Real estate has long been viewed as an excellent source of investment diversification. Whether through real estate investment trusts, direct ownership or participation in a private investment vehicle, property has provided a valuable source of yield and, usually, uncorrelated return when set beside conventionally available tradable assets such as stocks and bonds.
PwC periodically publishes reports on the state of the real estate market. Its “Emerging Trends in Real Estate” report is a must-read publication for those interested in real estate. Its outlook for 2020 presents a number of interesting observations. One that is worth every property investor’s interest is the emerging power of technology to preserve and enhance yields.
Winner-takes-most
While real estate has, in general, been a good investment since the Great Recession, a relatively small number of players have enjoyed the most impressive returns. The best operators have enjoyed great success since the current bull market and economic expansion began in 2010. This differential was clearly reflected in PwC’s latest survey:
“The lion’s share of success, opportunity, and bright prospects in multifamily accrues disproportionately to the few, the precisely invested, the operationally efficient, the deep-pocketed, the technologically sophisticated, and the superbly positioned vis-aÌ€-vis customer segments in fast-growing markets among professional-level and other high-earning occupations. This is why class A properties located in fast-growth, mostly Sun Belt local economies—i.e., in Florida, Texas, California, and Arizona—attractive to highly educated up-and-comer earners, have been driving development and investment portfolio activity among the savviest multifamily power players over the past eight or nine years.”
Geographically distinct hot markets have yielded remarkable returns. However, this has caused some operators, developers and investors to cast their eyes elsewhere.
Facing the squeeze
While efficient operators have found outsized success in a few key markets, that same success has caused the danger of price inflation, according to PwC’s survey:
“There is a reason many of the sector’s analysts, experts, and strategic leaders expect a tamping of the brakes over the next couple of frames, to a period of rent compression. It has largely to do with the finite limits of that more price-elastic group that can tolerate pass-along costs in their monthly rents, versus a far-larger and much faster-growing universe of people whose household incomes set lower rent tolerance levels.”
Multifamily operators are finding themselves “squeezed” by customers’ decreasing willingness to pay, even as they must continue to manage their fixed and ongoing costs of management:
“The big challenge for incumbent players in apartments is the squeeze between their costs—upfront and ongoing—and what households in this day and age are willing and able to pay. The other big challenge that goes with this one is that this dynamic never stops changing, as cost and rent increase inflation outpaces household income growth.”
Using technology to bend the cost curve
The current real estate market has been increasingly afflicted with a sort of “vicious circle” in which property owners and operators have been forced to contend with ever mounting cost pressures. However, solutions to the vicious circle facing multifamily real estate operators have begun to emerge, thanks in large part to the growing acceptance within the industry of next-generation technologies. Indeed, savvy operators have adopted the Big Data, AI, automation and other tech solutions developed in Silicon Valley to break the vicious cycle in markets across the country:
“Cost curves become bendable—which makes attainable market-rate apartment development business models make more sense.”
While property management and investment is often considered a stuffy, conservative business and not susceptible to Silicon Valley-style disruption, many operators have discovered the power of tech to expand margins. Automation and Big Data tools allow real estate investors to eliminate a host of variable costs, as well as some fixed costs of management. Large private operators and REITs are particularly well placed to benefit, as they can leverage these technologies to further magnify already existent economies of scale.
Verdict
Investors seeking exposure to real estate should look for operators, whether private or public, that understand the power of new data and tech, and utilize it across their portfolios. These operators and REITs will be far better positioned to reap superior returns as they bend the once seemingly immutable cost curve in their favor. These advantages will also serve to maintain yields, even in the event of a broader economic shock.
Allocating to proven, competent and adaptive real estate operators will be more important than ever as the current cycle winds down and the next gets going in the years ahead.
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