We want to go slightly off piste in this quarter’s QIR and ask, what lessons have we learnt regarding property investment over the years and how is this reflected in our current strategy? We will also canter through the global economy in our usual manner.
Economy and Strategy
With almost 10 years of continuous global expansion behind us, the casual observer would be hopeful that the result would be significant improvement in the lives of many global citizens, but this has not happened. The hastily engineered Quantitative Easing rescue package, set up by Gordon Brown and immediately repeated globally, would appear to have merely resulted in the continuation of the status quo. Global wealth remains firmly in the hands of the global wealthy. Many folk have sought to point the finger regarding these actions asking whether there was another way? We surmise that the fear of the unknown persuaded advisers and politicians alike, to simply follow the strategy of kicking the can down the road. There was a hope that robust economic growth would enable debts to be paid as they fell due however, it would appear that debts have simply been left in place for the next generation.
Our view is that bond yields may continue to rise over the next few years but, we should note that there are others who believe that the recent rise in the US 10 year treasury rate to c3.00%, is just a little blip on a continued lower trajectory.
Learning about property investment
When we began our fund management careers some 28 years ago, property investment management was very much in its infancy. At that time, each investor would simply work out their capital performance over the year and then add the rent collected, to give a total return. Generally, an annual calculation of returns was considered sufficient. The advent of the Investment Property Databank, now absorbed into MSCI, changed all of that and soon, property investors were demanding the same sort of analytics that they were receiving from their equity managers. Rather than one figure, once a year, with a ‘benchmark’ being provided some six months after the year end, investors were now demanding and able to get, a robust benchmark within a month of the year end, together with useful data on how their fund compared to their peers.
Within a short period, investors were balancing their portfolios between the major property sectors (retail, offices and industrial) and taking strategic bets regarding a retail weighting relative to a sector benchmark. In attempts to improve returns over benchmarks, investors took on development risk, including the buying of short let assets, and pushed along with the tail wind of cyclical rental growth, both helped to improve returns.
It is worthwhile looking at a few “old timer property investment rules” and examine whether they hold true today?
One former colleague once insisted that the best way to determine prime retail was by drawing a straight line from the mid-point of Boots the Chemist to the mid-point of Marks and Spencer. The centre of that line would be close to where ‘prime’ was considered to be on a high street. By buying shops in this micro location, maximum pedestrian footfall could be captured, with a resulting rise in rents. That was the theory. However, when a new retail scheme opened round the corner, this prime zone could move dramatically. Further, no account was taken of any change in covenant risk to such major retailers. Neither was any consideration given to the effect of alternative forms of consumerism such as online shopping, as the internet hadn’t been invented.
There are many examples to draw on, but here is an example of the Boots/Marks rule not working in Glasgow.
Sauchiehall Street is one of Glasgow’s best known streets and formed part of the famous retail Z linking with Buchanan Street and Argyle Street. Here however, Boots and Marks are side by side. Applying a red line to determine prime also fails to consider the impact on this portion of Sauchiehall Street of the development of Buchanan Galleries, a few hundred yards along the road. Incidentally, another large Boots store exists within the Galleries, further undermining the position of the original Boots store as prime.
This example crudely demonstrates that retail investment cannot be prescriptive. It requires sound local knowledge, along with managerial flexibility to adjust to an ever changing retail environment. We like to think that our experience in the market and our network of local experts, demonstrates that we have both bases covered.
In the late 1980’s, following the rise in use of the car, many postulated the use out of town offices and business parks. Many parks were built and they appealed to car driving senior managers who lived in leafy villages 20 minutes drive away. Sadly, many were not situated with public transport in mind. There was also the abundance of surrounding fields which could be concreted over and used to create more offices. In short, demand was constrained and supply was not. As a result, rents have shown sluggish growth. The lesson here is that offices work best in City environments, maximising worker availability through good public transport links. Cities also provide other broader benefits to workers such as retail and leisure uses in which office workers can indulge.
Generally, we regard the industrial sector as referring to large distribution sheds. After all, UK plc doesn’t really manufacture much and despite some recent positive news from Vauxhall, we don’t see that changing, irrespective of the impact of Brexit. Sheds are used to distribute goods throughout the UK. An ideal shed location is a four-way motorway junction. Typically, a good shed will be a building with 8m eaves height within a modern steel portal frame, have a concrete floor with dock-level access for trucks and up to 10% office area. Sheds have been attractive to investors because of their high yield, but this yield advantage is gradually being whittled away. With the massive change in how we shop still very much underway, it will be interesting to see what role the shed plays. There is a trend to much larger sheds with computerised and robotised interiors to cater for the instant delivery which we now crave. There is also a feeling that smaller, more local sheds, may hold a solution but our view is that the larger, automated sheds provide a more efficient distribution solution.
The scope of development is changing too. Now developers are thinking much BIGGER, witness Westfield in London. Westfield White City is now Europe’s largest mall at 1.65million sq ft. This flies in the face of difficulties across the pond where, in the USA, ghost malls are becoming more prevalent. Historically, there was a view that America was some 10 to 15 years ahead of the UK, however, in retail, it can be argued that there are subtle differences. The lack of space in the UK and density of London, probably makes Westfield safe. For large regional malls such as Metro Centre, Newcastle it may well be the case that unless they are able to adapt and change, then their time may well have come.
Development, of an appropriate size, may work on infrastructural projects such as the Crossrail nodes, where good public infrastructure brings people together. Large sheds, mentioned above, may also work but are too risky for anyone other the largest and specialist funds.
So what next for property investment?
At the end of the day, we believe that property investment should be about collecting rents. What we want are properties where tenants are happy and will be there for the sustainable future. We can’t predict what will happen to locations in the future, but do know that some changes may take time to materialise and probably even more money resolve. The time lag should give us a ‘heads up’ to devise suitable strategic and financial solutions. Some types of property do feel safer than others, and at present convenience grocery stores are in favour and we support this view but with several caveats. Where there is room for more stores to be opened or developed then the local monopoly of a store may be diminished, resulting in lost value. We would therefore caution where there is more than one store in a town or suburb.
Given the above, we stick to our view of finding a “natural home” for investments. A natural home will be a location where a tenant needs or wants to be located, or competition will want the opportunity of the location should the existing tenant vacate. A natural home may include a shed on a motorway intersection, an established convenience store with little opportunity for competition, or a newly built government building which will be required for many years to come. All of these feature in properties within our portfolio.
Offices will change with time. A few years back, with the advent of home working, some were suggesting that it would not be long before we would all be homesteaders, working remotely from our “but and ben” on the Isle of Skye, embracing the digital age while maintaining contact by skyping each other. That never happened, but things are changing. Broadband speeds are improving and connectivity issues are getting much better and the whole concept is gaining some momentum again. As property investors, can we really be advocating such a development? In a stressful world, maybe it’s not such a bad idea.