Interview...
Brian O'Flanagan - Publisher
REIT Analyst

O'Flanagan with Fergus Advisors, Inc., New York, NY, publishes The REIT Analyst web site. The REIT Analyst provides research, analysis and information on Real Estate Investment Trusts (REITs) and real estate operating companies for institutional and individual investors. O'Flanagan responded to three e-mailed interview questions on September 22, 1999.

Pike: Will e-commerce affect the value of retail REITs?

O'Flanagan: While I believe that e-commerce will have an effect on retailing, I think it remains to be seen what impact it eventually will have on the value of retail REITs. To illustrate, Forrester Research projects that total e-commerce sales will reach $327 billion, or 2.3% of total commerce by 2003, up from 0.1% in 1997. Thus, although the growth in e-commerce is expected to be exponential, it still will represent only a small portion of total commerce. I believe that the more significant impact will be on prices and margins as lower cost online competitors force retailers to lower prices. As a result, while retail REITs will clearly be hurt by lost sales to e-commerce and lower prices, the magnitude may not be as significant as many fear.

However, REITs must still adapt to the changing times. Clearly, consumers now have many more alternatives to the mall to do their shopping. As a result, retail REITs must be more proactive regarding the management of their properties and must find ways to compel consumers to come to the mall rather than shop online. A good example is the recent trend in entertainment-based retail centers that attempt to make shopping a more enjoyable experience for consumers by integrating retail stores with restaurants, movie theatres, and other attractions. The key point here is that while online shopping may be an excellent way to find products quickly and cheaply, the shopping center can provide additional services or an overall experience that consumers cant get online. Thus, REITs that reposition their properties to add more value to the consumer will be able to compete effectively in this environment.

Pike: Will the Internet reduce or increase the demand for office space?

O'Flanagan: I do not believe that the Internet will have a material impact on the demand for office space either positively or negatively. The argument that we have seen in many articles is that the demand for office space will decline because the Internet is giving workers the ability to work more at home or on the road, giving them the flexibility to stay out of the office. With more and more workers staying away from the office, the need for office space declines. However, we have not seen evidence of this happening to any significant extent.

But, the Internet will impact the way in which office space is used and the types of services that tenants will demand. Now that many more workers are working from home or on the road thanks to the tools that technology provides, many companies are implementing concepts such as hoteling to utilize their space more efficiently. But the most significant impact that the net will have on office buildings is that, as companies increasingly rely on the internet for their key business functions, they will require office properties that have the technological capabilities to serve their needs (such as broadband communications). As a result, property owners and developers must recognize the technological capabilities that their tenants require and ensure that they are able to deliver them.

Pike: Will the net impact operating expenses for REITs? How?

O'Flanagan: One of the reasons why REITs have a significant competitive advantage over small local operators is that in addition to greater capital availability, REITs have the capability to leverage the scale of their operations to reduce operating costs and maintain relationships with tenants, or prospects, on a national scale. However, these advantages are reduced by the costs of administering and coordinating these activities. I believe that the largest impact that the internet will have on the REIT industry will be the reductions in costs and increases in productivity gained from using the internet and other technological tools to streamline processes and coordinate activities.

For example, the internet can be used to streamline and automate the process of purchasing and maintaining vendor relationships. Currently, several large real estate organizations have begun to develop internet-based systems that allow their vendors and contractors to submit bids online. Other functions of these systems might include order and expense tracking, variance reporting, and project management. By utilizing these systems, REITs will be able to reduce the time and cost required for purchasing and maintaining vendor relationships, as well as increase the amount of information available to managers.

Obviously, I have only scratched the surface of the power of the internet and technology and the impact they will have on the REIT industry. But my key point is that systems are being developed that will dramatically reduce costs while increasing productivity and information flows. That is, the Internet will have the same revolutionary impact on the real estate industry that it will have on the rest of the economy.

--Peter