There is a lot of excited discussion and digital ink spilled about the notion of “disruptive innovation” related to technology in the business media, at conferences, at venture capital conference room tables, and in business schools all around the world. And there is the misconception that disruptive innovation applies to the real estate business simply because real estate is a business that is being touched more and more by technology.
Please hear me loud and clear when I say the following: disruptive innovation does not exist or apply as far as the real estate business is concerned, and it will not in the future, either. Not even in the case of Airbnb (explained below). Real estate product and its consumption are fundamentally different from non-real estate product and its consumption, and at this point in history, real estate markets are no longer likely to be disrupted.
We define a disruptive innovation as a change to an existing market, and the associated business model change, that creates a new market altogether, which ultimately and unexpectedly overtakes the existing market.
The impetus for the business model change may or may not be a new or improved technology, but we stress that it is the new/altered business model enabled by the change that creates the disruptive impact to the existing market, not the impetus that makes the impact, whether the impetus is a technology or not (Source). A clear example of a disruptive innovation is how the technology-enabled ability to inexpensively mass-produce cars disrupted the market for horse-drawn and train-based people transportation, eventually consuming it.
We define business model, at its most basic, as “a statement of how a firm will make money and sustain its profit stream over time.” In more detail, we define business model as ‘‘the totality of how a company selects its customers, defines and differentiates it offerings, defines the tasks it will perform itself and those it will outsource, configures its resources, goes to market, creates utility for customers and captures profits” (Source).
So, on to real estate and why disruptive innovation does not apply.
Here are the premises of our argument:
- A physical real estate property has financial value only to the extent that there is an income stream, whether one-time or recurring, that currently comes from and/or can come in the future from the property (let’s leave environmental/conservation land trusts out of the discussion because they are not part of the market), where that income stream is tied to the ability of a property end user to occupy and use that property for one or more uses for a period of time
- Service providers within the real estate business exist and derive their value only in that most real estate can and in fact does generate an income stream
- Nothing that has happened in real estate in the modern era has caused an existing real estate market to be overtaken by a new market (the definition of the impact of a disruptive innovation), and nothing will in the future
Let’s dig into the details first by looking at the past. Here are the major changes in the real estate market in the modern era:
- Property ownership: fragmented → more consolidated (creation and proliferation of REITs, increase in pension fund real estate allocation %s)
- Market information: scarce and asymmetric → less so due to broker research and paid databases and barter databases
- Market liquidity: highly illiquid → less so due to birth and growth of REITs, private equity funds, MBS and CMBS
- Property environmental impact: who knows and who cares → we know now and we care more
- Urban parking ratios: minimums → maximums
- Urban population % total population: growing
- Information management / financial analysis: by hand (and gut) → by software (and gut)
- Developer community engagement: reactive → proactive
- Sources of equity: the 1% → the 1% and the 99% (REITs, crowdfunding)
- Office worker location, on the margin: in the office → out of the office
Not a single one of these changes (some of which were and are technology-assisted) involved the overtaking of an existing market by a new market.
We need to understand the important difference between the application of technology to certain aspects of real estate, and how that application has simply facilitated the existing real estate business model further or extended and monetized it, versus the changing of the nature of how real estate properties derive their value, which is the utility of the space for one or more end uses, and the nature of the financial transactions that manifest the value as an income stream.
People talk over cocktails, coffee, golf and weekend bbq’s about how Airbnb is “disrupting” the hotel industry, and it drives me nuts because they are conflating media hype with reality, and just using a buzzword without cautious regard for what they are saying. Are Marriott, Hyatt, Wyndham, Best Western, Choice, Ritz-Carlton, Hilton, Starwood, Joie de Vivre and the rest of the gang buying or contracting with owners of hundreds of thousands of individual apartments and single family houses in tens of thousands of cities in over a hundred and ninety countries so they can market and rent these physically disparate properties out over the web through inconsistent (sometimes scary) photography and text descriptions, send room service to them, host large-scale meetings and banquets at them, and clean and maintain them daily? (Or are they abandoning these operating elements of their business?) Are they severing their ties to their current multi-unit properties? If they were doing any of these, THAT would be a legitimate disruption of the hotel market: the changing of the business model for providing the utility of the product. But that has not happened, and it will not happen because the economics do not scale and it is a logistical non-starter.
What Airbnb essentially did was layer a software-based reservations platform over the existing “stay at a friend’s or relative’s place while they are out of town” market (which took and received payment in goodwill/friendship capital), and they monetized it. They found and served an existing market niche: people who typically stay at hotels but would be open to staying at a friend or relative’s empty place if they could, if at a minimum it provides the same utility as the hotel room, and the cons of doing so (including the resulting imbalance in goodwill/friendship capital) don’t outweigh the pros. They simply connected your friends and your relatives to other people, and other people’s friends and relatives to you. Every one of the properties on Airbnb is that of someone’s friend or relative.
Good for Airbnb! It was brilliant and they deserve recognition, and they are raking it in. But let’s be clear that they did NOT consume the existing hotel market, nor will they. AND, let’s be clear that they are not a hotel operating company. On the margin, through their reservations platform, they are competing with the existing hotel market. But the transaction’s nature remains the same: you give me a place to stay and I’ll pay you something reasonable given supply and demand for that perishable room-night.
Airbnb’s model of heterogenous product with no standards, with heterogenous pricing with no standards, will absolutely not consume the hotel business or even come close. The mature hotel business format exists as it does today, and will continue to grow as it has for good reason: when you leave home, you want to know what to expect, even if it’s not the Ritz.
Professional hotel operators can consistently set and meet expectations better than any individual renting out their condo on a part-time or full-time basis ever could. And frankly, if one of these condo owners becomes so good at it, and they want to scale their operation to tens of thousands of room-nights or more per year, they will see the rationale and value, financial and otherwise, in owning physically contiguous, relatively homogeneous product, and they will buy or build a hotel.
Disagree? Please tell me why below.
Have something to add? Let’s hear it below!
OK, now let’s inspect the present and speculate about the future.
Airbnb and its copycats are old news. They’ve been around since 2008. On AngelList, as of 5/23/13, there were 154 startup companies that identify themselves as being in Commercial Real Estate, and 729 that identify themselves as being in Real Estate (primarily residential). There is some cross-listing overlap, so let’s say that there are 800 in total. Almost all of the companies are online operations, and they generally fall into the following categories:
1. Marketplace for the sale and/or lease of residential, lodging and/or commercial real estate, including:
- Short time-increment rental of residential units, retail space, meeting space or desks/offices, or what I like to call the “Vacancy Whac-A-Mole” model (best of breed: ? — it didn’t work in office space for Loosecubes, but others insist it will work for them, and some have found investors willing to place a bet)
- Residential, lodging and commercial property and space listings (best of breed other than Airbnb: 42 Floors, TheSquareFoot, SpaceList, LavaMap)
2. A service to support/enhance the marketing for those who list properties in marketplaces (best of breed: Floored, View the Space)
3. Investment capital aggregators/equity crowdfunders (best of breed: Fundrise)
4. Market data aggregators (best of breed: CompStak)
5. Asset management and financial analytics platforms/tool providers (best of breed: ?)
If you think about it, all of these companies are really just variations on the theme of the function they address. And I don’t say that to take anything away from the entrepreneurs behind them. (I actually love seeing all of these companies develop and love to see new companies succeed.) That’s what entrepreneurs do in 99.9% of cases: tweak something that is existing just enough so that they have an incremental unfair advantage in acquiring and retaining customers, even if that advantage can eventually be replicated by others.
These companies are facilitating the existing market for real estate transactions, not disrupting it. Let’s step through them:
1. If one or more of the short time-increment companies fluorishes, they will fluorish on the margins of the existing commercial space rental markets, where long-term space rental is the norm because predictability of future cash flows over multiple years is valued much more highly by property owners than intermittent, unpredictable space rental cash flows that require a constant screening of potential tenants and constant signing of leases for a given space
2. If one or more of the (non-lodging) property and space listings sites fluorishes, they will fluorish in the context of the existing space listings services, taking some share of the existing market
3. If one or more of the marketing support services fluorishes, they will coexist in the service part of the business with existing players only to the extent that their customers’ properties continue to have financial value associated with them (they certainly are not potential direct disruptors of the real estate business itself)
4. If one or more of the investment capital aggregators fluorishes, they will coexist in the massive global capital markets with other real estate equity providers
5. If one or more of the data aggregators fluorishes, they will coexist in the data aggregation part of the business, and the same goes for asset management and financial analysis platform providers (these are also certainly not potential direct disruptors of the real estate business itself)
Real estate is fundamentally different than transportation, telecommunications, technology hardware, steel manufacturing and photography, which are the textbook examples of markets that are impacted by disruptive innovation. At the end of the day, in real estate, there is a space fixed in place, an allowable use of the space, and the types of uses of those spaces and business models for extracting cash flow streams from those spaces are not going to change. No matter how well any of these real estate startup companies or their successors do, they are not going to consume their respective markets by having created new markets. They might eat some or all of the lunch of their competitors, but that is a market entrant dynamic, not a new business model-driven market altogether.
Interesting post. I can see how you make the case for real estate not being disrupted a la the horse and buggy / car example – but it does seem to me like some percentage of the hotel business is being undermined by Airbnb offering an alternative to hotels / friend’s couches. I agree that there is a whole group of hotel users who will not find the Airbnb alternative appealing – but there also does seem to be some percentage of folks who will start using Airbnb room rentals and not look back at hotels / motels.
While likely not being a classical ‘disruption’ in terms of this new home-sharing market overtaking and surpassing the existing market, I am sure that hotels are feeling the sting from lost revenue. (I know in Santa Monica that is the case.) By virtue of this impact to hotel bottom lines, it seems to me that Airbnb IS cut from the fabric of disruption by virtue of it unlocking a new market that was not previously viable for many travelers. It may not achieve FULL disruption status by your definition, but it certainly is making waves.
WOW Bruce!
Do I agree or do I not? It does not matter. What a great article!
Thanks Rylan and Duke for the feedback. I will write more on this topic soon.
Bruce, what are your thoughts/comments with ecommerce and retail
real estate i.e. bricks & sticks? Seems to me this comes pretty
close to “disruption” within the retail real estate space with many retailers
going out of business, and the continued shrinking of “big” box retail format and
other concepts across the board.
Hi Michael, thank you for contributing! You make a good point. We will have to see how it plays out further, but online retail sales are still under 10% of total sales, and the large online retailers are signaling that they need to enhance their sales with physical stores (http://finance.yahoo.com/blogs/the-exchange/online-retailers-retro-open-brick-mortar-stores-175109313.html).
Bruce, I agree that there will always be a hotel user that will only be satisfied by the luxury of a five star hotel, but for everyone else we are thrilled to use services like Airbnb/VRBO and just ask the hotel industry in a city like Austin, TX if they are feeling disrupted!
Enjoyed the article but I think the underlining piece you’re missing is that real estate is filled with stubborn old bastards who need to die to make room for technology and data to play a dynamic role in how real estate decisions of the future are made.
Cheers!
Hi Peter, thank you for contributing! I did not mean to imply that the hotel experience had to be luxury, just that it had to meet expectations. My guess is that Airbnb has a hard time doing that given they as a company likely haven’t even seen most of their inventory firsthand. Just as there are some “discrepancies” between online dating photos and the actual person, I would imagine that some of the properties don’t live up to their photography (or are marred by weird smells, noise pollution, insane neighbors, etc., all of which are “accidentally” omitted in the property description).
Agree there has been no real disruptive innovation in CRE but there will be as soon as owners/users want to dump the middleman… But as with most industries, you’ll have 2 tiers of service – DIY and “luxury”/someone do it for me.
The middleman will always be around as their function cannot be replicated sufficiently by software, at least not at a reasonable cost.
I have heard this for 15 years of how the internet was going to disrupt brokerage. Nothing has really changed. The internet has increased efficiency and expectations regarding response times and speed of transactions. CRE deals are relatively complex transactions and not like booking a hotel room or airfare. Whether someone can DIY really boils down to, do they have the expertise. I am probably as tech savvy as any CRE broker in the country, but technology hasn’t changed the core service I deliver, only improved efficiency in some select aspects of brokerage.
Hi Coy, thank you for sharing your insights. Those on the inside understand that real estate is very complicated; those who know nothing about it are certain that it’s not.
Well said Bruce, the only way to disrupt CRE is to reduce its complexity. How is technology going to minimize the financial, legal and technical (bricks and sticks) aspect of a CRE transaction? Real property is not a uniform commodity.
Based on this article http://en.wikipedia.org/wiki/Disruptive_innovation, I agree that most of these companies (including the one I co-founded, GroundBreaker (www.GroundBreaker.co) are not really “disrupting” the existing CRE market, in the strict sense of the word, since the market is still there. Perhaps the better term, if we want to stick to wikipedia, would be evolutionary or even revolutionary. However, forgetting semantics for a moment. Let’s, consider these two facts (there are more, but these are the first ones that come to mind with factual information):
1. In 2012, Airbnb was booking a hotel room every 2 seconds
Now, even if not all of these customers would have stayed at a hotel, I’d venture to say that the vast majority would have. That’s a lot of hotel rooms that were not booked. A simple google search will show how the hotel industry is lobbying against airbnb and similar companies. These big behemoths are the the first ones to admit it (just look at their 10K filings; they all acknowledge this is a problem).
2. Compstak has over 90% of commercial lease stats of every market it covers, and it is expanding to a new market every month.
That’s a lot of comps and I have seen their product: it is impeccable and a lot more useful and faster than emailing some chump who may or may not respond for a single comp that may or may not be the one I need. I doubt brokers in these markets will be calling each other to exchange comps anymore.
My point is, regardless of how we call it, things are changing. It happens with every industry, including real estate.
Hi Stefano, thank you for the feedback. Agreed, things are changing for sure. Airbnb does not book hotel rooms, though. It books people’s apartments. The Marriott family is not suddenly destitute. They are certainly watching, but again, if any of these hobbyist lodging providers ever wants to get serious about serving the market at scale, they will become a hotelier, because standardization and homogeneity just make sense, especially if one needs to raise capital to fund the operation.
Compstak is doing great, and I look forward to seeing them succeed further.