322. Capturing value in real estate’s new terrain

0:01Ben Dimson: From McKinsey & Company, I'm Sean Brown and welcome to Inside the Strategy Room. The basis of competition in the real estate industry is changing. The tailwinds of the last cycle are fading and emerging trends point towards selective growth in pockets within the sector. So how are leaders navigating this new terrain and creating value? To address that question, we're joined today by the co-authors of a recent McKinsey.com article titled Real Estate Builds on New Terrain, which we've linked to in the show notes. Aditya Sangvi is a senior partner in our New York office and the global leader of our real estate practice.

0:40Ben Dimson: Ben Dimson is a partner in our London office and leads our real estate practice in Europe. And Tripp Norton is a partner in our Atlanta office and a leader in our real estate and private capital practices. Welcome everyone. So to kick off Aditya, as we look at this new terrain of real estate, I thought maybe you could first share a little perspective on what you're seeing as the single biggest disruption. It might be AI, geopolitics, interest rates, and how it's influencing your client's investment strategies right now.

1:10Tripp Norton: Yeah, absolutely. For the last few decades, real estate has really enjoyed a very long cycle of low interest rates. And during that time, the basis of competition was really about selecting or building great assets in great locations, and then generating the returns and yield from that. And what has happened through the last couple of years in which real estate has underperformed is that the basis of the competition is actually changing. It is now similar to the change that happened in private equity in the early 2000s, where what matters most is asset selections, a true investment alpha, operational alpha, which is how do you improve the performance and the NOI of the properties that you have, and developing platform scale via digital and AI.

2:01Tripp Norton: The basis of competition, how to win in real estate is really shifting.

2:05Ben Dimson: And so what does the research tell us about what this shift means for the industry?

2:12Tripp Norton: So we want to start with some of the facts, and we always start with returns because that is what is most important. And in looking at returns, it's important not just to look at real estate or real assets, but look at all investments and see how real estate stacks up. And over the last three years, real estate has underperformed and dramatically, and it's trailed its private market peers in private equity, infrastructure and credit, and even public REITs as well. Private real estate now sits at the bottom of the pack and below the two specific asset classes that compete hardest for the same dollar, which is private infrastructure and private credit.

2:46Tripp Norton: All of us in the industry feel it. And the more interesting question in many ways is what does it mean? Because the instinct is to say that it's turning and 2025 was modestly positive. Debt was up 4.8%, Core Plus is up 1.5 % and opportunistic returned back in positive territory and 1.2%. But cumulative three-year performance is still negative, about minus 2.6 overall. So it's best described as stabilized, but not recovered. And so the change that we would highlight is that falling cap rates and rising valuations that drove the returns in the last cycle, as a tailwind, that tailwind is gone. And as I just said, the basis of competition is changing, and it's all about the alpha that you can generate.

3:27Ben Dimson: And Aditya, do you think this is a cyclical dislocation that's going to revert to the mean? Or is this more of a structural reset that's going to permanently lower returns?

3:37Tripp Norton: Yeah. So it is a cyclical change that is starting to move. It is structural factors, and it's these new global forces. These have all, over the last couple of years, been reasons why real estate is lagged. The cyclical factors are where you feel day to day. They're the interest rates, they're occupational headwinds, which basically means weaker tenants demand, there's inflation, it's a near-term cycle. And Sean, to your question, the cyclical factors are generally improving. The central banks eased throughout 2025, the Fed by 75 basis points, the Bank of England by 100, the European Central Bank by about 50, and markets are pricing for even more rate cuts in 2026.

4:20Tripp Norton: But the market hasn't recovered fully, which by the way tells you that rates are never really the whole story. The second is some of the more structural changes. So these are things around behavioral shifts, sustainability and aging demographics. You know, these you can't wait out. You have to underwrite them and they just continue to go. But then I think the one that's caused the most disruption this year has really been this new category of global forces. If you look at most investment memorandums from five years ago, they didn't feature this at all. And now it drives a lot of the conversation and a lot of the dynamics that we're seeing, you know, in how asset prices are moving and where people are choosing to invest.

4:56Tripp Norton: And so the firms that are doing well right now are the ones that are actually operating across all three of these. They're able to navigate the cycle. They're able to think and underwrite the structure. And then they're also able to create the optionality that's needed with some of the global forces. Right.

5:09Ben Dimson: And so Tripp, maybe you can unpack this a little bit. How has the last year looked for the industry in the face of these disruptions?

5:16Tripp Norton: So I think when we look at the last 12 to 18 months, by and large, they've not necessarily been a bad year from an activity standpoint. We've seen deal value increase year over year as transaction count was broadly flat. What this indicates to us is that value went up because average ticket sizes got bigger, which tells us that capital is starting to concentrate, not necessarily broaden. When you kind of look where most of that uptick has actually been in, it's been in more of the specialty property sectors, the examples of senior housing or data centers, et cetera. And this highlights the continued trend of specialty property gaining a share of total deal volume every year since 2023.

6:04Tripp Norton: This mirrors the LP interest in terms of how they are thinking about allocating dollars to more niche sectors in terms of finding, seeing those as pockets of where there are greater returns. And so, you know, I think fundamentally money is moving. It's just maybe moving to fewer and more specific places. And so that's kind of what we mean when we talk about a selective acceleration rather than kind of a broad normalization.

6:31Ben Dimson: And are you expecting the growth that we've seen from 2024 to 2025 to continue? And are there any other areas that you think are going to grow? Maybe office space, for example, is that starting to come back?

6:44Tripp Norton: Yeah, it's a great question. And I welcome other thoughts as well, because I think everyone would perhaps maybe have a slightly different perspective. But at least my view is I do think that overall transaction activity is going to continue to pick up. Right. I think this is in part, at least my view is that what you're seeing is you're seeing a little bit of the market digest and accept the little bit of the new reality that we are in. Talking about a lot of the fundamental shifts that we've seen that Aditya had previously mentioned.

7:13Ben Dimson: And Ben, Aditya, anything you'd like to add here?

7:16Aditya Sanghvi: Yes, I think what we're seeing is certainly the more contrarian investors are starting to have a look more at the office and retail space. And we've seen some of the kind of more risk on capital embracing that. There's some very attractive pricing to be had. It's all about the asset selection. So if you can get the right asset that has strong fundamentals, then that can be bought at really attractive prices. because there's a lot of people just not in the space at all. And so it's about being super specific on the underwriting and the analysis.

7:53Ben Dimson: And are there any other differences in trends by region? Maybe you're based in Europe. Any big differences you'd point out there or with other regions?

8:03Aditya Sanghvi: Yeah. So I think we've seen, if I just went through a few of them, so we've seen massive demand on the data center side globally, but I think that the US has been better placed to be able to respond to that in terms of the actual availability of stock. But there's a lot of interest, certainly in a European context. The senior housing probably has been a little bit more US focused. It's very well established and continuing to be very successful in certain geographies. So, you know, driven by US and Canada, Australia, New Zealand, Israel, it's quite specific markets. It's not something that has yet got scaled, there's been a lot of interest in Europe more broadly.

8:48Ben Dimson: And Tripp, could you tell us a little bit more about the level of activity you're currently seeing?

8:53Tripp Norton: Yeah. So when we talked about the overall activity that we saw in the last, call it 12 to 18 months, I think one important thing to highlight is that we still see illiquidity persisting in the market. And this is as when you look at the kind of aggregate deal counts across North America in Europe, it's running roughly at half of what the pre-crisis peak was in 2022. And when you compare this recovery to other crises after the GFC, it took roughly about five and a half years to get back to the same peak transaction volume levels. But that really was incremental gains year over year. And so there was always positive momentum from a transaction volume standpoint.

9:38Tripp Norton: But now when you look at the current recovery, it's been really nearly four years since the peak. It's been basically flat for the last two years. And I think two things help explain why this might actually be. First, you have buyers and sellers that are working off different marks. When you compare kind of the listed real estate versus some of the private appraisals, you get about 130 basis point differential. And second, it's really thinking about that maturity wall that exists in the industry. It's not necessarily shrunk. It's just kind of continued to move and be pushed out. Only about 17 % of projected 2025 maturities actually came due.

10:21Tripp Norton: And so at the core, what that actually means is you're seeing more equity impairments. You're seeing assets being pushed into extensions. You're seeing restructurings or recapitalizations rather than actual sales and realizations.

10:36Ben Dimson: And what do you think unlocks this liquidity? For example, what unlocked the liquidity after the global financial crisis? And do you see the same kind of trend happening post-2022?

10:47Tripp Norton: I think naturally, I think the easy answer is fundamentally interest rates. If we see a lower cost of overall debt, you're going to naturally see an uptick in overall activity just from an underwriting standpoint. You know, if we see private appraisals resetting back and mirroring more of what the listed market marks are, right, and seeing that valuation gap narrow, you're going to see an uptick in activity. In some parts, it's going to also be a little bit market-by-market dependent. But, you know, welcome the thoughts of Ben and Aditya. No, look, I would add just to what you said, Trip, then what matters the most is for people to be able to be fully honest about where asset values stand.

11:33Tripp Norton: In many other asset classes, there is a very clear mark to market. And it's obvious if the price has fallen, the price has fallen. In private real estate, we as an industry have survived for a long time with people kicking the can down the road and making it seem as though asset prices haven't moved. And that has frozen what transactions could happen. And, you know, as Tripp said, in the public markets, you can't do that. And they went through a repricing moment. It was very difficult. And now they're in a better place. So I think the sooner that that can happen, the sooner that the liquidity in the market can be released again.

12:11Ben Dimson: And do you see any specific unlocks to make that repricing happen?

12:15Tripp Norton: I wish I did. I think it's mainly about interest rates, as Tripp said, and just the time, like how long it's been you know since some of these assets since covid that forces the hand

12:29Ben Dimson: and ben it would be great to bring in your perspective here too especially what you're seeing in europe and and more broadly yeah i think there are kind of twin challenges

12:38Aditya Sanghvi: here one is a broader liquidity uh challenge in the market particularly in some of these core sectors like office and retail the second is is that you have a mismatch of the people that know the most about the most troubled sectors, it's very hard for them to double down because they've already had a lot of pain in those sectors. And so actually, there are great opportunities there, but it takes someone quite brave to then kind of come in from the sideline. I think there's some really good contrarian bets that people can make a lot of money on, but it's about the right capital chasing the right opportunities.

13:13Ben Dimson: Okay, and Tripp, let's dig in a little bit more into how real estate is competing against other asset classes. How does the risk return profile hold up against a infrastructure, for example? Yeah.

13:25Tripp Norton: So maybe picking up a little bit on a notion Dita mentioned earlier, because what we wanted to do is take a look a little bit at the returns by comparing real estate with the asset class that one of the asset classes that it's competing hardest against for that same LP dollar. What we did was we took a look at the 2014 to 2023 vintages. And when you actually look at infrastructure compared to real estate, you see infrastructure's median return being higher than that of real estate. And what I think is interesting when you look at the spread of returns, in some ways, what matters from an allocation committee standpoint is thinking about that downside risk.

14:04Tripp Norton: And when you look at the bottom quartile, infrastructure still made more than 200 basis points than real estate. And so as allocation committees think about where they're going to put their next dollars, right, you're seeing increased competition from infrastructure. Now, when you actually dig into the different risk categories within real estate, a little bit more uncomfortable message may be playing out than we want to realize, which is, you know, what we're seeing is as you move up the risk curve, the median returns don't necessarily improve. You see from opportunistic to value-add to core and even core plus, all roughly at that same median of 9%.

14:46Tripp Norton: What's occurred is investors are not necessarily adequately being compensated for the extra risk they are taking within real estate.

14:55Aditya Sanghvi: True. Do you think that the infrastructure investors, though, are pricing the risk correctly? Because a lot of that run has been underwritten by energy transition and data centers. And the infrastructure investor believes they're investing in things that are kind of pretty stable and low risk. But I just wonder on a risk adjusted return, whether it's been a particularly good environment for them for a few years, but maybe the risk hasn't been seen yet. It's a great question.

15:24Tripp Norton: And you're touching on a point, especially the notion around data centers, which is a sector that is bleeding between both real estate and infrastructure. And so you're having, and of course, it's extremely hot right now. And so you're seeing a ton of capital move into it. And you're seeing incredible returns for some of the data center projects. That is part of the fuel that is driving the overall infrastructure.

15:51Ben Dimson: And given what you're talking about on risk adjusted returns, I mean, do you just get it back by repricing? Or does that further imply that there's a pricing adjustment in the future to try and get the risk adjusted returns back in line?

16:05Tripp Norton: I think the repricing, it's a little bit of the notion that Aditya said. I think you're going to have to have some pain within the private real estate sector that perhaps hasn't necessarily occurred, right? And as that pain and investors take the knocks from those realizations of poor returns, that's going to necessarily kind of get over the hump and allow perhaps a more normal return distribution.

16:35Ben Dimson: And what are you seeing real estate do to compete? How safe really is core, for example, or core plus right now?

16:41Tripp Norton: Look, I think it depends on a little bit about the sector in which you're talking about, right? I think traditionally, a lot of core, core plus has been allocated to your, call it traditional food groups of office, industrial, retail, et cetera, less so niche, right? And those are some of the sectors that have been hit the hardest, right? But as you think about looking forward, perhaps that's also where there are the greatest opportunities to bend. And it may take brave investors to actually capitalize on them. But it's where, at least as I think about deploying forward-looking capital, it should be coming in at fairly attractive prices.

17:22Ben Dimson: And Ben, is asset pricing actually keeping up with the new market dynamics right now?

17:26Aditya Sanghvi: Yeah, look, I think it's all a question of whether your pricing is repriced and market tested. If you are buying assets now in the market, you look at the underlying occupational market. if you are in the right kinds of assets within some of those sectors, and that's very important, if you're in the right shopping centers, you're in the right office buildings, actually there's really resilient occupational demand, good rents, you're seeing the latest developments all the way around the world, all the major cities, many are breaking rent records, you're seeing really good occupancy. So if you are in the best of the best assets within these sectors, there's been massive repricing on the rent and also on the investment on the yield side.

18:08Aditya Sanghvi: The entry point is really good. And the underlying resilience of the income stream is also really good. So I think it's all a question of what's your starting point? And what is the actual fundamental of the asset or assets that you're buying into?

18:26Ben Dimson: So that sounds a little bit like a flight to quality. So Ben, there's a fair bit in the news right now about this bifurcation between the class A office space and the lower end and how class A still is actually thriving. So are you seeing any trends in terms of operators actually trying to upgrade lower class spaces to class A?

18:48Aditya Sanghvi: Yeah, absolutely. Obviously the development economics are quite tricky in many cities around the world at the moment. You know, you've got supply chain challenges on materials. You've had a lot of inflation, you've got labor shortages. But I think the people sitting on the really prime assets in the best locations where they can be refurbed rather than kind of knock down and rebuilt, we're seeing more and more innovation of how people are doing that from the quality of the offices, from an ESG perspective. But there's definitely capital going into that to kind of upgrade and improve existing. There's a lot of talk on the kind of grade B in the major cities around the office to RISI conversion, what we're finding is there's been much more talk than action because the fundamentals of the space often don't work.

19:36Aditya Sanghvi: You know, the floors are too deep. You can't get enough natural light going deep enough to the core. So it's a great play for a very specific subset of the buildings, but it's not a industry level solution to a grade B or C office problem.

19:52Ben Dimson: Maybe we can talk a little bit about exits for a moment. How are LPs handling the delays in exits that we're seeing in this current environment?

20:00Tripp Norton: Yeah, it's a pertinent topic. We see that coming through in a lot of the data that we source. We survey, call it 300 of the world's largest LPs twice a year. And one of the questions we ask is around what are the biggest concerns that they have in terms of what's on top of their minds, right? To no one's surprise, delayed exits and the lack of liquidity is by far the number one concern that sits on top of people's minds today, followed by valuations and the write downs that are naturally associated with what it may take to actually drive that liquidity. And then thirdly, it's geopolitical tensions.

20:38Tripp Norton: And this is probably even more present now than when this data was actually run, because this data was the last run of our survey was kind of pre-Iran war. You can imagine how this factor probably has actually actually increased. But what I think is actually more interesting than the pure ranking, if you want to call it, is actually when you, we also ask them kind of the, you know, how long do they expect these concerns to kind of linger, right? Really getting into the persistency of this. I think what stands out when you look at the underlying data is that clearly geopolitical is the concern that jumps off out of the data of where you've got more than half of LPs viewing this as lingering beyond two years.

21:25Tripp Norton: And to me, the way I read this is really LPs and investors, they seem to think they can wait out the other factors, right? It's a little bit of like, be patient, the market will turn, we'll get through this, et cetera. Whereas when you look at where geopolitical concerns kind of come in, that's the one that perhaps is actually going to drive more changes in terms of how they're thinking about allocations kind of moving forward.

21:55Ben Dimson: And are you seeing this consistently across regions or are there some regions where this is even more pronounced?

22:01Tripp Norton: Yeah, I mean, I think at least our data shows its consistency regardless of the region of investors, right? I think what we actually are talking about and what we are seeing, just to hit on a couple of the points around one, I think we're just seeing an overall increase in the number of conflicts, right? I think the number by one metric has increased double since 2020. And just the amount of conflict that is occurring just creates an overarching uncertainty in the market. We're also seeing global trade fragmenting, moving from free to fair trade, which has an impact on the level of near-shoring that is being considered.

22:48Tripp Norton: Right. And knock on effects on the types of logistics assets, whether or not those are more specialized logistics versus kind of the generic warehousing. You're also seeing money and people moving less freely across borders as capital is being restricted, as labor mobility is tightening. You know, on the on the latter point, you know, you saw peak migration in 2024. And that has had that has dramatically come back. Right. and Ben noted on it a little bit earlier of where from a labor market standpoint, that has a significant impact on construction labor, right? Which will ultimately drive your ability to deliver new projects on time, on budget, et cetera, for real estate developers.

23:31Tripp Norton: These are some of the factors that LPs are considering and that are starting to impact how they are thinking about where they're deploying capital from an allocation standpoint, from a where within the risk return spectrum, but also from a sector standpoint and a regional standpoint.

23:49Ben Dimson: Right. And given that geopolitics is expected to persist the longest as a factor, what are some of the second order effects that you're seeing? You mentioned things like trade, migration, hitting the real estate market, but what's going to hit hardest? And are any investors actually successfully underwriting and pricing that risk today? And if so, how are they doing it?

24:08Tripp Norton: One that I kind of always kind of come back to is something I noted earlier, which is around labor mobility. I think that for any developer, as they think about deploying dollars into new projects, you know, you need a healthy labor pool and access to the trades, et cetera, to be able to actually complete those projects from an underwriting standpoint. And with the uncertainty that investors have today around what those levels are, what they're going to have to, you know, the cost, any sort of delays, it makes underwriting individual assets extremely, extremely difficult. On top of, you know, all of the trade, you know, from a movement of materials standpoint.

24:49Thanks.

24:50Ben Dimson: And so we touched on this a little already, but Tripp, could you talk a little bit more about risk tolerance and how investors are thinking about where to allocate their capital?

25:00Tripp Norton: What we have seen in our data is that net interest since 2024 has been up in core plus and core, right? 18 % in core plus and 11 % in core. What this says, when you couple what we're seeing in that end of the risk spectrum with the opposite end of the risk spectrum in terms of opportunistic, which has actually gone negative in terms of interest, I think this is showing that LPs are going risk off. They are not necessarily in the near term seeing the right risk return profile in real estate, given what the overall environment is.

25:40Ben Dimson: And Ben, what's the outlook right now across different geographies? Is the overall trend of intent positive?

25:47Aditya Sanghvi: um there has been a positive shift in in outlook in the u.s so overall people are seeing some lights at the end of the tunnel they are more positive than there were a couple of years ago um the big mover though is uh western europe so we're seeing really substantial movements across almost all of our subsectors in western europe from 2024 to 2026 and in part that's because Western Europe on a relative basis has been a beneficiary of some of the aspects such as geopolitics that have caused Europe to become a little bit more attractive on a relative basis to some of the other geographers. So we're seeing big moves in residential industrial.

26:32Aditya Sanghvi: We're actually seeing hospitality in Western Europe move up to being kind of the preferred location globally for deploying capital into that sector. So quite substantive changes in a relatively short time period. And I think the question on our mind is, we've seen now a very big swing in this intent. We're not yet seeing it through all the transaction data. And so that's what we're going to be looking out for quite carefully in the next few quarters to see if this reported intent is coming through in the deals being done.

27:07Ben Dimson: I'm curious to ask, how durable do you think this swing is? Does it feel like the start of a trend that might continue, especially in Western Europe?

27:16Aditya Sanghvi: Look, it's always hard to have a crystal ball with these things. But I think the question then is, is the disruptions that have been caused, are they likely to persist or to change? And I think that when you look at conflicts, harder to call out. But if you look at many of the other things around sort of policy, geopolitics, tariffs, supply chain, and so on, there isn't an obvious reason why you would get kind of large scale shifts or changes on a forward look basis. And therefore, my assumption would be that they're pretty enduring these things.

27:51Ben Dimson: And are there any geographies that really stand out in terms of new opportunities that might not have added up before.

27:57Aditya Sanghvi: Yeah, I've had a lot of incomings recently from different investors in LATAM. I think there's a couple of things driving that. So obviously, one is a careful assessment of geopolitical risk and not treating it as a block, but being quite granular as to kind of where people are investing and in what. In a world where the low returns have not been attractive versus other asset classes, there are a variety of ways that people are chasing higher returns. Some of those, as Tripp talked about, are things like development or more niche asset classes, but some of those are geographic as well. And so we are seeing players extending in LATAM, either domestic players or Central North American coming in or moving through adjacencies of countries or through LATAM or connections, for example, from Iberia.

28:46Aditya Sanghvi: within that we're seeing quite a wide variety of ways to play that from more traditional asset classes often linked to to development through to very ambitious projects so you know whole new cities that people are looking to build so uh it's quite a varied landscape what i'd say is is the you know local knowledge and expertise is incredibly important in a in these kind of markets. So trying to operate from afar, historically has not worked well for people.

29:20Ben Dimson: Okay, so let's move back to data centers. Now, we touched on data centers earlier, and there's been a lot of coverage in the press, as well as public interest on the top in the topic, but not all of it's been positive. So Ben, maybe you could talk us through the investment focus that you're seeing there right now.

29:37Aditya Sanghvi: Yeah, I think as as Tripp touched on, we have had, in general a big rise in focus in alternatives. And out of all of them, it is data centers that has had the most demand and where the returns are sort of being driven hard. One of the things that is particularly interesting, though, is where we're seeing the capital coming from. And you're seeing a lot of competition coming in from infrastructure and real estate, often for the same assets. And so that creates an interesting dynamic, because they may value the same asset in a different way. And they may wish to play that asset also in a different way in terms of how they invest in the theme.

30:19Aditya Sanghvi: What is clear is there is massive growth in demand. And it's actually pretty hard to keep up with that growth in demand when you look at the availability of powered land in particular, because these connections are often taking three to five years and in some countries and cities they're even sort of seven eight ten year lead time so you have a mismatch between the the need from consumption booming month on month to the creation of these physical assets that's creating scarcity and creating huge competition and therefore driving the returns coming out of these because there's a desire that can't be met for more and them.

31:02Aditya Sanghvi: So it's clearly a hot market. I think if I take a kind of more balanced perspective, there are some fundamental questions that come out of it, which is, what's the correct play in this space from an equity investor versus an infrastructure investor versus a real estate investor, given the different risk and return profiles? And also, secondarily, are people really thinking through the underwriting correctly for these so you know there are the normally complicated financing mechanisms that are underpinning a lot of this growth and they're quite opaque and are they really being understood and priced correctly and are there kind of mismatches so you know sometimes you look at these and you look at the real estate asset and compare it to the credit default swap of the entity with which you're transacting on often quite long-term deals.

31:58Aditya Sanghvi: And you do just wonder whether everyone has priced these correctly.

32:03Ben Dimson: And Trip, Aditya, anything you'd add on that? Any comments on the impact of that pushback on the rise of data centers, especially in the US? And I understand it's also playing out in Europe. So So how is this affecting investors' willingness to take on and develop these data centers?

32:20Tripp Norton: Yeah, I mean, data centers both have all the markings of one of the greatest opportunities of our lifetime, but also one of the biggest and obvious busts of our lifetime. And it's very difficult to know for anybody which way they'll go. And it's obviously not a very binary thing. And so I think that a lot of the clients that we're working with are trying to think about the right way to play on data centers, you know, to figure out where are the places in which there really is unmet demand that they could meet. So a client, for example, is really focused on not the AI part of data centers, but the cloud part of data centers.

33:03Tripp Norton: They believe that that is the right strategy because maybe the AI side is overheated, but the cloud side is not. others are focused on, you know, larger facilities, which they think will be very important. Some of our clients are saying, you know, actually, we're really excited about being a development manager for data centers, but we don't actually want to take the equity. So I think there's a lot of models that are emerging in which people are able to find the way in which they want to play. Because, you know, there is very high reward, and there's also very high risk. And that's what everyone's trying to figure out.

33:34Aditya Sanghvi: Just to build on your other question, you know, I think there are really challenging central and local government decisions and trade-offs around this stuff as well. So, you know, there's a strong desire to have sovereign AI by many countries. It's seen as central to both the kind of security and the growth of the country. On the other hand, when you move to a more local lens and you're looking at what uses you might have, these are the same sites often that are being fought over that could be residential or could have a form of larger job creation that sit behind them. And you can really see that struggle play out at the micro and the macro level.

34:14Aditya Sanghvi: There's no one right answer to it, but it is a complex set of decisions that are faced by many, many stakeholders.

34:22Ben Dimson: Thank you, Ben. I'd like to pivot slightly now. I know you've done some research on the operationalization of assets and an increasing focus on value creation within the ownership period. So maybe you could explain a little bit of why we are seeing more of this now.

34:38Aditya Sanghvi: Yeah. Look, one of the other trends that we're really seeing at large is this operationalization of real estate. So when we had long periods of low interest rates, it was quite bond-like. It was all in the deal to get the return. And what you did with the assets when you held them was arguably less important. But what we're seeing now in this high interest rate environment is more and more of the returns are linked to the operations of how you add value during the ownership. And as a result of that, what we are seeing is much more vertical integration. So we're seeing scale, and we're also seeing people playing across the value chain.

35:22Aditya Sanghvi: And there's a few reasons for that. One is you can add value during the hold of the asset by having deep knowledge and expertise and talent on the operations. Two is that creates a feedback loop into your future investments that you really understand what is going to drive the future returns and therefore you can invest better and underwrite better. And three is that the scale itself has got benefits because this investment in tech and data and talent isn't free. And so the more that you can spread that investment over a bigger base, the more economic it is and the more it drives returns. Right.

36:01Ben Dimson: And so perhaps now is a good moment to talk about AI more broadly beyond data centers, right? What role is AI playing or do you see it playing not just in the investment decisions, but in generating alpha, whether operationally, as you just spoke about or elsewhere?

36:17Aditya Sanghvi: When we think about AI, we think really from three perspectives. One is, how does it impact your investment decisions? And we've already seen some of that around questions on officers and the attractiveness of data centers. Two is around, what's it mean for the occupational market? And we saw that a bit in the discussions on bifurcation in officers. So do you hold the best of the best that is going to be resilient? or do you have offices that maybe are filled with call centers, for example, where they're very susceptible to AI? But the third area that we're spending the most time on is around what does it mean for real estate companies themselves, for the investors, developers, owners, operators of real estate.

37:02Aditya Sanghvi: This chart shows a series of different areas in which we have been deploying technology at scale over the last two years. And there are two things that you will observe. One is that there are opportunities right across that value chain. And two is, they are tying very tightly to financial outcomes, whether that is growth of income, capital returns, driving out cost to efficiency, or non-financial measures such as risk reduction. And we're in a really different world to two years ago. I'd say a couple of years ago, we were doing a lot of pilots, experiments all over the place. The last couple of years, as we've seen the maturation in the technology, we're getting really focused efforts driving really strong financial outcomes for many of the leading players.

37:58Ben Dimson: Do you have any examples of where this at-scale AI value creation is happening right now beyond those earlier experiments? And what's distinguishing the winners?

38:08Aditya Sanghvi: Yeah, look, there's many of them. Let me just pick out sort of two or three. So if I take the kind of acquisitions and disposal side of things, you're getting very sophisticated agents that are able to assess deal opportunities. They're able to work alongside existing investment teams in order to do the underwriting analysis, to have a higher throughput, more certainty on the pricing and in the most advanced cases even you know generating the ic memo sitting in the ic in some cases if we take kind of construction we're seeing for large projects the ability to run thousands of permutations of a project in a quite similar way that you would think about algorithmic trading so trying many many permutations way more than a human could do to work out the best and then constantly optimized.

38:59Aditya Sanghvi: So you think about how you might use Google Maps or any other mapping software of your choice, and you get in a traffic jam and something's changed and it automatically reroutes. So the sophistication to continually optimize and see what's around the corner is being embraced. Lots of our work is being done in the asset management and the facility management spaces. So really helping people to be able to get that complete look across all of the assets to direct the effort in the right places, to price correctly, to use internal and external data in the decision making, driving the financial returns day to day, particularly on that rental income side of things.

39:43Aditya Sanghvi: And then on the FM and PM side, where it's quite labor intensive, How do you get the right people in the right place at the right time, fixing things first time? So it's really all the way through this. And we're working right across the value chain at scale now with players globally.

40:03Ben Dimson: And Aditya, anything you'd like to add here from your perspective? What and where do you see AI contributing?

40:09Tripp Norton: Yeah, I would add that real estate is really in many ways built for AI. And what we mean by that is, Agenda AI in particular works extremely well in situations in which there's a lot of coordination across the value chain. And in real estate, there is an incredible amount of coordination where every individual task that someone does isn't rocket science. But it's actually the stitching together of all those tasks that make someone very, very successful. And that's exactly where agentic AI can add incredible amount of value. The second reason real estate is perfect for AI is that every decision can be a lesson.

40:52Tripp Norton: So in real estate, we have millions of repeated decisions that happen. You have a lease being signed, another lease being signed. You have a work order request that comes in and the portfolio can almost become a teacher. That these static assets become these dynamic self-improving learning systems where you see, okay, what happened when we did this? Okay, we need to make it better. We need to make it better and make it better. And then the final thing is that the improvements that you do make through their learning can actually scale across the entire portfolio instantly. So the way real estate's always worked is you might have an asset manager or property manager or leasing person come up with an innovation and that stays very local.

41:31Tripp Norton: That stays with them and their property and their course of work. Now, if you figure out something different, you can actually go globally at scale to all units, to all properties, to all markets, you know, almost instantaneously. So there's incredible value that AI can deliver, you know, and just building what Ben said, I think there are clear domains in which the value is there. Renewals is a great example of that, you know, in which you can drive significant value by making the right offer to the right tenant at the right time, you know, that gets them to stay. So the hard part, and the status across sectors, is that 80 % of our clients are using or adopted AI, but only 6 % of them get material value.

42:19Tripp Norton: And the hard part of it is that you have to really redesign the way work happens. You have to fix your data, which many companies don't want to do. You have to think about the change management and actually getting the business to engage, not treat it like an IT project. But if you're able to do all those things, then there's an incredible opportunity that we've already seen clients start to capture in real estate from AI.

42:43Ben Dimson: Wonderful. This has been a really interesting conversation as we've walked through this new terrain that real estate is navigating today. But Ben, I wonder if you can close out our episode with some of the strategies that you're advising real estate investors to think about and how to respond to this disruption.

43:01Aditya Sanghvi: This is not good or bad news. It's a series of opportunities and challenges for each and every player across the value chain. We really think it boils down to kind of three core messages. One is around granularity. So it is no longer enough just to pick your sector and geography well. That is, of course, very important. You've got to go much more granular in exactly the assets that you are investing in and how you're picking those assets in a data-backed way. Secondly, the financial deal is not enough. You need to work the asset. There is a huge operationalization that is going on driven by AI that is only going to accelerate.

43:44Aditya Sanghvi: And it's going to create a massive disconnect between the best operators and the worst in terms of that capture of alpha. And that alpha is going to be much more spread between the deal and the operations post deal than it perhaps was in the past. And then thirdly, these different factors that are all happening all at once tend to favor either the big or the small. If you have niche players that are able to really respond to opportunities and act fast and harness new technologies, they're in a pretty good place. Or at the other end, if you are a big at-scale player that can spread these investments in tech, data, and talent over a big base, you are really well placed.

44:31Aditya Sanghvi: And we've seen that in the financial returns. The world is far less clear for those in the middle ground between those two extremes. And so being very tight on what your strategy is, and thinking about how these trends are going to impact you and your future is really important.

44:48Ben Dimson: Thanks so much, Ben. And Trip and Aditya, any final comments you'd like to share before we close out?

44:54Tripp Norton: hopefully this was some food for thought agree with ben that while some of this on the face of it may be concerning i think what it does is it does create opportunities to drive value and to capture returns so at least i know i'm excited about uh the next several years in terms of of what's to come yeah look i i think what's most important as a message for the industry to here is that the way in which players have won for the last 10 to 15 years is not the way in which the players will win for the next 10 or 15 years. And some of our clients have the mentality of waiting it out and seeing when things will return to the way that they used to be, and they're not going to return to the way they used to be.

45:38Tripp Norton: And I think making the shift of how does one do way better asset selection? How do you generate operational alpha? How do you lead into AI? How do you think about vertical integration? How do you navigate many of the geopolitical situations that are coming up that Ben and Tripp talked about? This is what will differentiate those who succeed from those who fail.

45:57Ben Dimson: Super. Ben, Aditya, Tripp, thank you so much for taking the time today. Really enjoyed the conversation.

46:03Tripp Norton: Thank you all.

46:03Ben Dimson: And thank you to all of our listeners for joining us today. We hope you enjoyed the conversation and we welcome your feedback and ideas for future episodes. Just email us at itsr at mckenzie.com, which stands for Inside the Strategy Room. You can also share your ratings and reviews on any podcast player with many thanks to all who've already done so. We really appreciate the feedback and comments we receive every week and encourage you to keep them coming. And if you enjoyed this episode and you'd like to subscribe, you can easily follow our weekly series on any podcast player, where you can also access our entire library of more than 320 episodes.

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47:12Thank you.