From offices to housing, hotels and even logistics, the American giant KKR approaches the real estate asset class with an operating company strategy, in line with its private equity DNA. Stéphanie Morelle, head of KKR's European Core+, Real Estate Private Equity, talks to Business Immo Global about the benefits as well as the risks, of a more operational approach to real estate investment.
Business Immo Global: What role does operated real estate play in KKR's investment strategy today, and how has it evolved in recent years?
Stephanie Morelle: Operated real estate is an integral part of KKR's strategy. In the broadest sense, our private equity DNA involves investing in real estate companies as a majority shareholder, and not just in direct assets (PropCo). It is therefore quite logical that we have built up a portfolio of operating companies (OpCo) enabling us to integrate a strong operational dimension into our investments, an essential pillar of net operating income's growth. This approach enables us to optimize the performance of our assets by mobilizing value-creation levers in addition to traditional ones.
KKR also has a subsidiary – Capstone – which identifies and implements operational improvement opportunities for our portfolio companies. In this way, we manage all the strategic development axes of our investment themes.
As for the evolution of our strategy over the past few years, it reflects the profound changes in the real estate market: the growing search for flexibility, in offices for example, in the face of the fixed duration of traditional commercial leases, the imbalance between supply and demand in sectors such as quality build-to-rent or student accommodation. These market developments create opportunities for an investor with operational capabilities, and offer a more attractive risk/return profile than conventional real estate.
What are the advantages for a real estate investor like KKR of adopting an OpCo investment strategy?
By focusing on the operator itself, we have strategic leverage across the entire value chain. If I take as an example Newton Offices, which we own for the office operated in France, one of the major attractions lies in what we call the 'operating premium.' Our customers rent equipped workstations for an average of three years. We provide furniture, meeting rooms, photocopiers, catering facilities, a gym and a range of other services. In our portfolio of 10 operated offices in France, we have observed net revenues some 30% higher than those of a conventional office, after deduction of OpCo's operating costs. This choice of operated office is also more economical for users, with comparable services in the early years. This outperformance can be explained by our customers' need for flexible turnkey solutions, and our control over profit and loss and operating levers. Value creation therefore goes far beyond the traditional 'rent and rates' duo.
Let's take another example, in the hotel sector: thanks to the expertise of the operating teams at our Amante hotel platform, we have the ability to reorganize our portfolio with optimal contractual forms, most often franchise agreements to operate hotels directly, which we set up while at the same time contracting licenses with major hotel brands. This enables us to benefit from the power of their distribution networks in terms of reservations. This enables us to develop less binary and more resilient business plans.
Finally, an underlying aspect of these strategies concerns the significant synergies between our different companies and the resulting economies of scale (cash flow, data utilization, information systems), usable across different asset types and different countries. This 'platform' approach also enables us to effectively serve our different investment strategies, whether core-plus or value-added.
Similarly, what risks should you bear in mind when implementing such a strategy?
This strategy does present specific challenges. First and foremost, service quality and customer experience are even more critical in the development of these strategies. We are constantly 'on stage' in front of our customers, whereas asset management has traditionally been carried out behind the scenes. The 'real-time' dimension adds a significant layer of managerial complexity and requires the right profiles, both analytical and commercial, for this 'people business.'
Then there's the question of OpCo launch costs. Financing such capacities implies significant fixed structural costs before breaking even. Teams have to be recruited, information systems invested in, branding and internal processes established, and all of this has to be done in parallel with the vagaries of time to build up a portfolio of critical size to justify the investment.
Other, more cultural challenges come into play, such as the type of commitments one agrees to make in order to operate, and the question of 'lease or service contract' soon arises in business development. As the European market is not very mature when it comes to valuing service contracts, many owners still use leases to secure the value of their buildings.
On the other hand, only a small proportion of investors are in a position to invest in OpCo. In fact, the majority of institutional capital is not destined to own these teams, and focuses on traditional real estate investments (PropCo).
From an asset management point of view, are certain sectors more conducive to an operational strategy than others?
Absolutely, certain sectors lend themselves particularly well to an operational approach, and our experience has enabled us to identify the most promising segments. I've already mentioned operated offices, with the example of Newton Offices. This segment responds perfectly to the growing demand for flexibility in quality buildings, to which applying a yield management strategy can generate additional income. It is also conceivable that owning such an operator in a large portfolio could add value to traditional buildings by providing flexibility prior to a period of restructuring work, or to take advantage of large-scale developments and the changing needs of their tenants.
The managed residential sector is also obviously very promising, with student housing at the top of the list. We are currently present in this segment through our Inhabeo platform in the UK, a market that has historically been more consolidated than continental Europe, characterized by a significant supply-demand imbalance, and where we plan to expand further. We have also invested in BTR strategies and have a strong presence in multifamily residential in Germany, through Velero, our integrated residential platform with over 250 employees managing 25,000 homes in the country.
Finally, the hotel sector, with our Amante platform, perfectly illustrates the advantages of dynamic pricing and direct P&L control. We are also exploring segments such as coliving, which present similar characteristics in terms of service potential and integrated operational management. Their common denominator: segments characterized by a strong demand for à la carte services, offering opportunities for higher revenues thanks to solid operational capabilities.
The logistics sector seems less conducive to the on-site operational dimension, which is highly specific to each occupier. We do, however, benefit from the expertise of the Etche and Mirastar teams, which enable us to redevelop and adapt existing warehouses to market trends, while mastering the design aspects of development and marketing in-house.
What are the most important elements of an OpCo strategy for an investor like KKR?
Over the course of our investments, we seem to have developed the firm conviction that a successful OpCo strategy rests on three fundamental pillars. Firstly, the rigorous selection of the right partner through cultural compatibility, business plan development and alignment of interests. Choosing the right partner is not only critical to the successful deployment of the model, but also salutary when difficulties arise along the way – together 'for better or for worse,' as it were.
Then there's the plumbing: systems and data. Monitoring KPIs in real time is absolutely critical to effective operational management. Our systems must enable us to monitor deviations as well as opportunities, and to optimize operations. This is not just a matter of technology or AI, but also of expertise and experience. We are convinced that this ability to steer through data is a decisive competitive advantage.
Finally, governance and discipline, with a particular focus on compliance and risk control. We have developed a whole set of procedures and rigorous reporting covering operations, treasury, human resources, purchasing, cybersecurity and, more generally, all operational risks.
What role do you see operated real estate playing in the future in the strategies of real estate players in general, and KKR in particular?
Our approach has proved its worth and continues to do so, so we intend to strengthen it while adapting it to the constant changes in the sector. We will continue to operate primarily through our portfolio companies, capitalizing on the expertise we have developed and the synergies we have created. Our strategy will focus on strengthening our existing platforms and exploring new growth segments.
The future of real estate will be increasingly operational. Structural changes in the market – digitization, new user expectations, the search for flexibility – mean that this approach is no longer optional, but essential, and those players who can master this dimension will gain a significant head start. At KKR, we are convinced that our integrated approach positions us ideally to capture these transformations.