Strange Bedfellows: Technology Issues in Real Estate Transactions, Part 1
Technology continues to infuse our homes, businesses, and places of employment. For example, the “Internet of Things” – as it is sometimes called – brings a lot of promise to a wide variety of industries and sectors, including farming, government, natural resources, and manufacturing. The list goes on.
Even though it often gets the (unwarranted) reputation as being slow to innovate, the real estate industry has joined the technological trend. Real estate developers, property managers, and construction firms are constantly on the lookout for new ways to incorporate the promises of new technology into the design, development, and maintenance of their projects and properties.
For example, automated parking garages have become an efficient way to maximize parking in markets where automobile space is at a premium. Some hotel chains are doing away with keys and permitting guests to access their rooms with smartphone apps. Homes and apartments are following suit. Construction firms are starting to gain FAA approval for drone use in connection with their projects. And finally, there is a smartphone app for just about every sector of the real estate industry.
Firms running large, complex real estate projects typically do not have the core competency to design, develop, implement, host, and/or maintain the technology applications and systems to run these innovative ideas, which is why these firms typically partner with third-party technology service providers to design, develop, and implement their technology needs.
Entering into these partnerships with third-party technology providers can come with risk and requires a contracting strategy. Has the company developed its own contractual forms governing technology services? Is the company content with negotiating on supplier paper every time? Companies operating in the real estate space that buy, license, or otherwise incorporate technology into their projects should be thoughtful regarding their contracting strategy and their approach to key risk and financial issues. Some of these key issues include:
- Pricing and commercial terms
- Service performance
- Data protection
In this Part 1 of this blog, I will discuss issues of pricing and service performance. In Part 2 of this blog, I will discuss data protection, infringement, and insurance.
Price and Commercial Terms
Typically, the pricing gets all the attention. As it should! If an innovative technology idea cannot be supported by the company’s budget, then the deal will be dead in the water before it even starts.
Whether a supplier’s solution fits into a company’s budget, however, is only one consideration. Just because the company can pay does not mean the company should pay. For example, some suppliers like to include cost of living inflationary adjustments in their proposed pricing. Given the nature of the particular transaction, is it reasonable to have an inflationary adjustment at all? If the service is highly automated, then likely not. Even if having an adjustment is reasonable, sometimes a supplier will propose an upward adjustment with no ceiling. In our view, uncapped inflationary adjustment is certainly unreasonable.
There are numerous other pricing issues to consider. When will the company receive its invoices – when it signs the contract or when the service actually goes live? Does the contract permit the company to dispute fees that are incorrectly invoiced? How long does the company have to remit payment on an invoice? Will the company be required to pay in advance or in arrears? Are there any “hidden” costs like travel expenses, per diem amounts, or late payment fees? Is there a minimum revenue or volume commitment? Companies negotiating technology transactions should be on the lookout for hidden expenses that can impact its base case.
A typical real estate company is unaware that a technology supplier’s level of performance can be subject to negotiation. The company should ask itself: does the contract with our technology partner contain sufficient performance standards or service levels? For that matter, what is a service level anyway? A service level is a contractual commitment by the service provider to perform its functions in accordance with a certain level of performance.
Sophisticated IT service providers will offer their customers a service level agreement, and these terms are usually subject to negotiation. One particular software-as-a-service provider (with whom I have negotiated several transactions) that operates exclusively in the real estate space never proactively offers service levels unless the customer specifically asks for them.
Having service levels can help drive better performance from the supplier, but only if the company has focused on the right service levels. For example, a service provider may contractually commit that its cloud offering be available for use and working normally 99.9% of the time each month (i.e., allowing approximately 43 minutes of system downtime per month). Given the critical nature of the particular system and service, is that metric acceptable?
Another service level might measure the responsiveness by the service provider to correct errors and bugs in a software or system. For example, if the software operating a sophisticated automated parking garage contains a bug that impedes the operation of the system, how fast will the software developer respond to and resolve the issue? Does that response or resolution commitment meet the building manager’s business needs?
Finally, are the service levels being enforced? Sure, a breach of the service level could be considered a material breach of the contract, but typical contract breach remedies (e.g., termination, suit for damages) are usually not commensurate with the nature of the performance failure. The parties may instead negotiate a predetermined amount of money – known as a service level credit – that the service provider will pay to the customer for the service provider’s failure to meet a particular service level. These credits drive the supplier’s incentive to meet the service levels and serve as a powerful self-enforcement mechanism. In other words, service levels are typically only as good as the associated service level credits.
As mentioned above, in Part 2 of this blog I will discuss issues concerning data protection, infringement, and insurance as illustrative topics for real estate companies to consider when formulating a contracting strategy with technology service providers.