This article is sponsored by PIMCO Prime Real Estate
Value creation relies on asset managers being able to preempt and predict rising investor demand and shifts in market momentum. The accelerated push toward sustainability in real estate has created opportunities, most prominently within aging existing stock, but being selective is essential when looking to acquire and renovate real estate assets that meet sustainability obligations, fulfil investor requirements in terms of value and enable tenants to attract talent back to the office.
Donato Saponara, head of the South and West Europe region and co-head of European investments at PIMCO Prime Real Estate, explains the ways in which managers can leverage this market momentum and deploy expertise in sustainability and technology to ensure real estate assets are attractive to investors and occupants alike.
What are some of the key trends you are seeing in real estate investment?
Today, if we look at the office market, location remains key. In addition, there are the secular trends such as hybrid working models and the macroeconomic trends including rent levels which determine the resiliency of the office market. Emanating from that is the prioritization of sustainable assets and the need to create spaces to attract talent back to work.
Within this, we see a clear bifurcation of the market. Green assets in prime locations in high-density mixed-use cities that have the right connectivity and can offer the right experience to employees – not only within the office but also the amenities and entertainment in a short radius – are highly valued.
In addition, this bifurcation is also being driven by legislative developments. This is only likely to accelerate in the future.
What sort of opportunities does this present to investors? How can investors make the most of these?
We are entering a new cycle and this will provide access to significant opportunities for those with the asset transformation capabilities and local presence needed to turn assets into high-quality buildings that match future tenant demands. And thus achieve a market premium for their investors.
There is a huge volume of the existing mixed-use stock on the market that needs to be repositioned. Focusing on asset transformation – or the brown-to-green transition – could unlock good opportunities for investment here.
We will see some distress in terms of liquidity, financing and availability of equity. In order to reposition assets, with many existing assets becoming obsolete, managers need to identify the right real estate locations and have the ability to deliver the required sustainability and technology interventions while controlling quality, costs and timelines.
Our approach is to focus on the European cities rather than countries, as we believe employees – and thus businesses – choose their city first. It is here that we can leverage our asset transformation expertise to create best-performing buildings. We favor cities in Europe that can attract talent, that can offer the right experience to workers, or that might have high levels of internal demand, such as those that specialize in certain sectors. We are looking at a number of prominent European cities, including Berlin, Madrid, Milan, Munich and Paris, as well as those with more advanced regulations in terms of sustainability like London or Amsterdam.
What can asset managers do to ensure their commercial real estate stock achieves optimal returns?
Despite the market shifts, the European office market remains very interesting. Compared to the US, for example, the density of mixed-use urban environments means the commute times are shorter, behaviors are different, there is a different configuration of cities, and a different culture. People seem to have a much higher propensity to go back to the office.
The opportunities are there. When acquiring assets in need of major refurbishments, or selecting assets within existing portfolios for intervention programs, as is always the case for real estate, location is key.
“Focusing on asset transformation – or the brown-to-green transition – could unlock good
opportunities”
But, particularly concerning refurbishments and repositioning, the thing to keep in mind is a clear understanding of how to deliver added value to investors. Namely, how to leverage the market premium of top-quality, sustainable offices and provide a long-term solution to the illiquidity of non-performing or stranded assets.
Environmental certifications will be important for managers to position their assets as companies are able to use this knowledge to support their own sustainability commitments. But credible commitments require thinking quantitatively in terms of long-term sustainability. Technology to improve the tenant experience should also be kept front of mind.
How important are ESG criteria to adding value to real estate assets?
Sustainability is not only a question of complying with legislation. Tenants are demanding green assets. Today, there is a clear pledge from tenants that they want to be sustainable. This is not only important for meeting corporate targets, it is increasingly important for recruiting the best employees too.
There is a clear premium for this type of asset. We are seeing this within our own portfolio where highly efficient, flexible, green assets are seeing stable valuations despite the current market dislocation.
This is also where we are focusing our acquisition and repositioning efforts – because we have the capability to transform assets from brown to green.
Are you seeing the deployment of smart solutions within many real estate assets? Is this about more than just environmental sustainability?
The use of smart technology within real estate is becoming more prevalent. Within our own portfolio, we have developed a smart upgrade program – what we call the Building Signature Program – which is essentially a standardized package of connected smart sensors and devices that collects operational and usage data and presents these to the asset manager via a smart dashboards. Also included are some AI-based tools which, by predicting occupancy patterns, can automate the adjustments of the building’s systems (heating, cooling, ventilation, water, etc) to be more efficient and which will also improve the user experience.
But this is not only about sustainability. This program gives us access to the building performance data which we can use to generate cash in the form of operational savings for tenants and landlords.
What role is regulation playing within the trends impacting real estate?
Incoming regulations will be an important catalyst of change, something that has already started in Europe. We see more and more pressure on decarbonization and energy efficiency. This regulation is not always uniform, however.
In Europe, for example, while EPC ratings have definitions that vary slightly country by country, it is clear that universal legislation such as EU Taxonomy on top of local regulations will start placing leasing and sales restrictions on assets deemed as low energy efficient. In London and Amsterdam, for example, from this year it will be illegal to let office buildings that do not meet minimum local EPC standards – and this covers new and existing leases. Again, estimates vary, but this means a large volume of Europe’s existing commercial real estate stock will need to be upgraded.
Given this, there are a lot of opportunities as mentioned for capable managers to reposition under-appreciated assets and create value for long-term investors.
Refurbishing prime real estate
Built in the 1880s, 7 Avenue George V offers a prime location in central Paris.
The departure of the previous long-term tenant presented PIMCO Prime Real Estate with the opportunity to massively upgrade this over 45,000-square-foot asset. The capex program included a complete refurbishment of the roof and façade, an increase in the capacity ratio, the creation of the highest standard open-work spaces, a private courtyard, the creation of a glass roof, the conversion of storage space into service and flex spaces and the introduction of smart features. The refurbishment was completed in Q1 2023 with handover to the incoming tenant – a luxury fashion brand – due in Q2 2023. The asset is targeting the top sustainability smart labels and certifications, including HQE excellent, OSMOZ, Ready2Services, BBC Effinergie Rénovation and SmartScore. On the completion of the refurbishment works, PIMCO expects the value of 7 Avenue George V to have more than doubled.
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