In a Commercial Real Estate — CRE — investment, the value of the asset does not depend solely on its location, condition or physical characteristics. It also matters who occupies it, what activity they carry out and under what type of contract.
An office building, a hotel, a student residence or a supermarket may have a very different value depending on the tenant’s or operator’s solvency, the length of the contract, the stability of the income and the allocation of risk between the parties.
That is why, in CRE, it is not enough to analyse the property. It is also necessary to assess the quality of the contract that supports the asset’s income.
Tenant and operator: two different figures
The tenant occupies the property and pays rent to the owner. This is the usual model in offices, retail, industrial or logistics assets. The relationship is structured through a lease agreement and, in general, the owner does not intervene in the activity that the company carries out within the asset.
The operator, by contrast, manages the business associated with the property. It is a common figure in hotels, student residences, flex living or certain healthcare assets. In these cases, the asset’s performance may be directly related to occupancy, rates and the operating expenses of the business.
This difference is fundamental: when there is a lease agreement, a large part of the operating risk falls on the tenant. When there is a management agreement, it is the owner who assumes greater exposure to the performance of the business.
Lease agreement: greater visibility over income
In a lease agreement, the tenant pays a fixed rent during the agreed period, usually updated in line with an index such as CPI.
This is the most common model in offices, retail units, logistics centres, supermarkets or care homes operated by a third party. It can also be found in hotels, although it is not the most frequent formula.
For the owner, the main advantage is predictability. Provided the tenant meets its obligations, the asset generates known income regardless of the day-to-day performance of its business.
However, that stability depends on several factors. A contract signed with a solvent company does not offer the same level of security as one backed by a business with a weak financial position. Nor is a long-term contract the same as one close to expiry or with early exit options.
That is why the analysis must consider both the rent and the credit quality of the tenant and the specific terms of the contract.
Fixed rent plus variable rent: balancing protection and growth
A second model combines a minimum guaranteed rent with a variable component linked to the revenue or results of the activity.
The operator guarantees the owner a minimum level of rent. Above a certain threshold, a variable component is added, allowing the owner to participate in the good performance of the business.
This type of contract seeks to combine two objectives: maintaining a certain degree of stability while also capturing part of the growth of the operation.
It is a common formula in some hotels and living assets. For the owner, it reduces exposure compared with a purely variable contract, but it does not eliminate the need to analyse the operator’s ability to meet the minimum rent.
It is also important to understand how the variable component is calculated, which revenues are taken as the reference, which expenses may be deducted and what control or audit mechanisms exist.
Management agreement: more operating risk and greater potential
In a management agreement, the operator manages the asset and receives a fee, usually linked to the revenue or result of the activity. It does not guarantee rent to the owner.
The company that owns the property therefore assumes the operating risk. If occupancy or rates are lower than expected, income is reduced. If the business performs better than expected, it may also capture a larger share of the growth.
This model is common in hotels, student residences and flex living. Its analysis requires understanding not only the property, but also the profit and loss account of the business.
In a hotel, for example, occupancy, the average daily rate — ADR — revenue per available room — RevPAR — and operating profit will need to be analysed. In a student residence, occupancy, price per bed, marketing period and management costs will be relevant.
The quality of the operator is especially important. Its experience, commercial capability, cost structure and market knowledge can determine the success or failure of the business plan.
Solvency is not the only factor
The financial strength of the tenant or operator is essential, but it is not the only element that should be reviewed.
The length of the contract directly affects income stability and the attractiveness of the asset to a future buyer. In CRE, metrics such as WALT or WAULT are used to measure the weighted average lease term and the remaining period until expiry or until the first break option.
In general, a long contract with a solvent tenant provides stability. However, in a value-add strategy, a short contract can be an advantage if it allows the asset to be refurbished, the tenant to be changed or rents that are below market levels to be updated.
Break options, meaning clauses that allow the occupier to leave the property before expiry, must also be analysed. An apparently long contract may offer less security if it includes an upcoming early exit option.
In retail assets, it is also useful to study the occupancy cost ratio: the percentage that rent represents of the tenant’s turnover. A high rent may seem positive for the owner, but it will be unsustainable if it absorbs an excessive share of the business’s sales.
How the contract affects the value of the asset
In CRE, the contract is part of the value of the investment. Two similar buildings, located in the same area, may have very different valuations if one is vacant and the other has a solvent tenant, a stable contract and a market rent.
The final buyer does not acquire only square metres. They also analyse the asset’s ability to generate income, the duration of that income and the risk that it may be interrupted.
That is why, during the stabilisation phase, one of the main objectives is to improve the contractual quality of the property: attracting suitable tenants or operators, achieving sufficient occupancy and closing agreements that are attractive to future buyers.
A refurbished but vacant asset still presents significant uncertainty. By contrast, an occupied asset with demonstrable income and solid contracts moves closer to a core profile and may be more attractive to funds, insurers, SOCIMIs or family offices.
The contract must fit each asset
There is no contractual model that is always better.
A fixed lease agreement may offer greater visibility, but it limits the owner’s participation in the growth of the business. A management agreement increases operating exposure, although it can also raise return potential. Minimum rent plus variable rent occupies an intermediate position.
The choice depends on the asset type, the operator’s profile, the investment strategy and the stage of the project.
In a CRE transaction, the question is not only how much the property can generate. It is also necessary to ask who assumes each risk, for how long and under what conditions.
Understanding the relationship between owner, tenant and operator makes it possible to better analyse income stability, value creation capacity and the quality of the future exit. In CRE, the contract is not an accessory element: it is a central part of the investment.
