In honor of GlobeSt.com’s 10th year anniversary, we’re looking back at the last 10 years in commercial real estate. What’s happened? A number of big changes:
- the application on a large scale of securitization;
- the resulting influx of Wall Street capital into the US CRE markets, and the resulting easy credit;
- the increasing aggregation of CRE ownership into larger entities;
- the development of complex capital stacks at the individual loan level;
- the parallel development of complex tranches of debt at the loan pool level;
- the commoditization of real estate lending;
- the crash of real estate values when the real estate lending bubble burst;
- the ongoing clash between the regulations and assumptions governing Wall Street’s investments into CRE (through CMBS bonds) – based on securities laws – and those that govern real estate – based on traditional local real estate practices, and the inherent limitations on the uses and real value of real estate;
- the rise of the “BRIC” (Brazil, Russia, India and China) economies;
- the increasing concern over reducing carbon based fuel use and developing sustainable/green alternative energy sources and ways of doing business.
What do these all have in common? Virtually all of these disparate changes have been driven, at least in part, by the ever-increasing development and application of computer technology around the world and in our industry.
Very simply, computer technology – pronounced dead by some during and after the 2000 – 2001 tech crash – is bearing fruit in simple and complex ways, which are ultimately changing how everyone in the world does business, assesses risks, and understands the world – and is also changing the world of US CRE and (maybe) that last proud holdout, legal practice. 21st Century technology may not be as glamorous as the jet-pack future we expected when I was growing up, but is every bit as disruptive as imagined, if not more so.
First, the rise of the BRIC economies. Computer technology has spurred globalization.
The ability to use the Internet to communicate across time zones, and for computerization of design and product development from computer chips to movies to engineering services has allowed multinational corporations to profit from arbitraging the costs of labor (and the equally important, but frequently hidden, costs of environmental regulation) around the world. (It has also radically shortened delivery times and improved inventory management for most businesses.)
This movement of manufacturing, and some services, to less developed countries has led to the development of huge educated classes in the BRIC countries yearning only for a chance to make it – and a corresponding flight of jobs from more developed and expensive Western countries to the BRIC and other lower cost countries. Those jobs created huge aspiring middle classes, all seeking to emulate the developed countries’ standard of living. Their demand, in turn, has spurred huge internal growth in the BRIC countries.
This has led to tremendous demand for raw materials, and likely will also lead to huge demand for energy, food and manufactured objects, as even more people worldwide seek to improve their standards of living. These trends, along with the ability of more and more people in our service economy to work remotely, is also changing – and likely lessening – the demand for CRE in the US, and also is changing how commercial real estate will be used in the future.
Second, the growing interest in renewable energy and sustainable ways of living and doing business comes partly from the rise of the BRIC economies. And part of it is motivated by a desire for energy security: simply put, we’ve fought too many wars for oil – we must develop a better alternative so we can no longer be held hostage by our energy demands.
But additionally, the interest in all things green has increased over the last 10 years because there’s more and more data available – and more of it can be collected, collated, and processed – with the help of computers – so that meaning can be derived from the amorphous blobs of data. This information is making it harder to ignore the impacts of humans (and our massive population growth) on the natural world.
(The idea that one should clean up after oneself and not pollute thoughtlessly, or not create – or applaud – a wholly disposable material culture is not a new one: my Depression survivor aunts, raised on a Midwestern dairy farm, had what can only be described as a family mantra, repeated to all of us cousins as a quasi-religious guide to life: “Use it up, wear it out, make it do or do without”, which seemed wildly old fashioned – even dowdy – to my modern suburban know-it-all self in the 1960’s and 70’s. Funny how right they were, and how old ideas come back into vogue. But I digress.)
Finally, all the changes we’ve seen in the CRE finance world resulting from the influx of Wall Street money, including the bubble in real estate values caused by easy credit and the resulting crash, are related to each other – and to the increasing use of computer technology.
Without the ability to crunch large amounts of data concerning the default rates and other financially relevant information, the promoters of securitized loans could not have developed persuasive models for the likely risks of default for the various tranches of their loan pools.
Essentially, these models treated each piece of real estate as if it were made up of a set of basically fungible variables that, when abstracted, would perform like any other piece of real estate that had the same variables. That’s essentially an abstract, “securities” outlook.
By contrast, a more traditional “real estate” outlook evaluates each real property as unique: for example, assessing whether a given retail corner is worth more or less than the other three corners, depending on whether it is on the “going home” side or on the “going to work” side of the street. While the truth likely is somewhere in the middle (pieces of real estate may not be absolutely unique, but are not as easily comparable and predictable as the Wall Street models hold), the abstract securities view of real estate requires numerical assessment of large quantities of data about large numbers of buildings in order to develop believable – and saleable – models on which investors would base investment decisions. (Of course, as with all models, the assumptions made in the models drive their ultimate accuracy, and the current rise in default rates demonstrates how difficult it is to account for all possibilities in such assumptions.)
The trend is for more and more development of computer programs to allow people to do things they want to do more easily and quickly, and at a lower cost. Obviously this trend has radically changed property management and portfolio management; I expect over time it will even creep into the practice of law, driving greater efficiencies in the production of documents. (It has done so to some extent to date, but frequently badly for a number of reasons, often resulting in expensive litigation.)
I expect we’ll see much more of an impact on commercial real estate demand and use in the US as more computer programs drive more efficiency throughout every business that is a user of real estate – and every business process. I hope we’ll get collectively a lot smarter about understanding what computers do well, and do poorly, so that we can make more critical evaluations about the models – and their conclusions – on which we build our own business models. Hang on tight – I expect the next 10 years will be as wild as the last, as our industry must respond to these global changes.
*Source GlobeStreet.com
