SPECIAL REPORT: Smooth operators

‘Operational’ real estate used to apply only to niche asset classes, but now there is a good argument for saying every type of asset is operational, including offices.

Historically, people have called it ‘niche’ or ‘alternative’, but what really is ‘operational real estate’?

A Google search of the term paints quite a vivid picture regarding the ownership of properties leased to specialist operators. For example, on CBRE’s website, the firm highlights hotels, pubs, healthcare, and data centres. There is also a section called Operational Real Estate Insight where articles exist on National Health Service (NHS) GP surgeries, retirement villages, and leisure assets including children’s activity centres, snowdomes, and cinemas, mostly in the context of Covid-19.

Last month, CBRE announced the hire of Tariq Hayat, a former corporate finance expert from KPMG to originate and lead corporate finance transactions for the advisor’s Operational Real Estate Team (OPRE). His work will address finance requirements across a spread of sectors, namely hospitality, healthcare, senior living, education, petroleum and automotive, self-storage, co-living and student accommodation.

In August of this year, Schroders Capital, the London-based global asset manager, also spotlighted ‘operational’ real estate with the announcement that the company was hiring James MacNamara as head of operational real estate strategies. MacNamara previously worked at private equity real estate firms Kildare Partners, Mount Kellet Capital Management and Perella Weinberg Partners (now Aermont), and has joined Schroders to strengthen its hotel investing team.

Paradigm shift
But Schroders does not limit its vision of operational real estate to hotels. In fact, just the opposite, and this is where an interesting paradigm shift is taking place.

Sophie van Oosterom, global head of real estate of Schroders Capital who joined this year from CBRE GI, said at the company’s Private Assets Media Summit in June that: ‘All real estate is in fact operational.’

Were it not for the fact that over decades the real estate industry has been almost oblivious to a service approach to tenants, this statement might have seemed cliché. But it isn’t. She said: ‘The last 18 months have shown you can’t sign a lease contract and sit back. Landlords need to think through business models to make their assets successful, strike partnerships with tenants and make sure their assets provide the services that tenants require, with minimum waste of resources.’

This implies that traditional asset classes, namely offices and retail, are now to be considered ‘operational real estate.’

The new approach is also being taken by other investors, such as AXA IM Alts. In a video interview, John O’Driscoll, European head of transactions, takes very much the same line as Van Oosterom.

He explains how AXA has been very active in operational real estate sectors such as life sciences, data centres, student housing, co-living, and retirement homes, which people also describe as ‘alternatives’.

‘But I think if you look at even our traditional assets such as 22 Bishopsgate – our flagship office asset in Europe – that is operational,’ he says. ‘It is a building of more than 1 million ft² and it is in constant evolution. We have to manage it actively as a multi-tenant experience.’

He adds: ‘I think there are very few sectors where you can sign a lease and disappear for 20 years. Covid has shown us that even if there are sectors where you are signing longer leases, there are going to be events that require agility. How you work with occupiers and share the risk with them – to me the world is operational.’

Justin Curlow, global head of research and strategy at AXA IM Alts, tends to think conceptually about operational real estate in terms of how ‘hands-on or hands-off’ an asset class might be. He says there is a kind of pecking order of operational real estate whereby some classes demand much higher levels of service than others. For example, life sciences, healthcare and hotels are more operationally heavy than self-storage.

That said, he agrees with his colleague that the demands of all types of occupiers are increasing: ‘I think offices are a great example. We used to talk about alternatives. Now I think most, if not all, real estate sectors have an operational component to them and that is why I think “alternatives” as a name is kind of falling by the wayside.’

David Batchelor, MD, UK operational real estate at CBRE, puts things into perspective as he looks back. ‘Historically, people have called it “specialist” or “alternative”,’ he says. ‘A lot of mainstream funds have had some of that mainly for yield, and latterly, mainly to access long income. But while they have been in the market sectorally, they have not really engaged with the operational real estate story.’

Beyond net leases
However, he observes a change.

‘The combination of lack of opportunity elsewhere and the CVAs (company voluntary arrangements, seen to disadvantage landlords in the UK – ed.), has meant real estate is having to engage with operational parts. Investors are starting to go beyond looking at favouring net leases and starting to think about how they partner with an operator. How do we drive the operational returns, how do we access it?’

In his view there is a ‘push-pull’ effect going on. There is a ‘push’ in that some tenants are saying to landlords they cannot or won’t pay rent, and there is a ‘pull’ in that investors are challenging fund managers. ‘If leases are getting shorter and CVAs give you less security, how are you actually going to drive the returns from real estate? This is how things are going.’

When accessing operational real estate, investors typically begin with turnover leases. But the next level of involvement would be a franchise agreement, or then a joint venture right up to management contracts where the operator gets paid a fixed percentage to run the asset and the property owner takes the profit of the business. Says Batchelor: ‘We are starting to see more management agreements.’

In 2018, AXA found its way into European data centres by acquiring a whole company – Data4 – with an existing portfolio of assets and a specialist team in situ dedicated to design, building and operating them. Two years later, the firm entered life sciences by acquiring Kadans Science Partner for €500 mln from Oaktree Capital Managers.

O’Driscoll is impressed by the specialist teams within these companies. ‘The knowledge base in Kadans is huge, for example how do you treat a life science occupier and what do they want? How are their businesses going to grow so that you can forecast the next phase of their space requirement? It is incredibly specialist.’

‘We have traditionally followed assets that tend to be in the higher growth sectors where the operational piece is trying to meet demand. With data centres, you need to build them to the right level of specification and efficiency, and the clients want to talk to technical people who understand their requirements. I think for data centres as well as life sciences, buying a portfolio company was the right way to go for us.’

Curlow adds: ‘It is not just the technical knowledge, remember the end-user of the building is constantly evolving. I can tell you the people at Kadans know what the tenants want before they do! If you have an SME with 10 people, they know what stage they are at with their funding round, and when they will do series 3 funding and what kind of lab they will need.’

Back to the future?
But what next? In a sense this might go full circle to the original point that all real estate is operational. Or, put the other way round, maybe the operational side of real estate is extending into more traditional sectors – retail and offices.

Moreover, with Covid, technology and ESG issues to the fore, ‘operational’ means working more closely with tenants than ever. The ESG debate is becoming critical, say experts, because it is about managing buildings and making a commitment to occupiers. Lower emissions and better air quality control are just two examples.

Says O’Driscoll: ‘If operational means working more closely with your tenants and having a different type of relationship, the ESG debate is critical because it is about buildings but also how you manage them and make a commitment to them to minimise emissions and operate in a way that is ESG-friendly. So, I think that will make us more operational across all sectors.’



Case study I - High Tech Campus Eindhoven
Case study II - Therme Group


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