Predictive analytics in Real Estate Financial Risk Management - challenges and opportunities
Updated: Nov 11, 2020
COVID 19 HIGHLIGHTING THE CHALLENGES ...
Clearly a lot of things changed. The fact that some parts of the economy did not follow technical developments and therefore did not adjust to the new digital era is remarkable enough. Though, this staying behind reveals much more adverse impact in times of COVID 19 with a lot of working restrictions in hand, like limited traveling or distance working via home offices. This pandemic stressed the problems and shortcomings in many industries, such as real estate, and we do not know how long this will take.
When we talk about digitalisation, data science and predictive analytics in the context of real estate, these new technologies did enter into the real estate business via IoT applications in technical fields, apps for tenant-landlord services or brokerage services... This is the area, a lot of startups are showing up and implementing solutions for smart buildings, digital tech twins and even contributing to smart cities.
Contrary to those developments, almost nothing happens in the real estate industry with respect to the financial risk management, which is still operated on basic approaches like business analytics or scenario analysis with a lot of lists and isolated data silos - if any. Business decisions are made the same way as it has been done during the last 50 years... based on management's personal experience, subjective expectations and within an environment of heavy uncertainty.
It is understandable that this way of making decisions is something management boards are already used to, as they have their own expertise and their own network which helps them to be on top of market happenings most of the time. However, taking the usual work load of a decision maker, an organisation's complexity and the number of units in huge real estate portfolios into account, those decisions are made under very uncertain conditions and, in most cases, with a lack of information.
...AS WELL AS THE OPPORTUNITIES!
This is especially striking, considering that nowadays we have possibilities to look into detailed scenarios from a financial and risk point of view, addressing risk probabilities and have a glance into the near future with very effective predictive analytics tools. We could compare this situation with traveling using an old map drafted 50 years ago, showing only the eldest existing roads and an approximate direction while Google Maps, being updated as we move, showing us traffic conditions, different road options and congestion predictions. Would you still use the old map? Especially, when everybody else is using smartphone and Google Maps?
In the new digital age the worlds economy is embracing new technology in all of the industries. The best way that the real estate industry becomes one of them is to adapt its risk and financial management in big corporations, by using market data and company's internal data much more efficiently. Believe it or not, in general up to 90% of data produced in a real estate corporation is not used for analytics at all.
We now have the possibility to take advantage of the latest developments in predictive analytics and to incorporate statistics and artificial intelligence/ machine learning state-of-the-art tools into our everyday financial decision routines. This allows us to see clearly our risk and our opportunities in the present and to predict them for the future, 24/7 no matter where our location is or where our portfolio is!
Comparing the benefits of such a system with the current decision procedures and habits, it is clear that this is a game changer in risk management. A company which is using those tools is able to objectivise its choices and actions, to reduce uncertainty and to react to crisis situations or market opportunities within a very short time. With a unique and responsive database, it is possible to have a "4 D" overview of the overall situation, based on objective data, automatically gathered, processed and analysed.
So, where is the problem, one would ask? Why are companies not using those toolkits offered? The answer is the same as for many other industries, which are slow to adapt to new technologies - the current system is still functioning, decisions are still possible to make within the old system, money is still earned... However, the fact that digital evolution is inevitable should prompt real estate companies to embrace new possibilities and to take a step into the future.
If we analyse the history of other industries where digitalisation already happened, we will be able to clearly see the repeating pattern of accepting new technologies. Let us for the moment analyse the very known cases of Blockbuster and Netflix.
IT HAPPENED TO OTHERS TOO: BLOCKBUSTER AND NETFLIX EXAMPLE
Blockbuster was THE place for customer entertainment from the mid 1980s to the early 1990s. The business concept was simple but very successful: brick and mortar shops renting DVDs. In 1994 Blockbuster's market valuation was USD 8.4 billions!!! At this time, it was sold to Viacom. Fast forwarding to the year 2000, its valuation dropped to shocking USD 50 millions (!) which led to its bankruptcy in 2010. Why? Because they were still insisting on renting DVDs from their shops while Netflix conquered the market with online video streaming services.
Netflix on the other hand, founded in 1997, was at first a video-rental-by-mail service, which was a half success. Its founder, Marc Randolph, offered to sell his company to Blockbuster for USD 50 millions, but was not taken seriously. With another investor the company took steps forward and introduced video streaming as a new technology.
So, while Blockbuster still was busy in figuring out how to improve revenues in order to cover the costs for all this brick and mortar infrastructure (after all 9,000 stores in its best times), Netflix was flexible enough to use the latest digital technology in order to improve customer experience and to win decisive market shares.
Now, Netflix has a market valuation of about USD 203 billions. It was digitalisation which opened the door for a scalable product, while constantly improving customer convenience and experience.
Netflix vs Blockbuster is an excellent example of what was very well described in "The Innovator's Dilemma" (by Clayton M. Christensen). Basically, Christensen argues that well established companies, still earning excellently in their market environment, may lose their ability to go with time and to recognise the importance of new technology. This is even more true when technological developments are in an early stage and their functionality is hardly to be recognized yet. A solid earning structure of those companies prevents them from building up the necessary pressure to embrace those upcoming changes until it is too late.
The Blockbuster/ Netflix story is one of the best examples to understand why it is so important:
- to go with the time
- to embrace new technology
- to be adaptable and after all
- to take the customer needs first.
Talking about customer needs! Well, in the real estate industry those customers may be different stakeholders to be treated with customer-like requirements. Decision makers, shareholders or debt funding partners - all of them have their requirements to be serviced in a fast, less complicated and convenient way. There will be a growing demand by a new generation of shareholder representatives, fund managers and debt financing employees for concise and constantly available information as well as data driven decision making procedures.
Real estate companies which are not able to match those requirements will lose the interest of investors and potential market partners, which will result in the diminishing of their market valuations and making them more vulnerable for hostile takeover efforts.
Times are changing - and for real estate companies, as it is with other industries, keeping up with digitalisation efforts in any area of the business is not a choice anymore. It is a must.
The COVID 19 pandemic only reminded us!