Real estate developers buy land and create facilities to match the needs of their prospective clients. Once construction is completed, the property is sold, leased, or rented, and the developer’s focus moves to the next project. This is the real estate development business and it has made many people very rich.
“Ninety percent of all millionaires become so through real estate. More money has been made in real estate than in all industrial investments combined,” said 19th-century Scottish-American industrialist and billionaire, Andrew Carnegie.
The real estate development landscape is changing, however. Undeveloped land with significant growth potential is few and far between, construction costs are rising, and the demands of building design in the smart building era are more complex than ever. Maintaining margins is becoming a challenge for real estate’s bigger players, and the business environment has become inhibitive for new entrants.
Scarcity, cost, and complexity, are not the only changes to real estate, however. In the new lifecycle of smart buildings, the balance of profit is shifting forward, and savvy real estate developers are realizing that they are in the perfect position to take advantage.
“Many real estate developers are exploring new ways to keep their business model profitable and - despite this ever-changing real estate world - sustainable. Even (or indeed especially) very successful players in this field are mindful of the general threats to their business model such as shrinking margins due to higher construction costs and land prices, higher execution risks, and increased pressure/scrutiny of society toward the project details,” explains Lukas Weidner, Senior Associate at DLA Piper.
“Several progressive developers do not see their future necessarily in scaling up their construction activity or the individual features of the property,” real estate law specialist, Weidner, continues. “From their perspective, the key is to diversify into actually operating smart buildings.”
Facilities management today is no longer just about maintaining elevators and fixing toilets, it is now as much about occupant health, digital security, employee productivity and attracting talent.
Those operating smart buildings are required to gain expertise in data analytics, cyber security, and other cutting edge technologies, while also retaining their capacity for managing physical systems, in order to provide a full suite of valuable smart building services. By 2025 the global outsourced market for facilities management services will be worth $1 trillion, according to a CBRE report, and who better than developers to seize this growing market.
The fundamental advantage for real estate developers is that they generally dictate, or strongly influence, the tender process for building operation. In most cases, the facilities management contract is there-for-the-taking by the property developer. Those developers will need to establish a facilities management division but would then automatically be in pole position, representing a significant competitive advantage over third parties.
Real estate developers know their properties, meaning this is not a leap into the unknown. In fact, a shift in focus to operations probably means that real estate developers would build better buildings. Greater consideration of the long-term maintenance costs, for example, would raise the business case for more robust materials, more sophisticated design, and more meticulous construction processes. While the intention to sell digital services to tenants will encourage better planning for sensor and connectivity infrastructure. Prioritizing operational excellence in the design phase would lead to smarter buildings that are cheaper to run.
Furthermore, the data and knowledge accumulated from operating buildings will provide the platform for real estate developers to build even better buildings. Currently, the data stream stops when construction is complete but if developers also operate their buildings they gain valuable information about how occupants use buildings, what attracts tenants, and where costs are can be saved. Obtained directly, these operational insights can influence the firm’s future building projects, allowing them to further improve buildings, reduce costs, and raise their reputation.
“A developer intends to build the best possible buildings in order to attract new investors. They require usage data to enable them to identify new trends and developments in the usage of buildings. The investor's aim is to obtain the greatest possible long-term rental income, which is ensured by efficient use of space and this is where smart building data can, for instance, help to identify and avoid inefficiencies,” says Fabian Hafenbrädl, Associate at DLA Piper.
Starting a facilities management division from scratch is no easy feat but as the trade becomes more profitable it will be hard for real estate developers to ignore the immediate market position they hold and the opportunity for stable reoccurring revenue streams. In essence, the expansion from real estate development to facilities management can be seen as vertical diversification, where upstream developers use their influential position to compete in the downstream building operations business.
“As with virtually all kinds of diversification (and played out in many other branches of the economy), the underlying rationale is a mixture of growth strategy and risk mitigation. Operating smart buildings goes far beyond providing a simple service to the purchaser of the property besides facility and property managers,” says Weidner.
“Vertical diversification strategies are generally most effective in mature areas. While this cannot be said about the proptech aspect to this business model, there is certainly no doubt about the maturity of the core business at hand. Therefore, the relevant players seem well-positioned,” he added.
Traditional real estate developers would never have bothered themselves with the “menial work” of operating buildings. Maintenance, security, cleaning, and dealing with daily tenant demands seem petty in comparison to negotiating land deals and constructing buildings. In this new era, however, buildings are no longer just buildings, they are smart facilities that are creating greater value after the construction phase than ever before. Making smart buildings is more expensive but the value has shifted along the lifecycle. It now seems that the best way for real estate developers to increase their share of the pie is to run their smart buildings themselves.