Disruptive Forces In Real Estate
Published on August 14th, 2014
By Matthew Cypher
The pace of innovation in the global economy is accelerating at a blinding rate, creating significant disruptions in business and society. These disruptive forces take a variety of forms, but technology, energy, and the intersection of the two are leaders in this space and are influencing all aspects of life. The real estate industry has already experienced significant change due to these disruptive forces, but the future is bright with innovations that could materially influence how real estate is used—or create new investment opportunities that previously did not exist or were less robust.
Although technology is a broad classification, three-dimensional printing and the “internet of things” have particularly interesting stories and the potential to make a lasting impact.
Three-dimensional printing is technically known as additive manufacturing, in which products are created through the layering of material until a complete, three-dimensional object is created. The design of the product is created through digital data in the form of a simple computer file that can be printed on a suitable 3-D printer. This approach differs from the way most products are produced today, which is either heavily reliant on the use of molds that are injected with material or the removal of product via machining.
The most cost-effective and time-saving use of 3-D printing currently is in research and development. The technique enables designers to rapidly create product prototypes without depending on typical, time-consuming manufacturing processes of mold creation or subtractive techniques. The 3-D technology is particularly interesting because it allows designers to create an object to exact specifications.
The long-term implications of 3-D printing on real estate are far from clear, but it is anticipated that in the future consumers will buy a product’s digital design file and print the product at home, reducing the need for warehouse and retail space and vastly altering the way retailers supply consumer products. Amazon has already taken a step in this direction through a recent partnership with the company 3DLT to offer 3-D printed products online through the internet giant’s online storefront. Consumers can also go directly to 3DLT, acquire the digital file, and print the product at home or through 3DLT’s partner network of print facilities.
While the technology holds significant promise, products available for mass consumption through 3-D printing today generally are plastic—items such as cellphone covers and pencil holders. But the number of product offerings will grow in step with improved printer technology and reduced cost. In the near term, consumers likely will be technology-savvy individuals interested in customized products, parts, or tools on a very small scale because mechanical and material limitations will delay broad acceptance. An interesting inflection point for the technology will occur when the tech-fluent millennial generation finds more access to 3-D products through further declines in printing costs and efficiency.
The internet of things (IoT) is generally defined as an environment in which everyday physical objects such as cars, shipping containers, and washing machines equipped with sensors, actuators, and other data-communication technology are connected via the internet and coordinated to share information about the internal and external state of the objects. It is essentially an enormous network of connected devices that use technology to automate processes and address problem areas, and it is continuing to expand along with the number of devices that are connected to the internet. Cisco Systems speculates that 12.5 billion devices were connected to the internet in 2010 and expects 50 billion to be connected by 2020.
A simple example of an IoT interaction is an alarm clock that notifies the coffee pot to begin making coffee when the alarm sounds. Another example, from the Dutch company Sparked, uses sensors implanted in cows to transmit health-oriented data to the farmers who can then monitor the well-being of their herds.
The real estate implications of the IoT are substantial, with numerous effects already occurring. Today, the principal use of IoT in a real estate context is that of building management systems that monitor utility consumption, fire alarms, building controls, and work-order systems and make adjustments to allow the building to operate more efficiently.
Longer-term implications for real estate are limited only by the connectivity of devices and the use of data. One example is the developing technology that employs smartphones to serve as keys to apartments or hotels, allowing residents or guests to bypass traditional methods of access such as the clunky resident call box at an apartment or a hotel front desk. Restaurants and stores could obtain this resident data and use it to promote their businesses through e-mails to the smartphones of individuals visiting or living nearby. Technology that monitors traffic patterns in shopping centers, hotels, and apartments is already being integrated into the design of these places and merchandise displays to maximize human satisfaction or sales per square foot, both of which could also be monitored.
Harnessing all the resultant data from the proliferation of internet-connected devices will be expensive, complex, and a potential security risk, as evidenced by a recent Pew Research Center study that highlights concerns about personal data being improperly accessed and used.
In addition to 3-D printing and IoT, the U.S. energy boom has been a popular topic due to technological innovations of horizontal drilling and hydraulic fracturing, known as fracking. The most eye-opening statistics on U.S. energy production capabilities relate to the expectation that domestic oil production is expected to surpass that of Saudi Arabia in 2019 and that, within the next year, the United States will import only 23 percent of the crude oil it uses, which would be the lowest level since 1970. Shale oil and natural gas are transforming U.S. energy production through access to new supply via improved technology and efficiencies, which will have direct and indirect implications on real estate.
The intersection of energy and technology has affected real estate through the rise of master limited partnerships (MLPs), a nontraditional classification of real estate focused on energy-related infrastructure. MLPs represent energy companies focused on the midstream segment of the value chain that links supply (upstream exploration and production) with demand (downstream refineries and sales) and have been garnering more mainstream attention from investors as the United States continues to develop its natural resources.
The midstream segment is focused on the provision of pipeline infrastructure and related facilities to meet the needs of the rapidly expanding U.S. energy market. The raw material of oil and natural gas being produced in Pennsylvania, Ohio, New York, and North Dakota needs to be routed downstream. But first, construction of the infrastructure was necessary, and it has largely been built through MLPs. A recent projection by IHS Global speculates that an additional $800 billion of energy infrastructure investment is needed to accommodate the anticipated production and export potential of the United States, which speaks to the longer-term implications of MLPs.
An MLP is a partnership that is publicly traded on listed national stock exchanges and whose business is focused on the exploration, mining, or processing of any mineral or natural resource. The partnership structure allows MLPs to function as a pass-through entity for tax purposes: corporate taxes are not collected at the federal or state level but at the investor level through an individual’s ownership of partnership units, which is distinct from the ownership of shares in a corporation. MLPs are required to distribute at least 90 percent of their gross income to unit holders to receive pass-through tax treatment. An MLP’s structure is very similar to that of a real estate investment trust in that, among other tests, 90 percent of its income is required to be distributed to ensure that taxation occurs only at the investor level.
MLPs are attractive investment vehicles because they produce large cash flows to the investor through the distribution requirement. The total return associated with MLPs is also competitive with other investment vehicles over the long term, yet that return has low correlation with commodities, equities, and fixed-income products, making them an attractive component in an investor’s overall portfolio.
From 3-D printing and IoT to MLPs and the U.S. energy market, technology and energy—and their intersection—will continue to evolve as disruptive forces and affect the real estate industry. However, disruption is positive because it provides new opportunities for individuals and companies that can manage the changing landscape.
Matthew Cypher, director of the Real Estate Finance Initiative at Georgetown University’s McDonough School of Business, is a professor of the practice in real estate finance.
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