Real Estate Outlook - Deloitte

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2019 CommercialReal Estate OutlookAgility is key to winningin the digital era

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital era2

Brochure / report title goes here Section title goes here ContentsThe ecosystem influencers―Investors ride on tech-enabled commercial real estate firms1Global capital flows2Technology8Cyber risk management14Talent18Proptechs22The winner cashes in on the investment dollars2702

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital eraThe ecosystem influencers—Investors ride on tech-enabled commercialreal estate firmsNew business models and competition, extensive use oftechnology, and changing tenant and investor expectationsare redefining the commercial real estate (CRE) industry.In our 2018 Real Estate Outlook, we emphasized that REcompanies will likely have to take some risks and embracechange to adapt for the future.1 Since then, we’ve seenthese factors occurring at ever-increasing rates, which hascontinuously challenged companies to deal effectively withthe relentless pace of change. As a result, traditional rulesof the road might not work fast enough to provide the agilityCRE companies of the future will likely require.Fundamentally, CRE companies should gain a thoroughunderstanding of the changing usage pattern of the builtspace. Take the example of WeWork, the co-sharing spaceowner that is positioning itself as a “services” companyrather than a property owner-operator. Since its inceptionin 2010, the company has grown from a single space inNew York City to 287 physical locations across 77 citiesand 23 countries globally, as of August 2018.2 At 20billion, WeWork is considered among the most valued techstartups, following Uber and Airbnb.3 The company’s growthoutstrips many traditional CRE companies.In our endeavor to help CRE companies understand the newrules of the road, our 2019 Commercial Real Estate Outlookdives deeper into the preferences of CRE investors. Oursurvey of 500 global investors, which provides insights onfactors that are influencing their CRE investment decisions,revealed the following key themes:What are the companies with new business models doingdifferently? These companies, which can be consideredchange agents, are typically retaining the core ethos of thereal estate business—the importance of location—whilechanging the mind-set about how the physical space isconsumed. Powered by technology, their value propositionlies in augmenting the user experience. For instance,WeWork’s goal appears to be to create not only a functionalexperience but also a memorable one through a vibrantambience, varied open-seating options, amenities, andnetworking opportunities for the on-the-go Millennial andGen Z workforce.1. A large proportion of respondents plan to increase theircapital commitment to CRE, with the United States,Germany, and Canada leading the way.2. Nontraditional assets such as mixed-use propertiesand new business models such as properties withflexible leases and spaces are expected to attract anincreased allocation of investment dollars.3. Many surveyed investors expect to prioritize theirinvestments in existing and potential investeecompanies that respond rapidly to changes in businessmodels and adopt a variety of technologies to makebuildings future ready.4. Survey respondents see a significant impact fromtechnology advancements on legacy properties infewer than three years.With investors seemingly committed to investing in newerbusiness models and a tech-enabled ecosystem, how canCRE companies cash in on the gold rush?1Change agents like WeWork are repositioning the CRE assetas not just a physical space but a service hub. In addition,they strive to differentiate themselves with a nimble andflexible business model. Once CRE companies are readyto change their mind-set, agility tends to be the mostimportant factor that can enable them to rethink the waythey approach change, remain competitive, and grow.Given the increasing uncertainty in the CRE sector, this year’soutlook takes stock of the current business environmentand uncovers key investor preferences on capitalallocations, use of technology, cyber risk management,talent, and the role of proptechs. We also provide actionablerecommendations for how an agile CRE company canrespond to these key investor preferences.

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital eraGlobal capital flowsInstitutional investors’ expectations:Reassess property and tenant mix to attractmore capitalGlobal CRE investments continue to rise on the back ofsteady economic and employment growth in key globalmarkets. This is despite some concerns about a flatteningyield curve, various country tax reform initiatives, andthe threat of trade tariffs as well as the yet to be fullydetermined impact of Brexit in Europe.4 In the first half of2018, global CRE transaction volume increased 13 percentyear over year (YOY) to 341 billion.5 The Americas’ volumerose by 9 percent YOY to 132 billion.6 The United Statesled the Americas’ growth with a volume of 122 billion ( 11percent YOY).7The trend is expected to continue, as 97 percent ofour survey respondents plan to increase their capitalcommitment to CRE over the next 18 months (see figure 1).Respondents from the United States plan to increase theircapital commitments by 13 percent in this time frame, whilethose in Germany (13 percent) and Canada (12 percent)show similar levels of interest. In terms of inbound capital,the United States is the most preferred CRE market globally,followed by Hong Kong and China.Surveyed executives plan to diversify their portfoliosthrough higher investments in newer and emergingbusiness models and thematic investments. Over half ofthe survey sample aims to invest or increase investmentsin properties with flexible leases, and 44 percent plan todo so for flexible spaces. Investors seem to realize thattheir investments should be tied to the changing natureof work and tenant preferences. As such, the new capitalcommitment is unlikely to flow entirely into traditional CRE.For instance, survey respondents specializing in mixeduse and nontraditional properties plan to increase theircapital commitment by a higher percentage than thosefocused on traditional properties (see figure 1c). Specifically,under nontraditional properties, those surveyed are likelyto increase investments in data centers and health care(including senior housing) facilities. While investors diversifytheir risks, they are expected to continue to value traditionalproperties and longer-term and high-credit-worthy tenants.97 percent of our surveyrespondents plan to increase theircapital commitment to CRE overthe next 18 months. Respondentsfrom the United States plan toincrease their capital commitmentsby 13 percent in this time frame,while those in Germany (13percent) and Canada (12 percent)show similar levels of interest.2

Figure 1. The investor pulse: Global capital flowsBrochure / report title goes here Section title goes here (1a) Investors plan to increase CRE capitalcommitment in the next 18 months(1b) Globally, US, Hong Kong, and Chinamost favored CRE marketsTop and bottom two respondent types across categoriesInvestment split across countriesProperty focus(1c) Investors plan to increase investments in mixed-use and nontraditional properties in thenext 18 months% itality6% 1%6%9%Geographic focus20%6%% increaseUS, Germany13%Canada12%China, Hong Kong9%Japan8%Assets under management7%13%US 1.1 billion – US 5 billion11%US 500 million – US 1 billion10%8%Above US 30 billion10%Investor category8%14%8%14%Banking or finance companies (asset management divisions)13%Private equity, sovereign wealth funds10%Hedge funds, pension funds9%49%47%Single family housingStudent housing29%Others26%Canada, Singapore66%Japan73%US, Hong Kong57%China70%UK, Germany55%Singapore40%Assets under management% increaseUS 10.1 billion – US 20 billion69%US 1.1 billion – US 5 billion50%US 20.1 billion – US 30 billion66%Above US 30 billion44%US 5.1 billion – US 10 billion59%US 500 million – US 1 billion41%Investor category% increasePension funds75%Sovereign wealth funds48%Hedge funds66%Banking or finance companies (assetmanagement divisions), private equity46%Hong KongSingaporeGermanyOtherSovereign wealth funds58%REITs or real estate operating 60%67%Decrease% increaseBrazil8%7%% increase% increase(1e) Investors are interested in newer andemerging business models and thematicinvestments11%IncreaseGeographic focusUK55%Mobile towers% increaseCanada67%Health care (includingsenior housing)Geographic focusUS(1d) Most investors prefer data centers and health careamong nontraditional assetsData centersTop three respondent types across categoriesInvestor category% increaseREITs or real estate operating companiesFor nontraditionalTop three respondent types across categoriesAssets under management15%% increaseLess than US 500 millionFor mixed-useNo changePortfolio and riskdiversification49%Preference for new andemerging business models48%Focus on thematicinvestments45%44%Superior returns35%Lower competitionOther1%Properties with:52%Note: The categories highlighted in the graphic tables suggest the following about the survey respondents:Property focus: Property specialization of investors; Geographic focus: Home country of the investor; Assets under management: Investor sizeSource: Deloitte Center for Financial Services analysis.3(1f) Investors are looking to pursue M&A,enhance user experience, and improveproperty features to generate target returnsFlexible leases44%Flexible spaces44%41%41%38%Rebalance portfoliothrough M&ARedevelop to enhanceuser experience10%AbandonInvest to enhanceproperty featuresRepurpose foralternative use

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital eraWhat should CRE companies do to bemore agile in attracting capital?With the change in investor preferences, CRE companiesshould consider rebalancing their property portfolios, focusingon creating memorable tenant experiences, and diversifyingtheir investor base to attract higher capital investment.Rebalance property portfolioInvestors’ capital commitment plans suggest CREcompanies could have an advantage if they stay close to anddemonstrate clarity on their core investment strategies, andrisk alignment against those strategies, while balancing anddiversifying their property portfolios. However, even themeaning of “diversification” could be challenged. Propertiesand portfolios could take different shapes and forms, suchas building more flexible spaces and making propertiesmore experiential and engaging.Most traditional property real estate investment trusts,except industrials and certain classes of nontraditionalREITs, are trading at a discount to their net asset values.8Accordingly, CRE companies may also be able to takeadvantage of mergers & acquisitions (M&A) and jointventure or partnering routes. Companies can leveragedata-driven analysis to craft a more robust strategy aroundcurrent market positions and analyze how expansioninto newer properties could complement their existingones. Strategy linkage driven by supporting data can helpdemonstrate how a single investment not only presentsoperational synergies but also evolves the broader portfolio.For instance, retail owners could conduct highest and bestuse analysis based on location, surrounding demographics,and other macro factors to repurpose some of their vacantassets into nontraditional uses such as data centers andsenior housing and create new sources of revenue.5Increase tenant centricityCRE companies should reimagine tenant experience byweaving technology throughout the tenant life cycle.This can help strengthen tenant stickiness and thereforevaluations. For instance, CRE owners and developers canuse a combination of augmented (AR) and virtual (VR) reality,commonly known as mixed reality, to allow potential buyersor tenants to visualize the new property using a 360-degreeimmersive experience and offer multiple finished siteoptions. This may also expand the reach to potential clientsacross different geographies. Companies could also leveragetechnologies such as Internet of Things (IoT), artificialintelligence (AI), and predictive analytics to(re)develop and tailor existing or new buildings to suitchanging tenant preferences and to anticipate tenant needs.This also provides an opportunity for CRE companies topartner with tenants to augment the end-user experience.

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital eraCompanies should reconsider their existing tenant mix, asphysical spaces that offer diverse experiences are providingan opportunity to yield higher occupancy and rents. CREcompanies should consider using traditional and alternativedata, AI, and predictive analytics for smarter tenantrepositioning by having a more diverse tenant portfolio. Forexample, some retail owners are now offering empty mallspace to retail incubators or even co-sharing work spaces.9These new arrangements seem beneficial to moststakeholders, even though these new forms of tenantsoccupy a relatively smaller portion of the leasable space.Retail incubators get a marketplace to demo their productsbefore they expand their physical presence, and peopleworking in co-working spaces get more networkingopportunities and increased “walkability” for their eating,shopping, and entertainment needs.10 And of course,for retail owners, all this generally means a higher-valueexperience for the entire property due to an attractivetenant mix and increased retention of existing tenantsthrough higher foot traffic.Companies can add other leading models, such asenhancing existing lease administration processes, to betteroffer short-term leases or a hybrid along with longer-termleases. With increased business uncertainty, traditionaltenants are looking at more flexible leases, while the newerform of tenants thrive on such lease models.11 Landlords,for their part, can see a direct benefit on their net operatingincome by leasing out vacant spaces. Moving from longerterm to short-term leases may require a change in financialforecasting techniques, as it would impact revenue streampredictability.By revamping the user experience, tenant mix, and leaseadministration processes, companies can not only reducetenant risk but also create a differentiating brand.6

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital eraDiversify investor baseReal estate has arrived as a meaningful and strategiclong-term play for many investors. With increased investorinterest in CRE, REITs can expand and diversify their investorpool. They can take advantage of the separate GlobalIndustry Classification Standard (GICS) of real estate andhelp generalist investors to better understand the nuancesof REIT operations, performance, and valuation. Companiescan frame a targeted expansion strategy for generalistinvestors—such as pension, endowment, and foundationfunds—who have traditionally under-allocated to REITs butare warming up to REIT investments.12For instance, on average, pension fund respondents to theDeloitte survey plan to increase CRE capital commitmentby 9 percent in the next 18 months (see figure 1a), and asignificant portion of this could be directed toward REITs.Further, the increased investor interest can particularly helpsmaller REITs (market capitalization of less than 1 billion)to gain exposure to more institutional investors, as theinvestors plan to expand beyond core markets in searchof yield.13 CREs are also able to use data insights to achievegeographical diversification by targeting investors fromdifferent countries. For instance, our survey respondentsfrom Canada (55 percent) are interested more in theNortheast region of the United States, while Chineserespondents (40 percent) focus more on the Sunbelt.The bottom line:Key questions the CRE C-suite should considerChange the mind-setAre you prepared to reassess the existing property and tenant mix? Do you position your real estate as aservice? What are your key considerations for portfolio rebalancing? Is there additional value to captureby prioritizing tenant expectations and experience while selecting, designing, and leasing a location?Start operationalizing your capital investment strategyHow are you planning to use investor capital to enhance the use of existing properties? Are you planningto acquire, dispose of, and redevelop existing buildings to increase their utility? Which technologies areyou likely to use to augment tenant experience?7

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital eraTechnologyInstitutional investors’ expectations:Upgrade digital strategy and infrastructureTechnology has permeated every aspect of the CREbusiness. Companies are adopting a variety of advancedtechnologies, albeit at a relatively slow pace comparedto some other industries.14 Compared with the rate oftechnological advancement, the industry continues to playcatch-up. In fact, nearly 53 percent of respondents believethat technology advancements will have the greatest impacton legacy properties within the next three years, and 15percent believe that the impact is already visible. Investorsalso have certain expectations about technology usagefrom their CRE investee companies. More than 80 percentof our survey sample believe that CRE companies shouldprioritize the use of predictive analytics and businessintelligence. In fact, over the next 18 months, nearly twofifths plan to increase the use of these two technologies tomake their investment decisions (see figure 2c).More than a quarter of the respondents believe that CREcompanies should prioritize the use of IoT technology in(re)designing buildings. Respondents from China(48 percent) and Singapore (43 percent) place a greateremphasis on the use of IoT technology compared torespondents from the United States (15 percent).Perhaps one of the challenges facing CRE companies isthe ability to prioritize investments between differenttechnologies and needs. Currently, most companies aretactically focusing on individual technologies relevant fora specific business area and not looking at an enterprisewide picture. As a result, CRE technology leadership tendsto spend significant time and resources in managing bothmodern and legacy infrastructure while not yet reimaginingthe power of fully utilizing data.More than 80 percent of oursurvey sample believe that CREcompanies should prioritize theuse of predictive analytics andbusiness intelligence. In fact, overthe next 18 months, nearly twofifths plan to increase the use ofthese two technologies to maketheir investment decisions.8

Figure 2. The investor pulse: TechnologyPercentage of respondentsIndustrial18%Robotics and cognitiveautomation%Mobile appsGeographic focusChina48%US15%Assets under management%US 20.1 billion – US 30 billion44%Less than US 500 million8%Investor category%Sovereign wealth funds60%REITs or real estate operating companies49%45%Geospatial analytics33%Cloud32%Office47%Business intelligenceOffice, multifamily43%%Predictive analyticsJapan73%Business intelligenceJapan73%Predictive analyticsUS 1.1 billion – US 5 billion45%Business intelligenceUS 20.1 billion – US 30 billion44%Assets under management%Predictive analyticsHedge funds46%Business intelligenceMutual funds44%(2f) Investors make a majority of their CREdecisions based on data analyticsPercentage of respondents21%62%36%34%News feedsOther2%Note: The categories highlighted in the graphic tables suggest the following about the survey respondents:Property focus: Property specialization of investors; Geographic focus: Home country of the investor; Assets under management: Investor sizeSource: Deloitte Center for Financi

2019 Commercial Real Estate Outlook: Agility is key to winning in the digital era 1 The ecosystem influencers— Investors ride on tech-enabled commercial real estate firms New business models and competition, extensive use of technology, and changing tenant and investor expectations are redefining the commercial real estate (CRE) industry.

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