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There’s still plenty of potential for investors in commercial property

Jitters over the outlook for the commercial property sector are overdone, says Max King. Investors should consider this Europe-focused real-estate investment trust.

Amid the sweeping prophecies that life will never be the same post-pandemic, it is refreshing to hear a more cautious view. “I am a slight sceptic of the widespread assumption of ‘a new normal’,” says Mat Oakley, head of pan-European commercial property research at Savills. “We see such forecasts in every crisis; change will happen more slowly.”

“Commercial property is a simple asset class,” he says. “In an expansion, we need more space. Currently, we are in a thumping great recession, but I expect a not-quite V-shaped recovery in which GDP recovers quickly but unemployment doesn’t return to 2019 levels for five years.”

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Property investment, now past the nadir, was 43% below the five-year average in the first half of 2020. But it was 51% down in 2008 and “the recovery will be better this time”. In the office market, vacancy rates are rising, there is downward pressure on rents and development starts are being delayed, but “we are not at the end of the cycle: the medium-term fundamentals remain good”. Less development will reduce vacancy rates and the pressure on rents.

What about the shift to working from home? Oakley points out that home-working is suitable for some tasks (reading documents, focused work and video or phone calls), but “a lot of things work better in an office so offices won’t disappear”. Offices are better suited to team management, meetings and the informal chats or chance encounters that can spark fruitful new ideas and strategies for the company, a key factor in services and creative businesses. Surveys show a marked swing in favour of working from home, but from one day a week or less to two or three days a week – not to full-time.

Retail parks have been more defensive than shopping centres, with weekly footfall down 20% rather than 60%. Retail parks are well suited to “click and collect” services and returns, while they also offer social distancing. In the industrial market, the take-up of logistics space in the first half was the highest for 15 years, but this type of property “is not as safe as it seems”. When vacancy rates rise above 12%, as they did in 2009, rents fall.

The best real-estate bets on the continent

Marcus Phayre-Mudge, manager of TR Property Investment Trust (LSE: TRY), is not ready to buy into the UK yet. Only 28% of his portfolio is invested in listed British shares; another 7% in directly held properties and 64% in continental shares. Of the latter, 45% is in Germany and Austria and nearly all the rest in France, Benelux and Scandinavia. He is cautious about Britain because since December 2015 European property shares have returned 45% in sterling, but British ones -20%.

Within the UK, favoured areas are “beds, meds and sheds”: student accommodation, healthcare property and self-storage, companies that are UK-listed but have their assets in Europe and two specialist real estate investment trusts (Reits), Supermarket Income and Secure Income. Student accommodation and Secure Income, owning hotels and leisure attractions, have been poor performers. Progress on the directly held properties may open the way to asset disposals.

Though the share price is down 32% since February, its European focus means that performance is far ahead of the UK property sector over three and five years. The shares yield over 4%, trade on an attractive 13% discount to net asset value and, with a market value over £1bn, are highly liquid. Phayre-Mudge is positive: demand from tenants, “excluding non-food retail, should prove stable while a lack of supply, due to the absence of a development cycle in 2008-2014 and the current development cycle being deferred, means that there is no surplus of new space to undermine rents… Real estate, particularly where income is long and strong, will be an attractive investment”.

By Max King

Source: Money Week

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London remains top gateway city in the world for commercial property investors

London maintained its position as the top city for global real estate investment in 2018, according to research published today by JLL. The report claims that investors continue to favour cities they are familiar with and that have well-established investment markets and high levels of transparency. Well-known, large gateway cities with the world’s deepest concentrations of capital, companies and talent continue to dominate the top ranks. Twelve cities–London, New York, Paris, Seoul, Hong Kong, Tokyo, Shanghai, Washington DC, Sydney, Singapore, Toronto and Munich–have appeared in the top 30 ranking every year for the past decade and account for 30 percent of all real estate investment.

The data shows that total volumes in 2018 were $733 billion, up 4 percent from 2017, the best annual performance in a decade. Cross-border purchases accounted for 31 percent of activity in 2018, close to the 10-year average, suggesting investors still have appetite to buy outside their own markets.

Expectations for 2019

JLL projects that investment activity momentum will be maintained into 2019, as real estate continues to look attractive in comparison to other asset classes. Fundamentals in real estate remain compelling, despite historic low yields, as robust corporate occupier fundamentals across most markets are leading to positive returns. As such, investment activity may slow, but only marginally from its current high, as investors look to hold their real estate exposure and become more selective in the search for assets with strong income growth.

  • The institutional real estate universe will continue to expand, driven by factors such as low volatility, diversification benefits, long-term income and an attractive pricing premium to core sectors. Asset classes such as student housing, senior living and multi-family have continued to attract more institutional money in 2018 and this is likely to continue in 2019.
  • Industrial now accounts for 17 percent of all investment, up from 10 percent in 2009. In contrast, the retail sector has seen less activity as investors adjust their investment approach to reflect changing consumer behavior. In gateway cities, the office sector tends to account for a higher proportion of investment volumes—68 percent in 2018, compared to 51 percent in global volumes.
  • The top 30 will continue to be dominated by the gateway cities in 2019. However, at the edges, investors will consider a widening range of cities in their strategies. Reflecting real estate investors’ risk appetite, secondary cities in established transparent markets, such as Osaka and Atlanta, are likely to attract more attention, as opposed to moving into entirely new countries.

Yields are now at historic lows in most markets across the globe. A sharp correction is unlikely, as there is still a significant weight of capital looking to invest in real estate, and corporate occupier market fundamentals across many markets are positive. This creates the potential for continued income growth. However, in 2019, overall investment volumes are expected to fall approximately 5 to 10 percent below the 2018 total, driven by a slightly reduced appetite from investors to sell, as well as continued selectivity in acquisitions.

Source: Workplace Insight

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Commercial real estate might be reliably disinteresting now, but don’t get too cosy

At a time of political and market turbulence in the UK, there is one area where we’ve seen relative stability. Commercial real estate data in recent months has been fairly constant, with no significant changes to the outlook.

The returns for commercial real estate have remained disappointing relative to recent years, yet there has been some comfort in the lack of surprises from the sector. It’s been reliably disinteresting.

UK commercial real estate has delivered capital value appreciation of 1.9 per cent this year, for a six-month total return of 4.5 per cent. For the rest of 2018, we see potential for capital values to modestly increase, though rental income will most likely make up the largest share of return delivered to investors.

Looking ahead, we expect slightly weaker performance next year. The Investment Property Forum consensus suggests that capital values will decline 1.4 per cent next year, with London offices down 1.2 per cent.

We consider these forecasts reasonable given the slowing economic backdrop in the UK, wavering demand for UK commercial real estate, and a supply increase. The data, then, looks fairly benign.

Yet there are a number of downside risks which have been bubbling under the surface – and investors would be wise to keep an eye on these.

Factors we’d put on risk watch include the UK interest rate environment, sterling strength, and Brexit negotiations. These macro factors could skew the outlook.

Investors should ask themselves the following questions.

Are UK interest rates back?

Interest rates have always been a key consideration for real estate investors, yet the lack of movement during the past decade has put them at the bottom of the priority list.

Real estate is heavily debt-financed, so the cost of debt is an important factor when considering profitability from the sector.

In August, we saw interest rates rise above 0.75 per cent for the first time in 10 years. While our base case is that we will see no Bank of England rate hikes in the near future, a change in economic fundamentals could cause the Bank of England to hike.

Further interest rate hikes cannot be ruled out altogether, and if sustained, could jeopardise capital values – particularly if rates rise against a weakening rental outlook.

Could sterling’s strength return?

Sterling strength is another key consideration. Brexit negotiations in particular can cause spikes and dips in the currency.

Michel Barnier’s comments that the European Union wants to keep close ties with the UK proved just this. His words triggered market optimism about the potential for a positive Brexit deal and caused the pound to move higher.

The referendum result weakened the pound, which has actually boosted international demand for UK commercial real estate. If the pound strengthens over the longer term, this could curb this demand and pose a risk to the outlook.

International investors accounted for over 70 per cent of purchases in the second quarter of 2018, according to Cushman & Wakefield – so this would be a significant loss.

Will uncertainty persist?

Brexit uncertainty has dragged on longer than most hoped and expected. If this continues, we could see increased relocations for some financial services.

Initial scaremongering of a mass exodus from the UK is likely unfounded, but continued uncertainty or a hard Brexit could change the picture.

Brexit uncertainty is also dragging on UK GDP. If it markedly lowers the outlook, total returns from UK commercial real estate are likely to suffer.

While we’re not as doom and gloom in our outlook on Brexit as many, it should be factored into investment considerations at the current juncture.

These risks are present but should not deter investment altogether.

Looking ahead, it is likely that rental income will offer the most potential in returns for investors in commercial real estate.

Since the previous capital peak for the sector, prior to the 2007 financial crash, commercial has delivered an average annual total return of nine per cent for investors. This can be crudely broken down into the return derived from the rental income and the growth in capital value of the property itself.

In our view, capital growth is unlikely to contribute markedly to the total return for investors in commercial real estate in the foreseeable future. It is the rental income which investors should focus on.

For investors in the current environment, then, it would be prudent to focus on quality assets and sound leases when investing in the sector.

Commercial real estate continues to offer some opportunity for long-term investors, yet downside risks must be noted.

Data may have led to many yawns in recent months, but we should not take the constants for granted. Keeping an eye on risks will help avoid any nasty surprises.

Source: City A.M.

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Commercial property investors warned of bombshell

The government must reform the British business rates system or risk “killing” a huge part of the UK commercial property market, according to a fund manager who runs over £2bn of commercial property assets.

Marcus Phayre-Mudge runs the £1.5bn TR Property investment trust for BMO, a trust which has 9 per cent of its capital deployed in physical buildings, none of which are in the UK.

The remainder of the capital is deployed in property shares, where the only UK exposure he has is to niche property businesses in areas such as student property and warehouses.

He said the dynamics driving property in the very centre of London have changed since the financial crisis, with banks now more reluctant to lend for large developments.

Mr Phayre-Mudge said bank loans have largely been replaced by capital from private equity and sovereign wealth funds, making prime London property less vulnerable to higher interest rates.

But he remains concerned about valuations, and what he said will be the significant impact of changes to business rates on commercial property.

He said: “The dynamics have changed since the financial crisis, with banks now much less likely to lend for large developments. This means UK commercial property is less sensitive to interest rates.”

The area of the market he believes will be “killed” by the changes to business rates is property let out to retailers.

He said the challenges faced by those companies from the rise of internet shopping has been made worse by the government’s changes to the business rates rules.

Business rates are levied based on the rateable value of a property. The rate varies depending on location in the country. A business with a property that is assessed as having a rateable value of above £51,000. If a property is given this value, then the rates bill faced by the business is £51,000 multiplied by 49.3p. For businesses with property at a rateable value of below £51,000 the value of the property is multiplied by 48p.

The government carried out an assessment of the value of properties in 2015, and decreased, or increased the rates owed accordingly.

The higher rates took effect from April 2017, two years after the valuations were made.

Mr Phayre-Mudge said online retailers such as Amazon have been advantaged by the change, as they require less real estate in cheaper out of town areas to do their business.

This means such companies have much lower costs than the bricks and mortar retailers who rent buildings from property companies.

It is the latter companies that are widely held in property funds bought by private investors and their advisers.

He said if the government do not act on the issue then vast amounts of retail property will lie empty, hurting the returns of property funds.

Robin Geffen, fund manager and chief executive at asset manager Neptune, said structural forces in addition to technological change means UK  commercial property is a poor investment.

Greater scrutiny of UK overseas territories that act as tax havens will also damage the returns available to investors in UK property, he said.

Mr Geffen added: “There is about £122bn of UK property assets owned by entities in these tax havens.

“That is a lot of money for one asset class, wherever that money has come from and whether it is hot money or not I think the greater level of scrutiny could lead to issues for that asset class.

“UK property has been a poor performer lately for other reasons, and I expect this is only the start of it. It is certainly not a risk I would want my 86-year-old mother exposed to.”

Mr Geffen added: “If you go to the top of a really tall building in London at night, look at all of the cranes. There is still a lot of building happening.

“But if you walk down somewhere like the Embankment in London at night, then look at all of the newly built flats, at how few of them have lights on.

“These companies can build the property at very low cost because interest rates are low, and then just hold them on their balance sheets, but they can’t do that forever.”

He said a contact of his who has been a professional investor in UK property for decades has the largest cash weighting he has ever had as a property investor, higher even than in previous financial crises.

Paul Stocks, financial services director at Dobson and Hodge in in Doncaster, said he has been much less keen to place client money in property funds since the global financial crisis.

A spokesman for HM Treasury said thousands of UK businesses don’t pay rates at all, and that the reforms they have implemented show they have listened to business.

Source: FT Adviser

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Buy-to-let crackdown starts to bite

Buy-to-let has historically been a popular route for would-be property investors. But, new data from UK Finance shows that the number of new buy-to-Let purchase mortgages in January 2018 fell more than 5 per cent compared to the same month a year earlier.

In recent years, the government has introduced a raft of changes to the taxation of UK residential property, which has led many investors to rethink their options.

On top of increased stamp duty on the purchase of additional properties, measures to phase out higher rate tax relief on mortgage interest have been gradually introduced. Tougher affordability checks on borrowers are also proving to be a barrier for many aspiring buy-to-Let investors.

We’ve seen first-hand how the crackdown, for many, has made the buy-to-let route simply uneconomic. When combined with the reality of owning investment property, including regular maintenance and securing tenants, it’s no surprise that landlords are beginning to think twice about the merits of Buy-To-Let. In fact, it can sometimes feel like managing a residential property is more like running a business, rather than making a simple investment.

Whilst this route is becoming less attractive, investing in property remains a popular aspiration.

Returns from bricks and mortar continue to outstrip the performance of the stock market and alternative means of generating income, with a long run average total return of 9.5 per cent per year from 1997 to 2017. Over the same period, the FTSE all share index delivered a total return of 6.3 per cent per year.

For many investors, it goes without saying that property should form at least part of a diversified investment portfolio.

Alternatives to buy-to-let investing

So how can investors access returns from property with the buy-to-let route falling out of favour?

Investors have previously turned to property funds. However, these vehicles are notorious for being illiquid and often opaque. Many investors will wince at the memory of the weeks that followed the EU referendum, when several UK commercial funds were forced to halt withdrawals.

Property crowdfunding has emerged as one alternative that has the potential to replace the buy-to-let investment route.

Property crowdfunding refers to the process of buying shares in individual properties alongside other investors. Investors target returns from both monthly rental income and through the increase in the value of the property. So, investors receive a regular income from tenants and hope to achieve long term capital growth on the basis that property prices have always tended to increase over time.

Another obvious benefit of property crowdfunding is that investors are able to easily diversify their holdings. For example, you can own shares in properties at opposite ends of the country without requiring the cash to purchase multiple properties outright. This gives investors access to multiple regional property markets and the ability to better protect themselves against price volatility in local markets.

Property stock exchange

Similarly, platforms such as ours now allow individual investors to diversify across sectors. Once the preserve of property funds, REITs and other professional investors, individual investors can now invest in blocks of purpose-built student accommodation (PBSA) or commercial properties at the click of a button.

Unlike property funds, property crowdfunding offers a more liquid way of entering the market.

Property Partner allows you to offer your investment for sale whenever you want through the secondary market, which functions as a property stock exchange.

Of course, investors should carry out the necessary due diligence before buying shares in a property. As with any investment, the value of your holdings and any income can fall as well as rise. With property crowdfunding you are exposed to movements in the property market. So, whilst there’s the potential to enjoy returns from any increase in the capital value of a property, there is also a risk the property could fall in value. This risk is partially mitigated through the monthly rental income received from tenants. Diversifying into a range of different properties across sectors and regions can also minimise this risk.

Where the modern buy-to-let ‘landlord’ once had to review reams of surveyor and legal reports it’s now possible to invest across a range of high quality properties across the UK.

For example, rather than committing a significant sum to acquire a one-bedroom flat in a corner of London, it’s now possible to split the same deposit across twenty properties, from Bangor to Brent Cross. Up until recently, owning a diversified portfolio of investment properties that spanned the UK would have required thousands of pounds in deposits. New technology means that it is now easier than ever before.

With the government’s crackdown on buy-to-let putting many investors off, equity crowdfunding continues to grow in popularity as an alternative way to access the property market.

Mark Weedon is head of research at Property Partner.

Source: Money Observer

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Commercial Property Investors become increasingly Selective in 2018

After a strong year for UK commercial property in 2017, it looks like things may start to change in 2018. Although not as dramatic as the stock market pullback in January, the February auctions were certainly not plain sailing.

Whilst quality investments continued to sell like hotcakes, the less exciting lots left much to be desired. The success rates of the leading national auctioneers were below 2017 norms (when 100% sales rate were not uncommon): Allsop (80%), Acuitus (ca. 75%) and Barnett Ross (ca. 85%).

Jesal Patel, Director at The Prideview Group, comments “There is still a hell of a lot of cash sitting on the sidelines, ripe for investment. But in the context of rising inflation and interest rates, that cash wants either solid long-dated income or genuine value-add opportunities i.e. investments that permit the investor to ride through the uncertainty ahead.”

The below blue-chip investments which The Prideview Group either bought or sold in February’s auctions are representative of the pricing for quality investments in the current market. If you are looking to invest in auction or privately in 2018, they have a number of opportunities available now. These include;

Lot 67 – McDonald’s, Leicester

Lot 67 – McDonald’s, LeicesterDescription: Freehold city centre restaurant investment

Tenancy: Let to McDonald’s Restaurants Ltd until 2036 (no breaks) for £109,000 FR&I

Location: Good location in pedestrianised town centre

Guide Price: £2m+ (5.5%)

Result: Sold Prior (ca. 4%)

Prideview Group’s comment: “A ‘trophy’ asset like this, let to the likes of McDonald’s for almost 20 years, is like a diamond in the rough. So it was our pleasure to be acting for the sellers on its disposal via auction, after having helped them negotiate a lease extension with McDonald’s. Interest was strong pre-auction but it needed to be a knock-out bid to prevent it from going to the room, and that bid did eventually come from a local entrepreneur.”

Lot 35 – Tesco Express & 2 Restaurants, Ickenham, Greater London

Lot 35 – Tesco Express & 2 Restaurants, Ickenham, Greater London

Description:Freehold convenience store, restaurant & residential ground rent investment

Tenancy:Convenience store let to Tesco until 2023, Restaurants for a further 10 years, total rent £89,365 p.a. FR&I

Location: On a busy commercial parade in an affluent north-west London suburb

Reserve Below: £1,250,000+ (7.1%)

Result: £1,405,000 (6.4%)

Prideview Group’s comment: “This investment caught our eye due to its attractively priced guide as well as its location in a part of London in which we are extremely active. With 2 more units let to independent tenants, it’s a nicely diversified lot. We successfully acquired it on behalf of a client who would not have bought at auction otherwise, within our pre-agreed limit.”

Lot 101 – Papa John’s, Newport

Lot 101 – Papa John’s, Newport

Description:Freehold takeaway & residential ground rent investment

Tenancy: Takeaway let to Papa John’s for 15 years from 10/02/2017 (TBO 10th year) for £12,000 p.a. and Flats sold off on long leases for £100 p.a. FR&I

Location: Arterial road in a residential suburb 1 mile from the city centre

Guide Price: £155k + (7.8%)

Result: £168k (7.2%)

Prideview Group’s comment: “It’s very hard to find a blue-chip investment with 9 years’ income under £200k, and when we booked this for sale in auction we expected it to fly. However buyers looking at this price point are typically novice, and could have been put off by either VAT (typically VAT properties do not appeal to those buying in their own names) or the legals (there were some outstanding certifications required for the newly built flats above). Whilst in the context of the wider market this looks (and is) a great buy, it’s always important to analyse each property on its merits.”

Source: Property Forum