Why Process Innovation Will Drive the Next Generation of Real Estate Alpha
Updated: Oct 7, 2019
Aaron Burr, the former Vice President of the United States, had traveled to London with a proposition for the heirs of the Morris family estate. It was 1809 and their aging mother, Mary, had fled New York years earlier with her now deceased husband, Robert. Loyalists to Britain, Robert and Mary uprooted as the Patriot cause was taking hold in America, leaving behind 51,000 acres of property up the Hudson River from Manhattan, roughly one-third of today's Putnam County. By the date of Burr’s visit, New York had sequestered the property and was leasing it to tenant farmers. Under U.S. law, upon the death of the Loyalist Robert and Mary, their innocent heirs would be entitled to reclaim the holdings.
Burr, representing John Jacob Astor, had an easy time convincing the Morris' to relinquish their right to the far away rural holdings and the cloud of legal uncertainty they carried. They accepted his offer of $100,000. When Mary Morris died in 1825, a legal battle did ensue as Astor sought to evict the tenant farmers. The case concluded with the Supreme Court ruling in Astor’s favor and the state agreeing to purchase the land from Astor for $520,000. A long hold period, but a solid return on investment.
A timely and unrelenting appetite for New York real estate helped propel Astor to become America's first multimillionaire businessman. But transactions like the Morris deal illustrate a paradigm in real estate that would persist for generations. Better information and relationships with those who had access to opportunities drove returns. Astor’s inside pulse on the New York market and his ability to gain support from the day’s influencers brought him access and advantages over other mere speculators in the market.
“I worked like a freak to get this massive amount of data down to a PC,” Andy Florance would later recall. In the 1980s, Florance was an undergraduate economics major at Princeton and a member of the student computing committee who got to use the university’s first personal computers. A pile of tax records from his hometown, Washington DC, stacked in front of him, Florance had written a program to store the records. Commercial brokerages were employing expensive research departments to collect and manage market information, and Florance planned to sell them the data he organized.
Today, Andy Florance remains at the helm of Costar, the company he built. Whatever one thinks of the $20 billion real estate technology incumbent, the modern wave of innovation in real estate data stems from the effort Florance rolled into motion more than thirty years ago. “I could see what Treasury was doing this morning versus this afternoon, I could see what a stock index was doing right now versus six seconds ago, but there was just nothing for real estate.”
A new generation of PropTech companies with a more open data and nimble approach have since accelerated the industry toward realizing better data transparency. The effort continues, but data portals, crowdfunding sites and online property exchanges have led to increasing availability of information and deals. Research teams at commercial brokerages – if they exist at all – serve new functions. Clients who once looked to brokers for their bank of information, now come armed with their own data, seeking a trusted advisor – a representative through the transaction process.
"When information and deal access are abundant and universal, it becomes processes that differentiate great investors from the masses."
The impact of commoditized information on investment returns over time has been tangible. Free flowing transaction data and widely circulated property offerings are leading institutional investors to compete for the same opportunities. Combined with an environment of low interest rates and increasing allocations to real estate, investment teams relying on legacy processes are finding more capital than viable deals, driving down returns.
Deals like those Astor capitalized on - where local intelligence and a confluence of unique circumstances overlap with macro trends to create outsized opportunity - still exist. But these hidden gems are typically not scalable for investors who are designed to deploy large sums of capital; or they require entering strategies that don’t come with existing roadmaps.
One such opportunity arose after the financial crisis depleted household savings and credit scores, and hampered enthusiasm for home ownership. People still needed a place to live and foreclosed properties were clogging bank balance sheets. Investors with access to local foreclosure auctions and trusted contractors could buy foreclosed homes, make improvements, and rent them to new tenants at attractive yields.
But the concept of managing single family homes as rentals with any scale was unproven. It took a group of pioneers to develop specific technology and systems that descended upon county auctions, evaluated opportunities in disparate markets and generated offers at scale, then managed clusters of free standing units across the United States. Today at least two publicly traded REITs have each amassed portfolios of more than 50,000 single family rental homes. The information and deals already existed, but the breakthrough required innovation in technology-driven processes.
"Real estate investment processes are still designed for an era when most value was created by having unique access to information and deals."
When information and deal access are abundant and universal, it becomes processes that differentiate great investors from the masses. As markets become more efficient, investors need to uncover new strategies to achieve value add returns. Asset types once considered too risky or ambiguous are now illuminated by data, allowing investors to execute with greater confidence. Historical performance of public REITs shows that these property types outperform over time (e.g. self storage). Shifting macro forces that are impacting how and where people shop, live, work, travel and seek entertainment, are creating an ever growing list of innovative real estate investment opportunities, but execution at scale will require process breakthroughs from investment teams.
Technology enabled processes can unleash the next frontier of data that’s yet to be commoditized – data locked in PDFs, property photos, or the written stories woven into marketing packages and emails from sellers and their brokers. Artificial intelligence can extract and standardize this information, providing its user with a unique set of actionable information, when such advantages are scarce.
Processes also synthesize data that exists in silos. The recent nearby property transaction, the new business opening down the street, the shift in demographics, and spike in online sentiment, all combine to signal an acquisition target. Humans can spot some of this. Artificial intelligence can layer in additional factors, then scan countless individual records to tell humans where they need to look next, backed by the conviction of data.
Automating repetitive tasks like populating financial models and creating deal summaries accelerates deal velocity - a necessity as efficient markets enhance advantages for early, well-informed movers.
Real estate investment processes are still designed for an era when most value was created by having unique access to information and deals, and financial models populated manually with information pulled from a few sources provided the confirmation needed to approve the deal. This creates opportunity for investors who want to find the next edge.
"Shifting macro forces that are impacting how and where people shop, live, work, travel and seek entertainment, are creating an ever growing list of innovative real estate investment opportunities, but execution at scale will require process breakthroughs from investment teams."
At DealStat, we've built A.I. custom designed to understand real estate and unstructured sources. We believe that unique investment strategies and thesis' deserve unique technology-driven processes. Automated workflows should be tailored to leverage human insights and generate actionable deliverables. We expect the next wave of innovation in real estate investing to focus on intelligent process efficiency, not for the sake of cost savings, but for investors to remain relevant and drive superior investment returns.
John Jacob Astor: America's First Multimillionaire by Madsen Axel.