Article | Intelligent Investment

What are the push and pull factors driving interest in operational real estate?

July 14, 2022 4 Minute Read

By Alice Marwick

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Investor appetite for Operational Real Estate (OPRE) has been growing over the last decade with over £8.5bn invested in 2021, up from £3.1bn in 2012. Until recently, many real estate investors viewed OPRE as an opportunistic investment, moving assets to gain a higher return profile than typically available in traditional real estate sectors. Reflecting the varying structures that are available, the yield premium has been eroded and investors have taken on functional matters such as fixed rent and trading risk. Investors are increasingly looking for long-term income, bond alternatives and, most importantly, exposure to the underlying operational businesses at the heart of the OPRE asset class. As such, there has been growing appetite from institutional investors who are looking at ways to balance the risk and returns while understanding the impacts of the operational model.

A difficulty for investors moving from traditional real estate into Operational Real Estate is the transparency and visibility needed of the operational business. Investors must be willing to learn operators’ core business, particularly how operators drive their revenues and cost base. Greater understanding of the core business leads to a better relationship between landlords and tenants. However, there needs to be a balance; investors must be able to operate the asset without interfering in the day-to-day management. Landlords can only perform as well as their tenants, so they must attract and retain the best occupiers.

As the OPRE sector has grown, so has the landlord tenant relationship. There is no longer a disassociation between occupiers and landlords. Closer integration and partnership between landlords and tenants are beneficial for all parties, and investors have started to catch on to this. For many real estate investors, the opportunity to create strategic partnerships is a major draw to the OPRE sector. If investors can attract and retain the best occupiers, then the subsequent rents and fees generated will equate to stronger returns.

As for risk profile, how much risk OPRE investors are willing to take on depends on the level of operational understanding of the asset. If it is income stability investors are seeking then, in order to invest in OPRE assets, investors must look at the tenant, the business and the drivers of revenues and cost base.

The value of the traditional 25-year lease structure has been tested since Covid-19 began. While there is still demand from institutional investors, the pandemic has shown lease lengths offers little protection in times of seismic change. Since the onset of the Covid-19 pandemic, the hospitality sector has changed its capital structure to drive liquidity, which has resulted in new partnerships being formed. The relationship between real estate owner and operator has ultimately evolved so that they are no longer viewed as separate and conflicting. That is because landlords need to understand the operational asset if they are to drive real estate returns. As such, investors and operators who are willing to learn each other’s business model will thrive, whereas those who stick to the status quo will be tied to antiquated operational models.

At the end of the day, greater collaboration between the landlord and the occupier will ultimately lead to a better operational asset, which in turn will benefit the consumer.

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Contact

  • Alice Marwick

    Head of OPRE Research

    Photo of Alice Marwick