On October 16, 2014, at the second annual Harvard Real Estate Conference “Disruptive Innovation in Real Estate,” seven global real estate industry leaders demonstrated that disruptive innovation in real estate development, building typologies, and finance has been critical to the growth of the real estate industry. These conference findings challenge public perceptions of the real estate industry, which is often regarded as being conservative and resistant to change.
Organized by the Harvard University Graduate School of Design’s Masters of Design in Real Estate and the Built Environment, the conference featured Harvard real estate faculty and real estate financiers, developers, and advisors with expertise in Europe, North America, and Asia. After professor Bing Wang’s keynote introduction, conference presenters—including Edward Siskind of Cale Street Partners and formerly of Goldman Sachs, Deloitte’s Sheila Botting, Matthew Lynch of UBS, Don Chiofaro of the Chiofaro Company, and KPMG’s Sven Andersen—highlighted innovations in real estate development, building typologies, and finance. Professor Wang and professor Ray Torto together moderated panel discussions following each speaker’s presentation and led a question and answer session with the audience.
Among the principal conference conclusions, Chiofaro found that the practice of real estate development has a long history of innovation that disrupts the status quo. Using Boston as a case study, Chiofaro reviewed this history and demonstrated how land use innovation continues in the 21st century. He discussed one of the most iconic examples of urban redevelopment in Boston, the Prudential Center, which was built in Boston’s upscale Back Bay neighborhood in order to halt disinvestment from Boston in the mid-20th century. It transformed 31 acres of land blighted by rail yards into a high-end destination with office, residential, and retail uses. After its completion in 1964, the center helped to usher in a new era of real estate investment in Boston.
In light of the success of visionary urban development projects like the Prudential Center, Chiofaro has made it part of his life’s work to transform Boston’s Financial District, which just 30 years ago bordered a polluted waterfront and was home to an unappealing mixture of vacant lots and the elevated downtown freeway known as the Central Artery. Chiofaro’s flagship project is the 1.8 million square foot, class-A office building called International Place, which he developed in phases starting in the late 1980s despite the massive risks involved and against the recommendations of his peers. Today, after the cleanup of Boston’s waterfront and the creation of the Rose Kennedy Greenway that followed the burial of the Central Artery, Chiofaro is determined to improve the connection between the Financial District and its waterfront by replacing a waterfront parking garage with ground-floor public space and a mixture of uses above. Executing disruptive innovation requires vision, tenacity, and the ability to convince others to embrace change that defies convention. Chiofaro demonstrated that innovative urban development has been integral to Boston’s history, and to that of the real estate industry.
Globally, disruptive innovation in building typologies is also affecting people’s lives in immediately tangible ways. Presenting on what is commonly known as the “workplace of the future,” Sheila Botting argued that rapid advances in computing technology are “completely changing the way business works,” and changes to the physical spaces that companies occupy are not keeping pace. An internal study at Deloitte called the “Bums on Seats” analysis found that only 30 to 35 percent of office space was physically occupied during the course of the day. According to Ms. Botting, today “work is what you do; not where you do it,” and office design must match this reality. Indeed, decreasing private office space and document storage, while increasing collaborative spaces, social spaces, and employee connection to daylight and the natural environment, can reduce occupier real estate costs while driving employee productivity and improving both the bottom line and financial returns. Global corporations such as Deloitte are facing an imperative to change their workforces from rigid and hierarchical to agile and networked. Transformation of corporate workspaces must follow suit.
The retail building typology is also undergoing rapid change in response to technology-driven disruptions in retail business models. Matthew Lynch argued against Marc Andreessen, who famously said, “Software eats retail.” Brick-and-mortar retail will not become obsolete; it will be the foundation for omni-channel retailing, where retailers have both physical and digital storefronts. Despite an e-commerce growth rate in excess of 24 percent annually from 1999 to 2012, e-commerce is still only 7 percent of total retail sales. Moreover, “two-thirds of customers who purchase online use the store before or after the transaction,” Lynch reported. Even the Internet retail giant Amazon.com will establish a physical presence in New York City this year. Retail stores are still tremendously valuable, but retailers must design new customer experiences where digital and physical storefronts complement, rather than compete with, one another.
Recent developments in housing typology, however, are over-hyped, continued Lynch. Micro-units, which average 300 square feet in size, are miniature apartments that can facilitate the millennial generation’s desire for urban living. Although expensive on a per-square-foot basis, micro-units can decrease the cost of living in prime locations due to their small size. Lynch cautioned that the business model of micro-units has not yet been proven; millennials do not prefer smaller spaces than previous generations, and as they age, they do not prefer renting over owning. The choices to live in smaller spaces and to rent rather than own are patterns of necessity. The success of micro-units is “very place dependent… It’s not clear that it will work everywhere,” said Lynch.
Outside of the physical realm of real estate, real estate finance has evolved particularly rapidly in the last 35 years in response to market disruptions. “Investment structures have evolved each time attempting to address the last crisis,” noted Edward Siskind in reference to the United States’s and United Kingdom’s financial and real estate investment industries. In the 1980s, financiers broke with the past and developed the private equity model in order to address market pressures, such as the pressure to better align the interests of investors and fund managers. Prior to the private equity model, fund managers were paid fixed fees regardless of investment performance. Private equity subsequently took hold in real estate after the early 2000s recession. Following a similar pattern, after the Savings and Loan Crisis of the late 1980s and the subsequent financial reforms, financiers developed the commercial mortgage-backed security (CMBS) to meet capital diversification and distribution needs.
Conversely, nascent innovations in real estate finance have the potential to disrupt business as usual. Sven Andersen demonstrated that crowdfunding is a centuries-old idea that, due to the rise of the Internet, has become a burgeoning investment mechanism. Real estate crowdfunding has a lower minimum required investment as compared to typical funds, thus offering an alternative to real estate investment trusts for the average investor who wants to add real estate to his or her portfolio. In practice, companies in the United States have been able to raise amounts as high as $18 million, comprised of individual investments as small as $5,000. Communities can use this model to invest in themselves; the model also facilitates investment diversification, time efficiency, and the avoidance of fees typically paid to middlemen. Future growth of crowdfunding, however, seems dependent in part on the introduction of a successful secondary market, which will enable investors to more readily manage investment risk.
In conclusion, Bing Wang summarized that from urban development to capital markets, disruptive innovation has been instrumental to growth and change in the real estate industry. As market cycles bring crises, innovation drives recovery. Perhaps more so than in other industries, however, industry fragmentation in real estate practice complicates coordination among key players, and thus increases the difficulty of fostering innovative processes and products. Few players can gain enough market traction to disrupt the status quo on their own. Ultimately, it remains an open question how to foster disruptive innovation in the industry, and how to teach the next generation of real estate professionals to innovate. Yet, without a doubt, disruptive innovation is a fundamental force shaping the real estate industry and urban environments around the globe.