The significant broadening of the institutional real estate investment universe is a welcome feature of recent years. Societal change, e-retailing and the pandemic, among other factors, has rightly questioned the merit of a strict focus on the traditional sectors of office, retail and industrial.

The new sectors that have emerged into institutions’ investment focus are varied and include infrastructure (such as airports, bridges, toll roads), solar parks, wind farms, hotels, built to rent residential and later-living/care accommodation. The investment rationale for these sectors, apart from initial yields, is growth prospects underpinned by demographic trends and an opportunity to make an ‘impact’ investment – ie, a real or perceived sense of well-being that emanates from an investment that benefits society often of an environmentally positive nature.

It is easy to assume that the usual investment and asset management rules apply to these new      alternative sectors. In some very limited cases, such as a new purpose-built student accommodation (PBSA) asset let on a long lease to a high-quality university, the rules may be similar to the usual underwriting focus on the creditworthiness of the tenant, and lease terms that pass to that tenant all repair and insurance obligations. However, this type of asset is both very expensive, with a low initial yield, and very much the exception to the true operational assets in these sectors. 

To be successful, the investor must have relevant experience of these sectors and understand the asset and operational risks that will impact performance. The successful investor must have a strong sense of the likely evolution of the sector industry and must be financially and strategically aware. 

The asset management contribution in these alterative sectors is very much more intense than for office, retail and industrial assets. The asset management of traditional real estate investments has little need for a focus on how, for instance, an office tenant runs their business from your investment. If they pay their rent, all is well, and if they fail, other tenants, assuming the asset is well located, will emerge to take a lease. Does it really matter if the tenant runs their business efficiently from your asset and do you really need to focus on the availability of staff for your tenant? The lease you granted to the tenant of the traditional asset types will afford you no rights to quarterly management accounts of the operation of the business, and it will give you no rights to terminate a lease if the profitability of the business is not at least twice the rental obligations.

Operational assets in the alternative sectors are usually leased on very different terms to the traditional sectors, allowing for far more interaction between landlords and tenants. In a care-home lease, the tenant must share detailed, often quarterly, performance data with the landlord and the landlord will have significant rights to bring a lease to an end following the failure to meet performance criteria even if the business is profitable. The leases have been drafted this way so landlords are not left with poorly performing businesses in their assets that will impact investment values. In an expanding market, such as care homes, so long as the asset is well located with the right specification, it is likely to be relet. To make the right strategic recommendations, the asset manager must understand the industry, analyse the numbers comprehensively, and have a close handle on values and the investment market. Operational leases tend to translate into vastly increased roles for asset managers. 

Can traditional investors and their asset managers not learn from the benefits of the increased landlord/tenant dialogue by adopting some clauses from the alternative sectors? For instance, would it not be a good idea to know if your office tenant was having difficulties recruiting staff locally? Would it be useful to a landlord to have a right to terminate a lease for a tenant’s repeated failure to adhere to regulators rules, such as those policed by the FCA? 

A greater landlord/tenant dialogue may result in the landlord making an investment into a bus route to enhance staff availability at a location or pursue a lease surrender if the tenant is undermining its reputation for repeated violation of FCA rules. It is easy to assume that, because the alternative sectors are new and fast changing, you need to have regular tenant reporting and sanctions, but office and retail sectors have witnessed seismic change and exponential threats that would surely merit a closer investor interest in a tenant’s business.

There will, of course, be a greater onus on confidentiality if the asset manager is to receive very sensitive tenant data. This seems to have been accepted within the operational asset world, with tenants prepared to trust their landlord and their advisers. There will be some trust barriers to overcome in the traditional asset sectors. 

In a society and its economy where the pace of change is only set to get faster, anything that increases dialogue between operators and investors must be good. Asset managers must evolve their skills, as there will be an increased focus on the monitoring and analysis of financial data so they can fully advise landlords on the ramifications for their assets. Landlords are not going to tolerate traditional asset managers saying that the landlords need to appoint accountants to advise on basic financial data!

Landlords need to be braver in seeking new lease clauses in the traditional sectors, learning from the alternative sectors. Having a lease with reasonable tenant financial reporting obligations should not be viewed as evidence the landlord was concerned about a tenant’s health at the start of the lease, but rather a sign of their willingness be to open and flexible in an appreciation that even office tenants trade in a rapidly changing society.