Flash Boys in Flash(y) Buildings

The Increasing Importance of “Fiber” in Commercial Real Estate

by Ali Ayoub & Nils Kok

In his NY Times bestseller “Flash Boys” Michael Lewis describes how hedge funds and other investors beat the market by being able to trade faster than competitors (perhaps helped by a bit of insider insight, but that’s an aside, and better described in another great read, Black Edge). The book starts with a detailed narrative on the digging of a trench for a fiber cable between Chicago and New Jersey, to reduce by milliseconds the time it takes for orders to reach the Chicago Mercantile Exchange. Equally impressive are Lewis’ insights into how investors buy buildings or locate servers in buildings closest to the NY Stock Exchange.

Based on Flash Boys, one could argue the old adage of the real estate sector “location location location” is as relevant as ever in today’s internet-based society. It’s just that the factors that make for great locations have changed. Beyond the ever-increasing importance of access to public transport and a 24/7 vibrant neighbourhood, access to fast internet — or “fiber” in industry jargon — is now among the top priorities of choice tenants. Mind you, today’s most desirable tenants are no longer just good-old financial services firms, banks, and household names in manufacturing. Facebook, Apple, Netflix, Google (the FANG stocks, or FAAMG stocks), as well as WeWork (currently the largest tenant in New York) and many of the other space-sharing companies, now stake a claim among tenants rapidly increasing their footprint in the office sector.

Fiber Accessibility As an Amenity

For tech companies, space-sharing companies, and banks (with trading floors) alike, fiber accessibility is paramount. Whether it is for cloud-based computing and data services, or for trading purposes, the speed of internet matters — a lot. An illustration in point is the well-known example of Google’s first NY office, located in Chelsea, bought in 2010 for a stunning USD1.9bln (in cash, mind you). As astutely described in this article “the appeal [of the building] probably lies in the fiber-optic cables transmitting high-speed data that lie under the former Port Authority building, primarily the “fiber highway” along Eighth Avenue/Hudson Street and Ninth Avenue that’s considered one of the most vital connection points to the world’s telecommunications networks.” More recently, Google added another building on Chelsea market to their portfolio, this time paying USD2.4bln (cash only, please) to Germany-based fund manager Jamestown.

Measuring “access to fiber” can be done in many ways — it is not a top secret where such cables are located. The map below (from Durairajan et al., 2015) shows the main fiber cables across the US. The other map (from our GeoPhy colleague Daynan Crull) shows the main fiber cables in NY specifically. A real estate developer, investor, or (prospective) tenant could measure a building’s distance to the fiber cable to get some basic understanding of latency. If such an amenity is desirable for a sufficiently large number of tenants, real estate prices may start to differentiate based on distance to fiber cables. Anecdotally, that seems to be the case (e.g., the Google example), and there is some emerging empirical evidence on the value of fiber for commercial office buildings.

The long-haul fiber-optic network in the US (Source: Durairajan et al., 2015).
Source: GeoPhy

A Nutrition Label to Measure “Connectivity”

But of course, the connectivity of a building is more than proximity to fiber access alone. A building may be situated close to fiber cables, but its infrastructure may not allow for consumption of high-speed internet (also known as a building’s throughput). Enter Wired Certification. Established by WiredScore in 2013, Wired Certification is akin to a nutrition label for commercial office buildings, assessing the presence of all components that make for a “connected” building. An analogy can be made to the LEED label, which measures the sustainability performance of buildings. While unknown to some, Wired Certification has actually taken the market by storm in just a short period. It provides a simple-to-interpret tool that not only enables landlords to identify marketable connectivity features to promote best-in-class building internet access, it also provides a means for tenants to easily identify those properties that fit their current and future connectivity needs. Wired Certification is now present in 6 countries, with a focus on commercial office properties.

Wired Certification across the US and Europe (Sources: WiredScore and GeoPhy)

For institutional real estate investors, such as pension funds and insurance companies (e.g., CalPERS in the US), the increasing importance of connectivity in buildings has likely gone unnoticed. Such investors mostly invest in real estate indirectly, through private equity real estate funds and publicly traded property companies (a.k.a. REITs, or Real Estate Investment Trusts). But those REITs and private equity fund managers with the awareness to incorporate “fiber” into property and asset management may well be better positioned in the market for tenants. That foresight potentially leads to outperformance at the operational level, which in turns leads to the ability to beat the market at the stock level.

How Connected Are REITs?

To understand how REITs across the globe are adopting “building connectivity” as a theme, we analyzed the diffusion of Wired Certification across the 321 equity REITs included in the FTSE EPRA/Nareit Developed Index. This index is the globally leading REIT index used by most of the largest active and passive REIT investors as the benchmark of choice. Each quarter, GeoPhy collects information on the asset holdings of each of the 320+ property companies, including detailed information about location, property size, age, quality, and if available, net operating income and valuation or transaction price. We then match this dataset with information on Wired Certification (WiredScore provided the data). The resulting constituent list shows the fraction of each REIT’s assets that is Wired certified, both equally weighted and value-weighted.

In total, 38 out of 321 of the REITs in the FTSE EPRA/Nareit Developed Index have one or more assets that are certified by WiredScore. Although mostly US-based, several of these companies are in the UK, France, and Japan. On average, 13% of each REIT portfolio is certified, measured by the number of assets. Measured by space (in square feet), 15.3% of each REIT portfolio has Wired Certification, with larger buildings more likely to be certified. These averages, however, mask some important variations. For example, while the Empire State Realty Trust (owner of, yes, the Empire State Building) has 82.5% of its portfolio rated for its superior connectivity — with other NY-based owners such as Paramount Group and SL Green Realty also ranking high. London-based property companies Derwent and Workspace Group have 49–56% of their floor space certified. (Download the full list here.)

Of course, not all buildings with great internet infrastructure are Wired certified. That means these numbers likely represent an understatement of adoption and focus on internet accessibility by institutional landlords. It’s worth noting the increasing importance of connectivity is not limited to that of office buildings. Retailers also steadily rely more on consistent in-store connectivity, while industrial warehouses have a strong dependence on the internet for order intake, order processing and communication with downstream distributors (warehouse behemoth Prologis is on our list as well, albeit with a single building. . .). Additionally, fast and reliable internet connectivity for tenants in multifamily apartment buildings has become almost as important as running water (for some, it’s probably even more critical).

Flash boys, speculative investors, trade on speed while institutional investors trade on knowledge of fundamentals. The former benefit from access to fiber. The latter would benefit from better understanding which REITs have assets with superior connectivity. After all, flash boys want to be in flashy buildings, and the new “location location location” may soon be determined by access to the fiber highway, rather than the physical highway.