In the midst of the pandemic, it was welcome news for the industry. Investment manager Barings acquired an office property in downtown Stockholm for €72 million in autumn 2020. A typical value-add deal: in two years’ time, after the current tenants move out, the building at Skvalberget 33 will be upgraded with a new entrance lobby, modern communal areas and a roof terrace. The existing 6,200 square metres of space will also be significantly extended. “We’re very confident making these decisions,” says Gunther Deutsch, Head of Real Estate Transactions Europe at Barings. 

Core plus and value add are back in demand in the office property market

As the Covid-19 pandemic swept across the globe, very few asset managers were prepared to adopt a strategy of unlocking untapped potential to deliver rent increases and value growth. But value add and manage to core are now rising up the agenda. “The segment has rebounded,” confirms Nico Keller, deputy CEO of BNP Paribas Real Estate. Forty percent of 

investors who previously engaged in value-add investment activities are planning to invest the same amount or more in this segment going forward; only 14 percent are intending to reduce their investment. Those are the findings of a survey of 1,500 investors carried out by Munich-based investment management company Wealthcap in spring this year. 

It’s not just specialists who are seeking assets with upward potential, an increasing number of traditionally more conservative investors are doing the same. Alongside private equity funds, the main players in this segment at the moment are core investors looking to diversify their strategies, says Keller. Large private investors are also showing an interest. Kristina Chorna, Co-Head Real Estate at HQ Trust, the multifamily office of the Harald Quandt family, says: “Now is a good time to take advantage of core plus and value-add opportunities in the office property market.”

Investors need to have an in-depth understanding of the value chain and should be very familiar with the market so they can avoid any surprises.

Gunther Deutsch of Barings shares that view. During Covid-hit 2020, the investment manager completed value-add deals totalling €330 million in Europe, while transactions in 2021 had already reached €408 million by mid-July. According to Deutsch, there are further deals worth €320 million in the pipeline, mostly involving logistics and office properties. “We’re still big fans of offices,” he says. Deutsch is confident that a post-Covid world will see strong demand for modern, high-quality properties in prime locations. One example of such a property is a former school building in Rue Saint-Maur in Paris, a historic architectural gem with airy, loft-like interior spaces. Barings acquired the building in April as a core refurbishment opportunity and intends to obtain BREEAM sustainability certification once the upgrading works have been carried out.

Investors focus on return potential and sustainability improvements

Repositioning carries risks. Accordingly, this type of investment continues to yield higher returns, mostly in the double digit range. What has changed of late are the requirements in terms of product: through manage-to-core strategies, older buildings can be made more environmentally sustainable and thus more attractive. Investment expert Keller sees this as a key driver of modernisation: “Existing stock is being subjected to very close scrutiny,” he says. Monika Gerdes, Head of Manage to Core at Union Investment, believes that a property now needs to meet basic sustainability requirements before it can be given the label “core”. “We take a carefully targeted approach towards identifying sustainable manage-to-core investments for our funds. This allows us to meet regulatory requirements and ensure that these properties can be held in our portfolio for many years. That applies both to acquisitions and to existing properties.” 

It’s also becoming increasingly apparent that Covid-19 is changing what users want from offices and workplaces: communication areas are becoming more important, more personal space is required in bathrooms and ventilation systems need to be more powerful. “Trends can be anticipated and incorporated when repositioning properties,” says Gerdes. Union Investment is putting that into practice at the MediaWorks Munich office ensemble and the Hamburg Süd office complex, with the latter having been acquired in June. When the shipping company of the same name moves out at the end of the year, this landmark building – which was completed in 1964 and fully refurbished in 2016 – will be adapted to meet future tenant requirements.

Seller’s market for updated office buildings

Julian Schnurrer, Head of Product Management, Structuring and Strategy at Wealthcap, believes that new occupier and investor requirements have given upgrade plays a strategic advantage. The supply of properties is increasing, he says, because small portfolio managers in particular don’t have the necessary cash resources for extensive repositioning. And once a property has been modernised, it’s a seller’s market – core remains highly popular. “The asymmetry of the market is attracting both private and institutional investors who want to balance their portfolio – for example, to achieve a minimum return.” However, specific skills are required to ensure that upgrade strategies pay off. Schnurrer says: “Investors need to have an in-depth understanding of the value chain and should be very familiar with the market so they can avoid any surprises.” Anyone without the requisite knowledge in this area would be well advised to look for reliable partners “with regional expertise, lots of experience and good procurement channels”. They should also focus on diversified concepts. 

Assessing whether an investment in upgrading a property makes financial  sense is a complex matter. The result also depends on where leverage can be applied to achieve added value. “The better the location and building, the easier it will be to let the property,” explains real estate expert Keller of BNP Paribas. For example, Nuveen Real Estate acquired a 1930s office building for its Cityhold Office fund in June with the aim of „renovating to core”. Fund management believes that the location of the property in the 15th arrondissement of Paris all but guarantees success: “The property is expected to generate stable returns for our investors for years to come.” Of course, there is one major unknown quantity right now, namely building costs.

Refurbishment or exit? There’s no one-size-fits-all answer

The decision whether to refurbish or sell is not an easy one for investors, whether it concerns a newly acquired property or an existing holding. Is an exit compatible with the company’s growth targets? Is the prospect of a void period too risky where a property is worth refurbishing but the tenant wants to extend the lease? 

Difficulties may also arise if an attractive building incurs costs that were not apparent at the time of purchase. “These circumstances may prompt owners to think about selling,” says Barings manager Deutsch. Which in turn can spell opportunities for other market players.

By Christine Mattauch