“Balkanization” of real estate: Now facing some push-back - by Daniel Calano

June 08, 2018 - Appraisal & Consulting
Daniel Calano
Prospectus, LLC

Back in the day, when you wanted to hold a special event, and needed a real estate venue to do it in, you would book a restaurant, a hotel or conference facility. Fast forward to now, and the venue could be a penthouse of an upper west side New York building that’s being rented out in increments of hours or days. Such celebrations have been happening under AirBnB, whereby entrepreneurs are master leasing apartments and subleasing them in increments as small as a few hours. And, there is beginning to be some push-back from neighbors and municipalities. In fact, after several years of AirBnB, there are new regulations on the horizon.

There is a natural search to figure out ways to take large blocks of assets, break them down into smaller pieces, and sell or rent them. This is not a new phenomenon, but it has certainly been advanced due to internet/mobile technology, communications, and large data bases. Historically, examples abound – from political candidate marketing to “crowd source” funding for small companies. 

As one early example, the NYSE in early 1800’s figured out a model to turn wholly owned private companies into companies owned by individuals, in smaller pieces. This not only provided a new means of building wealth for the common man, but also a way for companies to raise money and share the risk, as well as the profits, of innovation. It was one of the best and early examples of decentralization. 

Related to real estate, one of the first examples of decentralization is that of loans. Back in the day, real estate loans were typically made to individuals with personal recourse if debt was not paid. Starting in 1970, the U.S. Department of Housing and Urban Development created financial instruments whereby loans were securitized, that is, made into smaller pieces to sell to individuals in the financial marketplace. The common man could now enjoy a small role as banker, profiting from a reasonable interest rate, and the original or primary lender could decentralize its risk. 

On a somewhat parallel track, residential real estate “balkanization” was moving from buildings like hotels, an obvious historical example short term lodging, to cooperatives, condominiums, point shares and time shares. These were all great entrepreneurial ideas to create real estate in smaller portions, with more flexibility of ownership and use, for less cost to the consumer. Alongside of this came real estate investment trusts which allowed individuals to own pieces of properties, typically grouped by similarity of use, and managed by competent professionals. 

Real estate is also in the process of moving quickly towards concepts of office sharing, flex space, versatile open floor plans, in some cases “virtual office.” Technology is helping innovation in changing older real estate paradigms into more decentralized concepts, whereby entrepreneurial individuals can enter into the marketplace from small startup companies, financed by small startup investors, with small communication instruments such as smart phones and tablets. 

Where this leads to, one can only imagine. The concept has already been facing road blocks, ranging from unions (think Uber) to rental contracts prohibiting subleasing, to financial contracts limiting loan selling, to plain old cultural resistance. Neighbors have understandably been complaining, or filing lawsuits. Municipalities have been modifying zoning regulations to restrict such intensive activities. Courts are viewing this as an illegitimate changing of residential neighborhoods into commercial venues, without the obligations that commercial interests face. Taxing authorities are looking at it all as an opportunity for new revenue. While it all is a phenomenon that might not be stopped, it will certainly soon be regulated, appropriately, relative to the activity it has become. 

Daniel Calano, CRE, is the managing partner and principal of Prospectus, LLC, Cambridge, Mass. 

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