Intelligent Real Estate Due Diligence
Topical Discussions by Industry Experts
Stephen Spooner, Non-Executive Director, IREDD, Aug 2020
If you are in the insurance industry, even as a real estate specialist, you could be forgiven for missing the significance of the Open Standards Consortium for Real Estate (OSCRE) having made their data model available for free use. Here is the link, fill your boots!
Well done if you got past the first paragraph, it shows admirable fortitude. “Why is it of interest to me?” I hear you say. “Isn’t this just stuff for those involved in a technology niche serving property managers or possibly the arcane sub-niche of property valuation?” Good points, but no. Please stay with me.
Commercial real estate data is particularly opaque for two reasons:
1. It is complex because it is multilayered due to the plethora of interested parties and sources;
2. As a result of that complexity it is hard to create a unified picture of the data constellation that relates to each asset. Many businesses just don’t bother to collect or manage data beyond their immediate needs.
The massive, lucrative and economically critical real estate industry has traditionally handled this with a surprisingly consistent approach. It employs lawyers to take the risk that it may have misunderstood what it has bought. This is particularly prevalent when it comes to transactions.
The ancient due diligence ritual acted out when assets are traded, leased or financed requires a great deal of time to gather and minutely examine the epistles, scrolls, indentures, deeds and assorted instruments that together define the rights to be conferred on the purchaser, tenant or lender. To be fair most of these documents are now available in electronic form, although much of it is no better than taking a photograph. This is a soul-destroying task when carried out, even if it just once. I know this from personal experience but it gets worse. The exact exercise is often repeated on multiple occasions for the same asset because for each “event” at least one party has to perform the ritual, again. Why?
Essentially the desire to limit the risk that that value will be adversely affected by a previously unknown legal or physical impediment. There is no trust between parties operating, fundamentally, on a philosophy of caveat emptor. The parties have agreed terms for a contract on the basis of a set of facts, many of which are only assumed at the moment of that agreement. The party that instigates (and funds) the ritual is rarely interested in the artefacts themselves, in fact it is normally only concerned to know if there is any aspect if the findings that might trigger a loss. This is evidenced by the frequency of occasions on which the lawyer is asked to report on “exceptions” only. A reminder: this is the ritual which has probably been enacted before, possibly quite recently and to a higher standard.
We have a situation where data is extracted from text or graphics, analysed and dumped, again and again. Little or no effort is made to preserve or categorise this information, let alone give it structure.
There are several reasons. Thank goodness, because to do this with no, or even few, reasons would be crazy right? I submit that these are the reasons:
There is no benefit to those who are paying for the work because they only have an interest in that single transaction and there insufficient data to be relevant to other portfolio assets.
There is no benefit to the lawyer because the chances of being asked to perform the same exercise on the same asset again are small. Furthermore, the lawyer’s income is often generated by charging for hours spent reviewing and reporting, even if the outcome is simply a report that says, “it’s fine.”
The lawyer has a potential liability if the data is incorrectly translated from its textual source and re-used for other purposes. That liability would be reflected either in increased professional indemnity insurance premiums or worse, cover becoming unavailable
There is no point unless the data can be profitably be used in a structured form
Make no mistake the cost of repeating these exercises is very large but that is not the most expensive aspect. Time is the enemy of all transactions and these rituals are truly profligate in its use. Weeks or even months pass while the dance is dutifully performed. All anybody wanted was protection from the unforeseen, but the only defence was a microscope rather than a satellite. This is like getting a doctor to pay your salary if you have to take sick leave, without access to any research data or patient information other, than her own observations.
We are now in an age where vast databases are linked to give insight into risks, trends and causation but many aspects of real estate are (and will remain) invisible without the structure that data standards bring. Some examples of data models that are now available and open for use without incurring use charges:
Internationally, OSCRE members have supported and facilitated the creation of thousands of carefully considered definitions of real estate data points for over 20 years. The value of time and expertise invested in these “pigeonholes” in which to park and find information is incalculable but unquestionably vast.
In the UK a meticulously designed system for identifying “parcels” of real property, in 3 dimensions, has come through a long and troubled gestation to provide an anchor for an array of physical, social and economic information that is looking for relevance. https://ideal-postcodes.co.uk/guides/uprn
The Royal Institution of Chartered Surveyors is providing the means to trade in data that has been assembled to the meet their global professional standards which cover valuation, measurement and construction, with other areas to follow. https://www.rics.org/uk/upholding-professional-standards/sector-standards/construction/rics-data-standards/
These are just the most recent examples of an expanding infrastructure which will provide opportunities to:
challenge outdated practices;
employ technologies like machine reading;
bring real liquidity to real estate;
reduce transaction costs;
renew and adapt the built environment to meet challenges of climate change or pandemics;
provide valuable information to other aspects of local, national and global economies
The insurance industry understands and trades in risk by assessing issues and analyzing history; a process which cannot be undertaken without the light that data brings. Open data standards provide the light that reveals opportunities to assume risk and in doing so reduce waste while saving time, to the benefit of buyer and seller. This is a free resource and won’t be ignored by everyone, do you want your share of the bounty it can bring?
Mitigation of Covid-19 shock needs speed, the property industry must raise its game
Stephen Spooner, Non- Executive Director, IREDD, June 2020
I have now lost count of the number of “what happens next for commercial property?” webinars that I have attended from my study at home. I have heard plenty of wild speculation and some very tedious statements of the obvious, masquerading as expert opinion. Finally, I feel some themes are developing. Which is just as well as the world is starting to wake up and emerge, blinking, into the daylight. It may be a false dawn, but it can’t be ignored and the purpose of the vast piles of bricks, mortar, steel, concrete, timber and glass that make up our towns and cities look strangely different in the new light.
During my 45 years in the real estate business I have seen many examples of the problematic asset, particularly during the recession of the late 70s and early 80s. A massive restructuring of the UK economy started with a slash and burn policy that still creates rage amongst many who experienced it. The country has never fully recovered from the divisive engineering that brought the new version of the UK that emerged. The whole exercise was effectively financed by North Sea oil and gas revenues but disproportionately benefitted the south of England. Not because that is where the money was spent, but because that area was able to use the subsidies and freedoms to greatest effect. Other regions had to absorb the costs of recovering from vast contamination associated with the previous occupiers, heavy industry. This left less money for infrastructure. In 2020 things are different but the lessons of the Thatcher period are still relevant.
Urban Enterprise Zones V1.0 were a success; why? The essence of the Enterprise Zone was the reduction of red tape, planning was easier, the land was mostly in the direct control of the Government and taxes were, more or less, waived. This time the redundant land and buildings are not in the hands of the Government but there is an emerging sense that red tape still needs to be reduced and that planning processes should be less turgid. The other, and potentially conflicting, message is also that the environment matters. For once, there seems to be agreement between the public and private sectors that things need to happen, fast.
The transfer of these hobbled assets, whether retail or office, to entities that can re-purpose, adapt or replace is going to be a key factor in the future of the UK and all countries with service-based economies. The new ownership structures may well be a mixture of private, personal, institutional and state; but they will, in all likelihood, be substantially be different from today. This will mean a great deal of reshuffling and, given the scale of the shock that we have experienced, things will need to happen quickly and reliably. The weeks or even months that it currently takes to execute a transfer or financing transaction simply reduces the time available to get the plan in place. When local authorities are under pressure and valuers have so little relevant evidence to go on, there needs to be a new “can do” attitude because the comforts that we are used to can’t be there. The risks need to be understood, priced and accepted.
In my view, the real meaning of risk has been misunderstood in real estate circles for time immemorial. Legal processes seek perfection and performance is solely measured in terms for variation from the average. This is not a drill, we have to adopt new ways to make things happen quickly by selling the known risks to those who understand them and are capable of meeting the bill on those occasions when the dice fall badly. Stop spending precious time and money evaluating legal risks that are not core to your business, pay someone else to understand and assume that problem. You have enough to do in re- shaping the post pandemic world.