Commercial Investment Real Estate July/August 2018 | Page 30

BIG DATA
POISED TO
SHAKE UP
CRE FINANCING
by K.C. Conway, MAI, CRE
Capital markets are beginning to rethink how they are using big
data and artificial intelligence to better analyze, underwrite, and
mitigate risk. The variables that go into underwriting and valuation
are on the verge of radical change, which is creating huge implica-
tions for the commercial real estate industry.
Employment data is one of the key indicators for gauging de-
mand for all types of real estate. Traditionally, investors have used
Bureau of Labor Statistics numbers for underwriting. However,
that government data has earned a reputation for being horribly
inaccurate. In the era of big data and growing transparency,
commercial real estate professionals are finding new and better
sources of jobs data.
One new source is the LinkedIn Workforce Report. The LinkedIn
network now includes 140 million working professionals that con-
tinually are updating job status and changes. LinkedIn is able to
capture that data, and about a year ago started generating its own
Workforce Report with monthly job changes that are divided into
50,000 skill classes. It is incredibly rich data that companies can
use in their underwriting models.
Commercial real estate professionals also are bringing in ad-
ditional sources of big data to more accurately underwrite new
investments and financing. For example, underwriting a property
anchored by a department store such as a Sears or Macy’s used
to rely primarily on credit rating and the rent that retailer was pay-
ing. Underwriting now is considering new data sources that use
cell phone data to track foot traffic to those stores. If data shows
that there is zero foot traffic near Sears, then they can document
that Sears as an anchor has no value and the shop space sur-
rounding Sears also has less rent value.
Another change ahead relates to how real estate is classified
and compared. For example, the characteristics and performance
of urban adaptive use retail in a mixed-use project are very differ-
ent as compared to a suburban shopping mall in terms of rents,
demand, and even average size of the retailers. What is needed,
and what is likely looming around the corner, is a reclassification
of real estate from size to type of use or location.
The application of big data to better understand demand, use, and
traffic patterns for commercial real estate has the potential to turn
underwriting in the finance world absolutely upside down. We have
to rethink all of our variable inputs into investment analysis, because
many of the old ones are obsolete and don’t tell us what we want to
know. What the industry will see going forward is that big data will be
used to mitigate risk and also be incorporated into acquisition and
financing underwriting, valuation, and pricing of debt.
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July | August 2018
space. The concern for office is that net demand for office
space will grow very slowly.
Demand Remains High for
Apartments
The apartment sector is delivering mixed signals, with risk
of oversupply occurring in luxury apartments, while huge
demand still exists for affordable and moderately priced
housing. Going forward, developers will have to take a
close look at the job growth occurring in local markets, as
well as the existing multifamily stock in terms of the type,
quality, and price point of rental rates.
Job growth is the fundamental driver for every prop-
erty type, and it is especially important for apartments.
The standard ratio of 5:1 — every five jobs created sup-
port the absorption of one more apartment in the mar-
ket — has been an accurate indicator since the 1950s.
Recently, that ratio has been running almost 7:1 in terms
of jobs created compared to new multifamily construc-
tion. Generally speaking, that indicates that developers
are not overbuilding multifamily. However, there is risk
of oversupply in luxury apartments due to a high volume
of construction at the top end of the market, which is a
problem that has been compounded by rising land and
construction costs.
Looking Ahead
When considering the outlook for the second half of 2018,
it is likely that huge swings in stock market indexes will
linger along with the political uncertainty. But that vola-
tility can be good for commercial real estate. In this type
of environment, capital tends to favor tangible and less
volatile assets with stable cash flows, like commercial real
estate. That rotation is what we are evidencing, with strong
demand for commercial real estate. We once again need to
ask the proverbial question: “So, what could go wrong?”
Cleary, the market does face challenges with potential
Black Swan events, as well as adapting to an environment
with higher interest rates and higher cap rates.
One of the biggest opportunities ahead, and also the
most complex challenge, will be the adaptive reuse and
repurposing of properties across every property type. There
will be a bigger focus on repositioning obsolete and under-
utilized properties, partly because of the desire to recycle
existing assets, as well as rising land and construction costs
that will drive more value-add and opportunistic redevel-
opment. Often those complex projects require a deeper
skillset in dealing with everything from underwriting to
changing zoning.
K.C. Conway, MAI, CRE, is CCIM Institute’s chief econo-
mist and director of research and corporate engagement at
the University of Alabama’s Center for Real Estate.
COMMERCIAL INVESTMENT REAL ESTATE