October 2012

REAL ESTATE: The rise of destination shopping

ShopperDespite the recession, some UK and European retail centres have become sought-after investments. Nick Fitzpatrick finds out more. Unless you are around 15 years old and it’s a Saturday afternoon, you are not likely to find shopping centres pleasant. The only other person that might is an investor looking for income streams from real estate. Certain shopping centres in the UK and Europe have become sought-after assets as property investors continue to adjust their portfolios to the climate of low growth and yield scarcity. Yet it might seem strange that some are finding support from properties that are ultimately dependent on consumption at a time when consumers are supposed to be more bothered about saving than spending. Driving trend
Despite the recession, increased unemployment and consumer uncertainty, certain shopping centres have been resilient throughout the downturn, according to Anne Breen, head of real estate research and strategy at Standard Life Investments (SLI). “We prefer large dominant shopping centres generally [in the retail property sector] across most markets,” she says. What is driving the trend on the shopper’s side is ‘destination’ shopping, whereby consumers want lots of shopping variety in a comfortable, aesthetically pleasing environment with a good selection of leisure facilities, she says. Also, Breen expects prime shopping centres to benefit from the growing trend for click and collect shopping, whereby certain retail centres act as collection points for internet purchases and consequently receive an additional boost from impulse buying on collection. The retail theme is in contrast to another investment driver that seems so much more in tune with the current economic climate – that of distressed property investing, where opportunities spring from owners struggling with commercial tenants who cannot pay rents, or owners are saddled with some other problem that forces a sale or restructure (see box). But outside the prime shopping locations, that picture of distress starts to reveal itself a little bit more. In the UK, good quality shopping centres like Bluewater and Brent Cross – which are both in close proximity to London although they are historically low yielding – recorded total returns of 5.4% in the twelve months to the end of June 2012, according to IPD, a performance analysis firm. This contrasts sharply with high-yielding secondary centres, which are less well located and outside the relatively more affluent south-east of England. This type of shopping centre recorded total returns of -8% over the same period. Breen expects the divergence between the types of locations to continue. Beyond the drivers of click and collect shopping, the major underpin for the retail story from the investor’s point of view is income. At a time of low growth in asset prices (except for the occasional jolt from quantitative easing) income is expected by real estate investors like Standard Life to be the driver of property returns in the UK and Europe in the next few years. Focus
Simon Mallinson, senior director, European research at Invesco Real Estate, says: “A number of clients have gone from focusing on total returns to being income-focused. They want income returns that are found from good buildings with good tenants, and they are prepared to pay a premium to get that income.” The shift to the focus on income reflects a lack of faith in rising property prices. Mallinson says real estate prices in Europe are generally expensive at present. Property is not immune from the focus on income. The search for income has characterised thinking around other asset classes. Dividend-producing shares have been popular, along with corporate bonds in recent years as expectations for growth in capital values, at least in Europe, diminished. Volatility
Some real estate investors say the income offered from properties in the UK may prove to be a suitable replacement for income from UK bonds. “With cash returns and bond yields being so low, some pension funds want alternatives to these assets. A number of them will look at real estate, though they want to take as little risk as possible,” says John Danes, head of property research at Aberdeen Asset Management. “Index-linked government bonds have a negative yield, but from a supermarket you can get 4.5%.” Mallinson says: “A building on a five-year lease is better than a five-year bond,” though he adds that capital from a bond is returned at maturity and real estate is also more volatile. Breen, at SLI, says: “In the absence of strong tenant demand but historically low supply, we anticipate UK real estate will deliver real returns of between 4% and 5% over the next five years given consensus forecasts of CPI  [consumer price index] averaging approximately 2.5% over the same period. Hence, it would be our view that real estate is a suitable replacement for index-linked gilts.” The key to investing in property for income is a mix of long leases and tenant strength. Phil Ellis, client portfolio director for real estate at Aviva Investors, says traditionally properties had shorter leases, which carry more tenant risk. But as investors are not expecting strong capital performance in the UK and Europe and rely more on rental income for their returns, Ellis says, they want “secure income, strong covenants, tenancy strength and long-term contracts”. It is not only the prime retail sector that offers this, of course. Investors are looking beyond shopping centres, too. Invesco, for example, has done two deals in Sweden focused on logistics warehouses that also offered a mix of longer leases and strong tenants, says Mallinson. Aviva has invested in Australian properties in the logistics sector, and Tokyo offices. And capital values beyond the UK and Europe may also offer growth opportunities. Breen says the next twelve months could see strong growth in capital values in the US and she expects reasonable growth in Asia over five years. Due diligence
But for Europe and the UK, where income is expected to provide the majority of returns, due diligence factors such as covenant and tenancy strengths are major guides for re-orientating portfolios. Consequently, the much-derided out-of-town shopping centres are now much loved. “The likelihood of a strong supermarket chain going bust is minimal,” says Danes. Things may change again when capital values start to move. But when might that be? Breen says a modest degree of capital appreciation in Europe could be seen towards the end of her forecast period, while some increase in capital values could be seen in the UK three years from now as the economy improves. And once that starts to happen, it might be time to go shopping again, only for a different sort of property. ©2012 funds europe

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