Value-added investments: Actively shaping added value
In real estate, there are three possible investment strategies to choose from: the core approach, opportunistic investments, and a value-added strategy. The last one is ideal for achieving risk-adjusted returns. The London property 45 Folgate Street can attest to this.
The value approach has primarily been associated with investments in bonds and equities. This investment strategy is based on identifying undervalued assets through research-based analyses on the fundamentals of companies or markets. Value-added investments are primarily used to achieve higher risk-adjusted returns. Unlike core investments, which focus on long-term and robust payouts, value-added investments primarily aim to achieve increases in value. Typical targets for investments of this nature include objects where the potential for added value could be identified at the property or market level before the purchase. Construction measures, vacancy rentals, and financial strategies sustainably create added value, which can be realized for and distributed to investors when the property is sold. To be successful, managers must be able to optimize the identified deficiencies using in-depth expertise and a sufficient amount of available capital. Only then can the market value of the property be significantly improved. As a result, the prerequisite for the success of such value-added investments is the right identification and assessment of markets with favorable valuation and rental perspectives, which can only be done by experienced teams possessing broad acquisition networks and extensive expertise in rental and construction.
Achieving goals with different methods
The challenge and opportunity for such real estate investments lies in the fact that the investor has to estimate the anticipated value of the investment before placing an offer, as added value can only be generated in the future if the anticipated costs and income are assessed correctly at this initial stage.
The returns on value-added strategies react more sensitively to the real estate cycle and changes in the economic environment, which makes identifying markets with attractive valuation and rental market perspectives so important. Investors need to have reliable facts at their disposal. These include substantiated macro- and microanalyses as well as precise statements and valuations of the rental agreements. In order to be able to interpret such complex data and be able to tap into their full potential, investors need expert opinions ranging from construction expertise to managing the final contract. Market cycles have to be perfectly exploited and the repositioning of buildings must be deftly handled and communicated – with the goal of reducing vacancies and increasing rental income. Such a process can take years.
Experienced value-added managers can help investors achieve their desired returns using many different methods. Market selection is particularly important, since the focus is on markets with stable or improving fundamentals and favorable valuations. To actually seize the opportunities identified in the analysis, all of the macro and operational aspects should be combined and implemented in a timely manner and according to a business plan.
Strategic capital investment in London
London property 45 Folgate Street (UK) shows how this can be done. The business property in London's trendy area of Shoreditch was acquired by the Credit Suisse (Lux) European Property Fund in summer 2014 for the equivalent of CHF 11 million. Shoreditch is conveniently located near the City of London and is known for a high demand for commercial real estate. At the time of acquisition, the building was fully occupied; however, the rental prices were significantly lower than the rent level customary for the area. This opened up an interesting opportunity. Additionally, the WAULT (weighted average unexpired lease term) was short and the permission was granted to expand the building’s area by 20%. All these factors created ideal conditions to achieve added value by completely overhauling the building and attracting new tenancies.
With an investment of CHF 9.3 million, the property was completely modernized: an air conditioning system was installed, the facade was redesigned, and an inviting reception area was created. Upon entry, visitors are now greeted by appealing lighting elements installed in a concrete ceiling. Attractive office spaces on five floors can be flexibly partitioned. There is also a lobby on the ground floor and additional office space at the basement level. The recreated atrium invites you to linger and provides secure places for employees to store their bicycles – a valuable selling point in a metropolis like London.
Rental success in quantity and quality
The property has been an A-class office real estate property since the construction overhaul concluded in the first quarter of 2017. The interest of potential tenants was fantastic, and the building has been fully let since.
The average rent per square meter more than doubled after the repositioning of the property. At the end of March 2018, the building was sold for the equivalent of CHF 35.5 million. For the fund investors, this meant an internal rate of return (IRR) of more than 26% over a holding period of less than four years.
The expected yield does not constitute a projection, forecast, or guarantee of future performance or achievement thereof.