September 1, 2000
The Impact of the Internet on
Commercial Real Estate Sales
By Howard Hobbs, Ph.D., Real Estate Economist
FRESNO -- Technology in an economic context
can be anything that changes the production for economic goods,
including real estate, so that the goods are improved, or produced
more efficiently at lower cost.
The production function relates the inputs
to the production of real estate stock and services to the output.
The inputs include the factors of production of land, and capital,
as well as quality and a number of other types of amenities.
Technology can affect the production of
real estate through any of three points of entry.It may act "upstream"
to affect the efficiency of production or quality levels of the
inputs to the production process. Examples include the improved
insulating properties of glass curtain walls and the spread of
the secondary market and securitization in the commercial mortgage
It may affect the construction and operation
of the real estate structure itself. For example, the development
of critical path method (CPM) construction management techniques
in the 1960's enhanced the efficiency of production of commercial
real estate, just as the invention of the modern elevator in the
nineteenth century made high-rise development feasible.
Finally, it may influence the "downstream"
tenants of the property or other unrelated forms by increasing
their efficiency of production or actually serving as their product.
A current example is the dramatic impact
the surge of demand by dot.com firms is having on the rent levels
for office space in San Francisco.
Firms being impacted by technology can
have an effect on the local real estate market even if they do
not themselves demand space there, to the extent that they are
wealth generators in the economy in general.
Technology can operate at any of these
three points of entry at one of three levels: It may act incrementally
to simply produce the same product more cheaply.
For example, the development of PVC pipe
substantially reduced plumbing costs. It may result in the production
of an improved product. An example is the better insulating qualities
of glass curtain walls discussed above.
It may mean the development of an entirely new
product such as the elevator. We must remember two important facts
about technology in the context of real estate: First, technology
is inclusive not only of "high-tech" intervention into
the production process for physical goods. It is a part of all
production processes for all goods.
Improvements in the financial efficiency of the market
for "intangible" commercial mortgages and the "low-tech"
development of messenger and delivery services by office management
companies involve the application of technology, just as does
the spread of information technology and the Internet. Second,
It must remember that just because technology
increases the productivity of the economy overall, an increase
inthe demand for real estate stock and services, does not necessarily
do so for each sector of the real estate market.
The blacksmith shops and train stations
were rendered obsolete by advances in transportation technology,
just as some assert space based retailing could be adversely impacted
by the introduction of e-commerce.
Several major events that are products of recent
applications of technology in their anticipated effects upon the
real estate market. Improved quality and cheaper consumer goods,
especially electronic devices, new drugs and health therapies,
and bio-engineered products, are proliferating.
These influence the downstream users
of the real estate by creating demand to house the production,
distribution, and marketing of these goods and by creating additional
wealth in the economy that generates demands for additional consumer
Those areas will thrive that host various
elements of the market for such goods.
Transportation development and the development
of cities will continue current trends of decentralization and
growth of the largest metropolitan areas.
Forecasts of dramatic increases in the
spread of the city because of increased telecommuting will not
be realized because of evidenced continuing need for face-to-face
and a desire for spatial proximity for purposes other than work,
such as entertainment and socializing.
However, ultimately the size of the city
must have its limits, imposed by the time that those who still
physically commute are willing to use for that purpose.
The ultimate consequence of this for
urban growth is "conurbation", a number of proximate
clusters of specialized economic activity in a broader metropolitan
Construction technology has affected the
real estate market historically most directly through three new
innovations: the development of steel frame construction, the
invention of the elevator, and the introduction of mass manufacturing
methods in building constructions.
The first two made possible the development
of high-rise office and residential structures and larger employment
and residential districts within the feasible range of commuting.
Mass manufacturing techniques, include
standardization, prefabricated materials, and critical path method
(CPM) construction management techniques, which have considerably
lowered the cost of production of real estate structures.
Innovations will continue to be introduced
in the area of construction technology. Most notably, the "smart
building", with high?tech control systems and "wired"
for broadband technology, is coming into its own.
More efficient procurement systems are
also increasingly available through B-to-B e-commerce. Also,
financial engineering has definitely come into its own in the
provision of debt and equity capital to real estate. On the equity
side, the development of the REIT and RIOC markets over the last
decade have provided an efficient means of delivering equity capital
to commercial real estate.
Although only making up a small fraction
of total equity ownership, public market securitization of the
real estate market is more important for investment-grade product
and in certain sectors, such as regional malls and hotels.
It now is sufficiently large that it
provides a public-market reference point with respect to the evaluation
of risk and the health of the market that is increasing the efficiency
of the market overall and reducing the magnitude of real estate
The same is true of the debt side of the
market, where the development of the commercial mortgage-backed
securities (CMBS) market has enhanced liquidity and reduced the
swings in credit availability and cost. Both the securitized debt
and equity components of the market are expected to be helped
greatly by the continuing development of e-commerce, which will
facilitate their growth.
Manufacturing systems have had substantial
impact on industrial real estate through improved supplier-producer
relationships and just-in-time inventory methods. Manufacturing
facilities are becoming more specialized and centralized as product
mix becomes more complex and "lean manufacturing" techniques
As greater efficiencies are sought in
distribution management, just-in-time inventory management has
reduced overall inventories. This reduced the need for smaller
localized storage facilities. Industrial building investment as
a share of GDP will continue to decline, as these trends continue.
The Internet revolution is perhaps the
most important technological innovation to impact real estate
since the invention of the automobile and the elevator. It provides
four different levels of product to the real estate market, each
of which can have different degrees of influence. The
first level is the provision of information. This is the most
basic level of production for the Internet.
It makes up virtually all the substance
of individual company Web sites, and market data provision over
the Web has become a core product line for a whole host of online
data providers, including consulting firms, trade associations,
and government agencies. In spite of its basic nature, such data
provision is highly important.
A high degree of competition exists among
data providers that is resulting in consolidation of the industry
and survival only of those with the best (most reliable and frequently
updated) product, the easiest access, the most capital for expansion
and acquisition of competitors, and a broad infrastructure of
relationships within the industry.
The second level of product provision
by the Web is the provision of analysis, including everything
from appraisal methods to property management support, accounting,
tax planning, construction management tools, and specialized software
for statistical analysis.
Surprisingly enough, the firms that may
profit most from availability of this product may not be existing
large mufti-faceted players, but rather the up-and-coming technology
oriented "niche" players, which heretofore have
not had sufficient infrastructure or resources to support such
an extensive analytic function.
Consolidation will also come Web-based
purveyors of analytical tools as applied to real estate, although
this component of the industry is still in the start-up phase,
with many products being offered by the information providers.
The survivors ultimately will be those
that provide the most value-added to the most users, are adequately
capitalized, and have the best infrastructure to support their
product, including a capable user-support network.
The third and fourth levels of product provision
to real estate by the Web are the facilitation of real estate
transactions online and, ultimately, the development of online
real-time auctions of real estate interests, which eliminate the
"middlemen" who are necessary for traditional real estate
Facilitation of transactions online does
not actually transform the marketplace, but only the location
at which the transaction takes place, it becomes virtual as opposed
It could involve anything from online
completion of application forms and offering contracts to actual
acceptance and transfer of ownership online.
The development of a real-time online auction transaction mechanism
would be a fundamental transformation of the marketplace, dramatically
changing existing market roles.
Progress toward putting real estate transactions
online, however, has been uneven, with the residential primary
and secondary mortgage market being the furthest along, and the
secondary market for commercial mortgage debt being not very far
The Web also threatens residential sales, as many components of
the transaction can increasingly be provided remotely.
The segment of the market least likely
to be impacted by Web-based innovations is the sales process for
large commercial properties, which are a relatively thin market
and highly heterogeneous, requiring high levels of personalized
The market for securitized REIT and REOC
shares on Wall Street is a different animal, as it already is
an online real-time auction as part of the stock exchange, but
that should be distinguished from the sale of whole fee interests
in individual assets through the private markets, which will continue
to have a place in the real estate market.
A series of questions have been frequently
raised with respect to the anticipated impact of technology on
real estate, which our analysis now permits us to answer:
(1) Will new technology, and especially the Internet revolution,
make real estate redundant in the "New Economy"? No.
Commercial real estate values will continue to decline as a share
of GDP but will increase in real terms as the economy continues
to grow as the result of the application of new technologies.
(2) Will brokers, loan underwriters, appraisers, and other agents
in the transaction process be intermediated into oblivion as their
functions become irrelevant in the new economy of the Internet?
Those in traditional agency positions in the residential primary
and secondary mortgage market will be most affected by the wholesale
movement of a large share of that industry online.
The commercial secondary mortgage market
will be not far behind. The market for residential sales and "bulk"
sales of commercial property portfolios will experience movement
online with a commensurate reduction in the roles of traditional
As REITs and REOCs become a larger share
of commercial market ownership, the online electronic marketplace
of the stock exchange will penetrate further into the real estate
However, this level of activity is separable
from the transfer of whole-property fee interests in commercial
property in the private markets, which will continue to require
a high level of personalized due diligence owing to the thinness
of the market and the heterogeneity of the product.
The agency position associated with larger
commercial property transactions will prove the most immune from
Web obsolescence. Second-tier regional malls, power centers, and
big boxes may be at risk to the extent that they do not provide
subsidiary benefits to consumers such as food and entertainment.
The highest rates of penetration by e-commerce
are predicted to be for computer hardware and software, accessories,
music, consumer electronics, and flowers.
However, the overall level of penetration
into the space-based retail market by 2010 is predicted to be
only 5.4%, significantly lower than many optimistic estimates.
Census Bureau surveys of Internet usage found only an estimated
2% of U.S. households were using the Internet to shop online,
significantly lower than other estimates such as Forrester's 9%
figure for 1998.
The recent decline in the share prices
of many e-commerce dot.coms may portend the fact that neither
the economies, nor the broad base of demand exists for e-shopping
and that it may well exist more as a niche in the market, as do
the catalog and the shopping television network, than as a supplanter
of traditional shopping. Even if e-commerce
does take off in popularity, however, the resulting higher rate
of economic growth overall may more than make up for the loss.
Many inner-cities will continue to experience
soft office markets as decentralization continues. "Landmark"
high-end skyscrapers have rarely worked out well financially and
have not been visions of economic sense. However, clusters of
office space, lower density, and more functional will continue
to be in demand.
The CBD will continue as a viable office
cluster but a smaller one, relatively if not in absolute terms,
and only one of many others spread throughout the metropolitan
region. The amount of office space per worker will continue to
As cities become increasingly disperse
when the economic mandates for physical proximity and agglomeration
become less decentralization will continue.
Cities will be driven more by non-technological
factors than technology, including low density zoning requirements,
increasing affluence, a flight to high-quality schools and government
services, and U.S. tax policy encouraging the purchase of larger
Four things could cause a reverse migration
to the central city: increased transportation costs, an aging.
Internet technology and improvements in transportation systems
will reinforce of these trends.
Howard Hobbs, Ph.D. University of Southern. Cal. (1980)
Web Portal Inc.,
Real Estate Research Division (1999-2000) ;
Donald T. Campbell and Julian C. Stanley,
Eperitmental and Quasi-Experimental Designs for Rersearch
(1966) University of Michigan, John's Hopkins University
Carey Vandell and Richard Green,
Center for Urban Land Economics Reseaerch (1983); T.B.
Veblin, Theory of the Business Enterprise, Scribner, N.Y.(1934).
Letter to Editor
Copyright 2000. Fresno Republican Newspaper.
All Rights Reserved.