Wanted: Healthy Skepticism

By Hugh F. Kelly

Disruption is one of five principal forms of change. The others are cycles, trends, maturation and change of state. Most frequently, real estate discussion is dominated by the questions, “Where are we in the cycle?” and “What are the most important trends?” These remain very important topics, but more and more we are finding attention focused on the topic of game changers—innovations that confront business with discontinuous change.

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Hugh F. Kelly, PhD, CRE

To the degree that disruption is both extensive and largely unforeseen, it might be termed a black swan, after Nassem Taleb’s book on the subject. For the public, the game-changers implicitly involve a substantive alteration in the way we live, work, play and conduct our activities. In the process, change necessarily comes to real estate operations, development and investment.

Disruptive technology is very much the buzz at this time. Futurists promote the idea that one or more advances—blockchain, advancing artificial intelligence, autonomous vehicles, cryptocurrencies, transaction platforms that disintermediate human agents—will qualify as this-changes-everything type of interventions in the real estate industry or real estate markets.

Far From Revolutionary

No doubt, major changes have already been seen. E-commerce is one, drastically impacting the retail property sector. Ride-sharing applications like Uber and Lyft are altering transportation, not only threatening the traditional taxi industry, but also offering the potential to serve as a paratransit option for urban commuters. Data has, in general, been commoditized, and expertise entails being the interpreter of information, rather than its gatekeeper.

Truly revolutionary change is rare, and adaptability is a survival mechanism for humans, as it is for all species. Carl Linnaeus, the great Swedish botanist and inventor of modern species classification, famously maintained that “natura non facet saltem”—in other words, nature does not make leaps. More than a century later, Alfred Marshall used Linnaeus’ phrase as the epigraph to his seminal 1890 economics text, Principles of Economics. Thomas S. Kuhn stressed in The Structure of Scientific Revolutions (1962) that the term “paradigm shifting” should be reserved for innovations that fundamentally alter systems, not for every new invention or new approach that nudges our activities in a particular direction. How do the “disruptive changes” in real estate measure up to such a standard?

Unwanted Side Effects

E-commerce has triggered a move to omnichannel retailing strategies, with stores adopting web-based distribution and online providers adding physical locations as adjuncts to their distribution platforms. The basic phenomenon of consumption, and the role of real estate as the connective tissue linking producers of goods to the final consumer, hasn’t changed all that much. Customer service remains the key, and the present shrinkage in retail space may be primarily due to the U.S. coming back to global norms in the amount of store area per capita. As at least one investor has observed, “America is not so much over-retailed as it is under-demolished.”

The rise of Uber and similar sharing economy services has indeed broken the hold of the regulated taxi industry, while responding to the lowered propensity of young Americans to own automobiles. However, its explosive expansion has in many ways saturated its market and, collaterally, increased urban street congestion. Uber, as a corporation, is reportedly worth $72 billion and while it has narrowed its operating losses as of the second quarter of 2018, profitability has proved elusive. Its business model may prove unsustainable as a market phenomenon and is unlikely to escape regulation as its diseconomies trigger rising public costs.

Airbnb has nudged into positive territory (“a rare profitable unicorn,” according to Forbes), with $100 million in profits on $2.6 billion in revenue as of the first quarter. That translates to a margin of just 3.8 percent. Like Uber, Airbnb faces pushback on its business model not only from traditional hotel competitors, but from municipal governments defending the integrity of their zoning ordinances and their tax revenues from travel and tourism operations.

On the office front, WeWork is now the largest tenant in Manhattan and its venture capital investors estimate it to be worth $20 billion. While enjoying the impact of WeWork on occupancy, however, office owners are acutely aware that lenders will only underwrite WeWork space at the market rent of substitute tenants as they consider the underlying credit of the leases to be weak.

Data: Value vs. Risk

The ubiquity of data has led many to conclude that any right of personal privacy is effectively beyond practical defense. Hacking has affected retailers, credit agencies, hospitals, public agencies and even the national political process. Reliance on data portals has opened operational risks of individuals, institutions, and even governments to intrusions, including ransomware demands and the compromise of vital management systems and control over communications. As data becomes monetized, there is a legitimate question as to who owns the data.

For real estate, there is no question about stemming the tide of new and potentially disruptive technologies. The challenge is in identifying those innovations which create value—Shumpeter’s oft-cited “creative destruction”—and in recognizing the potential of new products and services to do damage in excess of their benefits. Enthusiasm and euphoria have often led markets in the direction of foolish investment, never more frequently than when a new economic paradigm is trumpeted. Many can still recall with chagrin the claims of the 1990s’ dot-com revolution and the amount of capital lost in the collapse of the tech bubble at the turn of the millennium.

So, real estate needs to maintain a healthy skepticism about the predictions that innovations will fundamentally alter basic economic relationships, including the mass substitution of artificial means for human inputs. Real estate can embrace new technological tools, but the industry should resist the temptation to let the tail wag the dog. Technology should always be deployed in the service of human values. That means leaning toward chosen goals of individuals and society, rather than pushing the question toward how the humans serve technological ends per se.

Hugh F. Kelly, PhD, CRE, is director of graduate programs & chair of the Curriculum Committee with Fordham Real Estate Institute at Lincoln Center. A real estate economist, he taught for more than 30 years at New York University’s Schack Institute of Real Estate and served as the 2014 national chair of the Counselors of Real Estate. He is also president of Hugh F. Kelly Real Estate Economics, a consulting practice.

Read the December 2018 issue of CPE.