We live in a world of increasingly blurred lines. As consumers desire more simplicity and efficiency, companies move up and down value chains taking on new product lines and services. Phones now double as cameras (and much more), booksellers are in the business of selling e-readers, retailers act like lenders, and ridesharing app companies have transformed the way we interact with automobiles.
Now we are seeing the same trend in real estate, with real estate asset classes combining product types more frequently and softening the lines between residential, office, industrial, and shopping uses. As mortgage rates and inflation rise, real estate investors should take advantage of convergence and seek outsized returns from mixed-use ecosystems in which each use contributes to the whole.
Historically, the real estate industry divided itself neatly into different product types. Office, industrial, multifamily, and retail were seen as distinct investment opportunities. Investors would look at the volatility and returns of each asset class and allocate capital against an efficient frontier. The guiding principle was that real estate operators needed to stay in their lanes.
This is not how investors will be allocating capital the next ten years, as product types blend with each other at a higher rate than ever before.
In the last few years, bricks-and-mortar retail became a disfavored asset class amid the explosion we saw in e-commerce. But such retail has continued to perform well, such as at CityCenterDC in Washington, D.C., which has seen sales increase year-over-year during this same period as well as remarkably high average gross sales.
Meanwhile, office space faces the challenge of companies struggling to meet employees’ expectations for flexible remote work policies. Some office projects are ripe for repositioning into multifamily, such as South Temple Tower in Salt Lake City, which is being converted from office to multifamily, while others are blending multifamily experiences into office settings by providing high-rise balconies, rooftop terraces, and other common areas that resemble luxury apartment offerings.
Many industrial tenants now face a tight labor market, as office tenants do, and now must similarly rethink the amenities they offer, as at the Yatomi Distribution Center in Nagoya, Japan, where workers have access to high-quality amenities like those found more often in office buildings, such as indoor and outdoor dining areas, business lounges, and shower facilities for tenants. In addition, the lines between retail and last-mile logistics have blended, as many retail outlets like Whole Foods now serve as distribution points for e-commerce or provide grocery delivery.
As a result, investors considering any urban site must be product-type-agnostic and focused on the highest and best use. However, to take full advantage of convergence in real estate will require creating an ecosystem within the built environment in which individual components—such as office, retail, and housing—are deeply connected with each other and help each other thrive. Some of the best projects incorporate all product types—such as Fenton in Cary, North Carolina, which is the area’s first mixed-use destination and has 2.5 million square feet of retail, office, restaurant, hotel, and multifamily.
This is not just mixed-use, in which each product type sharing the site simply stands on its own. Instead, retail and entertainment uses are strategically curated to appeal to the development’s office workers and residents alike, and all uses are thoughtfully integrated with each other and the site as a whole to create a walkable, lively environment morning to night. Companies can more successfully attract employees to come back to the workplace if the office is located in a vibrant place where people want to spend their time even after work hours.
It is critically important for investors and developers to have a vision for the ways the individual pieces of a given development will work together and support each other. The “software”—everything that keeps the site active, from farmer’s markets to concerts to retail—is just as important as the “hardware”—the physical structures, the buildings and open spaces and passageways. In an age where the lines between working, living, and playing are fading, having the skills to integrate hardware and software with each other and create dynamic environments will be the true differentiator.
David Steinbach – Global Chief Investment Officer and Co-Head of Investment Management at Hines