The return of inflation and higher interest rates in 2022 led to the Real Estate (RE) asset class seeing its global Assets under Management (AuM) decline from USD 1,678.2bn in 2022 to USD 1,609.1bn in 2023. While this decline is forecast to be reversed in 2024, most alternative asset classes saw continuous AuM growth and are expected to perform better, particularly in private equity.
Figure 1. Global Alternative AuM* by asset class (USD bn)
Note: *AuM figures exclude funds denominated in yuan renminbi. Private capital excludes hedge funds; alternatives includes hedge funds. Source: PwC Global AWM and ESG Research Centre, Preqin. All figures are nominal.
Moreover, the number of deals and the aggregate deal value of RE funds has dropped significantly, particularly in Europe. From 1,918 deals in 2021, the figure has seen continuous decline since then, with only 742 deals registered in Europe in 2024.
Figure 2. Number of deals and aggregate deal value of RE funds (USD bn)
Note: The region indicates the location in which the deal took place. Source: PwC Global AWM and ESG Research Centre, Preqin.
Facing such headwinds, it was only natural for RE managers to start looking for alternative options.
Best of both worlds
According to INREV, OpRE is defined as “an investment in a real estate asset structured so as to create a strong correlation between returns to the asset owner and the underlying operational performance of the operator or occupant, by investing in both the property and also in its underlying business”
In fact, in OpRE investments, the asset manager achieves vertical integration by controlling different elements of the asset’s utilisation. The manager thus invests in assets whose value appreciates over time while generating promising cashflows. For instance, the manager would own both the storage space as well as the operating company that manages the day-to-day administration.
in OpRE investments, the asset manager achieves vertical integration by controlling different elements of the asset’s utilisation.
But the opportunities go far beyond storage. Whether it entails student housing, co-living facilities, industrial warehouses, logistics facilities, or even hotels and other pillars of the hospitality sector, OpRE investments offer substantial diversification benefits while mitigating risks and hedging against inflation.
A growing number of managers have realised this and are embarking on OpRE investments, primarily using three different models. In the first one (Model A), the manager owns the operator and can hence play an active role in the asset’s operations. While the manager benefits from the value generated in the operator, this model also exposes them to market, operational and governance risks alongside potentially high costs.
Model A. Operator owned by the asset manager
Source: INREV, ‘ Explaining Operational Real Estate ,’ Professional Standards Paper, October 2023
In the second model (Model B), the fund owns the operator, hence capturing any value generated by the latter, while the manager needs to be contractually capable of overseeing the operator. While the fund can become an integrated platform that can be sold for a premium, market and operational risks are transferred to the fund’s investors while the fund itself bears the operational costs.
Model B. Operator owned by the fund
Source: INREV, ‘ Explaining Operational Real Estate ,’ Professional Standards Paper, October 2023
As for the third model (Model C), the operator is owned by a third party and is connected to the fund and the manager by operational services agreements which should clearly lay out time commitment expectations and rights of exclusivity. The risks faced by the manager and the investors are thus limited, but so are the returns.
Model C. Operator owned by the fund
Source: INREV, ‘ Explaining Operational Real Estate ,’ Professional Standards Paper, October 2023
Challenges and considerations
OpRE investments have a unique risk-return profile, which tend to require greater time commitments and a certain degree of critical mass to reach the yields desired. Afterall, these investments entail both acquiring real estate while running a business, which means that operational risks are more prevalent than in traditional RE investments.
OpRE investments have a unique risk-return profile
Moreover, operational assets might have different and unique regulatory frameworks or definitions of RE income depending on the jurisdictions in which they are located. This could have an impact on asset allocation, capital adequacy requirements and the feasibility of the investment.
In addition, OpRE investments present unique financial reporting challenges. In Models A and B, where the asset manager directly or indirectly owns the asset’s operator, traditional IFRS reporting will not accurately reflect the true value of the OpRE asset – in other words, both the value of the RE asset alongside the value of the operational side, the cashflows generated and even the brand of the operator.
Nonetheless, these challenges are not insurmountable. Industry associations such as INREV are actively working on developing new guidelines and promoting transparency in OpRE. The risks entailed in OpRE can be managed well with proper planning and foresight. The potential yields and diversification benefits, particularly when traditional RE is going through a downturn, are substantial. The future looks promising for OpRE, and in the future, we may very well end up considering it as a wholly separate asset class.