This article is sponsored by Cromwell Property Group
Driving returns in European property markets is far from straightforward at present. The covid crisis has prompted a flight to core assets, with accompanying price increases. Asset classes popular because of their resilience, like logistics and residential, have also seen tightening cap rates, while future viability, and therefore pricing, remain unpredictable for many office and retail assets. Three Cromwell Property Group executives – head of real estate, Europe, Wouter Zwetsloot; head of asset management for Europe, Stephen Cahoon; and group head of development, Chris Hansen – tell PERE’s Stuart Watson that understanding tenant needs and taking the right kind of active asset enhancement and development risk lie at the heart of a successful approach to investing in the region as it emerges from the pandemic.
What is the most effective way to create value in European property markets right now?
Wouter Zwetsloot: You need a combination of local market intelligence with European oversight and specialism, and a co-ordinated approach to dig out every opportunity. We still see yields tightening for core space because of the wall of capital seeking a home and the limited returns available in other asset classes.
By focusing on core-plus and value-add strategies, it’s still possible to create additional value through active asset management and potentially through development. But there’s little core-plus or value-add property being brought to the market because of the uncertainty around pricing levels caused by the pandemic. To drive performance in that sort of strategy, managers need to provide capital partners, particularly those who are international, with access to the kind of opportunities that can usually only be sourced by expert local teams; then execute a business plan that’s about more than just leasing up vacant space.
Because the post-covid market is evolving rapidly, a lot of value generation lies with investing in assets so they cater for future needs. That creates the ability to drive a higher return than would just be available by sourcing opportunities on-market or buying core product. The industrial and logistics market is very tight, and in the office segment you need to do a lot of market research and use local knowledge to minimize downside risk. Nonetheless, there are attractive investment opportunities to be had. But it requires additional effort, attention to detail and local market knowledge to secure them.
What role does tenant engagement play in maximizing value?
Stephen Cahoon: In times of uncertainty or disruption, like the pandemic, that’s when tenants most appreciate hearing from their landlord. They want to feel supported. For them, the priorities are being able to access the right person within the asset manager’s business when they have a query or need to report an issue; getting communication that is clear and concise; and seeing that the manager is proactive in maintaining and enhancing the building.
A good asset manager should spend as much time on site as they do sitting at their desk. We’ve always had an extensive tenant engagement program, and during covid we further increased the frequency with which we engaged with our tenants.
That provided us with real-time understanding and insight into how the pandemic was affecting tenants’ businesses and operations. That deep working knowledge of our tenant base is invaluable to drive tenant inertia, create value and inform wider investment strategy.
WZ: Covid accelerated trends that are changing occupiers’ needs, and those needs are continuously evolving. KPMG’s August 2020 CEO outlook survey showed 69 percent expected to downsize their office space. But in a follow-up survey in March that figure was just 17 percent. That’s a big change in a very short period of time.
Communication with tenants is always a continuing cycle of adjustments, especially in these times. You cannot have a one-off conversation with them and understand their requirements. CEOs may not all now be expecting to reduce office space, but that doesn’t mean they will all be using their space in the same way as they did previously. They might use it more for social gatherings to encourage communication and creativity. Those tenant discussions will shape how we change our property offering going forward.
How can development be used to enhance returns?
Chris Hansen: Landlords are responding to changing workplace trends by trying to attract and retain quality tenants through delivering safety, versatility and a well-managed environment. That allows occupiers to encourage their staff to return to the office, while balancing work-from-home arrangements and maintaining a workplace culture.
Many tenants are undertaking reviews of their future office requirements, sometimes rethinking workforce location, and the design and use of space. They need enhanced technology, sustainability and building resilience, both at a building services infrastructure level and also at an operational level. That drives the need to assess assets for their potential for development or redevelopment, and it provides an opportunity to create real value.
Landlords that can provide a flexible workspace that suits both teams and individuals, through analyzing data to capture building usage patterns, will be at an advantage. They’ll also reduce their risk of being left holding stranded assets which aren’t attractive to investors and don’t meet future tenant and market needs.
WZ: There’s an opportunity in many types of development, depending on the location and the driver for the opportunity. We acquired a large ground-up speculative development in Amsterdam, The Joan. We’re also undertaking smaller-scale projects, such as adding additional floors to an office property where the tenant wants to expand. That will meet the tenants’ needs and create value, with relatively little risk attached to the leasing side.
CH: Part of the process is undertaking a best and highest-use analysis. There might be an opportunity to create a mixed-use development from an asset that was single use. If you can find assets that are well located and have development upside, then capital will be attracted to them rather than trying to buy stabilized assets in a competitive market where it’s harder to create value.
What is the appetite for development risk among capital providers right now?
WZ: Available product is limited. We see core investors going up the risk curve, while private equity investors are going down the risk curve. Developments and build-to-core is an opportunity to step in at a slightly higher yield, which gives returns a boost provided you have a good understanding of the risk you’re taking. Meanwhile, development strategies can create additional value within the existing portfolio.
SC: Investors at the value-add or opportunistic end of the risk spectrum are still very happy to explore capex-heavy redevelopment and repositioning opportunities. The key is to demonstrate attractive upside, which is also supported by a robust downside scenario. To execute these strategies well, it helps to have a vertically integrated business like ours, with investment, asset, project and development managers all in house. That model offers consolidated advice and end-to-end underwriting and analysis.
Moreover, having strong teams on the ground allows us to be really forensic about each opportunity; not only identifying an attractive submarket within a city, but pinpointing the exact streets and buildings that best fit the strategy. Being able to demonstrate this granular level of market knowledge and understanding undoubtedly helps to de-risk the opportunity somewhat for our capital partners.
CH: At all stages of development, you have to identify, value and mitigate risk as part of the decision-making process: selecting sites underpinned by market demand; undertaking market analysis; and making sure of the core fundamentals of connectivity and asset quality. Those are the starting points for all development.
Then conducting a robust analysis of not just the value on completion, but also the downside scenario to make sure risk protection is built in is absolutely vital. A high level of governance flows through to deliver a superior outcome for the investor that will also meet the expectations of the end user.
Tackling real estate’s throwaway culture
Repurposing, rather than demolishing, obsolete buildings can help reduce asset managers’ carbon footprint, argues Cromwell’s chief sustainability officer, Phil Cowling
“ESG considerations have long been a driver for improved operational asset performance. However, what began as reducing energy, water and waste consumption has evolved to include green building construction, operational efficiency and occupant wellbeing. With awareness and mounting concern over climate change, the Task Force on Climate-related Financial Disclosures (TCFD) has recently outlined 11 recommended disclosures for companies to report on how they are addressing physical risks and transitioning to a low-carbon economy.
As identifying a pathway to net-zero emissions becomes more important, companies’ supply chains will increasingly draw scrutiny. Businesses will need to begin looking at the ‘environmental balance sheet’ of their assets and operations, and identify ways in which emissions and waste can be minimized, materials recycled and reused, and biodiversity supported in order to mitigate future environmental impacts.
By renewing and repurposing, tired old buildings can be converted into leading-edge, highly efficient assets. The key benefit of this ‘adaptive re-use’ approach, as opposed to demolishing and rebuilding, includes retaining the embedded carbon in the many hundreds of tons of materials including the steel and concrete used in the original construction.
Cromwell recently undertook a A$170 million ($129 million; €109 million) project with joint venture partner, LDK Seniors’ Living, converting the empty 1990s-built Tuggeranong office campus in Canberra, Australia, into the LDK Greenway seniors’ living village. Retaining most of the main infrastructure, coupled with additional sustainability initiatives, has resulted in emissions savings of almost 30,000 tons of embedded carbon over the lifecycle of the development, not to mention saving the financial cost of demolition and building anew.”