The growth of the operational real estate (ORE) sector is one of the most significant recent trends in global real estate markets. ORE is relevant to a wide range of real estate asset classes and subsectors, and an increasing number of diverse investors are attracted to the strategy.
So what is ORE? Why is it attractive to owners and operators? And why is it attractive users and occupiers?
What is ORE?
The Investment Property Forum defines ORE as “a real estate investment where the return is directly and deliberately linked to the revenues and profits of the business conducted on or from the premises.”1 Whereas returns in traditional real estate investing usually depend mostly on leasing property to occupants or users, ORE investments tie returns to property operations.
Investment models can range from simply linking lease rates to operational performance, with virtually no participation in running operations, to fully managing the operations of the business that uses the underlying real estate asset. Most models lie somewhere between these two poles, with investors taking some role in operations, whether directly or through a third-party specialist team or platform (see below for details on specialist teams and platforms).
Compared with traditional real estate investment strategies, ORE has historically been considered higher risk because ORE investments are more complex and often opportunistic. But the potential for higher returns on invested capital can be significant.
Consider hotels as an example. ORE investments in the hotel sector depend on the ability of the operator to manage a complex and dynamic business, which involves a tenant base that turns over on a regular basis with volumes fluctuating based on seasonal and other factors. Revenue and costs structures can be incredibly dynamic, and operational expertise is critical to success.
ORE is growing as more investors include ORE investments in their portfolios, including in areas such as:
- Car parks
- Data centres
- Hospitality and leisure (including hybrid-hospitality, holiday parks, cinemas, food and beverage sector, golf, ski resorts, marinas)
- Hospitals and medical practices
- Life sciences and laboratories
- Purpose-built student accommodation
- Senior care
- Serviced offices
- Specialist residential
- TV and film recording studios
Why is ORE attractive to investors and operators?
Investors are increasingly attracted to ORE because it offers greater upside potential compared with traditional strategies, particularly given the very low yields recently available in sectors such as core offices, and the fierce competition in higher performing sectors such as logistics.
As previously noted, ORE investments involve greater risk, given that they are linked to the operational performance of the business using the underlying real estate asset. The additional risk may stem from a variety of factors that can affect operational performance, including shifting and uncertain demand, revenues, and costs. Success depends on the ability to manage these and other risks to achieve higher returns on invested capital.
Other factors that make ORE attractive to investors include:
- Opportunity to be a first/early mover in emerging sub-sectors
- Potential to capture economies of scale that drive efficiency and create value (a key driver for private equity investors engaged in “buy and build” portfolio strategies)
- Ability to generate additional value via brand creation or recognition
- Opportunity for diversification of income streams, lease structures, and property types
- Limited availability of core/traditional real estate investments in a competitive market
As investor appetite for ORE opportunities has grown, the number of specialist teams and platforms with the expertise to manage operating businesses has increased. Specialist teams can have one key person or a small group of people with deep experience in a particular sector; platforms are larger, including staff with extensive management experience and deep operational expertise across asset classes and subsectors, often with genuine global reach. These players take a fee for managing the day-to-day operations of the businesses operating in or from the underlying real estate asset, but they usually do not make meaningful investments in real estate. Increased investor appetite for ORE assets has allowed more specialist teams and platforms to partner with capital providers to start, develop, and grow successful ORE businesses.
Why is ORE attractive to users and occupiers?
Users and occupiers increasingly expect more from property than just “four walls and a roof.” They want more flexibility in how they use property, and they demand more services and facilities than were typically provided in the past.
This trend has been developing for years, but it was accelerated by the COVID-19 pandemic. It is playing out in people’s pursuits of new ways of living, which is often enabled by working from home. We also see it playing out in how businesses are developing office environments to attract employees back to work. And we see it in the way hotels and other businesses are seeking to activate underutilized spaces to provide better experiences for guests and occupants (and potentially increase revenue per square foot or meter).
ORE investors that can drive superior operational performance have greater potential to attract users and occupiers who are increasingly looking for services and other offerings, not just space.
Outlook for the future of OREThe ORE sector is expected to be less affected by the current global economic downturn than many more traditional asset classes. Expect more investors to add ORE investments to their portfolios in the next few years as they seek to capitalize on ORE’s potential for higher returns. As exposure to ORE assets increases, it will become ever more important for investors to partner with experienced and effective operators to drive growth and execute on operational business plans. Participants in these arrangements will sharpen their focus on the terms of investor-operator joint ventures and management incentive programs.
 Investment Property Forum, “Operational Real Estate: Risk and Reward” (February 2021).