Commercial Real Estate Innovation

Many of my friends, colleagues and clients work in the commercial real estate industry. Even after the credit markets come back, commercial real estate will be engaged in some exciting and fundamental transformation. A comment left on my real estate blog at The Real Corner elicited two interesting questions from Mark Waligora of Pinetree Commercial. He asked,

"What are the trends that we can anticipate and take advantage of as stakeholders (principals, brokers, lenders, tenants) during this transformative cycle? Where are the hackers in our industry?"

As I attempted to answer the questions, I decided to focus on two key trends that help me to understand what is happening and what may happen in the future. There are, of course, many macro trends affecting this sector; demographic trends, changes in technology, economic growth, debt and equity, legal structures and a new regulatory environment are all very important. But I believe that these two sometimes overlooked trends have a tremendous amount of potential to transform commercial real estate. They are:

1. Office and Retail need less space per person.
2. Sustainability and Energy Use issues will not go away.

To start with, it is time to acknowledge that that square feet use per person is on a downward trend - both in office space and in retail - and is unlikely to jump back up once the recession is over. The second baby boom will help offset the loss of square footage demand as new workers enter the workforce, but as the use of the Internet, mobile networking, flexible office space and on-line retailing only increases, population growth cannot keep up with the fundamental shift in how our society uses real estate.

When it comes to office space, why do businesses need to have large private offices when the average desk chair is only occupied 30% of the time from 9 to 5 Monday through Friday? They don't - and more and more businesses large and small are reducing their square footage per person. It's no longer a flaky idea to have flex office space and telecommuting. With everyone using a laptop computer and a cell phone, offices no longer house all the tools for people to work. The remaining purpose of office space may ultimately be to conduct meetings and brainstorming, not sitting at a computer and taking calls, that can be done in any number of places. Commercial real estate service companies have been advising corporate clients for quite some time on how to better use - and ultimately decrease the total amount of space they use for offices. Owners of office buildings that understand that will have far more luck keeping their buildings occupied.

In retail real estate, some of the most imaginative, innovative and frankly brilliant real estate pros work in retail. However more and more people now use the Internet for entire categories of purchases - such as books, electronics, groceries, and clothing. Even though there will always be a need for some form of in-person retailing - it will require a lot less space. Retail real estate must come up with another use for all those empty shopping centers - otherwise yesterday's community big box center will become tomorrow's community problem. For more on retail vacancy read this interesting overview in a blog regarding "ghost boxes" here.)

Secondly, energy and sustainability issues will not go away - they will only become more important. A third of the energy used in this world and almost half of the release of carbon in the atmosphere is related to buildings. That means that real estate is equally as important as manufacturing and transportation when it comes to solving the issues of global warming and energy use. This is about more than getting a LEED certification on the corporate headquarters building. Every real estate investment and every lease needs to be looked at with energy use and carbon in mind - not because it's the right thing to do - but because it will have more and more of a financial impact on the profitability of that asset every year. Do not be fooled by temporary lower energy prices and a slow government's reluctance to initiate a carbon tax. This stuff is coming, and those real estate players - whether they are investors, developers, owners, brokers, managers or corporate users will get burned if they don't pay close attention.

At some point very soon, the environmental impact of a building may have as much importance as its location. The players that figure that out first will have the advantage.

Who are the hackers?

You can find them everywhere - they are the people who are trying to redefine their jobs and their companies - the tenant reps that are positioning themselves as portfolio consultants, the investment sales reps that are figuring out where the new sources of capital are coming from, and the owners, brokers, tenants and managers who are figuring out how to make the energy and environmental crisis work for them.

Why are they hacking?

Recently an industrial real estate guru and friend, Sam Foster, sent me his insight on innovation that is particularly relevant to that question,

"No one innovates until survival requires it. Yes, there are the neurotic few that can't help themselves, but for most of us, not so. Getting laid off and not being able to find another job requires one to innovate."

Real estate professionals, even if they still have a job, are seeing their old sources of income shrink or even dry up. When buildings aren't flipping every couple of years or companies doubling in size every couple of years, real estate, by necessity, has to figure out how to make a living again. Commercial real estate is a transaction business at its heart, and when the transactions slow down, the best people in the industry will work towards finding the next great opportunity.

It is not an easy time to work in commercial real estate, but it may be one of the most important times. If real estate professionals can solve for the two trends of diminished per person space and sustainability, they will go a long way towards building a brighter future.