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Magazine Issues » August 2009

PROPERTY: Shop shopping

A recession surely isn't a good time for property investors to invest in shops. But some of them are. Nick Fitzpatrick visits the property market in the UK and Europe...

shops.jpg Commercial property buyers are coming out of the woodwork, albeit slowly. The UK market, which is seen as a trendsetter for Europe, returned -36.7% in each of the last two years to the end of June. This is a worse return than even FTSE All-Share equities could muster at -30.8%, while bonds returned a positive 26.3% each year.

Yet an unnamed pension scheme recently bought a £91.19m (€106.39) shopping centre just outside of Newcastle. LaSalle Investment Management advised on the purchase and the firm also announced it had bought three other retail units for pension funds, including two units in Exeter.

Property returns are closely linked to economic cycles. In the retail sector, British shoppers gave sales a slight boost as they hunted for summer clothing recently, but otherwise retailers have been hit by the recession. In the last few months some major retailers have collapsed, such as Woolworths and MFI.

Therefore investors that are prepared to buy property, whether retail units or factories, want occupants with strong credit strength. In the same way that investors in derivatives markets worry about the stability of counterparties, confidence in the ability of occupiers to pay rent is similarly important to property investors. Tenants with at least a BBB credit risk might be a benchmark.

The two tenants at La Salle’s Exeter units, Burtons and Evans, are owned by Arcadia, the UK’s largest privately owned clothing retailer.

The two units were bought for £5.8m and they currently produce rent of £395,000 per annum, reflecting a net initial yield of 6.4%. 

But well-known tenants or not, the purchase of retail units by La Salle in a recession could serve as a sign of increased business confidence, which is much needed for commercial property as a whole to turn a corner.

Kevin McGrath, managing director of F&C Asset Management’s real estate investment trust, argues that the retail property sector does contain unrecognised value. F&C recently sold seven retail units in the UK producing yields ranging from 4.75% to 6.5%.

McGrath says: “We have had a fantastic response and on some of these properties, Harrogate in particular, we received a yield that is approaching 2007 peak levels.

“These sales have proved that the market for retail investment is much stronger than the market, the banks and the valuers currently perceive it to be.”

On the face of it commercial property, including offices and factories, is still in the doldrums. At the end of June UK property capital values had fallen -44.1% since their peak in mid-2007, while the twelve-month capital value decline stood at -30.8%, according to the Investment Property Databank (IPD).

Also in June, the British market accomplished 24 months straight of monthly declines in capital values – although at -0.9% it was the shallowest fall since August 2007.

Timing it right
But just like in securities markets, property investors are now looking for the market to bottom out. And they appear to sense that it’s near.

Martin McGuire, at Axa Real Estate Investment Managers in the UK, says: “We are seeing a bit more activity in the market now. Transaction volume has picked up and we are probably coming towards the bottom of the trough in the cycle.”

McGuire also says that markets in continental Europe are catching up with the UK, but there are probably further valuation falls to come in many European countries.

Germany’s Union Investments says confidence in UK commercial property is picking up, while there are signs that the property markets in Germany and France are reaching a bottom.

David Skinner, head of real estate research and strategy at Aviva Investors, believes the UK peak to trough has further to fall than the -44.1% recorded by IPD. He expects a decline of 50% to 55% before the market reaches the bottom. According to Cordea Savills, this will happen by the end of the year.

But Skinner does also see what may be early signs of a turnaround.

“The rate of repricing has abated very substantially since Q4 last year, although we are still seeing 1-2% falls every month in the UK.

“We have also seen the amount of buyers increase significantly and the depth of investor interest has increased. Investors are moving to capture low valuations.”

But another change in the market, which is not positive, is a fall in demand, which affects rental income.

Ian Cullen, co-founding director at IPD, a property index provider, said: “June was the first month in 24 in which falling occupier demand, rather than investor diffidence, played the lead role in driving capital decline.”

The Royal Institution of Chartered Surveyors (Rics) also noted that tenant demand fell in the UK in the second quarter of 2009, although the pace of decline eased back markedly.

Fall in rental values
The ongoing contraction in the economy and the continuing rise in available floor space have weighed on surveyor expectations for the rental outlook from property, and surveyors remain pessimistic about rent values. Fifty-three per cent of them expect a fall rather than a rise in rents, according to a Rics survey. Rental expectations remain bleakest in the central London office market.

But despite the poor outlook for occupier fundamentals in certain corners of the property market, properties are perceived to be mispriced, says Skinner at Aviva.

Aviva recently sold a Bournemouth out-of-town retail park to Orchard Street Investment Management for £25.5m. The property forms part of Orchard’s Special Situations Fund.

Again, it has well known tenants including Homebase, BHS, Currys and PC World. Average rents are approximately £21 per sq ft and the total rent roll is £2.65m per annum.

Chris Bartram, chairman of Orchard Street, says: “We like the property and the sector, which we think offers very good value to investors with a five- to six-year investment view.”

Cordea Savills predicts that the yield for IPD All Property Index will reach 9% by the end of the year.
George Tindley, director of investment at the firm, says: “The UK is one of Europe’s core property markets, accounting for 29% of its investable market. Recent short-term changes in pricing can only help to increase the relative attractions of investing in this market over the medium to long term, particularly considering the deteriorating prospects of the Eurozone.”

He says there has been a noticeable change in sentiment towards property in recent weeks, caused by factors such as diminishing fears of systemic risk to the UK economy.

This, he adds, is a “golden opportunity” for investors to cherry pick assets that demonstrate strong covenants in established locations and with long leases at a discount to historic market levels.

©2009 funds europe