Real estate offers investors an opportunity, not available in other types of assets such as bonds or shares, to add additional value to their original investment through asset development, refurbishment or enhancement initiatives.

For investors who do not want to just ‘buy the market’ building, refurbishing or improving property can be expensive, but done smartly, it can be well worth the capital outlay. Indeed, as markets run hot, now is an opportune time for property owners to look at development opportunities in their portfolios.

Why Develop?

There are a number of benefits that accrue to the various stakeholders within the development process. Developments can help revitalise local areas and neighbourhoods, provide jobs before, during and after construction, and the economic benefits can spread up and down the supply chain.

For private investors investing in a development or asset enhancement initiative usually proceeds only when they believe the opportunity will provide them with an appropriate risk-adjusted return.

While the level of return each may seek will be bespoke to their particular situation, the return for commercial office development is generally realised through the delivery of a higher quality asset, in a good location, supported by improved amenity which in turn will attract a strong, or stronger, tenant covenant. The asset is then valued based on the security of this income over the duration of the hold period and eventually the development profit when it’s sold.

Workplaces Drive Change

Workplaces were evolving even before COVID-19. The pandemic has simply accelerated the process and many tenants are proactively reviewing their future office requirements, from location to amenity and the design and use of space as well as sustainability, wellbeing and health and fitness benefits.

To attract and retain quality tenants, landlords need to continue to provide versatile and well-managed environments that allow tenants to maintain a positive workplace culture while balancing work-from-home arrangements and facilitating the safe return of employees to the office.

Enhanced technology is a critical factor for improving building services infrastructure and operations and the ‘customer experience’ of the occupants. Properties that can better service tenants’ requirements will be more desirable, allowing them to secure ‘quality tenants’ and ‘reliable cashflows’ than those that do not. This will make them more appealing to investors when the time comes to sell.

Managing risk

Development can be expensive but, with a good development strategy, the uplift in yield and capital value more than compensates for the cost.

An integrated approach to risk management is key. This requires expertise in development, project management and sustainability, as well as technical knowledge and skills and an in-depth understanding of what prospective tenants and the market are looking for. Being able to identify attractive locations and submarkets, down to specific streets and buildings, also helps minimise risk.

Cromwell’s redevelopment of 19 National Circuit, Canberra is a good example. With a 20-year history of investing in the ACT, Cromwell was comfortable progressing a development given the site’s location in the tight Barton market. The property is within close proximity of Parliament House and other key federal government agencies and opposite the National Press Club of Australia. There is hotel accommodation both adjacent to, and across from, the site.

Deep and ongoing working relationships with tenants are also invaluable. Understanding tenants’ changing requirements not only assists in retaining occupancy, it also provides opportunities to create value and informs development decisions.

Cromwell’s proposed development at 475 Victoria Avenue, Chatswood, which seeks to increase the precinct’s floorspace with an additional commercial offering and alternative to the existing commercial towers, has been heavily influenced by a rethinking of the modern workplace for the benefit of both existing and future tenants.

The end-of-trip facilities, heating, ventilation and air-conditioning (HVAC) system upgrade and office foyer refurbishment, in addition to the new commercial office development, have been redesigned based around key sustainability, safety and hygiene considerations.

The project is targeting a minimum of five stars for Green Star, energy and water ratings and will be complemented by the planned Chatswood to Sydenham Metro Rail expansion due in 2024.

A counter to inflation

A development strategy can also help commercial property investors futureproof their investment against inflation. Worldwide, inflation rates have been supressed by the effects of COVID-19 but many experts are forecasting above-average medium-term rates as countries emerge from the pandemic.

Real estate is a hedge against inflation. This is because commercial property leases can include fixed annual rental increases, giving investors an income boost that offsets the effects of higher rates.

Higher inflation also generally signifies increased economic activity which can lead to increased demand for properties. Higher demand therefore allows landlords to increase rents, particularly if it comes at a time where there is less new construction, which can occur in such environments.

This is due, in turn, to the increase in costs of building materials, making development more expensive, therefore increasing risk in some cases, and ultimately influencing returns. When coupled with higher borrowing costs, new construction can become less attractive, although this does depend on the individual opportunity.

Take control

Investors who respond to changing tenant needs and actively seek to add value through development and asset enhancement initiatives can improve their returns, subject to a keen appreciation and understanding of market conditions. With current low inflation rates and borrowing costs this is an ideal time for property investors to consider the development opportunities within their portfolios.