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Fund-through office deals - An effective approach to support flight to quality

Fund-through sale structures are a practical and effective way for new developments to take place with long-term investors accessing product ahead of the completion through structured acquisitions. This type of structure can benefit both developers and investors, by providing security of capital to a developer, while giving the investor access to high-quality brand-new product, generally offering secure and long WALEs. 

In a fund-through deal, the capital partner provides construction finance to a developer for the construction of a building in exchange for the transfer of the land, a development agreement for the delivery of the completed building and a regular coupon payment on all monies drawn-down throughout construction including the land purchase price. The developer bears the delivery risk, with mitigation measures in place for the investor. 

Important considerations that provide enhanced returns for incoming investors is the ability to increase depreciation costs through the acquisition of new product and associated plant and equipment; together with the significant stamp duty savings by acquiring the development based on the current land value prior to development.

Another critical component to most fund-through transactions is the pre-commitment and the strength of the tenant covenant. Over the past four years, fund-through deals have been supported by an average pre-commitment rate of nearly 50%, reducing the inherent risk for the capital partner. Given the development time frames, the majority of the pre-committed space is usually agreed with large corporate tenants operating in finance, insurance, energy, and resources sectors, or to government agencies. The typical strength of the tenant covenant constitutes an attractive investment proposition for the capital partner.

We have seen strong fund-through activity in the Australian office market over the past four years. Colliers have estimated that fund-through deals have facilitated A$6.8 billion of office sales in Australia since 2017, supporting the construction of nearly 20 new office buildings and adding circa 564,000 sqm of prime grade office space. Domestic developers and institutions were the most engaged vendors in fund-through deals negotiating institutional capital for a total of A$4.3 billion, equivalent to 63% fund-through transactions since 2017. 

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In 2017, over A$2.5 billion of fund-through office sales were completed. This included the Brookfield Place development in Sydney with 50% sold down to capital funding from UniSuper and AMP (AWOF). This Sydney-based project is reshaping the Wynyard station rail precinct with the development of a mixed-use community under the Brookfield Place brand. It was supported by a 45% pre-commitment at the time. Brookfield Place Sydney is expected to reach practical completion over the second half of 2021, adding circa 75,000 sqm of premium office space. The development is attracting high-quality commercial tenants and has now a pre-lease rate of over 90%. 

2019 was also a strong year, with nearly A$1.8 billion of fund-through deals negotiated across the Australian office market. This included the acquisition of 50% of the stake in the Chevron development in Perth by Invesco for A$400 million. This deal allowed the developer Brookfield, a de-risked development position by divesting the end product ahead of the project commencing. The deal was supported by a 78% pre-commitment from Chevron for a period of 15 years.

In 2020, despite the challenges triggered by the pandemic, we have estimated that new fund-through developments reached over A$1 billion, with projects in Adelaide, Melbourne and Brisbane. In Adelaide CBD, the South Australia Government Emergency Services Command Centre in Keswick and the South Australia Bragg Centre Building are expected to be completed by 2021 and 2023 respectively. They will add circa 38,500 sqm of A grade net lettable area, or the equivalent of circa 5.7% of the current prime grade stock in the Adelaide CBD and metropolitan office market. This is an example of how forward funding structured deals can result in the regeneration of the office market.

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Most current developments funded via fund-through deals have an estimated completion date between 2020 to 2023. Circa 190,000 sqm in Sydney and Melbourne reached practical completion in 2020, including the completion of Olderfleet, 477 Collins Street in Melbourne and the Glasshouse building located in Waterloo Road in Macquarie Park. From 2021 to 2023, circa 350,000 sqm of new office supply partially funded via fund-through arrangements is expected to be added to the Australian office market.

Fund-through sale structures will continue to play a decisive role in supporting the renewal and expansion of Australian cities. Occupiers are expected to continue favouring high-quality office accommodation and the flight-to-quality trend will shape the performance of the Australian office market. Buildings that will provide spacious layouts and the latest in hygiene and wellness facilities will be in high demand. New office developments will play an important role in meeting these requirements and forward-funding investments are an effective way to support the development of a new standard of office buildings.