• Operational opportunities look attractive

Operational real estate is continuing to attract more attention, as investors seek new opportunities to improve returns.
New research by INREV, the European Association for Investors in Non-Listed Real Estate Vehicles, shines a light on the opportunities within the niche. Via interviews with those active in the business, it uncovers in more details the reasons for taking a look at the business of real estate as a service.
Notes the report: “This trajectory towards a real estate product to service spectrum is accelerating for all real estate sectors, regardless of whether real estate is a core component of the occupier’s business.”
Inrev says there are two megatrends driving investors to take a closer look at operating models, as opposed to ownership. One is the idea of providing space as a service – something already established in models such as serviced offices. The other is accelerating economic and social trends, which are pushing fund managers to seek ways to uncover better returns from their assets.
The organisation’s most recent investment intentions survey, earlier this year, puts capital allocations to stand-alone operational real estate sectors in Europe at 11.8% currently. “Given the strength of underlying demand drivers and increasing investor requirements, operational real estate’s share of the investment universe is expected to increase over the next decade,” it predicts.
“This research maps out a clear direction of travel for the future of non-listed real estate: a shift in investment mindset from space delivered as a product to embracing space as a service,” said Iryna Pylypchuk, INREV’s director of research and market information. “What is fascinating is the sheer diversity of potential investment options and risk mitigation structures available to investors and managers. For investors with the ‘real estate as a service’ mindset, it is also a choice to move up the value chain and partake in developing segments of the new economy.”
The paper notes the hotel sector is the most mature operational real estate sector. But despite this global label, there remain opportunities, “driven by the demand, supply and competitive landscape at the city and micro-level and this will vary by the targeted consumer segment, for example luxury, business or budget.”
Sometimes, the move into operating can be a defensive move. “Delivering space as a service either directly or indirectly through an intermediary may be essential to adding and protecting value. This is leading to a polarisation in investor mindset between viewing the investment opportunity as asset- based or considering the asset as providing an opportunity to invest in an economic growth sector.”
The research discovered that investors are attracted to operational real estate for a number of reasons. Some see long term structural change, and view a move as being counter-cyclical with a longer term benefit. Their approach means picking off niche segments within a sector – such as boutique hotels – as well as eyeing those sectors subject to structural growth, such as student accommodation.
The report notes that those attracted to operational real estate see it as having “the potential to generate durable, stable income streams that tend to be somewhat dislocated from economic cycles”. Such opportunities also seem to offer a risk premium for those prepared to jump in.
For those looking to spread risk, different operational real estate sectors offer differing return rates and risks, and have differing levels of maturity across international markets. Senior living, for example, may be considered a mature market in the US, Australia and New Zealand, while in the UK and Netherlands it is classed as an evolving segment, with the commensurate potential for upside, but also early market risks. As such, investors have a choice depending on their appetite for risk and return.
The report defines four categories of operational involvement, which it calls leasehold, management contract, shared interest and hold co. It takes a look at partner selection, and at the resources needed to participate in the various levels of operational involvement. Ultimately, the report notes: “Delivering space as a service either directly or indirectly through an intermediary may be essential to adding and protecting value.”

HA Perspective [by Andrew Sangster]: Here again is Covid as an accelerant rather than an agent of change. Operational real estate was on the way before the pandemic and, despite the economic impact of the virus devastating many of the verticals encompassed by operational real estate, the shift away from traditional triple net leases has accelerated.
Partly, this has been driven by necessity. Landlords have realised that tenants cannot pay their rents and therefore need to switch to a more flexible model such as turnover leases. For a landlord, rather than make a temporary cut to the fixed lease it is often more lucrative to agree a turnover rent that will allow them to gain a greater share of the upside as the economy recovers.
The list of landlords adopting turnover leases is long and growing. Notable names include Cadogan Estate, the Howard de Walden Estate, Capital & Counties, Shaftesbury, and the Crown Estate.
But there is also an opportunity factor at play. Landlords are realising that being passive is not the way forward. And if they are having to take an active role, it makes sense to benefit as much as possible from this effort.
It was interesting, for example, to see the Howard de Walden Estate listed as a joint creator of a new casual dining concept alongside operator the Marylebone Leisure Group. For many landlords, the days of signing a long lease and collecting quarterly rent cheques are behind them.

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