Investors in commercial property generate returns in a number of ways: from the rental income paid by tenants, to capital appreciation in the building itself. A less well-known, but potentially profitable option, is skilful management of the property itself, ensuring it is used to its best effect.
Commercial property is not highly liquid, so it is not possible to ‘trade’ assets to generate higher returns. However, investors in commercial property don’t have to be satisfied with the average rental yield or the growth available in the wider market. It is possible to generate a higher income and higher capital growth by improving properties in high quality locations.
A recent example in the portfolio is our office building in Paris, one of 13 properties held in the Schroder European Real Estate Investment trust. The building is well-located, situated in the Boulogne-Billancourt region, where people live, work and socialise (we like places where there is a competing demand for use). The building has been let for some time to the same company, who enjoy its location.
Nevertheless, the building was ripe for refurbishment and, in negotiation with the tenant, we have decided to invest c. €20m in improving it. They agreed to pay a higher rent once the changes were made and committed to a long term 10 year lease, thereby mitigating a key risk for any development project. When finished, the building will be greener, have extra space, state-of-the-art technology equipment and improved services, plant and equipment. It is truly transformational, turning a Grade C €40m building into a grade A €85m building.
As well as improving the quality of the portfolio, it improves the risk profile of the fund and makes it more liquid – a high quality building in a key city is more easily sold than a lower quality building. We have a ready market of Institutional investors with an interest in all or part of the building should we choose to sell.
While one of the major risks is mitigated by the fact that we have a sitting tenant, with a 10-year lease agreed, we also want to ensure that it is in a location with positive structural growth characteristics. This can help super-charge any investment. We have built much of our strategy on identifying ‘winning cities’, those cities with superior growth dynamics from a population, GDP and employment perspective. This not only delivers superior demand and competition for uses but also stronger rental growth.
These include Berlin, Hamburg, Frankfurt, Stuttgart and Paris. On our analysis, these have the potential to grow 20% to 35% faster than their domestic economies, buoyed by a number of positive dynamics emanating from rapid urbanisation. These include first class infrastructure, diversified employment opportunities, services, social networks and tourism. In general, these cities have highly skilled work forces, good universities and schools, plus a City council that invests and has a positive urban vision.
To mitigate the development risk of the project, we have specialist asset management expertise across Europe, with teams in each destination. They have built a strong network over many years and know the right people – from skilled architects and project managers to the right construction team. They have relationships with local planners so that any new planning arrangements are negotiated rather than coming out of the blue. We would never simply turn up at our local planning office and say ‘this is what we’re doing’ – it’s a collaborative approach. We’re also careful that it is fully in tune with the streetscape and local plan.
The contractor legal agreements are tightly drawn and made at a fixed price to limit construction cost risk. Timing is another key risk so we ensure that there are penalties for delays.
The Paris building will become the trust’s largest asset and represents a unique opportunity. As it stands, we have no plans to sell the building, but if we received the right offer at the end of the project, we would consider it. It may make sense to sell 50%, which would give us an opportunity to recycle into other options, such as logistics or offices. For the time being, however, we can enjoy the enhanced income and tap into growth.
This is one type of asset management. We may also undertake smaller asset management projects on our other properties: it is all about using assets to their best use. For example, in our Berlin property we own 4 hectares of land. It may be that the building, currently used as retail warehousing, is more valuable as residential or mixed use. It’s not zoned for that today and we wouldn’t do a redevelopment ourselves but depending on planning we might sell with change of use. This is a long process and we have a long-term tenant in place, but we are liaising with the local authority as to how this site could fit in with their broader master planning targets.
We also have a shopping centre in Seville. Retail has been tough and we have worked hard to preserve the value in the asset. We’ve brought in a leisure specialist and worked to create more of a leisure ‘experience’, bringing in rock-climbing and trampolining for families.
Maximising the value of each asset we hold is an under-rated, but vitally important, part of what we do day to day on the trust. It requires a skilled multi-national team, but can help transform properties and create real value.
What are the risks?
- Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them can go down as well as up and investors might not get back the amount originally invested.
- Companies which invest in a smaller number of assets carry more risk than those spread across a larger number of assets.
- The Company may invest solely in property located in one country or region. This can carry more risk than investments spread over a number of countries or regions.
- The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the assets purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
- The fund holds investments denominated in currencies other than sterling, changes in exchange rates will cause the value of these investments, and the income from them, to rise or fall.
- The dividend yield is an estimate and is not guaranteed.
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