FEATURE: A game of operation

Listen to real estate investment managers that have invested in alternative property types in Europe and one of the first takeaways is that the range of investments they are willing to engage with is expanding. Healthcare and student accommodation is the main focus for many, but data centres, police stations and even renewable energy plants are creeping into the mix for some. The second takeaway is that, in addition to the customary bricks-and-mortar know-how, each property type requires a different level of operational expertise to make the investment work.

“It’s not even really real estate,” explains Manish Chande, senior partner at London-based private equity real estate firm Mountgrange, of renewable energy plants. “Only the getting of planning (consent) for the plant really is.” 

Chande sees sufficiently high returns coming from gaining planning consent for renewable energy plants – which he jokes as being industrial compounds with giant chimneys – then selling them to firms actually in the energy sector to develop. As such, Mountgrange has a real estate strategy for this property type that ends after planning consent is achieved and its real estate expertise gives way to the operational expertise of others. 

GI Partners, on the other hand, is happy to take on the operational risk as well. The Menlo-Park, California-based private equity real estate firm offers its investors exposure to assets like data centres, where corporations store large troves of information away from their offices, and to the technology services needed to run them as well. “You can invest in data centres simply as the landlord,” says Mark Tagliaferri, a managing director at the firm. “Or you can operate at the private equity end in the technology provision as well.” 

The right hat

While more institutional investors are adding alternative properties to their portfolios, engaging in the additional risk of an operating business is not a decision taken lightly. Indeed, the level of operational risk that an investor is willing and able to take on is becoming increasingly important, particularly as the net of different property types that interest private investors widens. Furthermore, although there are indices for certain niche property types from data providers like IPD, alternative property performance oftentimes can be hard to track. 

Cognisant of that, a growing number of investment managers in Europe are placing as much emphasis on their knowledge of an operating business as they are on the property it uses. In so doing, alternative real estate investing is fast becoming closer to private equity-style investing. 

“You need to have the ability to have a private equity hat,” says Dan Bowden, head of Paris-based AXA Real Estate’s alternative real estate platform. “If you don’t have that, you will have issues.”

AXA is one of Europe’s more bullish real estate investors when it comes to alternative property types. When launching its London-based alternative property platform last October, it predicted it would double the approximately €750 million of alternative assets on its books within three years. “We’re on track to doubling our assets well before three years is up,” Bowden claims.

The €42 billion asset manager first dedicated resources to alternative real estate in 2007 with the launch of APIV, a closed-ended fund that attracted €400 million of equity and today is fully invested. Witnessing higher-income spreads than vanilla property types were managing and the liquidity of properties like healthcare and student housing in the US, the initial thesis was to “put in a little leverage and hope the capital markets come through,” Bowden says. He admits, however, that didn’t happen. 

“What we did see is cap rate stability and good levels of return coming through,” Bowden adds. Indeed, APIV has generated distributions of about 5 percent per year for the past three years, and he says that has prompted investors to consider entering into other ventures with the firm.

Predictably, healthcare and student accommodation are AXA’s main focus. While Bowden does not believe the firm need be an expert in the operating businesses of either asset type, the requisite expertise still would be in place if AXA is able to sub-contract or partner with the right firm. 

As an example, Bowden points to one of its upcoming healthcare deals, in which assessments are conducted on each of the asset’s patients to determine the level of care needed. “Clearly, we are not the people to do that,” he adds.

GI Partners, meanwhile, manages $2.1 billion of alternative property across three private equity funds. Its investments include Advanced Childcare, a UK childcare business that provides residential, educational and fostering care for children suffering from behavioral disorders, and another business called The Cambian Group, which provides for people requiring mental health rehabilitation. In both cases, the firm is the landlord and the operator. 

“These can be good businesses, although they are about as far from straight real estate as you probably can get,” says Tagliaferri. “Yes, it is real estate, but it comes with operational risk.” 

The opco-propco balance 

The balance between the operational and property expertise required to make an investment work varies from one alternative property type to the next. In addition to renewable energy plants, Mountgrange and its joint venture partners are converting unused offices into what Chande describes as Ryan Air-style hotel space. Again, planning is at the heart of the strategy. 

For this hotel conversion venture, Mountgrange can rely on its conventional real estate wisdom and property credentials much further. Since 2009, the firm has sought secondary commercial properties where there is local authority support for switching their usage to hotel space. Located close to important transport hubs, Chande has found that early investments in London have proven popular, and he boasts of near total occupancy levels. He admits, however, that prices paid then are hard to replicate in the capital city today and, awkwardly, that the concept might not work outside of London, where demand is less certain.

Nonetheless, expertise in converting real estate from one use to another can be both an advantage for an alternative real estate player and a defensive measure should an investment’s original thesis not work. According to property services firm Savills, investors in The Netherland’s struggling office markets of Amsterdam and Diemen, for example, are seeking alternative uses such as student accommodation for those properties. “[It] is helping to alleviate a problem in both markets,” says Joroen Jansen, head of research at the firm. With a near 16 percent hike in student registrations anticipated in the country by 2025, absorbing the country’s oversupplied office segment is one possible salvation for investors in the space.

AXA’s Bowden says his team sometimes is called upon by other parts of AXA Real Estate for similar circumstances. Conversely, he notes that an investment originally deemed alternative, like Swedish police stations, could have other uses and that should be recognised as well. 

Bowden illustrates: “The ground floor was a police station, but everything above was actually office space. It was being mispriced as people were not thinking about what it could be used for in the future.” While the asset benefitted from long income streams from the Swedish government, he notes that AXA’s investment was not “purely a credit play on the tenants’ income. We always look at other uses,” he insists. 

According to its joint research with property services firm DTZ, AXA states that €1.5 billion of alternative real estate changed hands in Europe in 2010. In 2011, the number was €2.6 billion. With more new property types now considered viable real estate plays, the number should keep growing. The challenge for firms active in these largely unchartered markets is to recognise when it needs as much (or more) expertise in the operation of the property as it has in the property itself.