Commercial real estate is in the midst of a digital revolution, and some of the biggest upheavals will affect professionals who work closely with property owners and tenants.
TECHNOLOGICAL INNOVATION is accelerating in the commercial real estate space, and it has the potential to disrupt a large segment of the brokerage business.
In 2017, according to CREtech, more than $5 billion was spent on developing and implementing real estate-related technology, and there are more than 3,000 developers working on real estate software systems in the United States alone. Blockchain, artificial intelligence, machine learning and predictive analytics will change the way real estate is leased, sold, sourced and valued (see more on page 52). These technologies will improve direct interaction between property owners and tenants and challenge the very need for a broker to be involved in many lease transactions, significantly reducing commissionable activity.
The residential real estate space shows the two directions technological innovation can take. The first direction is digital technology that empowers agents. The second direction is coming along more slowly, but it is where technology displaces agents by empowering sellers and buyers to do most, if not all, the sourcing, market comparisons, showing, negotiation and processing of documentation involved in a transaction.
The “Sins” of Commission?
In commercial real estate, the commission system of compensation has always been troublesome for the property owner. Brokers play an integral role in creating an income stream for properties, but the downsides are the high transaction costs and loss of control for the property owner. Additionally, tenants rarely (if ever) have any idea the degree to which using a broker to find space and negotiate a lease has affected what they pay over the lease term. That’s because the commission is almost always paid by the property owner without disclosure to the tenant.
Tenants have not been able to assess whether a broker created more value (or saved them more money) than the lawyer who drafted and negotiated the terms of the lease for an hourly fee. Brokers get a huge commission for showing space, while lawyers make significantly less for structuring an enduring contract that will guide the relationship between the landlord and the tenants for years, sometimes decades. Additionally, it’s been difficult for tenants to determine if a broker was biased in the presentation of space based on a better commission from one building versus another, or biased toward property owners who pay commissions willingly versus those who resist paying the commission.
Perhaps the biggest reason property owners have problems with the commission system is that the cost of the commission is rarely aligned with the value of the work that earned the commission. Too often, full commissions are paid to brokers, even tenant representative brokers, who simply introduce a prospect. The property owner provides market comparables, prepares the letter of intent, moves through the negotiations and finalizes a lease. Complaining about the imbalance of this cost/benefit relationship to the procuring broker could result in a property being poorly presented or not presented at all in the future. Property owners have not had access to robust technology solutions that provide thorough, accurate market data or that could provide the marketing exposure needed. They have had to rely on brokers and accept that the commission was a cost of doing business.
A Technological Tipping Point
Today, brokerage firms are investing in and building out their own technological solutions for more extensive data collection and compilation, marketing, space visualization, client contact-management and other competencies. The assumption has been that the current commission structure will continue to support and pay for these investments. In many cases, the technology is designed to support an existing way of doing business that will not be embraced by the client base going forward, so they could well be building out the wrong technology based on an old business model.
The independent market is investing in another set of technology solutions to support the commercial real estate industry. Many of these will be “open” databases with information available to everyone, and they’ll eventually provide the type of market detail previously not available outside of research owned by brokers or expensive data providers. They will be resources for property owners, tenants, appraisers, brokers, lenders, facility managers and others. Ultimately, they will incorporate more in-depth information on property management, maintenance, capital investment, tenant features, tenant retention, contracts, transaction costs and a lot more. And much like consumers have found more access, control, pricing power, time savings and knowledge using Amazon to buy everything from books to dog food, these commercial real estate solutions will give tenants and landlords the same advantages and minimize the need for a broker.
A commercial real estate change that’s occurring as this technology is being developed is demand for “space as a service.” It’s powered by the growth of coworking and flexible space options. These solutions provide space quickly and for shorter terms that match a company’s ability to expand and contract with business and economic cycles. Rather than a lease, tenants sign user agreements that enable them to pick from a menu of space and service options.
Technology, transparency and “space as a service” will replace commissions with fee structures that are more closely related to the actual value created or added by the unique skills that a broker brings to the transaction — if and when a broker is even needed. As a result, the role of the broker will become more respected, meaningful and valued by those who pay a fee, directly or indirectly. While the number of commercial brokers will diminish, as will the number of brokerage firms, those who remain will look and act completely differently five years from now than they do today.
Prepare for Tomorrow Today
For those developing the new technologies to thrive and for those using them to prosper, some fundamental changes in assumptions or past methodologies should be considered and acted upon:
Make Information Actionable. Soon, everyone will have access to the same details about a property, tenant, landlord or investor. Many users will feel empowered and informed, and they’ll make commitments and decisions on their own. But not everyone will have the time or knowledge to draw meaningful results, applications or connections from the information. For brokers, the ability to cut through the clutter and pinpoint data relevant to potential customers will be the new value-add. Some already do this; others will need to follow suit.
Relationship Building. “Cold calling” to cultivate a potential new tenant client will be replaced by valid, meaningful, 360-degree research about tenants, potential clients, local market conditions and other factors that’s shared in a compact and understandable way with a much broader audience. Future success will require inclusivity and transparency, providing more information to boost relationships rather than for transactional benefit.
Inclusive Design. The best commercial real estate technology for the future must be designed from the perspective of multiple end-users, not just the brokerage team. The technologists need to seek out the best wisdom from multiple generations of developers, property owners, investors, relocation consultants, industry groups such as NAIOP, corporate real estate managers and other industry players, not just brokers and their organizations. Commercial real estate is learned from apprenticing, exposure to multiple markets, living through multiple cycles of the market and economy, failures, losing clients, not being able to find financing, and on and on. Technologies also need to consider non-urban marketplaces and efficiencies for small tenancies and property owners. Building platforms solely based on large, urban marketplaces won’t necessarily translate to the mass market. So one size will not fit all; a range of platforms will be necessary. They must meet the needs of institutional investors, individuals and small businesses, as well as everything in between.
Prepare for a Change in Accounting Standards. ASC 842 (Accounting Standards Codification), which goes into effect for publicly traded companies in 2019 and for private companies in 2020, requires businesses to include the entire rent stream of a lease as part of their reported liabilities on their balance sheet. Previously, rental obligations were only required to be summarized in the notes section of the financial report. To avoid the financial impact of this rule change, tenants will be looking for ways to reduce the rent liability, negotiating shorter lease terms or rent structures that separate out the variable portions from the fixed rents. Variable expenses, because they can’t be known by nature, would not need to be included as liabilities. Shorter lease terms and/or lowered rent basis will further impact commissionable income for brokers.
No “Broker” Needed. If technology enables a tenant to source all available space in the market that meets their needs and timetables; if a robot and 3-D imagery can show those spaces to them; if they can validate market comps, learn about the property owner, get detailed building information, review the lease form and submit an offer all on their own, what is left for a broker to do? When one is needed, it will be for a much more nuanced and sophisticated skill set. Tenants and landlords will still face complicated adjustments to the financial analysis of competing options. Mathematical wizards have creat-ed models for financial analysis. They are very good, except for one thing — they cannot adjust for or acknowledge the underlying market forces of supply and demand at that moment and in the specific sub-market where a transaction is being contemplated. This is when knowing the nuances of all the available data is critical and where a broker can add value.
Document Specialization. Well-crafted Letters of Intent and Requests for Proposals will become much more important for larger tenants or complex transactions. Customization and sophistication with these documents will tease out the details and nuances that really matter to a tenant and to the potential landlord. After that, the broker must perform potentially complex analyses on the unique responses that artificial intelligence cannot be expected to evaluate, because these specialized issues are qualitative and subjective.
Manufacturing Opportunity. Tenants who aren’t of interest to a landlord present a market opportunity for brokers. These might be companies with a poor reputation, strained financials, a hard-to-understand business use, start-ups, or those that are atypical for the market. A broker can help them with a good business case, making a market pitch for their tenancy, and clarifying realistic expectations for options. The broker can then be an informed and credible matchmaker. This requires in-depth strategic knowledge and thinking on the part of the broker to create deals out of seemingly unrelated opportunities.
New Ways to Use Information. As existing real property assets in this rapidly changing market are repositioned and repurposed, brokers can play a role in putting teams together to envision new futures for these buildings. They can use the information found through blockchain and artificial intelligence algorithms to hypothecate when a property has or will reach the end of economic viability, as well as demographic changes that could support new uses, cost/revenue modeling, and team creation based on the verifiable past successes of each member. This kind of deal mining will reduce risks, improve deal flow and reposition what was a “broker” into a professional real estate teammate.
New Traits and Mentorship Teams. Brokers of the future will need to be selectively hired, mentored and invested in so they can create steady income streams for their firms and themselves. Compensation will come from providing sound real estate strategy on a fee-for-service basis paid by the user, rather than a commission disconnected from the value to the user. Empathy, ethics, and social and emotional intelligence, combined with a willingness to deeply learn the real estate business from multiple viewpoints, will be the traits that distinguish successful new brokers of the future.
Rethinking Training And Education
As technology shakes up the industry, brokerage firms should retool their mentorship approach to new-broker training. Fresh ideas and outside perspectives are needed now more than ever as companies recalibrate for technology-driven expertise in the hands of millennials and the next generations. Find an opinionated, successful property owner or property manager, as well as a lender in the local market, to serve on mentorship teams. The property owner/manager will provide the unvarnished feedback needed to both focus and expand training approaches.
Many people in the industry have hilarious, sad or pathetic tales of cold calls by new, untrained and certainly unprofessional brokers. Unfortunately, these poorly trained brokers can tarnish the entire commercial real estate profession. It’s possible that a sincere effort on the part of the brokerage community to increase and improve its professionalism by seeking the input of those who have been paying commissions would be well received and productive.
Bringing a lender on to the mentor team provides another type of professionalism and a deeper awareness of underwriting, as well as knowledge about how to value and qualify a business or tenant prospect. Adding feedback loops would be the next important step. Brokers and property owners should have respectful discussions to dissect the pros and cons of the process each used in both successful and unsuccessful leasing efforts. This kind of qualitative and subjective discussion will benefit brokers and property owners and ultimately create a positive impact on the whole commercial real estate industry.
Adopting this expanded form of mentorship, professionalism and feedback will enhance performance and job satisfaction. It will also help ensure that the disruption of the brokerage model by commercial real estate technology won’t leave one looking in the rear-view mirror — or worse, obsolete.
"Brokering in the Digital Age"
A new on-demand course offered by NAIOP’s Center for Education will show brokers how to apply technology in their profession. Topics to be covered in “Brokering in the Digital Age” include building stronger relationships by using social media effectively, understanding the benefits of storing relationship data in a customer-relationship management (CRM) system, learning how to build a database of deal information, and applying proven strategies to form deeper relationships with clients. The course will be available in January 2019.
For more information, visit www.naiop.org/Learn/Courses
Joan Woodard is the former president and CEO of Simons & Woodard, a management, architecture and development firm based in Santa Rosa, California. With over 45 years representing property owners around the country, she has executed more than 10 million square feet of lease and sale transactions.