Six new imperatives for real estate players

‘If you build it, they will come.’ For decades, that’s been as true for well-located office, retail, and residential real estate as for the baseball field in Field of Dreams. But today, paradigm shifts, higher inflation, higher interest rates, and climate change are forcing real estate investors and operators to face a fraught reality: today, if you build it—or buy it—in the usual way, they might not come.

It goes without saying that the COVID-19 pandemic upended where and how the world uses spaces. In some regions, office attendance is still dramatically lower than it was before the pandemic; in the United States, for example, it hovers at around 50 percent.¹ Consumers have returned to brick-and-mortar stores² but are shopping closer to home.³ Greater expectations for same- or next-day shipping have increased demand for industrial square footage near the places where people live and work.

Perhaps even more transformative than altered demand is the fact that occupiers have a new set of needs, beyond what real estate companies have traditionally provided. Hybrid work and omnichannel sales require that landlords supply creative physical designs, as well as innovative services and solutions. Tenants, lenders, and other stakeholders increasingly look for buildings that play a role in fighting climate change. Digital sophistication has become essential to help real estate players act more quickly and make wiser decisions, to enable emissions reporting, and to track and analyze how space is used.

Complicating the panorama is the fact that after a decade-long growth market, capitalization (cap) rates have expanded across sectors.⁴ Interest rate hikes,⁵ combined with higher inflation in many parts of the world,⁶ have dramatically altered the financing costs and expected returns for owners, developers, and managers. Coupled with lower labor availability, these higher costs have made development and redevelopment more challenging and less profitable.⁷ Further, raising capital is more difficult today than it was just a few years ago,⁸ since some limited partners have reduced their annual commitments—in part because their public-equity portfolios have declined sharply in value, so their real estate portfolios, as currently valued, exceed their allocation targets. (This is called the denominator effect.)

Inflation and uncertainty about the direction of the global economy have made housing significantly less affordable, made gaining access to credit even more difficult in emerging markets, and created a challenging fundraising, deal-making, and return-generating environment for real estate investors and operators. Those who invest in and operate real estate as they did five years ago may underperform and lose share. In this unique moment, real estate players should adopt a new mindset: replacing “if you build it, they will come” with “if you operate brilliantly and please tenants, they will stay.” In the current market, the success of a real estate investor or operator hinges upon whether they adopt the following six imperatives:

1. Create solutions for clients, not just physical spaces.
2. Use developments to generate momentum, not merely to capture momentum.
3. Find value creation opportunities throughout a project’s life cycle, not just at the end points.
4. Embrace sustainability as an opportunity, not a compliance process.
5. Embed digital solutions and advanced analytics in everything, not just by sporadically adopting individual solutions.
6. Focus on operating efficiency, not just on income.

Acting on these six imperatives will require investments or partnerships to access technology, analytics, operations, and climate science capabilities. Investors and developers have long been the stars of real estate organizations, but today it’s clear that the value created by people with digital talents and capabilities may come to equal that created by “traditional” real estate people.

Real estate executives face new challenges in navigating today’s shifting demand patterns, the changing needs of occupiers, and a difficult macroeconomic climate—while transforming organizations both sustainably and digitally. In this article, we examine the actions that have become crucial for investors and operators seeking a competitive edge.

Create solutions for clients

With some companies cutting back on the office space they own or rent, competition to attract tenants is stark. Over the past three years, a net 125 million square feet of office space became available in the United States and United Kingdom combined, the result of three consecutive years of more space being vacated than newly rented (Exhibit 1).⁹