The Second industrial revolution

We think the world is changing at a rate that has not been witnessed since the Industrial Revolution. This has profound implications for where we live and how we use buildings.

As the world industrialised in the mid 19th century, the new factories required capital formation in order to grow. Crucially, the bankers, lawyers and accountants who facilitated this financing did not need to be near to these factories. This white collar expertise started to form in larger conurbations – cities. The advent of new technology – cheap postage, the telephone and electric lighting – meant buildings in cities could still serve heavy industry located more remotely.

The advance of technology as a catalyst for city formation was an inflection point in the history of our cities. We are at the second inflection point.

Technology companies

The parallels that we draw today are the sheer scale of the companies dominating the economy and our daily lives. We are, of course, talking about technology companies.

The difference between today and the 19th century is that the largest employers were outside the city, now large technology companies need to be inside the city. This increases or decreases demand from companies for certain locations. We call this the re-centralisation effect.

These technology behemoths are major employers and need a large, well-educated workforce. Unlike the large employers of the industrial revolution – the factories – the tech companies need to be in cities to attract the right calibre of employee and take advantage of mass transit to get people to the workplace. The technology sector is the reason for re-centralisation.

This tech demand impacts on which cities do well and which don’t. We are witnessing a bifurcation in the economic strength of global cities, as more regional centres become marginalised. Only a few cities will be able to accommodate the largest employers, resulting in a winner takes all scenario.

Investing in specific locations, as per the Schroder Global Cities index, has never been more important.

The top 50 cities for real estate investment

Source: Schroders. For the basis of the rankings see here. Darker blue circles indicate a higher global city ranking score. The size of the circle represents the size of our exposure to that global city.

The impact of tech on real estate

Technology companies are not only a source of huge employment which impacts the economic health of a city, but their products impact changing demand patterns for real estate in those cities.

Technology is changing the way we use real estate. Take ecommerce as an example. Currently 16% of all retail sales are transacted online in the US.

Source: Morgan Stanley as at November 2017.

The impact this shift is having on demand from retailers is re-shaping bricks and mortar retail. If an estimated 84% of spend is not utilising ecommerce, then there is a long runway, as younger ecommerce adopters replace older bricks and mortar users. Already we are seeing department stores go bust and numerous other businesses succumbing to the power of Amazon. The data would point to the fact that this is just the beginning.

Again, the parallels to the Industrial Revolution are clear. In Victorian times, the advance in manufacturing opened up new areas of demand and caused huge societal change.

Fast forward to today and technology is impacting almost every area of our lives and the boundaries are being re-drawn. The way we shop, travel, communicate and source information is being undertaken from handheld devices.

The consequences of this change are driving investment returns.

What’s hot; what’s not

The use and adoption of new technology is reshaping real estate and this demand is occurring at the points of mass consumption – cities.

Let’s provide some examples. The demand for warehouses has risen as packages are ordered online; the demand for data centres has risen as more data is transferred and stored; the demand for flexible office providers has risen to accommodate different work patterns.

The flip side to this is a drop off in demand for physical retail stores; and a drop off in demand for de-centralised office space.

The point that is born out is this: if you do not own the right type of real estate, there is a very real danger that technology has done to your investment what Amazon has already done to the book trade and Uber is now doing to taxi services. Boundaries are being re-defined, ‘disruptors’ are moving in and real estate is not immune.

We do not think that this change has reached its denouement. Far from it. We observe a number of broad changes that are just beginning to play out.

One interesting paradox is that the ability to work remotely does not result in de-centralisation. Quite the opposite. The rise of the flexible office providers is proof that massing of skills is more important than ever to build networks. The difference is that the location of that workspace is not the same building every day. We are moving into the era of remote working, as distinct to homeworking. Technology allows us to work almost anywhere; flexible office providers such as WeWork facilitate it.

Conclusion

Never has investing in the right assets in the right locations been more important. The need to re-centralise is based on knowledge sharing but out of multiple locations, not just one.

Large companies are massing more people into fewer places and technology is changing demand patterns, rendering some types of real estate hugely valuable, others obsolete.

Using the unique global cities approach of identifying companies with the best cities exposure, we can invest in key global locations and pick the demand pockets within those locations.

Second guessing the direction of the global economy is impossible. However, we remain optimistic that our strategies will provide durable returns to our clients, particularly if we do move into more uncertain times.