Operational real estate is becoming increasingly mainstream for investors, driven by strong relative performance in asset classes which typically employ an operational model (such as certain living sectors), more operationally intensive, shorter-term occupational arrangements and the general growth of service orientated business models.
However, there is also a significant amount of immaturity in many operational real estate sectors in Europe and an inexperience in dealing with the particular investment risks they present. Such transactions typically require owners and operators to consider a broader spectrum of risks, from IP, employment and data and privacy considerations to matters of oversight and enhanced governance. The valuation methodologies also presently lack market consensus. Evaluation and management of all of these risks requires a significantly different skill set to a conventional real estate investment. This is further heightened by the fact that, should an operator fail, in many European markets there presently isn’t a deep pool of substitute operators from which they can be replaced; leaving investments potentially exposed.
The impetus to rapidly reposition portfolios towards such relatively well-performing sectors also presents opportunities. The upside for investors of a well-structured, operational real estate investment is potentially significant, enabling them to capture both pure real estate investment performance and also the upside generated within the operational business - be it through taking an equity stake in the operator itself or other financial mechanisms. There is also ample opportunity for advisers and industry bodies to support and provide assistance to the various stakeholders by developing market consensus and guidance. The nascent operational sector in Europe (hotels aside, you may argue) also has the advantage of learning from its more mature counterparts in the US and Asia.
The growth of the operational real estate sector also has the potential to impact upon the real estate funds sector. As operating businesses mature they are likely to start looking for deeper pools of capital and may look to a co-mingled fund model. Operators and investors who may have traditionally looked to a REIT to raise capital or provide an exit route in the context of a joint venture may find that the significant component of non-rental income generated by the business prevents them from pursuing a REIT model. Consequently, in this context, a long term capital vehicle with an element of liquidity could provide an attractive alternative to a REIT structure.