The Power of Data Podcast
Episode 75: Managing Risk In The Commercial Real-Estate Market
Guest: Matt Richardson, Co-Founder and Chief Executive, Income Analytics
Interviewer: Nick White, Head of D&B Accelerate, Dun & Bradstreet
Hello, and welcome to The Power of Data Podcast. I'm Nick White Head of D&B Accelerate, and I'm pleased to be joined by one of the Accelerate family, Matt Richardson. Matt is the Co-Founder and Chief Executive of Income Analytics. Welcome to the podcast Matt, how you doing today?
All right, although it’s pretty hot up here in my attic.
I thought you were gonna say Miami.
First question today, Matt, let’s start with a little bit about you. You've had over 30 years of experience in the property market and in 2020 you started your own company Income Analytics. Can you tell listeners a bit about your journey and your experiences that helped you to create income analytics?
Yeah, my background: I started out in the commercial real estate investment markets in the late 1980s in the tail end of the Thatcher boom and worked for a very small startup company back in those days called Investment Property Databank who many people in the real estate market will be familiar with, it's now part of the MSCI family. And subsequently went on to work for a company called Hillier Parker, who became CBRE, which is now one of the major brokers. And then had a seven year experience of working out in Asia where I was based in Hong Kong, but worked in Southeast Asia, Mainland China, and a little bit time in the US as well before coming back here to the UK, the beginning of the year 2000. Most recently, I worked for just over 11 years at Fidelity International where I was the Director of Research and Investment Strategy, European Real Estate. So as you can see it's been a wide ranging journey, taking in most of the world, but the core thread here actually has been working in commercial real estate investment markets, and really watching them migrate from being a localised, small, domestic industry to becoming a globalised asset class, which is now traded by international players. And that was really the journey of Income Analytics, where we've set out really as a business to work with the investors in the market, give them the tools so that they can work as part of the institutional investment markets. And we've seen tremendous changes over the last 30 years in how the whole sector’s developed.
What's the business essentially there to help your customers solve for Matt?
The most interesting aspect or biggest change in commercial property markets is not only the nature of the buyers and sellers, and the liquidity to become very international, but one of the strange parts of the industry and probably a throwback to its earlier days is the obsession that property is about price and the price of physical assets and it certainly is, but it has always frustrated me throughout my career, how much time is spent on focusing on how much the price of property is going to move up and down. And institutional investors have become obsessed with this as well, when in fact, any careful analysis of how the market works should really focus on the importance of the income that property generates. Because unbeknown to most people, if you look at most developed property markets around the world, you can go to Australia, North America, Western Europe, Hong Kong, Singapore, and what you'll discover very quickly is that the predominant driver of performance is always the income or the future income attached to a property. And this is something that's often overlooked. So the thing that always interested me and my colleagues who helped me set this up was how little emphasis was placed on looking at the importance of that income and the cash flow generated from property. And, structurally, this is what Income Analytics was set up to do, was to focus in on how good or how secure are the rents paid in the buildings. And the reason this is tremendously important of course, is it's fundamentally why a lot of the big funds, pension schemes, insurance companies and high net worth individuals buy property, they buy it, because it generates cash flow. And also, it's invariably linked to crises, usually banking crises, because most of the loans that are out there are predicated on how well tenants in the buildings can repay their rent, which is supporting the loan books. And time and time again, if you look back through crises, the late 80s, and more recently, the GFC, it nearly always has a link to property and the ability of property debt to be serviced by tenants. And that's why Income Analytics was set up to say, listen, we keep going down this same blind alley, what we need is a greater insight into understanding how secure cash flows from property are. We have it in the bond market, we have a huge amount of research done in the equity markets, but actually, there's very little work done in the commercial property markets to help investors and lenders.
It's fascinating, Matt, and obviously, I've got to know your business well over the last 18 months. For those who are new to this industry. Could you give us a real-life example, let's just say the O2 is an asset in its own right, and somebody owns that asset and then there are other tenants within the asset that are paying offsetting of the debt. Can you simplify it for our listeners, so they understand the mechanics of it in a real-life situation?
Well, if we took a specific asset like you said, like the O2 which is a very, very wide ranging asset because it takes in leisure it takes in retail, it takes in hospitality or you took a City office, in any case, the individual asset would be bought. Typically, these days, large assets like that there's a limited pool of people can afford them. These assets are very, very large in terms of several 100 million, or in some cases, billions of pounds each. Within that building, or buildings, there'll be a range of tenants potentially, in the case of the one you raise there with the O2, as I said, you'll have restaurants, you'll have retailers, and you'll have the leisure facility in the offer itself. So, the owner, of course, wants to make sure because the owner themselves has paid a price for that, and the price will usually come with a yield attached to it; the lower the yield, the higher price, obviously. So, what you'll tend to find is that the owner will have worked out their numbers based on what the potential future cash flow or rental growth from that building would be. And what that person will be doing is looking into the future and saying, I'm going to make some assumptions about the rental growth prospects on these buildings and that will give me my present value and it will also give me a projected value into the future should I wish to exit from the investment. So far, it's all pretty simple. But of course, invariably, that investor will not just be investing their own cash, there may well be a fund who has investment requirements to insurers or to pension scheme exposures, and more importantly, they may have borrowed money to buy that property. So now not only do we have the owner looking to service their investment requirements, we now have a lender who's looking at the owner and saying to the owner, how secure do you think the cash flows are that are going to underwrite the repayments, you're going to make me to service this debt? So now I have two tiers of exposure to those underlying tenants, I've got the owner, I've got the bank or the debt fund who is lending the money to them. And all of this now links back to one simple question, which is, can the tenants pay the rent for the duration of the lease? It’s a very simple question and one that's often overlooked within our market. To give you some scale on this put this in context, EPRA, which is an industry property industry body in their report last year, Global Real Estate Total Markets, they estimate that this year, based on the value of the market, about 1.4 trillion US dollars is going to be paid around the world to commercial landlords. And all of that money is underwriting the investments that all those owners have made and all the debt that's sitting on the back of that. So, we're assuming typical debt ratio of somewhere around 30-35%. That means there's something like 10 and a half trillion US dollars of debt being serviced by that rent. And that gives you the quantum of what we're dealing with here, both on the direct side, and then the debt side. And yet there is no structured means of rating the quality of those cash flows, or no industry standard, which is quite staggering when you look at the size of that market.
It is, it knocked me sideways when we first started to talk about this as an opportunity Matt, how little due diligence and effort is spent in understanding at the simplest form the risk associated to the tenant, because that's how all of this is served and paid.
I think there's two components there Nick, there's not just the due diligence piece, because quite often, investors and lenders will run a traditional credit check and of course, credit reports and not necessarily designed for property people. They perform a very good function in giving people a point in time analysis of what the credit quality of a particular company is. The bigger issue here is the fact that often typical leases are five to 10 years, so these exposures are long term exposures. And so, there's two pieces really or two issues that need to be addressed in the property market. There's standardising the measurement of the risk at the point of loan or investment. But more importantly, it's monitoring that risk through the lifecycle of the investment. And that's something for instance that’s done in the bond market very assiduously by investors and equally in the equity market. And yet, strangely enough, there are very few people monitoring the quality of the cash flows in the direct real estate market.
And I guess Matt even if they had been, a little thing known as COVID-19 turned the world on its head last year, and has had huge impacts on so many industries and sectors around the world. How has it changed the landscape for commercial real estate?
Well that’s a big, big and wide-ranging question. I'll probably chunk it up into a few bits. I think there's probably a popular misconception that COVID is the root cause of the current problems in the retail sector. There problems in the property retail sector predate COVID, by quite a long way and the structural changes that were under underway, in terms of shifting to the internet for a lot of retailers and the structural changes about how consumers buy things, probably haven't necessarily changed with COVID. What has happened is a cycle that would have probably run for another five to 10 years has been condensed into 12 months. And we've seen a wholesale shift in consumer behaviors and retail behaviors. So, I think in that area COVID in a sense has been an accelerant to the trend that was already in play. The area that's been hit very, very hard, of course, is the leisure and hospitality sector, because that's been the great growth area, particularly since the 1970s and 80s with conspicuous consumption. That's been a great growth area of the property industry along with retail, because we've shifted from being producers to becoming consumers, and very large parts of our income is disposable and is spent in leisure activities, whether that's eating out going bowling, going to the cinema, staying in hotels, etc. And of course, COVID is the thing that's really hit that because COVID stopped that very basic human need, which is interaction. So funnily enough, of course, if you look at what's happening now in the equity markets, a lot of the bets are now being placed back into the property exposures around leisure, because obviously, as and when a lot of the restrictions unwind, you're going to see some very sharp recoveries in values and in the stock price, a lot of companies associated with those, the ones that survived simply because you're going to see a lot of pent up demand going back to the leisure sector. The office sector is altogether a bit more complex, because what we have seen is the fact that people adapted to working from home far more quickly than many supposed. So, there's an argument at the moment that will we ever go back to needing all of the office space, and there's probably an argument for no, not all of it. I think the knee jerk assumption that we will stay at home and not go back to the office needs to be avoided. And it needs to be avoided for a number of reasons, not least that one; people like to interact and meet of people that working environments with similar people to themselves. And that creates creativity and supports teams and all the other things. Having said that people have got used to working at home. So perhaps what we're going to see is far more flexible working. But again, that was a trend that was already underway before COVID came along. COVID has accelerated that trend perhaps. Where COVID has hit the market very hard is in the serviced office sector. Because the service office sector WeWork and people like that, Regis or IWG is predicated on the fact that people will pay a slight premium, for the flexibility of being able to just use one desk and a bit of space here and there as and when they need it. Now, that's fine outside of a pandemic. But of course, what's happened with these big guys is their costs i.e. owning and running the buildings is fixed long term, usually via a lease or ownership, whereas the income that they need to survive the short term from these very flexible, small tenants. And they're the guys who've been very, very badly hit, because effectively they're committed long and their income is short. And that's a very dangerous place to be in commercial property. So, I suspect that we're going to see a lot of flush out in the service sector, there'll be a lot of stuff coming to market. And this is very important for markets like London, where you have a lot of flexible space around the core district. There still seems to be a feeling that in the end with bigger companies, people will still want to go back into the office. And there's a very important point here, people say but I can work from home, you can but let's not forget that all those networks that you have in place that you leverage to do your work were created when by and large, you were working in an office. So there needs to be an environment for new people coming into the market to create those networks themselves and create that work environment to keep it going. I suspect the outlook is going to be pretty tough for elements of the market. But I do think that the office market itself at the core level, there will still be a big demand for the right space. It's a very mixed picture.
Yeah, it's fascinating to get your perspective, Matt. And actually, the serviced office space is an area that I personally thought would benefit from this change in the working dynamic, you know, gone would be the days of a 5,000 strong office space in the middle of Canary Wharf to a more flexible, agile office down the road that you can go and use a couple of times a week, and maybe you get together with some peers when you need to. But it's interesting, I hadn’t even considered the fact that most of that real estate is borrowed long and therefore is exposed.
I think there's a there's a fair point, we're still going to need flexible space. I just think that the current market incumbents are in a lot of trouble. I think that's the issue here, that people providing service have been hit very hard by the pandemic and it's going to be difficult for them. I still think there's going to be a demand for flexible office space for other reasons that you outlined, but maybe not be the guys who are currently incumbent in the market that are providing it in the future.
Thanks, Matt, thank you. We're going to change tack a little bit here and move to conversation a bit more data related. So, has data become more important as a result of the pandemic? And I guess assessing risk has never been more important. Your thoughts and perspective on that Matt.
Can I split that into two bits? Financial markets or financial services is the purest form of information trading. They're as close as you get to pure information businesses and if you think about what all investment markets - particularly London and New York are dominated by - its data and information. I mean, that's essentially, whether you're a broker, a fund manager, you're running private equity, you're a banker, in the end, what you're selling is your expertise and your expertise is based on data and your ability to interpret that information to minimise the risk and maximise the return for your investors. And Financial Services has been at the forefront of data and driven the whole data agenda since the 70s. And if we look at virtually all major global data providers, they are in some way directly or indirectly to financial markets by legal and other things as well, because that is essentially what financial markets are about. So, what does the pandemic do? A pandemic introduces the reality of a new risk, we'd all sort of known that there is a risk that we could one day have a pandemic, but no one had taken it seriously. So suddenly, we now have something that was for many people, a black swan event now, probably for the rest of our lives in the back our mind, saying, could we have another one? Yeah, so we've introduced a new risk, and risks are mitigated by researching them, getting data on them, and working out ways to avoid the pitfalls that you mentioned in the first time. So the interpretive analysis of the data, the analytics. I think the demand for data will have gone up across markets, because there's a new type of risk to think about and to price into our models. But specifically in property, COVID, has done two things; it has focused the attention on the ability of tenants to pay the rent more than ever. And we've seen why, because it was very, very direct, it went straight to the heart of the property market and it injured the business models of most of the major tenants in portfolios. And that created a very immediate demand to say, actually, I've got no idea really who’s in my portfolios and how they're going to be affected, I could apply some broad brush, there's going to be a lot of movement at local and sub sector level. And secondly, COVID has had another big impact on macro government policy, which means we're going to have more borrowing, more or lower interest rates for longer and the impact of that invariably, when you have cheap money, asset values go up over the long term. So, what we're seeing is a lot of money coming into the property market, and it will continue to come into the property market, because in a zero-interest rate policy, the bond market simply isn't delivering a yield. So,people will look for assets that can deliver cash flow, and come to look for property, which is why we've seen a very big bull run in property since the GFC. And then underneath this, there's now a very fast-growing demand to understand the structural risks of the tenants in your portfolio, not just are they credit worthy, but what industries are they in, are these growth industries? What's the outlook for employment in these industries? Do I really want exposure to a group of tenants who are broadly in the same sector? How do I diversify my risk, etc. I do think the demand is going to go up more and more and more. And we're seeing that across the market, most of the big institutional property investors are investing very, very heavily in technology at the moment.
Great, Matt, thank you. It leads nicely on to my next question, which is what's the future for Income Analytics? Where do you see the organisation over the next three to five years?
What we would like to do is establish the business as providing the tools for the industry to standardise measures of tenant failure, default risk, so that effectively we just become a part of the furniture, we're helping people answer the questions they need to answer about the tenants measure that risk not just locally, but being able to measure what probability of loss from rental cash flows is internationally, across borders over time. But more importantly, create a standard whereby a letting agent in Germany is using a similar approach to measuring these risks as a complex team in New York constructing securitised bonds off the back of property debt. In a sense, what we're trying to do is create a thread that allows the practical people on the ground in property to work with the financial side of property in a way that they understand. And finally, what we really want to do, we want to position this is almost acting as a translate. So finally, people in other financial markets, equity, debt and other markets can look into property and understand the underlying risks to the cash flows in a way that are quantified, they're not subjective, and that they can measure them, analyse them, and begin to mix them up and use them as part of their own strategies, etc. It's really creating a level playing field for everybody where everyone can communicate with each other and understand what the other person is saying without necessarily having to fully understand all the details of their business model and what they're trying to do.
Thank you, Matt. I have no doubt and no concern that you'll achieve what you need to achieve. The offering is incredible, it's very unique, and the timing in the market is absolutely everything and I think the time is now. As we bring this podcast, unfortunately to a close, I move on to my last question, which is a little bit more personal Matt, I hope you don't mind. Have you had any mentors throughout your career? And if so, has there been anyone that's instilled a lesson or a piece of career or business advice you'd like to share with our listeners, something that you're going to pass on to those that are coming up behind you.
Oooh, it is a tough one.
You can't say me, Matt.
I would probably say a few people who've impressed me that I've worked with. In the very early 90s I was working for a surveying practice, Hillier Parker and I had a boss there called David Price, who will probably be known to a lot of people in the property brokerage community. And he was very candid and honest with me one day, he said, I don't know how I got to this job. He was he was head of investment time and they were very big brokerage. He said, the only piece of advice I can give to you is surround yourself with good people and trust them. That's an extremely good piece of advice, the older you get, you realise that being CEO of being in a leadership position is not about you know, issuing diktats from Mount Olympus , it's about identifying good people who understand what their role is and let them get on with it. That's probably a great lesson. And I was lucky enough whilst at Fidelity on a few occasions to have some long chats with a very well-known fund manager there called Anthony Bolton. And Anthony Bolton had a very long and successful career, and it wasn't really things that he told me, it was things about him that impressed me. They were he listened, he very rarely spoke, for somebody who was very well known and lauded across the market, he was incredibly self-effacing and modest. He always listened at meetings very rarely spoke. When he did speak, he had something to say. And I always found him incredibly polite and easy to deal with and I suppose the lesson I took from that was that, despite what the popular image of people in finance and businesses, actually, in the end, people like to do business with people who are trustworthy, honest, and decent people and nice people to be around. And that was the second biggest lesson. And hopefully, that's something within our business that collectively, we've made a very core part of Income Analytics is that people want to do business with you. And I think that's tremendously important, that trust. And I think that just comes from being as honest as you can and doing what you say you're going to do.
Our partnership is certainly built on that Matt and it's something that I've thoroughly enjoyed about working with Income Analytics over the last couple of years is that open, transparent, honest approach to everything. It does instill a level of trust in how you're going to work together. And it comes from you Matt across the entire business so well done. I've thoroughly enjoyed this chat, Matt, it's been an absolute pleasure. I wish you and Income Analytics every success in the future. Not that you need that from me. I thank you for your time this afternoon. Thank you for listening to The Power Data Podcast. And thank you Matt Richardson for all of your time for this afternoon.
No thanks very much Nick and I said it's been a pleasure working with Dun & Bradstreet over the last nearly two years actually now, since we very first spoke. So, thanks for your support collectively as a business and having the vision to work with us on this.