How Digital Technology can play a Bigger Role in Creating Real Estate Value.
Introduction
Real estate, from both an asset and industry perspective, is about two things: cost and value (which, depending on how you look at it, is really just one thing seen from across the table...). This is a fundamental understanding for anyone engaging with the commercial property market, and this reality is reflected in the fact that a building's worth is based on the price to build it, the price it can be sold at, the price it can be leased at, and the cost of owning it. Yet, as the industry evolves, our perception of how value is created and managed during the lifecycle of a building needs to expand to include new elements, such as the role of digital technology in influencing price, rent, and cost.
The Static Nature of Buildings and the Digital Challenge
Buildings are static objects—fundamentally physical structures that primarily function as shelters and facilitators of human value-generating activity. A building's market value is based on covering the cost to build and operate the structure, plus the value it adds to the people who use it.
Buildings are spaces where people live, work, and play, with the value of these activities reflected in their rental or purchase price. Introducing digital technology to this equation doesn't automatically translate to added value. Adding new technology incurs costs, and rarely are buildings bought, leased, or sold based on their technological enhancements alone. However, it is not a stretch of the imagination to conclude that there must be a role for digital technology in buildings to help us operate them more effectively and make them better places for their occupants.
The real estate industry has seen elements of this benefit through decade-old technological innovations such as building management systems (also known as building automation systems) and digital control systems.
The challenge in connecting the hypothesis of added value from digital technology to real-world value lies in its indirect relationship to measurable monetary benefits. The benefits of more digital technology are notoriously difficult to measure and prove. Consider the 3-30-300 rule (originally developed by JLL), which suggests that a company spends approximately $3 on utilities, $30 on rent, and $300 on payroll per square foot per year. In essence, this rule sets out the value landscape, where the majority of financial costs—and, subsequently, the opportunity—reside within the users of buildings rather than in operation. This is exactly where technology needs to be focused to truly demonstrate an impact.
Market Dynamics and Stakeholder Perspectives
Throughout my consulting career, I've encountered both techno-optimists and more than a fair share of techno-sceptics. The scepticism often levelled at technology covers two main criticisms: firstly, a fundamental lack of belief that any form of new technology has something useful to offer (as a consultant, I usually give up on winning this argument), and secondly, that the benefit delivered by technology is so hard to measure that investors worry they won't get any return or even be able to build a business case around it.
This latter challenge is easier to overcome, but it still relies on investors adjusting their mindset and adopting a more strategic approach to technology investing. A comparison that exemplifies the required mindset shift for some technology investments is the cost of aesthetically pleasing architecture. While this doesn't apply to all buildings (there will always be a need for cookie-cutter designs), real estate investors are comfortable with the idea that paying more for an architect to create beautiful buildings positively impacts the ultimate asset value.
Simply put, investors understand that a beautiful, aesthetically pleasing building should cost more than an unattractive, generic one. However, this same logic is rarely applied to digital technologies that can make a building a more pleasant space to occupy. While digital technology will rarely achieve the same impact as good architecture, a shift towards incorporating technology as an intrinsic part of the building fabric will pull investors closer to seeing it as a fundamental element that adds value.
Strategic Investment in Technology
The real estate landscape is rapidly changing. Factors such as fluctuating energy costs, new ways of working post-pandemic, and the existential need for more sustainable buildings are all significant market drivers. Moreover, the real estate market involves multiple layers of stakeholders, each driven by a need to see value returned but differing in their operational focus and priorities. This spreads the perceived value of technology, making the return on investment (ROI) margins lower and more decentralised.
Investing in real estate technology must therefore be strategic and cater to the financial characteristics that attract relevant investors. As we've seen time and again, overarching economic conditions can drastically impact the behaviour and growth of the real estate industry. When borrowing costs rise, real estate slows down, making investment in hard-to-measure technologies almost impossible to justify based on a short-term outlook.
While some investors can afford to look ahead to the inevitable economic recovery, others are forced to react to navigate immediate market headwinds. For these investors, the key is to focus on technologies that directly reduce operational costs or introduce innovative features capable of commanding a premium. The most successful technology projects in real estate are those where the value and beneficiaries are clearly defined.
A Layered Approach to Investment
Regardless of market conditions, a layered approach to technology investment is typically the most successful. A foundational layer of technology investment should involve technologies that provide clear operational savings and reduce the cost of asset ownership; this creates enough 'fat on the bone' to fund other technological investments. For example, it is common to invest in energy-saving technologies to save capital that can then be reinvested into value-generating opportunities, such as digital engagement technologies that improve user experience.
In the long term, all new technologies in a building must demonstrate value. The benefit of using savings to offset additional investment is that it significantly reduces the capital risk of investing in new technologies and makes the business case much easier to justify. This conclusion isn’t rocket science, but it is dependent on investors adopting a different perspective on technology. Investing in digital technology isn’t akin to investing in LEDs—technology can fundamentally shift how well a building works and how much that building is worth.
