REITs Adapt to New Technologies

By Ranjini Venkatesan, Analyst, Moody's Investors Service: While changes in technology are disrupting business models across sectors, REIT landlords have responded well to market changes—so far.

R-Venkatesan-Moodys_750x550Changes in technology, computing power and social media are enabling and disrupting business models across many sectors, including retailing, banking and entertainment.These changes are also affecting the real estate sector, but REIT landlords have, so far, responded well to market changes by managing their tenant mix, being more selective with locations, investing in existing and new assets, and adopting new technologies to make their operations more efficient.

Here are several notable changes that are impacting some REIT segments:

  • Growth in off-price/e-commerce retail sales: REITs have been reducing exposure to retail segments vulnerable to online competition, such as books and office supplies, while they are increasing the amount of space they lease to off-price retailers. It is, however, too early to judge the impact of some of the more experimental retail initiatives, such as online retailers and grocery stores expanding their home delivery footprint and curbside pickup.
  • Tenant mix is changing in malls: The proportion of tenants offering experiential products and services—such as restaurants, movie theaters and other entertainment options—is increasing, and in many instances, is replacing the anchor tenants as a draw. The increase in the non-retail tenant base helps mall companies maintain interest and energy levels among shoppers, as some department store tenants are shrinking their footprint.
  • “Green” office buildings and open floor plans: Tenants are increasingly gravitating to “green” buildings to reduce costs and fulfill their corporate sustainability goals. In large metro areas, most Class A buildings have energy-efficiency certifications. In markets with a large proportion of Millennials in the workforce, landlords are redeveloping some spaces to accommodate the new standard of smaller per-employee space and large, amenity-filled common areas.
  • Airbnb and the like have not materially affected lodging REITs—yet: Lodging REITs have generally focused on mid-scale-upscale properties that are materially different from products offered by peer-to-peer (PTP) home renting providers such as Airbnb. Therefore, the exponential growth in rooms booked through PTP has not meaningfully affected the demand for the traditional lodging product. Hotel operators are, however, developing/redeveloping customized and unique assets in some markets to cater to client preferences.
  • E-commerce and supply-chain network modernization are dual tailwinds for industrial REITs: The growth of e-commerce has multiple implications for the warehouse and logistics business, including greater demand for space as online retailers hold more goods in the warehouse, and demand for distribution centers that are close to the end-user to achieve shorter delivery times. As companies transition to non-linear supply-chain networks, logistics providers that allow companies to be more flexible with their product configurations, supplier base and distribution networks are in a competitively advantageous position.
  • Data traffic trends and transition to offsite data centers are mostly good news: Global IP traffic is forecast to double to 2.3 zettabytes (1021 bytes) in 2020 from the 2016 estimate, according to the Cisco Virtual Newtorking Index forecast. Flat to modest growth in enterprise budgets, as forecast in the Uptime Institute’s Data Center Industry Survey, is in part because of improved performance parameters and the transition to cloud-based solutions, is another significant development. Off-site assets will account for a majority of the enterprise budget by 2020, from about 29 percent in 2016, according to the Uptime Institute survey. Some tenants could opt to build and operate their data centers, and a concentrated tenant base could diminish the pricing power of data center landlords.
  • Regulatory changes hold the key in the health-care sector, and scale might become more relevant: One of the main change factors in the health-care real estate sector is modification to the reimbursement system and its effect on the relative attractiveness and profitability of care settings. Implementation of value-based payment could favor larger and financially stronger providers that can afford to make the investment in technology and human capital necessary to meet the new standards. If the benefits of scale are material, providers and landlords could consider partnerships, acquisitions and mergers.

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