The Finance Function Gets Smarter
New data sources, new technology approaches and new attitudes to the commercial real estate capital markets are combining to make the finance function a lot more intelligent than it ever was.
Local talent. That was the primary metric, as it turned out, that Amazon was using when it was searching for its second headquarters. It was decidedly not, as many originally thought, using the typical site selection factors that a large firm turns to when evaluating different locations.
Amazon’s criteria for this investment is the perfect illustration of the changing way companies approach investment in commercial real estate—that is, they are taking into account new sources of data as they evaluate various choices, according to K.C. Conway, chief economist at the CCIM Institute. So too are some lenders as they underwrite properties, he notes.
One example: “the industry still values industrial CRE on a price per square foot basis but the way companies are investing and determining value is on a cubic foot basis,” Conway says. Warehouses are getting taller, in other words, and a cubic foot basis is more appropriate.
Some lenders, such as those in the debt space, are using these new metrics in their valuations, Conway says. Others, though, are not, namely the construction and traditional bank lenders. This dichotomy can be seen in other areas as well. Forward-looking lenders, for instance, are also increasingly adopting new technology to help better source and service commercial real estate transactions.
It is natural that the twain are starting to meet—new data sources coupling with the latest in such advances as predictive analytics. The result? A finance function that is getting smarter and smarter for both lender and borrower alike.
In the case of the borrower, says Patrick Rafferty, vice president of Product at Reonomy, many are now better informed about which lenders could be the best to work with. “They might have an acquisition opportunity they are pursuing and are looking for a partner for financing.” New tech and data sources make it easy to see who has made loans recently on similar assets.
Lenders, too, have a wealth of new options that deliver benefits—benefits that eventually filter down to the borrower.
Reonomy, for instance, works with a number of lending institutions and debt brokerages to identify leads at the top of the funnel, Rafferty says. One product offers a view into properties that not only include such facts as square footage and prior sales price, but also offers insights tied to those properties. “It understands the sales and mortgage history, for example,” he says. “It knows who the key decision makers are that sit behind that LLC. Ownership in commercial real estate can often be obscure.” He adds that the company is starting to score properties using that information to come up with insight into a borrower’s proclivity to refinance, but that product is not on the market yet.
Such technology is a departure from the traditional lending model, which is still very relationship oriented in many quarters, focusing on a broker’s network and the lender’s brand, Rafferty says. As this technology comes into focus, “people will start to be much more proactive with lending.”
Many other lenders, even if they are not reaching for these advanced methods, are using more standard technology to change their lending behavior. For example, Rafferty says, many lenders are now using technology to expand downmarket. “Instead of just having high-powered sales people trying to facilitate financing through their networks there are also trying a few more approaches. These range from digital ads as well as inbound calls centers to target smaller mid-market opportunities. “I don’t know if anyone has completely figured this out yet, but it is clear that the appetite to move downward is growing and people are trying out technology to facilitate that,” Rafferty says.
The ultimate goal for CRE finance technology—one that hasn’t been reached yet—is a dashboard that tells users how the market is behaving and what it is likely to do next, Rafferty continues.
“We have introduced descriptive data into the mix. Soon we will see prescriptive analytics applied to that data. This technology will be able to make predictions that are based on the descriptive data.” Rafferty believes the market is about five years away from predictive scores that are accepted as industry standards.
We are starting to see signs of this trend already. Last year Host Hotels & Resorts announced a joint development agreement with IBM Research, designed to enhance the company’s predictive analytics capabilities. The partnership combined Host’s enterprise analytics platform with IBM’s expertise in AI and machine learning, “to seek to maximize investment value across the portfolio.” Earlier this year Sourav Ghosh, senior vice president of Enterprise Analytics at Host Hotels, gave the market an update on that partnership when he told Nareit that the REIT’s partnership with IBM has allowed it to make better capital allocation decisions, “whether it’s from an investment perspective, from a disposition standpoint, or even when we’re investing capital for renovations.”
Not all companies have the heft, or resources, to partner with IBM on such a project. The forward-looking ones, though, are aggressively tapping new data sources that can deliver an advantage, CCIM’s Conway says.
Consider the metrics used to evaluate the local job market. “We have been conditioned in our training that job growth drives demand for commercial real estate and that the government’s Bureau of Labor Statistics (BLS) is the resource to consult,” he says in a report. “Due to dated methods, BLS struggles to accurately estimate employment growth.” Companies have found though, that ADP’s National Employment Report (NER), produced jointly with Moody’s Analytics, and LinkedIn’s Workforce Report with Skills-Gap Analysis are good alternative options.
ADP processes payrolls for approximately one-fifth of the nation’s private payroll employment, and its monthly employment data is a credible estimate of private employment activity, according to the CCIM report.
LinkedIn’s Workforce Report draws on employment data from the more than 190 million workers in the US with LinkedIn accounts. LinkedIn’s monthly jobs report also includes skills-gap analyses at an MSA level stratified across 50,000 employment sectors, from brokers to welders.
“Had Amazon utilized the LinkedIn Workforce Report with Skill-Gap Analysis before making its HQ2 split decision, it would have known that New York ranked worst for available skilled workforce—below even Seattle or San Francisco,” Conway says.
NEW DATA SOURCES CRE INVESTORS SHOULD TAP
CCIM Institute has compiled a list of new data sources that commercial real estate investors will find invaluable as they source new deals. Following are excerpts from that report.
Global Business Intelligence
A good global resource is Trading Economics. Leveraging official sources, the site offers verifiable data from 196 countries including “historical data for more than 20 million economic indicators, exchange rates, stock market indexes, government bond yields, and commodity prices.”
A Proxy for GDP
A great proxy for GDP is the rail traffic data produced by the Association of American Railroads. Weekly and monthly rail traffic data and the more comprehensive RTI report tell us what commodities and goods are moving, where they’re headed, and at what volumes.
If you’re looking for a comprehensive “CliffsNotes” to the economy, head to Calculated Risk, a finance and macroeconomics site that tracks and synthesizes all the pertinent economic news of the day, the month, and the quarter. Here you’ll find just about every macroeconomic data point and historical trend aggregated from the primary sources—filled with prebuilt charts and rich analysis to put any economic metric in perspective and proper context. One of the site’s most valuable tools is its Weekly Schedule that tees up everything you need to know—from jobs and GDP to housing starts and the Federal Reserve.
Small Business Metrics
Small and midsize business activity is critical to the health of local communities and commercial real estate activity and material to leasing activity. The monthly Small Business Optimism Index from the National Federation of Independent Businesses is a must if you’re conducting feasibility studies or market, valuation, and underwriting analyses. With over 45 years of small business economic trends data at its disposal, NFIB delivers insights on everything from labor markets to capital spending to credit markets. For instance, the index reached a record high of 108.8 out of 120 in 2018, helping explain small business growth last year—and maybe its decline to 101 in 1Q2019.
Supplementing this resource is the National Center for the Middle Market, which promotes and supports the growth and expansion of middle-market companies. This business sector—companies with annual revenue between $10 million and $1 billion—represents 33% of private sector GDP in the U.S. and is the third largest global economy. Housed at The Ohio State University, NCMM is the leading source of research and data analysis on the middle-market economy and acts as an incubator for the next generation of unicorn startups.
Sector-specific Sources
Another noteworthy source is Dunnhumby, a customer data provider whose expertise in retail and grocery industry is of particular interest to commercial real estate. The company goes beyond the general information offered by other organizations and takes a deep dive into behavior and trends of the nation’s top 56 grocer brands.
The Association of General Contractors produces a monthly survey that provides a thorough understanding of what general contractors are experiencing and forecasting.
The Engineering News-Record offers a monthly periodical with a construction economics section and a 20-city index that details current and historical data on actual material and labor costs.
WILL VTS AND SIMILAR SOFTWARE ELIMINATE LEASING BROKERS?
Backed by investors led by the technology investment arm of Brookfield Asset Management, with GLP, Tishman Speyer and venture capital firm Fifth Wall, VTS is aggressively investing in and expanding its software that helps landlords track and manage tenant leasing. It raised $90 million in a recent funding round in a record CRE tech venture financing. The company stated the funding will continue to deepen its current software capabilities, and accelerate the launch of its end-to-end commercial real estate leasing product Truva, which will go live later this year.
One real estate industry expert in the proptech space characterized the crux of the VTS software as providing owners the ability to do deals directly with the end users. “It’s about eliminating brokerage commissions. So, this is really bad news for JLL, CBRE, Cushman or other brokerage firms,” he said.
He explained with a hypothetical that if an owner can increase their net income by not paying commissions to brokers, the impact on the value of their portfolio would be much larger than just the dollar amount of commissions that were saved, because real estate is typically valued at a multiple of net income, called a cap rate. If a cap rate is 5%, each dollar of saved commissions increases the value of the portfolio by $20 dollars.
“If the real estate firm’s portfolio is worth $350 billion, and the firm increases net income by 6% by not paying commissions to brokers, the impact on the value of the portfolio would be $35 billion,” he said. “That’s why the big property companies are willing to invest big dollars up front. The software will dramatically reduce commissions. If I can invest $90 million in VTS and potentially make $35 billion in portfolio value from it, I would do that deal all day long.”
VTS allows pricing management where owners share information on rents. Through benchmarking, they can see what other owners are pricing. “There is no broker involved because it’s owners sharing that data,” he explained.
Companies like Brookfield have multiple people in buildings, including security guards and property managers. Once tenants get information online, they can directly visit the buildings. The company employees could show the property.
Jonathan Kaufman Iger, the CEO of Sage Realty, the leasing and management division of The William Kaufman Organization, says that his company was one of VTS’s first customers. He opined while not eliminating the role of brokers the technology will be enough of a disruptor to change brokers’ jobs.
He said technology is the disruptor of the real estate industry. But he pointed out even with the flourishing of online resources like Trulia and Zillow, residential brokers continue to thrive.
Iger described the VTS software as “starting to provide tools to truly unlock data to make it unbelievably actionable for landlords and operators.”
VTS landlord clients pay additional fees for modules that provide information outside traditional brokerage services, according to Iger. For example, VTS can indicate whether the landlord is going to get a return on investment. The system tracks rents and TI costs, replacing more cumbersome record-keeping of deals on Excel spreadsheets.
But as to how it will directly affect brokers, Iger said, “Technology is making it more transparent and easier to find space. But that’s not the only thing that brokers do.”
On one end, he described a hypothetical with a broker taking a tenant to 10 spaces, trading paper on three or four, helping the negotiations and handing it off to an attorney—maybe staying involved in the negotiations for a couple more months. The broker finally receives a $500,000 check (gross payment), not from the client but from the landlord. “I think 99% of the time if the broker is truly being honest with you, they cannot say, ’Yeah, I provided $500,000 of value.’ That’s just the bottom line,” said Iger.
On the other end, he added that if you’re JLL’s Frank Doyle with an 18-month assignment to relocate Deutsche Bank into over a million square feet of space, accounting for significant dynamics with their relocation, their future growth or contraction, and how they tie into base building systems, that clearly points to the advisor’s providing value.Iger says VTS and similar technology will make brokers more service-oriented.
“They are going to need to provide financial analytics for tenants to make informed decisions on the terms of the lease that they sign,” he said. As an example of added value, Iger stated, “The broker can make sure that you’re asking the right questions to understand with how you operate your business if it’s the best building for you. It doesn’t and it shouldn’t come down to simple dollars and cents and whether I like the look of that lobby.”
The source who opined the software is more of a direct threat to brokers, stated JLL and CBRE are clients who also use the system—because the landlords who hire such firms require the brokers’ participation. However, Iger also noted brokers can use the VTS system as a tool to build tour books to show listings to tenant clients.—Betsy Kim