockets — it has $98 billion in cash to spend — might be influencing the market.
“Given the vast amount of attention on the Vision Fund, people have become more curious,” he said.
Opendoor, one of the largest start-ups in the proptech category, gives the Vision Fund an entry into residential housing. The Silicon Valley company was founded in 2014 by the venture capitalist Keith Rabois and Eric Wu, who is Opendoor’s chief executive. With the money from SoftBank, it has raised more than $1 billion from investors including Khosla Ventures and GGV Capital.
Opendoor’s goal is to make moving as simple as the click of a button, according to Mr. Wu. While that remains a far-off reality, the company has simplified the process of selling a home. It uses a combination of data, software and a team of 50 human evaluators to assess a home’s value. If a customer accepts Opendoor’s value for their home, the company will buy the property, charging a 6.5 percent fee on average.
The company said it offers sellers certainty — many conventional home sales fall through — and flexible closing dates, helping them avoid paying double mortgages. It also eliminates the need for a real estate agent. Opendoor employs 100 licensed real estate agents to advise customers if they request it.
Opendoor buys only homes built in 1960 or later, worth $175,000 to $500,000 and not in need of major renovations or repairs. Operating in more than a dozen cities, mostly in the South, it bought $316 million of homes in August, up from around $100 million in January. After some light fixes, it sells the homes in an average of 90 days.
Before its latest cash infusion, Opendoor planned to expand into one new city a month. Now it plans to double that pace. The company said it expects to be in 22 cities in the United States by the end of the year.

Its growth has spawned competitors: OfferPad and Knock offer comparable services to Opendoor, and Zillow and Redfin, which are both publicly traded, have entered the house-flipping market as well.
“For a while, we were literally the only ones doing this because it’s complex,” Mr. Wu said. Size is an advantage, he said: More transactions mean more data to help Opendoor price its offers more accurately, as well as more buying power with local suppliers for renovations.
Mr. Wu said he believed that reducing the annoyances and costs of moving would entice more people to do it, which would increase the size of the market.
“There are a finite number of homes, but if people are moving with more frequency, that increases the liquidity of the supply in the system,” he said.
Opendoor’s business model has not been tested by a major dip in the housing market, causing some skepticism about whether it can work over the long term.
“The vast majority of investors who hear about it initially think it’s a bad idea,” said Stephen Kim, an analyst at Evercore ISI, a market research company. But the skepticism often fades as they realize Opendoor makes money by providing a service to home sellers, rather than on price appreciation, Mr. Kim said. Even if the company breaks even on a sale, the transaction fees are a meaningful business.
Jason Childs, Opendoor’s chief financial officer, said the company’s geographic diversity and 90-day average flips helped shield it from a potential housing market crash. In the housing crash a decade ago, the holders of long-duration assets were affected the worst, he said.
Opendoor’s Phoenix operations are already profitable, excluding the cost of its headquarters in San Francisco, and Dallas is “on the edge of profitability,” said Mr. Childs.
The company’s long-term success relies on its ability to accurately price homes. Half of the people who now get offers from Opendoor sell their home to the company. Opendoor did not provide data on how close its offers were to the ultimate sale price of the homes it did not buy.
In recent months, aided by the promise of cash from SoftBank, Opendoor has also expanded into the business of selling homes directly to customers, instead of going through brokers in the traditional way. It acquired Open Listings, a home shopping site, to offer a service it is calling a “trade-in,” where Opendoor handles the entire buying and selling process for a person or family. That service is now available in Dallas. It also began offering mortgage and title services to buyers.
But Mr. Wu does not foresee one thing going away completely: the job of the real estate agent. Rather, he expects an agent’s work to shift to more of an advisory role, instead of an administrative one.
“The thing that cannot be automated is this notion of advice — what neighborhood, what school district, how much you can afford,” he said. “It’s important to have someone who is an expert alongside you.”


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