Investing in Operational Real Estate
Achieving desired returns from traditional asset classes like office and retail has become increasingly challenging in today’s economic climate, and in searching for greater returns, investors are continuing to increase their allocations in favor of operational real estate (ORE). Across key jurisdictions, different subsectors of ORE are at varying stages of maturity.
A new and emerging subsector seen as a huge opportunity for investors is film and TV studios and soundstage facilities (we use the word “studios” to mean both). Demand for studios significantly outstrips supply, which has created an urgent need for development. Tax incentives sweeten the deal in many locations. And ESG benefits can also be attractive.
But investors will have to embrace ORE and engage with specialized operators to capture value and achieve their desired returns in studios. (See “Capturing the Operational Upside in Real Estate Investing” for general details on ORE success factors.) Those who can provide ancillary services are in the best position to capture additional upside.
Why invest in studios?
The rise of streaming platforms and longer leases
Over the past few years, streaming platforms, such as Netflix, Apple TV+, Amazon Prime, and Disney+, as well as traditional national broadcasters have been ramping up investment in film and television production to meet the growing audience demand for original content. According to FX Research, there were 599 adult scripted original series in 2022, a 7% increase compared to 2021. This was a record, and the number of original series had been increasing at a cumulative annual growth rate of 8% since 2012, when there were 288 such series. This skyrocketing demand is due in large part to the “binge model” of certain streaming networks and the ability of end users to consume media at any time and in any place through their smartphones, tablets, and computers. This trend dramatically accelerated during the COVID-19 pandemic. The resulting need for more original content is driving the need for more studio space.
Historically, leasing of studio space involved short-term license agreements for days, weeks, or months at a time. However, streaming platforms like Netflix changed the landscape when they entered the market with a strategy of leasing studios on a long-term basis, satisfying, and developing the market for, long-term content-creation commitments. The fact that these media and technology companies are investment-grade tenants willing to enter into long-term leases makes investment in studios an attractive proposition for institutional stakeholders underwriting investment in the sector.
Supply and demand imbalance
The current supply of purpose-built studios in key geographies is insufficient to keep pace with the rising demand for new content. This shortage is placing sustained upward pressure on rents, driving up capital values and the case for new development and investment in the sector.
Since studios have not historically been considered an investment-grade asset, statistics on the amount of space and occupancy are not understood with a high degree of certainty. However, a 2020 report from CBRE estimates that more than 11 million square feet of soundstage space exists in North America, more than half of it in Los Angeles. The report also noted that occupancy rates for production space in most major markets had exceeded 90% for several years. Demand suggests that more studio space will be urgently needed.
The situation is the same in the UK, where total spend on film and television production is forecast to double over the next five years and so. Assuming the space required for production also doubles, an additional 6 million square feet of studio space will be required over this period.
Investment in studios is made even more attractive by a range of state subsidies. Local, regional, and national governments are competing to attract film studios and content producers through tax incentives, with such incentive offerings becoming the cornerstone of production companies’ financing plans.
For example, for all British qualifying films, the UK offers a cash rebate of up to 25% on expenditure “used or consumed” in the UK (that is, costs incurred on filming activities that take place within the UK, irrespective of the nationality of the persons carrying out the activities). This government initiative has made the UK a competitive and stable location for investment and is supported by both major political parties. Similar incentives are offered in other jurisdictions, including the significant film production markets of France and Spain.
In the United States, tax incentives have helped facilitate the development of studios outside of the Los Angeles hub. For example, the Georgia Entertainment Industry Investment Act grants an income tax credit of 20% to qualified productions, which include feature films, television movies or series, documentaries, commercials, and music video projects. As a result, Georgia now boasts 4 million square feet of stage space. In order to meet growing demand, new projects like BlueStar Studios, a 53-acre campus with more than 600,000 square feet of space, are currently under development just outside of Atlanta.
Investing in studios also has the potential to boost investors’ ESG credentials. For instance, the innovation of “volume” technology during the production of Disney’s The Mandalorian allowed filming that would otherwise occur on location to take place on specially constructed soundstages where all of the walls are covered with high-definition television screens. Meanwhile, the UK recently completed the first “carbon neutral” production by shooting on “volumes” — using a 180-degree video wall, one actor can stand in front of multiple backgrounds, allowing a production to be shot without going on location and therefore removing the carbon impact of traveling to a particular location.
The job creation potential means that investors in studios are also contributing to local economic growth and development. For example, recent research by the British Film Institute indicated a gross-value-added return of more than £12 billion from the increased business related to the UK government’s screen tax relief initiatives.
We are starting to see significant industry and institutional investment in studios:
- Hackman Capital. In November 2021, a joint venture between affiliates of Hackman Capital and Square Mile Capital Management purchased the iconic CBS Studio Center in Studio City, California, for $1.85 billion. The joint venture plans a $1 billion redevelopment of the studio, which will involve building up to 25 soundstages, totaling 2.2 million square feet, plus more than 1.4 million square feet of office space.
- TPG. In November 2021, TPG Real Estate Partners purchased studio campuses in Toronto and Chicago from Cinespace Studios for approximately $1.1 billion.
- Blackstone. In August 2021, a joint venture formed by Blackstone Real Estate Partners and Hudson Pacific Properties acquired a site near central London for £120 million. The joint venture expects to invest more than £700 million to develop and expand the site.
- Disney. In September 2019, Disney entered into a long-term lease on stages and production accommodations at Pinewood Studios in Buckinghamshire, UK.
- Netflix. In July 2019, Netflix signed a long-term lease to rent the bulk of the Shepperton studio site in Surrey, UK, to create a dedicated production hub.
Studios tend to be located in or near major cities where the entertainment industry is already thriving. The best locations provide access to a skilled workforce as well as quality infrastructure and transportation links. Tax incentives are also key. Los Angeles remains at the center of the studio universe due to the quality and abundance of its physical studio infrastructure and human capital (producers, writers, lighting grips, camera operators, and other professionals necessary to make a production a success). But studio space is expensive to develop in Los Angeles, and investors and producers are turning to other markets: for example, Atlanta has become a hot spot in the US, offering access to open green space, a skilled workforce, and tax incentives.
In a unique way, owners of studios have an opportunity to diversify their income streams; in particular, while the key requirement for film and television production is specialized physical space, producers require a huge range of ancillary facilities (such as catering, lighting, security, and postproduction services provided by specialized technicians). Increased returns are therefore available to studio owners who can charge fees in addition to rent to procure these services, with the possibility of scale to help drive further efficiencies.
Short-term leasing to drive further value
The asset class is highly specialized, with experienced managers and operators being key to success. The studio leasing business has historically been rather insular and built on long-term relationships. It is important for a successful studio operator to be plugged into the system and have contacts and relationships to ensure that the studio is being used and occupied to its maximum value. The trade-off for institutional owners with entering into long-term leases of studio space is that such leases are at a lower net effective rent than the studio would otherwise receive if the studio was instead leased on a weekly, monthly, or annual basis.
Operating a studio using a short-term license model is operationally more intensive, but in the long run this strategy can yield higher revenues. Although a short-term leasing strategy ultimately may be more accretive, institutional investors are traditionally attracted to the certainty of long-term leases and may not have the internal relationships or convictions to operate a studio on short-term license agreements. This means an opportunity remains for sophisticated and experienced operators to create a brand name for studio operations and a platform that operates multiple studios and hones operational expertise to increase net rentals. Once there are a number of these operators in the market, investors may begin to view these studios in the same light as hotels and resorts, which operate on nightly leases with no credit tenants, and may have the level of comfort to shift their leasing strategy to be economically more accretive.
Over the next few years, we predict that the rise of studios as an alternative real estate asset class will continue. It will have room for diverse investors with an appetite for a variety of operating and leasing strategies, from long-term leases with investment-grade tech and media tenants to agile studio space for shorter-term creative projects.
Connect with our Operational Real Estate team and let us know how we can help.
 However, at the date of this article, there are proposed changes in UK “rateable values” for studios (which will lead to an increase in property taxes payable by a large number of studio owners in the UK). This may slow the positive effects of tax incentives in the UK in the short term.
Alex JacobsPartnerCo-Chair of Real Estate Joint Ventures and Real Estate Finance & Restructurings