Opportunities for sale?

Despite poor market results in other sectors, UK property still holds an attraction for charity investors. Andrew Allen reports on the opportunities and explains why it should form part of every charity’s investment portfolio

The UK economy has had a difficult period in the last 18 months, with a sharp and deep recession impacting across all parts of the market. The UK property market has been hit hard and values have tumbled across all property sectors. There are signs of stabilisation with potential recovery emerging, albeit commercial property prices are now around 45 to 50 per cent lower than June 2007 (Investment Property Databank or IPD, the independent performance measurement company).

One implication of this is that income yields are at their highest for more than a decade. Furthermore, these yields are also at their highest recorded level against that of UK Government bonds, making property attractive on a relative basis.

Where to put your money?
With regard to investment prospects, there are two key points to consider. Firstly, this price reduction has attracted new investors into the market, mostly from abroad, seeking to capture the attractive pricing opportunities. These investors are largely seeking to secure typical prime-quality buildings where high quality tenants are secured in modern buildings on long-term rental contracts (greater than ten years). Indeed, market knowledge suggests that prices are already rising for these buildings.

Secondly, asset allocators are increasing their appetite for property, on a relative basis. While economic indicators may imply ongoing occupier market weakness, the relative attraction of the high income that can be delivered from the secure leases in UK property is proving a real attraction to investors.

In the retail market, ongoing structural weakness is continuing across the high street and, indeed, the failure of well-known names such as Woolworths is just one illustration of the tough conditions that prevail. Another threat to the high street is the supermarkets, as they continue to take trade from established retail destinations.

Investors should again be looking at supermarkets and out-of-town retail. Long leases secured against some of the UK’s best retailers should be an attraction for long-term investors who are able to capitalise on the best pricing for many years, but the prospects for many high streets are unfortunately bleak.

Business traffic
In the office market, the downturn in the financial and business service sectors has reduced rents in the West End of London by up to 50 per cent in just 18 months for the best quality space. However, such headlines can obscure some interesting dynamics within this sector. While prime Central London office space rents boomed in the last few years, the same is not true of many of the large provincial markets and, indeed, in some locations rents are no higher in summer 2009 than 20 years ago. Again, this potentially presents interesting opportunities to invest in properties with high quality tenants at low rents, where income security is relatively high.

In the industrial market, high and relatively dependable yields can be secured. London and the south-east markets have a shortage of land that will continue to support asset prices. Again, the high yields that investors can secure here should be a real attraction too.

There are many ways that investors can access the commercial property market. Traditionally, most charity investors would invest directly in properties on their own account. While this has the benefit of control, it does add other risks that can be lessened by investing in pooled funds. Asset allocators argue that, to invest directly in property, typically requires around £50 million invested across ten or more properties so that diversification benefits can be achieved. This is often well out of the reach of many charity investors seeking to invest alone and, indeed, even at this suggested scale there remain the issues of access to professional management and further economies of scale that can be achieved in pooled funds.

Charity might
The Charities Property Fund was established in 2000. It was the first common investment fund available to charities that invests directly in UK commercial property.

It provides an opportunity to gain exposure to the UK property market for those charities that may not have sufficient funds to create their own portfolio. The fund currently has a £200 million portfolio of 37 properties (as at June 2009), located across the country with a varied tenant base.

The fund targets a high and dependable income stream and in doing so it has managed to limit income risks. For example, at June 2009, the portfolio had a vacancy rate of just 3.3 per cent, which is substantially below the market average of 12.1 per cent, as measured by IPD. Furthermore, with regard to the quality of the financial standing of the tenants in the fund, an independent assessment made by IPD suggests that it is relatively well protected. Three-quarters of tenants in the fund’s properties are classified as being of “public sector or low/negligible risk”, this compares well to the market average of two-thirds. The IPD assessment of the fund is that it is on the 10th percentile for both tenant quality and void rate. In other words, 90 per cent of funds are weaker than this fund on these two measures.

The performance of the fund has been relatively strong, having outperformed its peers in the Association of Real Estate Balanced Funds Index over the last three months, 12 months, three and also five years. Much of this performance comes from the income focus and, as at June 2009, the net initial yield of the properties in the fund was 9.1 per cent against a market average of just 7.9 per cent.

As noted above, the property market is starting to see net new investment as the relative attraction of the asset class is becoming increasingly apparent and this is also reflected in the investment into the fund. Investors have provided substantial net new investment in both Q1 and Q2 2009, providing an opportunity for the fund to benefit from the current attractive market pricing.

Andrew Allen is director of research and strategy at Cordea Savills, and is property manager of the Charities Property Fund.

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