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Home Cromwell: where our future lies post-European exit
November 12, 2024

Cromwell: where our future lies post-European exit

On 15 May 2024, Cromwell announced the sale of the Cromwell Polish Retail Fund for €285 million ($465 million) to Star Capital Finance, a diverse real estate investor based in Prague.

Later that month, Cromwell informed the market that we had entered into a binding agreement for the sale of our European fund management platform and interests – including the Cromwell Italy Urban Logistics Fund and Cromwell European REIT – for a total consideration of €280 million ($457 million) to a Geneva-headquartered, multi-strategy real estate investment manager, Stoneweg SA Group.

Speaking on the European platform sale agreement at the time, Cromwell Chair Dr Gary Weiss said, “this is a turning point for Cromwell to focus on leveraging the exceptional team we have in Australia; to drive value from our local asset and funds management business.”

“In the current operating environment, numerous options were considered to simplify and de-risk the business, and we believe that this transaction will provide the debt reduction and working capital needed to move forward in a focused and value-accretive way.”

Now, with the sale of the European fund management platform sale imminent, Cromwell is completing the simplification of the business, and entering the next exciting phase of our strategy.

We are continuing to refocus on traditional property sectors primarily in Australia – a market in which we have a proven record of active asset management, driving value through enhanced leasing activities, asset upgrades, and ESG repositioning.

In this article, we will examine some of the property sectors that have been identified for future investment, following the settlement of the European platform. Our investment approach is guided by both top-down and bottom-up analysis, with consideration given to a number of cyclical, structural, and secular drivers of performance – such as behavioural shifts, demographic demands, economic factors, market fundamentals, and investor requirements.

This is a turning point for Cromwell to focus on leveraging the exceptional team we have in Australia; to drive value from our local asset and funds management business.
Dr Gary Weiss – Chair, Cromwell Property Group

Office building investment

In Australia, Cromwell manages an investment portfolio of $2.2 billion and funds management platform of $1.5 billion. Central to our business success has been, and will remain, office buildings in large metropolitan centres. We view several segments of the sector as favourable for investment, including Core/Core+ Value Add, Creative Fringe, and ESG Rejuvenation

Core+ / Value Add

The ‘core’ category of office property investments includes a focus on high-quality, stable properties located in prime markets – particularly capital city CBDs. The hallmark of core investments is their ability to generate consistent, long-term income through different cycles and market conditions. These properties form the foundation of Cromwell’s current Australian investment portfolio.

While the office sector continues to face challenges due to global market pressures, there are nuances across and within markets regarding vacancy rates and rental growth outlooks. In Brisbane, for example, the CBD vacancy rate is at the lowest level since 2012, and occupied space has increased since the onset of the pandemic, contributing to higher rents1. Similarly, the majority of Australian CBD buildings remain well-occupied, with real estate investment research company CBRE estimating more than half of all office buildings have vacancy of less than 5%2. This disconnect between sentiment and actual market conditions presents opportunities for investors to acquire quality office assets at attractive prices.

At this point in the cycle, we also see substantial opportunity to generate additional value for investors by leveraging the skills and expertise of our in-house property and project management teams. Delivering carefully considered capital improvements, space fit-outs, and a targeted leasing strategy, can reposition an asset’s proposition and profile for potential occupiers. This process has been successfully repeated by Cromwell across our assets in recent years.

207 Kent Street third space – CoLab at Kent

In early 2025, Cromwell will open our newest third space – CoLab at Kent – at our 207 Kent Street property in Sydney. Construction began mid-year after Australian interdisciplinary design practice Hot Black was engaged to design a space that would meet the diverse needs of our current and future tenants. The new third space will encompass a 365sqm area on Level 6 of the building. Features will include:

  • A refreshment area
  • A kitchen/breakout area
  • A business lounge
  • 25-person training/multi-purpose room
  • A 70-person training/multi-purpose room
  • Quiet and focus areas
  • Furniture/equipment storage space

 

 

Creative Fringe

Fringe markets are adjacent to major CBDs and provide a number of the same agglomeration and accessibility benefits as CBD precincts, while offering proximity to diverse amenity and a unique cultural feel. In particular, non-traditional and difficult-to-replicate office assets within fringe markets, such as converted warehouses or heritage buildings, often strongly appeal to growing technology and creative industries and support the cultural and brand identity of a firm. This is increasingly important as providing an engaging and dynamic workplace and employee experience becomes more of a central focus.

A key advantage of targeted opportunities in the ‘Creative Fringe’ is the ability to better cater to smaller occupiers. These tenants have been exhibiting a stronger propensity for in-office, face-to-face work, and have been growing most strongly over the last five years in terms of both headcount and office space3. This trend is contributing to the performance of fringe markets, which have ranked first, second, and third for net space demand since the onset of the pandemic4. Given their location, they can also be a more affordable option for tenants, reducing the risk of financially induced downsizing and providing a runway for rental growth if demand conditions remain conducive.

 

ESG Rejuvenation

To ensure that Cromwell maintains optimal returns for investors over the longest possible duration – that the assets we manage generate the returns expected – we need to ensure that Environmental, Social, and Governance (ESG) practices are genuinely integrated and brought to life across all the activities we undertake, across all our investments.

Given the current delays in commercial building construction across Australia, refurbishing existing assets to meet ESG requirements has the potential to be a more , time-efficient – and simultaneously the “greener” option – as opposed to constructing new buildings for tenants. Indeed, preserving original buildings as much as possible will be critical to achieving our net zero targets.

We have the opportunity to identify buildings that are lagging in ESG specifications and apply our collective knowledge to implement strategies and initiatives to enhance ESG ratings and performance. Such improvements can expand the pool of potential tenants, increase net income (via higher rents or lower operational expenses), and support a stronger asset valuation.

Cromwell has already made progress in this space over the past two years, including the McKell building electrification project in Sydney; completion of our solar programme installation; and replacement of HVAC facilities at other locations.

By identifying and modifying existing properties to align more effectively with the long-term sustainability goals of our tenants; our investors’ expectations; and changing market demands, we can create assets that provide long-term, ‘future proof’ returns for investors.

Medical offices and community support services

The healthcare and social assistance sector remains an essential and growing industry, accounting for 8% of the Australian economy5 and 16% of employment6. Healthcare property encompasses a range of asset types, from hospitals to medical centres, life science facilities and specialist disability accommodation. While some sub-sectors – such as private hospitals – are facing well publicised issues, we believe medical centres/offices are resilient to these challenges and well placed to benefit from several demand tailwinds. These assets are essential to communities across the country, providing a range of primary and secondary care such as GP, specialist, and allied health services.

Why target for investment

Supply of healthcare services across the country is currently being outpaced by demand, which is being driven by long-term demographic trends, such as population growth, the ageing population, and longer life expectancy. Additionally, lifestyle factors such as poor diets and lack of exercise, coupled with improved detection and diagnostics, are seeing the rate of disease incidence increase on an age-standardised basis. This environment is resulting in health service pressures and longer wait times – necessitating a greater focus on more efficient models of care.

We believe shifting towards primary and preventive care is critical to achieving a more sustainable healthcare system, and that medical centres are an important component in that shift. Providing care in a non-hospital environment, such as a medical centre, can:

  • be cheaper due to lower overheads;
  • reduce the risk of infection and deliver better health outcomes;
  • enhance patient comfort and satisfaction; and
  • improve convenience, due to the proximity to local communities.

The shift from hospital to non-hospital care is already underway, as evidenced by spending and policy prioritisation. Latest available data shows growth in primary healthcare expenditure outpaced growth in spending on hospitals from 2011-12 to 2012-227. Additionally, a number of policies have been announced that put greater emphasis on primary and preventive care, including a $99 million Federal Government initiative to connect frequent hospital users with a GP to reduce the likelihood of hospital re-admission; $79 million to support the use of allied health services for multidisciplinary care in underserviced communities; and $3.5 billion to triple GP bulk billing incentives.

Medical centres are an increasingly important part of the essential and growing healthcare industry, representing efficient and fit-for-purpose facilities that can help alleviate the capacity constraints of hospitals and improve the sustainability of the health system. Tenants are typically stable, long-term occupiers, which have higher rates of lease renewal compared to traditional office space8.

We believe medical centres’ alignment with demand trends and Government healthcare spending priorities, together with attractive investment characteristics, such as CPI-linked income and defensive land holdings, puts them in a favourable position compared to other healthcare property investments.

Large format retail (LFR) property

Large format retail currently accounts for approximately 24% of all retail sales in Australia9– or an estimated $102.3 billion – according to June 2024 data from the industry’s peak body, the Large Format Retail Association. Large format retail now makes up more than 35% of all retail floor space in Australia10.

The sector emerged in the 1970s with the development of stand-alone retail stores that sold homemaker products, including furniture, floor coverings, homewares, or whitegoods – a consumer need that had been previously met by traditional department stores.

Why target for investment?

As an investment, large format retail property can offer a more attractive yield and lower capex requirements compared to other sectors, given the simplicity of the property type’s physical structure and associated infrastructure.

In addition, large format retail has faced competition from industrial uses for new sites, constraining supply and contributing to one of the lowest vacancy rates on record11.

Like healthcare property, increases in demand for large format retail shopping centres are closely linked to strong population growth, particularly within the ‘household formation’ lifestyle stage – the period of time that couples or families are establishing a place to live. By extension, high migrant-driven population growth at present is increasing demand for these resources, as these people find and fit-out their new homes.

Urbanisation and smaller households provide another source of demand. The number of occupied dwellings is growing faster than the overall population12, meaning there is a need for more rooms to be furnished and greater demand for the shopping centres that primarily cater to home-oriented retail categories.

Importantly, the sector has proven to be relatively resilient to online shopping – with consumers preferring to ‘touch and trial’ homewares in easy-to-navigate shopping centres with substantial convenient parking.

 

Small lot industrial property

Industrial property has been the top-performing real estate sector over the past decade13, propelled by strong rental growth as demand for space outpaced development of new supply.

‘Small lot’ industrial refers to industrial assets that are typically smaller than 8,000sqm; support a variety of occupier uses; can be multi-tenanted; and are often located in urban ‘infill’ areas. These assets differ from ‘big box’ assets, which are larger; often logistics-oriented; usually single-tenanted; and situated further from the heart of metropolitan areas, given their size.

Why target for investment?

In 2024, customer demand, scarcity of supply, along with a diverse tenant base, are key drivers for rental growth in this sector. Small lot industrial properties’ proximity to customers is a significant benefit for tenants – occupiers are able to provide customers with products faster, and more flexibly, at the time promised and with lower delivery costs. Being in proximity to customers has the potential to provide stronger rental growth – given that transport is the biggest cost for logistics operators, a location that reduces transport costs is worth paying more in rent for.

The small lot industrial sector caters to an array of industries and uses, from warehousing through to manufacturing. As different industries have different demand drivers and can thrive at different points of the property cycle, having a diverse tenant pool provides leasing optionality.

Often overlooked by institutional capital due to a lack of scale, and by passive private investors due to escalating active management requirements, small lot industrial offers compelling total return opportunities for those with the expertise and capability to identify and improve underappreciated assets.

Convenience retail property

Convenience retail property assets are generally smaller, standalone shopping centres – often anchored by supermarkets – that service the surrounding suburbs by providing convenient access to essential goods and services.

Why target for investment?

Convenience retail centres have consistently been the top-performing centre types over the past 30 years14. These centres have shown to provide resilient, inflation-adjusted cashflow that is less exposed to the cyclicality of discretionary spending – cashflow which is largely underpinned by blue chip, national tenants.

In 2024, convenience retail is an in-demand sector with less long-term uncertainty than discretionary shopping centres. This is partially due to their alignment to long-term shifts in consumer preferences – from goods (big screen TVs, home theatres, etc.) to groceries, services, and experiences. A major driver for these shifting preferences is the cultural and lifestyle changes consumers are making, which has implications for which retail categories can sustain growing rents.

Convenience retail is also less exposed to the competition impacts of e-commerce – people like to pick their own apples, and haircuts are yet to be made available online! While the rise of online shopping may have some impact on incremental space demand, much of the once-off impact has been incorporated into rents and valuations.

 

Conclusion

Cromwell has a strong record in traditional property sectors locally, driven by our exceptional team who deliver enhanced returns through active asset management.

By repositioning and developing assets, an area in which we have consistently excelled, we aim to generate meaningful securityholder value.

We will continue to drive value from assets in Cromwell’s investment portfolio and the assets in our retail funds through active asset management initiatives – this will support asset valuations and unitholder value through the next part of the property cycle.

Footnotes

  1. Cromwell analysis of JLL data (Sep-24)
  2. Source CBRE, Australian CBD Office Occupancy Brief (Sep-23)
  3. Cromwell analysis of JLL (Sep-24) and ABS (Jun-23) data
  4. Cromwell analysis of JLL data (Sep-24)
  5. National Accounts, ABS (Dec-23)
  6. Labour Force, ABS (Feb-24)
  7. Constant prices. Cromwell analysis of AIHW data (last updated October 2023)
  8. Exploring Australian healthcare opportunities, JLL (Jun-22)
  9. Large Format Retail Association
  10. Large Format Retail Association
  11. Cromwell analysis of JLL data (Jun-24)
  12. Cromwell analysis of ABS data
  13. The Property Council of Australia/MSCI All Property Digest, Jun-24
  14. Cromwell analysis of The Property Council of Australia/MSCI All Property Digest, Jun-24