4 Ways Better Data is a Competitive Advantage for REITs
Managers take a different approach to operating Real Estate Investment Trusts (REITs) than they do to operating privately held commercial real estate companies. The very elements that make their existence possible ensures this to be the case.
REITs pay no corporate taxes and enjoy a stream of low-cost capital through the public markets. In return for these perks, REITs must pay out 90% of their taxable income in the form of dividends to their shareholders. Moreover, their income generation is limited largely to the cash flows extracted from their real estate holdings.
In order to be listed on major stock exchanges and access their tremendous pools of capital, REITs agree to the painful process of filing quarterly reports to the SEC (and their own board of directors).
Then, there is the issue of stock market volatility. Historically, REIT valuations have been correlated (even if only loosely at times) with the health of the stock market. The risk here is that a general economic downturn has a greater negative effect on publicly traded REITs reliant on their valuations for financing terms than it does on traditional illiquid investments.
All these specific benefits, requirements, and risks lead to considerations and decision-making principles that wouldn’t be found in other commercial real estate companies. Specifically, there are many downstream effects from relying on income produced by the assets themselves and the need to continuously raise equity and debt instead of reinvesting profits.
Among REITs, there is a unique drive to hold on to high quality assets and maximize net operating income (NOI) by maintaining high occupancy rates and cutting costs. In addition, REITs must collect and report on every little detail of the business to comply with regulations and to attract investors.
After a volatile 2018, where REITs raised $52 billion of capital, the lowest amount since before 2011, many in the industry are looking to various technologies to differentiate themselves to both tenants and investors. Here are four ways that granular building operations data can be a competitive differentiator for REITs.
1. Eliminating Waste to Increase NOI
Because REITs must derive 75% of their gross income from real estate related sources, effectively managing their properties is critical. The most immediate sources of revenue growth are higher building occupancy rates and increased rents. However, as much as revenue growth has to do with decisions made - investing in the correct amenities and effectively marketing the property - the market ultimately dictates the ceiling of this growth.
When property fundamentals slow, new supply comes online, or other macro-environmental challenges occur, REITs must demonstrate to the market that they can continue to maintain profitability. The transparency required of REITs means that there’s no hiding weak earnings.
To hedge against factors out of their control REITs are especially incentivized to eliminate any wasted operating expenses in their buildings.
This waste can come in many forms. The first place to start is identifying manual processes that could be streamlined or completely automated. For example, the tenant submetering process in many office REITs still relies on human meter readers physically writing down numbers and transcribing them into spreadsheets. Not only is this slow and expensive, it often leads to errors and discrepancies that negatively affect the tenant experience.
Another source of excess cost is found within the operating expenses on the P&L, namely the line items that make up 48% of all expenses: maintenance and utilities. This type of waste is found everywhere, but is especially common in apartment REITs, where there are generally fewer well-trained staff on site to maintain equipment. Staff in multifamily residential assets often spend their days responding to emergencies instead of doing preventative maintenance, which only defers costs and leads to more issues down the road.
Whether it’s digitally reading tenant submeters or capturing performance data from the individual pieces of equipment in a building, eliminating waste to increase NOI starts with data. To learn more specifics, watch our videos on What You Need to Know About Metering Technology and How to Evaluate Fault Detection Technology.
2. Maintaining Shareholder Confidence
One of the primary components of life as a REIT is radical transparency, which can be both an asset and a liability. Investors generally reward firms for providing more detail about their operations, but this can also backfire when things are going poorly.
As mentioned, in times of challenging markets, there is no hiding in the REIT space. If shareholders adopt a negative view of a REIT, the consequent lower share price can damage the terms on which the firm raises equity. Investors tend to move in sync. Clearly, managing shareholder expectations is a full-time job and critically important to the portfolio.
One way REITs can demonstrate to their shareholders that they will continue to drive profitability is through highly granular data about the cost of operating their assets. Data from IoT sensors can be translated into all sorts of useful key performance indicators (KPIs) that provide benchmarks regarding how the portfolio is being managed.
While shareholders may not always be clear on what “good” mean time to failure (MTTR) or mean time between failures (MTBF) values are, reporting on these KPIs can lend the company an air of sophistication and responsibility that reflects well on its prospects as an investment.
For instance, there is already growing investor demand for REITs to disclose their environmental, social and governance (ESG) measurements to the Global Real Estate Sustainability Benchmark (GRESB). Yet, the GRESB is little more than a survey and fails to capture information at a level of granularity beyond the assets themselves. With the Internet of Things (IoT), REITs could report on a much more granular level, and in turn, maintain shareholder confidence through tough times.
To learn more about deploying the IoT, check out our blogs on 5 Important Factors in a Successful IoT Strategy and How to Align IoT Solutions with Your Business Needs.
3. Additional Revenue Streams
Because REITs are limited to the income that their assets can produce, there is justifiably a focus on filling up spaces and driving higher rental rates. However, once their assets are fully absorbed and rental rates are as high as the market will allow, the only way to drive further revenue growth is to build or acquire more buildings.
However, REITs are beginning to recognize that while they are limited to their real estate holdings, there are sources of revenue other than rents. On top of these rents, REITs are finding ways to offer additional services to their tenants to grow revenues without necessarily growing their footprint.
One example of this is providing retrofits as a service, which is especially relevant in industrial REITs that offer triple net leases. Under this model, the REIT underwrites the capital expense to do a retrofit upgrade that will produce utility savings, and then charges their tenants a significant percentage of those savings in the form of a a service contract. This produces immediate utility savings for the tenant and an additional revenue stream for REITs.
Having granular operational performance data enables this service in that precise savings can be measured at the equipment level. A common version of this is lighting as a service (LaaS), in which a share of LED lighting retrofit savings are paid back to the landlord as a service contract. The industry started with lighting because lighting expenses are relatively predictable and easy to estimate. Now, it’s cost effective to capture operating costs from every piece of equipment, which has unlocked many more opportunities to simultaneously upgrade assets while adding new revenue streams.
To learn more about the retrofit as a service model, read out blog on 5 Important Reasons You Should (Finally) Embraces LEDs.
4. Automated Reporting
In addition to the risks of investor defection as a result of burdensome transparency, there is also a direct cost associated with all the reporting required of REITs.
While the benefits of registering with the SEC to become listed on the public markets can be enormous, the costs of compliance can be considerable. The expenses associated with an internal accounting team or the fees the REIT must pay to an external accountant coupled with fees paid to an independent auditor can be substantial.
This is especially true with the nitty-gritty, everything-and-the-kitchen-sink data that is included in annual 10-K filings. Any opportunity to streamline this reporting with automation would be a welcome reduction in the reporting burden for REITs.
REITs are leveraging technology at every level to digitize their operations, in a push to move away from spreadsheets and streamline their reporting capabilities. In terms of building operations, calculating operating expenses can now be aided with sensor data.
In addition to annual operating expenses, the aggregation of this data is enabling portfolios to benchmark their equipment. This can help predict required capital investments coming down the pipeline.
To learn more about creating a dynamic inventory of equipment across a portfolio and the process of figuring out when upgrades will be required, watch our video on Why Equipment-level Benchmarking is the Future.
Conclusion
REITs are unique in how they drive growth, relative to other real estate companies as well as other publicly-traded companies. Because they are only allowed to retain a minimal amount of their earning and cash flows, they have a need to continuously raise debt and equity capital from external investors.
Skillfully managing a REIT requires a wide range of capabilities, including the ability to finance growth with a balance of debt and equity that will yield a cost lower than the return on new properties.
However, in addition to this financial management, REITs need to be able to maximize cash flows through effective management of their assets and efficiently report on their operations and progress to investors.
Capturing granular data about the assets under management can be an effective tool to achieve this end. With this data, a range of better decisions can be made, whether they concern tenant space utilization, working capital and investment projections, or identifying opportunities to extract additional revenue streams.
Do you operate a REIT? See how Enertiv’s building operations platform uses data to maximize NOI and quantify maintenance KPIs. Schedule a demo today!