How to Create Value in Real Estate

Hint: It helps to know the future…

The best thing about real estate is that one could pursue a multitude of strategies and succeed. One could also pursue a multitude of strategies that fail, as well.

In commercial real estate, just like anything else, there is a fair amount of both skill and chance that are involved across every outcome.

The Skill vs Luck Continuum from ‘The Success Equation’ by Michael J. Mauboussin.

Here are some examples of each:

Skill

An investor buys a building in an established market that is not fully occupied by tenants (we’d say “leased up”), invests in upgrades to the building to attract tenants who will pay market rent, and is able to turn around and sell the building for a considerable premium.

Chance

Silicon Valley’s Continued Technology Boom has driven job creation, population inflows, high household incomes, competition for office product, and restrictions on development (to name a few), which has made the Bay Area (Silicon Valley, San Francisco, and the East Bay) a home run investment area for those who were early and established it as a core market for institutional investors.

The New Normal

In the past, (1) having market data around recent deal trades, demographic and market trends, and where leases are currently pricing, (2) being an effective and efficient operator that could achieve market rents and minimize expenses, or (3) knowing investors and banks who could finance deals with attractive capital costs would almost guarantee relative success compared to competitors. But with technology tools like CoStar, Real Capital Analytics, REIS, and others, deeper specialization, and broad capital market exposure provided by commercial brokers and investment banks, these skills are still necessary, just not sufficient anymore. We’d probably liken this to beta.

Unlocking Value

Real relative value, or alpha, is created by getting ahead of major trends before the market has recognized these trends to be the new normal. A good example of this is the office investors who purchased cheap, underutilized warehouse buildings in SoMa with the intention of converting them into cool, open floor-plan office space for venture-backed technology companies. Externally, these investors might have looked a bit crazy buying empty buildings in less desirable locations, but they might have seen the influx of technology companies from the Valley to San Francisco and the desire for cooler office space to attract and retain talent. As this trend played out, these investors couldn’t have looked smarter. They also made a fantastic return on their investments.

Future Trends

Some of the biggest future commercial real estate trends that I am trying to understand strongly relate to the major new technologies we use on a daily basis:

  • How does Uber, Lyft, and Google’s self-driving car change transportation, how people think about city living, and even better uses for garage space?
  • How does AirBnb and HotelTonight change the hotel and multifamily industries?
  • How does co-working (WeWork), co-live (Common), and inexpensive mobile productivity tools (Google Work, Microsoft Office 365, Dropbox, Box, etc.) change where and how we live work and interact?

It’s exciting to see how influential current technology trends will be for future real estate development and investment.