Analysts spluttered over their Cornflakes last month when a throwaway line in the morning news briefings appeared to shake the foundations of real estate investment logic. Managers of Bluewater, Europe's largest shopping complex, casually suggested abandoning rents and charging customers an entry fee.
It seemed crazy, but the logic was ingenious. A modest entry fee would be less than travelling to, or parking in, nearby towns. It would also more than compensate for lost rents. But why suggest this now? Retail centres have been attracting huge crowds for almost a decade without denting investment traditions.
It's the Internet, stupid.
Crazy is becoming commonplace as new technology threatens to undermine real estate fundamentals. Landlords who scoffed at the dangers are now showing hints of hysteria about stores losing custom to online shopping. The reaction at Bluewater is that lifting the burden of rents might allow them to evolve into showrooms, where visitors view goods they buy on the Internet.
US broker and attorney Mark Borsuk has spent years warning that the Internet will rip through the sector, leaving redundant malls for conversion to apartments, serviced offices or even multi-storey mausoleums. Stock market vultures called 'cybersurgeons' will also rip apart traditional retailers, shifting goods only and selling off stores.
The chorus on both sides of the Atlantic has become increasingly splenetic, suggesting that all traditional real estate investment could be doomed. A new generation of 'cybersavvy property players' will use the virtual age to reinvent the asset class, says Rosemary Feenan, head of UK research at Jones Lang LaSalle.
It needs reinvention. In the US, the National Association of Real Estate Investment Trusts equity index showed negative returns of almost 5% in 1999 - the first time since 1974 that figures have gone into the red for two successive years. In the UK, property companies are struggling with share prices as much as 50 per cent below net asset values.
Retailing is particularly vulnerable not because of the obvious leaching of business, but also a history of underperformance. Growth in real sales per sq ft has been negative or neutral for more than 10 years in US shopping centres because of booming supply and a shift to retail warehouses, says John McMahan of the Centre for Real Estate Enterprise Management.
Annual rent increases of more than 5 per cent in the UK might paint a rosier picture, but not to David Hunter, head of Argyll Investment Managers. He is a hard-headed sceptic over the impact of technology on real estate. 'Ten years ago we were told companies would flee the cities and home-working would make office blocks obsolete. They are still there and still full,' he says.
But he feels e-commerce threats have not been recognized. Almost 39 per cent of the Investment Property Databank index is based on high street shops. Argyll has trimmed its holding to 8.5 per cent below that benchmark, transferring attention to prime centres, industry and warehousing, which Hunter believes will benefit from the Internet.
Peter Damesick, head of UK research at Insignia Richard Ellis, says the retail sector faces re-rating and investors should be nervous about secondary locations. The Bluewater suggestion reflects a view that shopping will become a 'destination', much like leisure parks, so an entrance fee is not so far-fetched. Centres with 'something extra' will attract visitors while the mundane will wither.
Perhaps Paul McNamara should be worried. As head of research at Prudential Property, he has 25 shopping centres to monitor - including a major stake in Bluewater. He admits there will be a depressing impact on rents but only 1 to 1.5 per cent a year, dropping to around 0.5 per cent in the North, where home shopping could be restricted by fewer home computers.
'We are not complacent,' he says. 'But it is too easy to get carried away with the possibilities.' He is keeping his powder dry until the extensive research commissioned by the Pru clarifies real trends. Meanwhile, each property in the 7bn pound portfolio is monitored quarterly for signs of weakness.
Some landlords are acting now. Martin Barber, head of Capital & Regional Properties, has an insight into real estate on both sides of the Atlantic after helping establish CentrePoint, one of the biggest US industrial REITs. He aims to merge real and cyber space by creating an Internet portal for his UK shopping centres.
Simon, the leading US retail REIT, is well along this path but Barber is going further. C&R is dropping the 'Properties' from its name, emphasising the view that the old model of landlord and tenant is obsolete. In the drive for performance to match other sectors, real estate investors must evolve into service providers, particularly the interface enabling tenants to link into the Internet.
The rationale of real estate will be changed by the impact of new technology, says Feenan, and landlords should be transforming their real estate to 'e-readiness'. The first step is to realise that buildings are just part of a package offering flexibility matched to the speed of change of modern business. Income flow comes from a range of services rather than rents.
Serviced offices are a classic example. Another is the 'wired building', offering a range of broadband services so tenants can 'plug and play' as soon as they move in.'Buildings can, and should, be created as portal for business,' she says. A few already are, such as the Rudin family development at 55 Broad Street, Manhattan, and Resolution's Greater London House in the UK.
McMahan is enthusiastic about prospects for residential managers becoming Internet service providers, producing a rich cashflow from home shopping, cable TV and telephone services. In fact, multi-family residential is the only real estate sector which will not feel some negative affect from the technology revolution, he says, as it may encourage more people work, shop and play from home.
Advisers are putting money where their mouths are. Insignia Richard Ellis has set up EdificeRex, a web portal for 200m sq ft of office property managed in the US and UK. Jones Lang LaSalle is drawing up a 'wired' lease and looking for stakes in dot.com businesses related to property.
A message is being shouted by Cohen & Steers Special Equity Fund, the US real estate mutual, which made a total return of almost 29 per cent last year. This not only counterpointed the negative returns of other REITs but outperformed the Standard & Poor 500 index. The secret was investment in Reckson Service Industries, which has stakes in serviced offices and Internet provision to office tenants.
Many appear unable to hear the message, however. 'Monetize your virtuality before you are disintermediated,' jokes Feenan, in the techno-babble which leaves investors confused about which way to turn. Borsuk uses a clearer analogy.
Railway companies failed to invest in air and road transport in the 20th century, sewing the seeds of their own decline. 'They failed to realise they were in the business of transport, not the business of railways,' he says. Real estate investors must understand they are in the business of providing services, not just bricks and mortar.