Introduction
“Real estate technology” has quickly gone from practically an oxymoron to a force driving investment and innovation around the world. In fact, about 70% of the $6 billion invested in real estate technology, or PropTech, has occurred in the past two years, and is projected to come in around $3 billion in 2017. As such, the ways in which companies buy, rent, sell, design, and construct multifamily and commercial properties have been revolutionized seemingly overnight.
But the way in which properties are actually operated remains tragically stuck in the past. From meter readers barging into tenant spaces to write down how much electricity has been used, to operators relying on their intuition because they don’t trust their building’s equipment documentation, it’s clear that technological progress has not been even.
Building operations are like the engine that makes your car go. It doesn’t matter how nice that new paint job is, if it doesn’t get from point A to B, the passengers will get frustrated. In real estate, the passengers are tenants, and when their lease is up, they can get out of the car and into a new one if it’s not living up to their expectations.
And expectations are rising; when you see a new paint job, it’s natural to expect that the performance of the car will match its sleek look.
Commercial tenants now view the indoor environment of their offices as a significant factor in overall competitiveness. Recent studies indicate that proper space temperature, humidity conditions, and indoor air quality reduce sick days, and increase employee productivity and happiness in the workplace. More and more, this is being reflected in leasing decisions.
On the flip side, the short length of multifamily tenant leases means more mobility and a constant risk of tenant vacancies if the space is not comfortable. Given this, it’s not surprising that 54% of apartments turnover every year and only 6% of renters say that they like their rental space so much that they couldn’t be convinced to move.
While these are issues for all real estate companies, it is somewhat shocking that building operations have not garnered more attention from Real Estate Investment Funds (REITs), which have an obligation to shareholders to maximize profit.
It’s easy to look at the numbers and say: “our operating expenses are fixed, we need to market our properties better, so we can maintain high occupancy rates and drive profits.”
But what about keeping those tenants in their space? And equally as importantly, what about keeping your operating costs down so you don’t get killed if there is a vacancy?
To exemplify this concept, we will start with some nice round numbers:
Tenant Comfort
Underneath those newly renovated lobbies and brand-new Alexas there are hundreds of pieces of equipment that enable a building to perform its minimum necessary functions. Hot water, air conditioning, ventilation, and working elevators are not usually counted as features when marketing a property. But if any one of these areas become consistent issues, tenant health and comfort will be compromised, and turnover more likely.
As mentioned earlier, the average turnover of apartment tenants is 54% per year. While tenants often move out for reasons that are beyond the landlord’s control, there are measurable effects of providing a better experience to tenants.
For example, the same study found that the average apartment turnover for properties that were submetered was only 45%. That’s a 17% drop in turnover annually from a relatively small change to how tenants interact with their space. Plus, considering all the things wrong with standard tenant submetering services, there may be further room for improvement. We should always be mindful of assuming that correlation equals causation, but no one should doubt that providing a better tenant experience, through a variety of strategies, can bring down annual turnover.
Perhaps the most crucial strategy is timely and effective maintenance and repairs, since there is a direct impact on tenant comfort when building systems do not operate properly. Technology can now notify building operators in real time when equipment is not performing optimally. This not only helps to ensure that issues are identified quickly, but enables operators to implement solutions before tenants even notice.
For our hypothetical property, let’s say that submetering tenants and having an effective maintenance strategy results in a reduction in turnover similar to what the study found for submetering alone. Conservatively, a 15% decrease in lost revenue due to vacancies as well as 15% reduction in marketing costs for finding new tenants to replace turnover would increase the net operating income of the property by 4.5%.
Maintenance
Speaking of maintenance, it’s not only about keeping tenants in their spaces, there are also direct costs associated with maintaining a building. All too often, these operating expenses are assumed to be a fixed cost of doing business. But this is not necessarily true. There are often significant inefficiencies that result in an estimated 18–30% of every dollar spent on maintenance being wasted.
This waste comes from: preventative maintenance schedules that require activities to be performed too frequently, time spent investigating the root cause of problems, time spent on determining toolkit needs and retrieving tools, “band-aid” fixes performed because of rushed jobs, and fixing major failure events that could have been prevented with better routine maintenance.
Unlike in manufacturing, where maintenance has been accepted as crucial to keeping production outputs up, commercial real estate has largely failed to recognize the direct and indirect costs of maintenance. In highly-scrutinized REIT portfolios, this fact could increasingly become a differentiating factor for companies that implement effective strategies. It may not be the sexiest investment, but it is essential to maximizing shareholder value.
In our hypothetical example, let’s say that implementing a strategy that corrected for maintenance waste reduced somewhere in the middle of the estimated 18–30% range. With a 25% reduction in maintenance costs, net operating income goes up by 2.5%.
Energy
Years ago, the EPA estimated that 30% of every dollar spent on energy in buildings is wasted. Despite some progress, energy cost reductions are often seen as marginal, “nice to have” items in commercial real estate.
However, coupled with a strategy for reducing maintenance costs, energy cost reductions can have a sizeable effect on the bottom line. There are seemingly infinite ways to reduce energy expenses, ranging from programs to encourage tenant behavior changes, to large capital investments for on-site energy production, such as combined heat and power (CHP) systems.
One strategy that is often overlooked is operational efficiencies. These are no-cost adjustments to how a building is operated that can save costs in a way that is more measurable that behavioral changes, and doesn’t require the large capital expenditures of major retrofits.
For example, large equipment such as boilers and chillers are operated directly by schedules or dynamically with temperature set points. To ensure that tenants remain comfortable, these schedules and set points are often set very liberally. While this may help avoid some tenant discomfort, it also ends up using energy and water resources for no particular reason. Technology can now identify the correct schedule, down to the minute, so building operators can ensure tenant comfort while eliminating energy waste.
Another example is peak demand costs. Most utilities charge commercial real estate properties a rate based on the highest 15 minutes of demand over a billing period. If this peak can be identified and predicted, operational changes can shift that load, resulting in a lower rate per unit of energy for the entire billing period.
Obviously, not all savings can be achieved through operational changes. Delivering deeper savings over time will require replacing equipment with more-efficient models and/or adding equipment controls. Because these decisions are made much more sporadically than daily operations, getting them correct is essential. Technology can now isolate energy costs to specific systems, so retrofit proposals can be analyzed much more rigorously and continuously verified going forward.
For our hypothetical example, let’s also say that operational strategies and targeted retrofits result in 25% reduction in energy costs. This adds an additional 2.5% to our net operating income.
Conclusion
If we take all of these cost reductions into account, our hypothetical property has reduced operating expenses by 9.5%. At a 5% cap rate, this extra $47,500 in net operating income translates to $950,000 in asset value for the property.
The next question inevitably comes to the cost of the technology to bring about these improvements. Technology in building operations has historically been dominated by Building Management Systems, which cost an average of $2.30 per square foot to install. Assuming the same improvements to tenant comfort and reductions to operating expenses, it could easily take four or five years to recover the costs of the system.
The bulk of the expense of Building Management Systems come from the controls. By stripping those away, and focusing on real-time data collection for equipment systems and tenant spaces, the cost to install comes down dramatically. In fact, the cost to install submeters and IoT sensors is generally an order of magnitude less expensive than a BMS. Assuming the same cost savings, the payback period would be anywhere from six months to a year.
Enertiv’s Asset Intelligence tool enables all of the improvements mentioned in one solution. Schedule a demo today to see how!
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