28 November 2015, Financial Times
When times get tough, commercial property provides the perfect backdrop. Abandoned office blocks, half-finished developments surrounded by barbed wire and cranes standing idly on the skyline: in an economic downturn, real estate is one of the first sectors to suffer.
With this in mind, most investors approach commercial property with caution. Memories of the crash of 2008-09, in which many office developments ground to a halt, are still strong. So for those investors keen not to get caught out again, what are the best ways to tap into the opportunities in the sector without taking on too many of its risks?
Commercial property encompasses retail, industrial estates and office blocks. “[It] can refer to anything from the acquisition of a local Domino’s franchise to negotiating with the Barclay brothers to acquire their prized Ritz hotel on London’s Piccadilly,” says Edward Minter, a development consultant at Black Brick, an independent property buying agency.
And while the majority of investors are unlikely to be taking tea at the Ritz — let alone buying the hotel — Mr Minter’s point is a good one. Properties — or lots, as they are known — bought in the commercial sector tend to be much larger than purchases in the residential market. Norway’s sovereign wealth fund, for example, recently snapped up a 150-year lease on 25 per cent of Regent Street, one of London’s main shopping centres.
“It is likely that you will need to spend around £10m-plus to get good quality assets,” Mr Minter says.
Money is flowing into the sector. Investors pumped more than £60bn into the commercial property markets in 2014, figures from Legal & General Property reveal, up from £52bn the previous year — and almost twice as much as was raised in 2012. According to LGP, at £47bn, investments so far this year are set to surpass last year’s performance.
“We are on track to have another really strong year in the commercial property market,” says Chris Ireland, UK chairman of property agents JLL.
With the barrier to entry set so high — unsolicited bids received for the Ritz in 2012 valued the property at £625m — the most well-trodden route to commercial property is through one of the range of funds available or by investing in a listed real estate investment trust or Reit.
Investors buy shares in a Reit, which delivers any additional rental income to shareholders within a tax-efficient structure.
The range on offer also reflects that of the property market as a whole. British Land and Land Securities are more exposed to London offices, Hammerson and InTu are huge retail landlords while Segro is a specialist industrial property play.
Investing alongside others in a listed fund immediately cuts any liquidity issues — whether you will actually be able to sell the building itself — as you are buying units, rather than the asset itself.
For wealthier investors, various syndicates — usually groups of up to 20 people — offer the chance to invest more directly. However, in this instance, you are buying the building itself, and if you want to sell up, you will need to find someone else (usually another syndicate member) to buy your share. Often the investment is geared, that money is borrowed against it to enhance returns, but with opportunity for greater rewards comes bigger risk.
Ireland’s property sector collapsed because speculators had borrowed money from domestic banks. And when the credit crunch came in 2008-09, investors were hit not only by falling property prices but also by failing banks.
More suited to experienced investors, these syndicates typically start with a lower investment limit of between £50,000-£100,000.
Exchange traded funds, which mimic the actions of an index or market, are another way to invest. “Investing through ETFs allows investors to gain exposure to the characteristics of physical real estate while preserving the liquidity and ease of access of a Reit,” explains Manuela Sperandeo, head of iShares Emea specialist sales at BlackRock.
“ETFs, with their ability to be bought and sold in small denominations throughout the day on exchange, give instant access to an asset class that is otherwise considered to be illiquid and with high barriers to entry.”
First, and probably more important than the returns on offer, is the diversification factor. Property offers a means of making money beyond equities and bonds.
In terms of returns, there are three main drivers: income from the rent that is paid; income growth as the rents increase; and capital value or the actual worth of the building itself, which will hopefully grow over time.
Levels of income vary by sector. Rental growth in central London, for example, has been running at an annualised 5.4 per cent over the past five years, according to LGP. This was 9 per cent over the past three years, indicating the recent strength of the market.
Retail is struggling, hit by a double whammy of the recent economic slowdown and the more structural problem of how to respond to the rise of online shopping.
Not any more. The London market is still booming, but undergoing what the fund managers call “yield compression”. Put more simply, there is less value in central London properties: they are too expensive and while rental growth is still strong, it is growing at a faster rate in the second-tier cities of Manchester, Birmingham and Leeds.
“There is very little supply of new office space for tenants to take,” explains Robert Stassen, Europe director of capital markets research at JLL. “That does mean that over the last six to 12 months, you have seen real rental growth not only in London.”
One factor is that the credit crunch prompted building work in the UK to come to a halt, leaving a two-three-year gap in the supply of new office blocks and, later, rocketing rents and property prices. “Mayfair is now the most expensive place on earth to have an office,” says Eugene O’Sullivan, managing director of Morgan Pryce, the office search company.
Property is a notoriously cyclical investment. Prices, not just in such sought-after locations, have gone through the roof. “It feels like we’re at the frothy top of the market,” says Mr O’Sullivan.
The end of quantitative easing and the potential for a rise in interest rates are both likely to hit the commercial market. Many consultants said their clients were sitting on cash at the moment, wary of investing in London in particular.
After “a good run” over the past three years, it is hard to find value, says Tim Sankey, manager of the £3.6bn Aberdeen Property fund. His fund is taking demographics as its cue, looking more carefully at student accommodation, elderly care homes, hospitals and the residential market. “We’re having to go around the fringes to find value,” he says.
Mr Sankey is not alone. David Skinner, global head of strategy and portfolio management at Aviva Investors, also warns about central London’s reliance on overseas’ investors. “We have seen lots of investment from China, Malaysia, South Korea and Japan,” he says. And while this remains strong, any weakening in the global economy could see the market quickly collapse.
Ultimately, property — and particularly commercial real estate — should be seen as a diversification play. As such, advisers warn that investing in a Reit, as it is an investment trust, will leave you exposed to the equity markets.
Yet yields in London, in particular, have been compressed and the gap in the supply pipeline of new developments caused by the industry shutdown in 2008-09 has largely been filled. The capital has become too expensive, but opportunities abound in the second-tier cities in the regions. And despite many sounding a note of caution, there are others who remain optimistic.
“We don’t think we’re near the end of the cycle,” says JLL’s Mr Ireland. “This cycle has got further to run.”
Black Brick is a leading, independent buying agency, providing expert advice to buyers in London, the Home Counties and the South East. As Buying Agents, we only ever act for the buyer, giving you an unfair advantage and putting you ahead of the competition when it comes to securing the right property.
We would be delighted to hear from you to discuss your own property requirements. For a non-obligatory consultation, please contact us:
+44 (0) 20 3141 9861