Fans of disruption and technology will be familiar by now with the term fintech. But in recent years the disruptive world of alternative finance platforms, payment processors and cryptocurrency fiends has been joined by a longer list business impacted by ‘tech’ -InsureTech is the next big new thing followed by Reg9ulation)Tech. Now we have a new ‘tech’ to add to our ever-growing list – PropTech. In fact, this new disruption is so old in the tooth that it’s already arrived at its third iteration according to a new report which I think is essential reading for anyone interested in investing in real estate assets. The paper is called Proptech 3.0: the future of real estate by academics at the University of Oxford, led by Andrew Baum.
It’s a cracking paper and I thoroughly recommend downloading it here.
So, what exactly does Proptech consist of then? According to the report there are three PropTech sub-sectors (verticals), and three drivers (horizontals). The verticals are Real Estate FinTech; Shared Economy; and Smart Real Estate. The horizontals are information; transactions (or marketplaces); and control.
“Smart Real Estate describes technology-based platforms which facilitate the operation and management of real estate assets. The assets can be single property units or entire cities. The platforms may simply provide information about building or urban centre performance, or they may directly facilitate or control building services. This sector supports real estate asset, property and facilities management.”
“The Shared Economy describes technology-based platforms which facilitate the use of real estate assets. The assets can be land or buildings, including offices, shops, storage, housing and other property types. The platforms may simply provide information for prospective users and sellers of space, or they may more directly facilitate or effect rent- or fee-based transactions.”
And finally, …
“Real Estate FinTech describes technology-based platforms which facilitate the trading of real estate asset ownership. The assets can be buildings, shares or funds, debt or equity; ownership can be freehold or leasehold. The platforms may simply provide information for prospective buyers and sellers, or they may more directly facilitate or effect transactions of asset ownership or leases with a (negative or positive) capital value. This sector supports the real estate capital markets.
Why should we all get excited by these developments? The report highlights the increasingly obvious deficiencies of real estate as an asset class. Drawing on the research of Andrew Baum it lists the following distortions:
- “Property is a real asset, and it wears out over time, suffering from physical deterioration and
obsolescence, together creating depreciation. The cash flow delivered by a property asset is controlled or distorted by the lease contract agreed between owner and occupier. US leases can be for 3 or 5 years, fixed or with pre-agreed annual uplifts. Leases in continental Europe may be 10 years long, with the rent indexed to an inflation measure. Leases in the UK for high-quality offices are commonly for 10 years, with rents fixed for five-year periods after which they can only be revised upwards.
3. The supply side is controlled by planning or zoning regulations and is highly price inelastic. This
means that a boom in the demand for space may be followed by a supply response, but only if
permission to build can be obtained and only after a significant lag, which will be governed by the time taken to obtain a permit, prepare a site and construct or refit a property.
4. The returns delivered by the property are likely to be heavily influenced by appraisals rather than by
marginal trading prices. This leads to the concept of smoothing.
5. Property is highly illiquid. It is expensive to trade property, there is a large risk of abortive expenditure, and the result can be a very wide bid-offer spread (a gap between what buyers will offer and sellers will accept).
6. Property assets are generally heterogeneous and large in terms of capital price. This means that property portfolios cannot easily be diversified, and suffer hugely from specific risk. Research and due diligence costs are significant.
7. Leverage is used in the vast majority of property transactions. This distorts the return and risk of a property investment.
8. The risk of property appears low. Rent is paid before dividends, and as a real asset property will be a store of value even when it is vacant and produces no income. Its volatility of annual return also appears to be lower than that of bonds. This is distorted somewhat by appraisals, but the reported performance history of real estate suggests a medium return for a low risk, and an apparently mispriced asset class.
9. Unlike stocks and bonds, real estate returns appear to be controlled by cycles of eight to nine years.
10. Real estate is time-consuming and expensive to manage.
Proptech aims to overcome some of these factors and limitations via the judicious use of technology – and new business models. The complex looking graphic below maps out the various businesses looking to provide a solution to making property more liquid, more accessible and more transparent – and increase productivity.
From a practical point of view, my suspicion is that most real estate investors will focus on the conclusion for a vision of what might matter in the future.
The following excerpt sums up nicely what I think is on its way for investors: my emphasis below is in italics below
“The growing confusion between retail and logistics space seems set to continue as drones and driverless cars facilitate last mile delivery. Again, the rebound of suburban development to hold warehousing and delivery functions alongside the automated office seems likely. Driverless and automated vehicles will change parking locations, which should move to the urban periphery.
“Changing land use patterns will have a knock-on effect on residential locations. Continuing urbanisation and the vertical city dependent on rail transport for lateral connections will be encouraged by big tech, and it is those high rise vertical constructs that will lend themselves to smart building technology, the Internet of Things and flexible use – co-living, co-working and flexible rental/ownership. Rural areas will focus more on agriculture, energy production, leisure, second homes and retirement/senior living. We can expect a reaction against urbanisation and automation, and a second hippy movement focused on tiny homes, traditional crafts and rural life. There will more jobs for carers and social entrepreneurs.
“Investable real estate will continue to migrate to new uses, mixed uses and social infrastructure. As offices, retail and logistics continue to evolve and mutate, the risk of these formats will rise, encouraging much greater investment in residential and social enterprise – sectors that will require large private investment in the face of reductions in government spending.
“Student housing has already become a mainstream investment market; other emerging private real estate sectors will include schools, universities, hospitals and medical centres, prisons, data centres, a new generation of re-cycling plants creating energy and value from ever-increasing obsolescence and waste, parking for automated vehicles, fuel storage and generation facilities and senior housing parks. Co-working, co-living, vertical spaces and micro urban apartments will be supplemented by tiny rural homes.
“It seems highly likely that the sector definitions which we are currently familiar with – office, retail, industrial – will fade in importance as the multi-purpose high-rise building (already evident in cities such as Hong Kong and New York) will grow in dominance. More clustering of urban centres and vertical travel between co-living space, co-working space, corporate HQ, hotel/gym, shopping centre, school and medical centre is a natural development requiring only more flexible planning regulations and inventive design.”