The long road from shortening leases to operational real estate
Charles Ferguson-Davie, chief investment officer, Moorfield
As we tentatively circle the edge of another recession, fund managers and investors who understand operational real estate are going to be ahead of the curve. With leases getting shorter and occupier demands more sophisticated, we must think more operationally about how we manage all assets and their occupiers: from residential on to shopping centres and even offices.
The operational approach has often been restricted to the alternative real estate sectors, such as student accommodation, hotels or retirement living. Investment into these sectors is typically based on research into structural and societal demand drivers as well as changing customer preferences.
There has been much to learn from investing in operational real estate: from efficient management and maintenance to marketing and branding and the use of technology to manage and report on the performance.
Now, the alternative sectors are not alone, they themselves are maturing, and it is increasingly recognised that the traditional real estate sectors are becoming more operational. This has been driven by a few different factors.
Leases have been getting shorter, which means more tenant churn and more operational style management to keep voids down. A recent note by JP Morgan said the average office lease in London was just 7/6 years in 2022, compared to 11/10 in 2017.
Tenants themselves – or customers as we should call them – are asking for more, and essentially demanding from landlords and investors what boils down to be an operational service. Additional share amenities are also creating more operational need – whether a gym in a build-to-rent block or shared meeting rooms in an office tower to curating entertainment to attract footfall in physical retail.
This has been enabled by more understanding and acceptance of the value of operational models by investors and managers – to the extent there are even some that prefer it, provided it is well run.
Solid operations can mitigate risk and stabilise income. Efficient management can add to the bottom line, while branding and effective marketing can create a premium product in terms of pricing, whilst avoiding voids.
There are other advantages. In many operational assets you can get inflation linkage by resetting rents frequently and you can drive higher performance by creating a better product that grows revenue faster.
This may seem like a lot more work – it goes without saying that operational components demand a level of local and sector expertise – but the days of being able to sit on a 20-year lease have largely passed. ‘Let-and-forget’ is no longer possible.
Assets do however need to be priced correctly to account for risk and managers have to monitor, analyse and underwrite each market appropriately.
Familiarity with using the right management structures in the right situations can also be hugely important.
For instance, in the past it might have been necessary to create an operational platform to enter a sector. Now, depending on the sector’s maturity, it’s perfectly feasible to take on the operating risk of an asset but to appoint a specialist operator to help you manage the asset.
This can help investors who want flexibility to sell assets when it might suit them and if they do not want to be under pressure to grow a sizeable portfolio to justify the head office costs of an in-house operational platform. It is still critical however to have some in-house operational expertise to manage these outsourced relationships.
Whether an office or a student block; design, technology, branding, marketing and customer experience are hugely important and ESG initiatives also increasingly require an active and continuous engagement. Real estate and its occupier, or customer base, is becoming increasingly intertwined – essentially each asset must be treated like a business in its own right.
We believe investing in operational real estate, with the benefit of everything we have learnt over more than 25-years operating in the UK, will continue to serve us well in this inflationary and higher interest rate environment.