How can investors better understand opportunities in the operational real estate (OpRE) sector and find ways of balancing the risks and returns?
A rapidly developing market segment, 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.
The segment is argued to be outperforming traditional asset classes, however it’s critical to first understand the challenges. “Liquidity at the moment is pretty thin. We saw quite a big repricing in the last quarters on the back of turbulent capital markets,” explains Paul Atema, director of real estate at Dutch pension fund APG.
APG-backed aparthotel brand City ID recently expanded into Portugal while its joint venture Archer Hotel Capital completed the acquisition of the Royal St Honore hotel in Paris for €87 million late last year.
MariaPia Intini, development & investment director, Europe, for hotel brand CitizenM, which secured a €480 million sustainability-linked loan earlier this year, says that while the way the group sources deals has not changed, it has become much more difficult, and equity and debt becoming more expensive has impacted shareholders’ equity returns.
“We used to value our assets by looking at unlevered internal rate of return (IRR), whereas now we really look at levered, you also want to understand your ability to service the debt,” she says.
She adds that in a climate of very high interest rates, while she would usually expect cap rates to be softer, this hasn’t been the case for major cities in Europe.
“Besides London, this repricing is not happening, so clearly there is this mismatch between what we think we should pay and what is asked,” she says.
CitizenM as a group also tends to heavily invest into redeveloping its assets post-acquisition, which has been another challenge for the business, says Intini.
“We spend almost the same amount on capex that we would spend on the acquisition,” she says. “We talk about development prices coming down, but the reality is, if you consider that development processes last quite some time and you have to factor in the price escalation factor, on major development projects that is a big hit which we can’t underestimate.”
Less uncertainty ahead?
Pavlos Gennimatas, managing director of real estate firm Hines Europe, says there are reasons for positivity despite the increase in cap rates, construction costs and interest rates: “They have already increased and probably things will get a little bit worse before they become better, but we know that now. 12 months ago, we had much more uncertainty. All these changes can help us create better strategies,” he says.
Hines raised €900 million of equity from institutional investors at the first closing of its new value-add fund last year, with HEVF 3 seeking to raise €1.5 billion in total, and is involved in the development of a new hotel at MilanoSesto.
Creativity and flexibility have also helped players get around some challenges – although CitizenM prefers freehold acquisitions, Intini says the business is flexible depending on the market.
“It’s important to say that these alternative structures are only possible in the cities where we feel they are common,” she explains. “The moment you have a ground lease in a place where it’s not very common and would be highly penalised by valuers, it doesn’t help the overall value of your portfolio.”
The group recently bought back the freehold of one of its assets in Paris, for example. “It worked to do the deal, but we were conscious that that is not something that the market sees very highly – it’s not very liquid, so the moment we had the opportunity to buy out the ground lessor, we did so,” she says.
“We are open when it comes to ownership, joint ventures, minority/majority, whatever works for the deal to function, and then of course we adjust the strategy later on in time when we find it suitable based on the conditions of the market.”
Hines, meanwhile, is a fan of hybrid exposure leases, particularly in the hospitality space: “Unless there are specific reasons that we would go to a plain lease agreement, there are hybrid forms, from fiduciary as we have in Greece, a lease with an upside,” says Gennimatas. “Being flexible during this period of time works as a win-win for all parties.”
All those quoted in the article appeared on stage at the International Hospitality Investment Forum (IHIF) held in Berlin between May 15 and 17, in a session called: Valuing, Financing and Pricing OpRE Assets.