The Evolving Dynamics of PropCo and OpCo in Real Estate

Real Estate investment has evolved over the years, giving rise to various asset classes, models and strategies. Among a few, two key segments have emerged called: PropCo and OpCo. In this blog, we’ll delve into the distinctions between these entities, the nature of the relationship and how it’s evolving, and trends we are seeing about this for the future.  

 

PropCo: The Foundation of Physical Assets

PropCo, or Property Company, primarily is in the business of owning real estate assets on its balance sheet. PropCos core focus is to raise capital, identify opportunities to build or buy Real Estate assets and hold onto them for further growth.

Their operational approach to identifying assets usually happens in 1 of 3 ways : 

PropCos enjoy both the cash flow that’s generated from the underlying asset, and profits accrued through sale of the eventual sale of the asset as well. 

Many real estate developers, real estate private equity, family offices and HNIs are PropCos. 

 

OpCo: Where Operations Take Center Stage

OpCo, short for Operating Company, helps PropCos to manage, maintain and monetize their portfolio. Let’s take an example to better explain the concept of OpCos. 

 

A commercial (say office) asset owned by a PropCo, is converted into a coworking space by an OpCo.

While the core of an OpCo remains a property management offering, OpCos have become very popular over the past decade as there is a lot of value addition happening at this level. Flexible leases, interior transformation, shared spaces, high service levels, and many other offerings by OpCos are valued by end customers (Tenants) and not something PropCos were keen to do themselves. 

OpCos work on either a revenue sharing model or on a lease-sublease model with the PropCo that owns the underlying real estate. 

Examples of OpCos are: 

Commercial: Coworking company (WeWork), Managed Office Space Providers (Regus)

Residential: Coliving companies (Habyt, HelloWorld, etc.), Student housing providers (Yugo), Property Management Companies (Greystar)

Hospitality: Hotel management companies (Marriott Group, IHG), Hostel chains (Zostel, Generator)

 

Relationship between PropCo’s and OpCo’s and How They Function Together

PropCos and OpCos have to work together. It’s a symbiotic relationship where the success of one directly impacts the other, and both require each other to accentuate the success of the underlying real estate asset. 

They might be adjacent to each other yet they work on a different set of values – 

1. PropCos focus is on identifying the kind of assets they want to acquire, how to finance the acquisition and how to time a successful exit on the asset 
2. OpCos, on the other hand, focus more from a consumer based perspective where their priority is to build a brand, to scale it in a B2B or B2C level and how to increase operational efficiency and streamline processes

Thus, to build a sustainable asset, there is a need for both these entities to coexist in the Real Estate Industry. 

 

Trend of OpCos getting equity in the PropCo

An interesting trend that everyone should be on the lookout for is OpCos taking a small equity stake in the PropCo itself. The general feeling of such OpCos is that there a lot of value addition happening in the PropCo mainly on account of their services, and they are not getting their share of the same. 

We are seeing between 1-10% of the PropCo equity being given to OpCo based on the performance . This is a super interesting trend and we believe this is here to stay. 

Why so? 

Value Addition at the Asset Level 

Let’s take a PropCo owned asset that generates a cash flow of $100,000. At a 10% cap rate, the asset will be valued at $1 million. Supposedly, an OpCo comes into the picture and helps increase the cash flow of the asset to $150,000. The OpCo here might get a bigger chunk of the additional cash flow they’re able to generate (Possibly up to 80% of the new cash flow).

The challenge/opportunity here is that the value of the underlying asset at the same cap rate, but with new cash flow increases to $1.5 million resulting in increased asset value of $500,000. This entire increase in value is enjoyed by the PropCos and OpCos aren’t getting the benefit of this, despite this increased value being a direct result of their work. 

This has shifted OpCos interests towards owning a stake in the real estate asset. While revenue share models with the PropCos are helpful, OpCos are starting to feel they are leaving money on the table by restricting their business model to only that. 

Increasingly, OpCos are getting involved at earlier stages of a PropCo including in helping identify assets, planning the interior transformation, helping project future financials and cash flow etc. and reinforces the earlier point of OpCos wanting a deeper relationship with the PropCo. 

 

Trend of PropCos taking a strategic interest in OpCos

Another side of the story here is that PropCos have been taking a strategic interest in OpCos through a minority investment or complete acquisition. What was earlier a partner or vendor relationship has started changing drastically. PropCos want deeper synergies with the companies responsible for managing and monetizing their assets. 

There are many reasons for this trend, but the prime reasons are – 

• Risk of failure of OpCo: In segments like Hospitality, large players have established themselves as credible partners for PropCos, but in other segments, this hasn’t been the case. WeWork (in the US) is becoming a classic case study, wherein the PropCos who have partnered with WeWork are going through crisis at the moment due to failure of the OpCo
• Need for greater control in operations: The revenue generated from the asset is at the control of the OpCo, but has a large impact on the asset value owned by the PropCo
• Value of being a Consumer Brand: Oyo, WeWork and many other operators have established a consumer brand identity for themselves and has resulted in value creation for many of the underlying assets through premiumization. PropCos don’t get a piece of the value created at this level as they are primarily only a real estate owner

History would suggest that PropCos refrain from getting involved on the operational side of their assets. However, many of the above reasons are allowing for a case to be made for the same. 

 

Conclusion

The evolving landscape of OpCos and PropCos has a lot to bring to the Real Estate Industry. As OpCos lean towards real estate ownership and PropCo’s seek more influence over management of their assets, we’re witnessing a convergence of interests that promises to reshape how the real estate industry transforms. 

At Monk Tech Labs, we are a partner to both PropCos and Opcos and enable management of real estate through TheHouseMonk and TheOfficeMonk. We are excited to watch this industry evolve, and keen to continue supporting its digital transformation efforts.