Our Thesis on Innovation in Commercial Real Estate

Summary

• Multiplicity (Innovation Consultancy) and Kanata Ventures (International Venture Fund) are focusing on Commercial Real Estate
• Commercial Real Estate is experiencing three causes of disruption simultaneously
• WFH and the rise in eCommerce (driven by COVID) have changed the dynamics of all four major real estate asset classes
• Based on almost 6 months of conversations with industry contacts and our work in CRE innovation over the last 3 years we have developed a thesis on technology adoption in the CRE industry
• Since mid August, we have conducted +20 discovery conversations with 17 contacts across 13 Canadian and International CREs with an aggregate AUM of +$280B. We shared our thesis, collected feedback and compiled our learnings below.

Summary of Our Thesis

1. We think there are 8 aligned innovation objectives across CREs, unifying asset owners, property operators, integrated and facilities managers etc.
2. We argue technology contributes to value creation in CRE more than it is given credit for (value creation extended beyond the traditional location, location, location thinking)
3. We have developed a technology and innovation roadmap for CRE (explored in Part 2)
4. We have identified 8 key technologies of where to start first in your innovation journey (explored in Part 2)

Why Now

During the first COVID lockdown in mid 2020 we spent a lot of time thinking about the sources and causes of disruption to business operations. The result of that thinking became our framework called Disruption Resilience, which we use to predict and analyze disruptive risks to incumbent businesses. We have since packaged this style of thinking into an Innovation Team & Executive Team joint planning workshop, which you can read more about here. As part of our Disruption Resilience framework we identified three sources of disruption:

What we find it interesting is that, for the past couple of years, Commercial Real Estate has been experiencing all three forms of disruption simultaneously, and we expect this will continue to for the foreseeable future.

Business Model & Technological Innovation

It’s no secret that the PropTech space has been buzzing with new startups and venture capital investments for a few years. Anecdotally, it wasn’t hard to curate a list of mainstream business and technology publications (non-CRE industry) such as Forbes, NPR, NASDAQ, CrunchBase, TechCrunch covering recent PropTech industry developments.

Using a more empirical approach, according to data pulled from CrunchBase, global venture capital investment into real estate focused startups was approximately 550 deals (gold line) and $10B invested (blue bars) per year over a 5 year average period (see graph below).

Disruptive Events: WFH & Tenant Experience

The entire CRE industry is acutely aware of how the COVID lockdowns caused the WFH movement and the rise of eCommerce shopping, which changed the dynamics of all four major real estate asset classes. WFH caused a downward pressure on the demand for office assets and upward pressure on residential assets. Meanwhile, the rise of eCommerce shopping put and downward pressure on retail assets and upward pressure on industrial assets.

Specifically focusing on office assets for a moment, desirable tenants who are less price sensitive to high face rates (both strong inputs into Cap Rate) are often technology companies, financial firms and professional services firms. What these tenants have in common is the fact that they all highly value premium office space as part of their corporate cultures and use their spaces as one of the perks to attract top knowledge-based talent. Their employees are highly mobile. They have the option for some kind of hybrid work schedule, and have been enjoying all of the comforts of working from home while they adapted over the last 1.5 years. This means for these desirable tenants and their highly mobile employees, the bar has been raised for the tenant and occupant experience to attract employees back to the office environment (unless employer mandated).

The Economist ponders:

“As companies try to tempt workers back to the office, developers and investors are betting on new buildings with alluring amenities. But a huge uncertainty hangs over them: will enough people come?”

“Covid-19 has sharpened the demand for newer buildings with better facilities. JPMorgan Chase, a bank, will reduce its overall office space even as it builds the second-tallest skyscraper in Manhattan for its new headquarters. More than half of tours across New York City by prospective tenants are of high-quality “Grade a” offices, compared with 38% before covid-19.”

PitchBook notes:

“Leading tech companies including Microsoft and Salesforce have signaled that they intend to pursue a hybrid model. Salesforce went as far as to cancel a lease for 325,000 square feet of office space in San Francisco.”

The combination of increasing supply of venture funded startups building CRE industry focused solutions with the increasing demand of desirable tenants for high quality spaces and experience should create a growing demand for innovation adoption.

Our Thesis on Innovation in CRE

Based on numerous conversations with industry contacts [Note 1] over the last 6 months and our work in CRE innovation over the last 3 years, we have developed a thesis on technology adoption in Commercial Real Estate. Our thesis is based on four key beliefs:

1. We have identified 8 aligned innovation objectives across the majority of CREs (unifying Asset Owners/Managers, Property Operators, Integrated, Facilities Managers etc.)
2. We believe technology and innovation plays a significant role in the overall value creation for CREs. We argue technology contributes to value creation in CRE more than it is given credit for (value creation extended beyond the traditional location, location, location school of thought)
3. We have developed a technology and innovation roadmap for CREs (explored in Part 2)
4. We have identified 8 key technologies of where to start first in your innovation journey (explored in Part 2)

8 Aligned Innovations Objectives of CREs

The first traditional industry thinking we want to dispel is the idea that Asset Owners, Property Operators, Integrated, and Facilities Managers don’t have any innovation objectives in common. On the contrary, we have validated that majority of CREs have varying mixtures of the same 8 innovation objectives:

Technology’s Contribution to Value Creation in CRE

The next traditional industry thinking we want to dispel is the idea that technology only plays a minor role in creating value in CRE portfolios. As touched on earlier, the traditional industry thinking is that value in CRE comes from location, location, location. In the diagram below, we deconstructed the BOMA definition of Class A buildings as a proxy of a desirable asset. We segmented the sources of value into three categories of Physical attributes technology adds no value (i.e. number of floors), Digital attributes that technology adds significant value (i.e. data collection), and Phygital defined as physical attributes that are incrementally improved by technology such as smart building systems.

Industry Feedback & Learnings

We pride ourselves on our unique perspective and approach to corporate innovation, which is influenced by our entrepreneurial DNA. Sean and I have each co-founded and built several startups over our careers. Specifically what makes our approach unique is that we will flip components of the Startup Playbook into the context of corporate innovation. One of the tools in our toolkit is a tactic to gather customer feedback popularized by startup Godfather Steve Blank called Customer Development.

Since mid August, we have conducted +20 discovery conversations with 17 contacts across 13 Canadian and International CREs with an aggregate AUM of +$280B. We shared our thesis, and collected feedback.

Breakdown of our Audience

77% of the firms we talked to had some version of asset ownership business model (purely Asset Manager or Integrated). 46% of the firms had some version of a property operations business model (purely Property Operators or Integrated). 66% of the firms participated in development of new properties.

Almost all (92%) of the firms we talked to had exposure to Office/Commercial, while most (69% for each) had some mix of Multi-residential, Retail and Industrial.

Real-World CRE Innovation Objectives Versus our Thesis

Earlier in this post I identified the 8 aligned Innovations Objectives of CREs from our thesis. Much to our pleasant surprise the innovation objectives disclosed by our contacts aligned almost perfectly to our thesis, with one notable exception: Culture.

We didn’t expect culture to be an objective identified by those organizations we spoke to but, this is also a pleasant surprise. The culture objective can be summarized by the idea that innovation teams do not have infinite headcount and therefore cultivating a culture of innovation across the entire CRE firm is imperative to rapidly identifying and solving problems and implementing projects.

Key Takeaways

• Commercial Real Estate is experiencing three causes of disruption simultaneously
• There is an increasing supply of venture funded startups building CRE industry focused solutions. This, combined with the increasing demand of desirable tenants for high quality spaces, tenant experience, the industry trend of upgrading of older or lower class buildings, and the repurposing of space [and this recent announcement from Oxford] should create a growing demand for innovation adoption.
• Asset Owners, Property Operators, Integrated, and Facilities Managers all to have some varying mixtures of the same 8 innovation objectives
• CRE Innovation Teams do not have infinite headcount and therefore cultivating a innovative corporate culture is becoming an increasingly important objective

Coming up in Part 2

As mentioned in the beginning of this post, we have two more arguments to our thesis left to discuss:

1. We have developed a technology and innovation roadmap for CREs
2. We have identified 8 key technologies of where to start first in your innovation journey

Notes, Sources & Additionally Reading

• Multiplicity is a Toronto-based Corporate Innovation Consultancy. We leverage our diverse backgrounds and entrepreneurial DNA to approach innovation and problem solving with ownership, customer empathy and non-obvious thinking.
• Kanata is a Canadian venture firm focused on creating opportunities in the Canadian Startup Ecosystem. We collaborate with partners to attract the best global B2B founder teams to settle in Canada.
• Multiplicity’s Disruption Resilience: Executive & Innovation Teams Joint Planning
• 09/23/ 2021 — CrunchBase How Proptech Benefits From The Squeeze Between Investors And Institutions
• 08/03/2021 — NASDAQ: Take Real Estate Tokenization to the Next Level
• 08/24/2021 — NPR: A Startup Is Turning Houses Into Corporations, And The Neighbors Are Fighting Back
• 07/12/2021 — Forbes: Seven Ways Technology is Disrupting Real Estate
• 06/03/2021 — The Economist ​​What a work-from-home revolution means for commercial property
• 04/01/2021 — PitchBook: From WFH to WF?: Data startups tackle office uncertainty
• 10/26/2021 — Bloomberg: Fifth Avenue Building Set to Test Market for Older NYC Towers
• BOMA CANADA: What Is A Class A Building?
• CrunchBase: 2017 to 2021 YTD Global Venture Capital investment into real estate focused startups
• The Lean Startup by Eric Ries
• Customer Development by Steve Blank

Special Thanks

Note 1: Special thanks to John Chung at QuadReal and Adam Kanza at Montez for taking numerous hours of their time since June to help us craft, flush out and provide feedback on this thesis.