ASSETS TRANSITIONING

On the morning of the 21st of May, an intimate group of investors were gathered in an Editorial Breakfast organised by Iberian Property, which counted with the support of Clifford Chance. At the law firm offices in Madrid, the consensus was that there is a huge opportunity in transitioning that goes beyond single assets, meaning it should be thought as a way to revitalize cities and "peripheral" areas through innovative mixed-use projects.

The event featured Investment funds, Consultants, Lenders and Lawyers, contributing towards the goal of discussing the risks, the needed skills, and the market availability to asset transition, repurposing and upgrading existing obsolete buildings.

Carlos Portocarrero, Partner & Head of Real Estate at Clifford Chance in Spain, kicked-off the discussion defending that Asset Transitioning has always happened naturally to transform European cities when most needed. In his opinion, we are going to see a revolution with an increase of flexibility across asset classes, a (r)evolution subject to change, not only in regulation, but also of the sector’s general attitude.

In charge of moderating the roundtable discussion, Alexandre Lima – Director at Iberian Property, and Roger Cooke – Editorial Advisor of Grupo Iberinmo, opened the debate with the principal different challenges of transitioning vs. refurbishment. Does transition buildings require specific skills?

For Leticia Ponz, Asset Manager for Spain, Mexico and Portugal, at Union Investment, the transitioning process in Spain poses both risks and costs, and as such is less likely to be adopted by core capital funds. For the conservative investors the preferred option is to take a prudent approach of slowly recovering/improving occupation before moving on to a costly transformation.

When we talk about transitioning, there are 2 derivatives, being the change of use the immediate one that everyone thinks of. However, the adaptation of the real estate product to the new trends within the same use is also an important format of transitioning, as sustained Jorge Lopez Naya, Head of Investment and Development at GMP Property SOCIMI.

“For real transitioning we need new urban development plans that adapt to the needs of the cities, that is to say, we need agile mechanisms”. In the case of GMP, which is a listed company, it is obvious to consolidate a cautious approach, but more and more funds have institutional capital behind them, and by having qualitative procedures with undefined procedure times what investors perceive is uncertainty, and that is unfortunately blocking a lot of investment.

Considering the amount of existing obsolete office buildings not taxonomy compliant, which will be left standing, that there are no flexibility mechanisms to create asset portfolios and more efficient changes of use, an increasing need given the ‘brutal’ demand for beds in the big cities.

The present lenders demonstrated that financing has a big role in developing the transitioning, and according to Deogracias Bonoha Diaz, ESG Director for Real Estate at ING, banks are already working to devise joint strategies with investors. “Even though ING is a core and conservative bank, we guarantee better financing conditions to those who invest in transitioning”. ING is currently most active in the financing of residential, logistics, shopping centres and core office assets, with a clear focus on financing retrofit plans that align with the bank’s goal of becoming net-zero until 2050.

Covering both debt and equity, Javier Quintela, Alternative Lending & Investment for Real Estate at Cheyne Capital, shared that more than 80% of the firm financing is directed to asset transformation, specifically in less traditional asset classes. “The market is showing that the new uses are working, proof of that is the first Flex Living assets developed in Spain which have already been refinanced, so there is liquidity. This is an indicator that reassures us and excites alternative financiers”.

Sharing the fund experience, Javier López, Managing Director at BentalGreenOak (BGO), agreed that a change of use is more easily pursued by value-add capital. In Spain, BGO did a project in the north of the country, specifically a conversion of a factory with contamination challenges, described by the director as “a very tough process”.

As he explained, “when you have a specific time horizon, the dialogue with different entities, the several permits needed, and all the risk, makes you rethink the project. In the end the project turned out to be a great initiative, and we are still looking at this type of actions, but there is no doubt that with more flexibility we would be able to invest more and improve the local communities”.

Given this increased need of specific expertise and knowledge to conduct these challenging transitioning initiatives, María Mayoral, Senior Director Investment Properties at CBRE Spain, explained how the consultancy has (roughly about a year and a half ago) created a Multistrategy department.

Transitioning involves a very rigorous and very detailed urban and architectural analysis of the assets, to confirm that their transformation is viable, and the reality is that there are many assets that are left by the wayside without even having reached a financial analysis of the opportunity. Furthermore, María mayoral highlighted that this asset transformation is an opportunity to revitalise areas and create mixed uses, mainly in the periphery, through new value, communications and renewed services.

“The process is so complex that investors are valuing having advisors with multidisciplinary teams in this process”, she concluded.

In the Madrid region, everything points out that a law is to be passed to facilitate changes of use, and it is precisely this flexibility that is needed to give investor confidence, commented María Pradillo, Real Estate Councel at Clifford Chance. The lawyer also shared an important issue raised by many investors, that there has not yet been a price adjustment that makes it economically attractive to buy these assets, given the implicit cost of transforming and changing the use.

Andrés Tirado, Senior Associate of Real Estate at Clifford Chance, underlined that 80% of the changes of use is taking place at the city centre, predominantly in Madrid, and the most common path is moving from offices to housing. This is happening particularly because of the prevailing need for housing in many cities, and the need goes beyond traditional residential assets.

Categories such as Flex Living or Coliving, are inserted in the tertiary category, nonetheless they represent a valid solution for the shortage of living supply. Like so, “the sector should aim not only for this regulatory change of use towards residential, but also that tertiary buildings can have a new living purpose”.

On Carlos Portocarrero view, there are plenty of interesting spaces that could benefit from different uses, besides the Living spectrum, take for example the transformation of an obsolete shopping centre into a hospital or a university.

Repositioning an asset can also serve as a protection mechanism against future declining valuations. In the case of GMP, the Socimi Capex policies are aggressive enough to justify with numbers that assets become more resilient, argued Jorge Lopez Naya. “There are investment choices that are more or less forced such as the ones inherent to taxonomy, but there are proactive choices to match current demand, improve cash flows, have better lease renewals, better financing terms and in the end what we generate is an asset with a history”.

A lot of the solutions to generate a future-proof asset involve going against the real estate principle of getting the maximum return from every square metre, i.e. making a commitment to amenities, services and comfort, which in the long run can translate into higher occupancy levels and more stable tenants.

Leticia Ponz also believes that it will take time before seeing the value reflected on the fund balance sheets, but Union Investment sees the fundamentals...in other words, the current work of asset managers is to ensure that the asset will remain tradable in the future.

Maria Pradillo argued that in the long term, the biggest risk of not transitioning is running out of financing, tenants and investors to buy out the asset. Countries like the UK have already stated that by 2030 all assets non-taxonomy compliant won’t be transactional.

Asking for BREEAM and LEED certifications is no longer enough for lenders. Javier Quintelaaddressed how Cheyne Capital is already requiring certain benefits targeting the development of the communities.

Although it shouldn’t be seen as a tool, Javier López confessed that when funds pay attention to the social aspect of these assets transformations they also benefit because it is easier to obtain certain permits and licenses, and for sure get better conditions to obtain capital.

BGO runs through several sources of capital, depending on the project. In the case of value-add strategy the first approach tends to be traditional banking to optimise costs, and if is not available, alternative debt would be the next scenario. Still, if the investment ticket allows it the fund may also opt for using its own resources to be “more relaxed with time and risk management”.

Also given insights on its financing options, Jorge Lopez Naya explained that the DNA of GMP Property Socimi is to focus on green financing following the effort to ensure that its assets are also green. “At the corporate level we have it so well assimilated that we are not even looking for another type”.

Julia Villalon, Senior Associate Lawyer at the Clifford Chance tax department, answered one of the trickiest factors of the assets transitioning. Indeed, this process entails a cost, not only the Capex itself associated with the transformation, but also Transfer Tax (ITP) tax on documentated legal acts (AJD), cadastral regularisation costs, and VAT (being perhaps the one with the most weight).

When changing from a commercial use to a residential one, in particular for rental housing, the operation is subject to VAT but not exempt, which means that VAT is not deductible, i.e. it is a final cost; furthermore, if 10 years have not yet elapsed since the purchase of the asset before the change of use, it should also be considered what part of the total deduction of the VAT payments borne may need to be regularised.

Going around the table to collect the main conclusions, the idea that persisted was that once the legal and fiscal challenges are solved, we will have more flexibility and more certainty for investors, and if we add public-private partnerships, we have a tremendous opportunity to regenerate our cities and for assets to become more and more ESG compliant.

In the second IP Talks of 2024, under the format of an Editorial Breakfast, Iberian Property counted once again with the support of Clifford Chance who was so kind to host the event in its offices in Madrid.