Some of the world's most powerful institutions have been buying commercial property. Richard Willsher asks if now is the time for private investors to follow?
Almost eight years on from the collapse of Lehman Brothers and the crisis in financial markets, risk assets are now back on big investors' agendas.
They have decided that they are ready to pursue the search for yield because their favoured asset class, government bonds, is not producing adequate returns, and equities remain too volatile. Commercial property, on the other hand, meets many of their needs.
"NORGES BANK HAVE INVESTED £452 MILLION IN THE CROWN ESTATE'S LONDON REGENT STREET PROPERTY PORTFOLIO."
One early mover was Norges Bank, the manager of the Norwegian Government's NOK 4.3 trillion (€717 billion) pension fund, which is tasked with investing Norway's vast oil wealth. As long ago as January 2011 it announced its first major real estate investment alongside the UK's Crown Estate. The nature of this investment was key to understanding how the professionals invest in commercial property. Its £452 million investment1 entitled it to 25% of the net income from the Crown Estate's London Regent Street property portfolio, among the most valuable commercial real estate in the UK. The Norwegian Government pension fund decided to allocate up to 5% of its resources to property assets, against an allocation strategy of 60% equities and 40% fixed income at the end of 2010. Since then it has continued doing property deals in prime centres around the world and is just one among many sovereign wealth funds, pension funds, insurance companies and big private equity firms to do so.
The world's big hitters have stepped up to the property plate in no uncertain terms. Research carried out by property consultancy DTZ found that in 2014 £15.4 billion2 was invested in central London shops and offices.
"A KEY ASPECT TO THE TRADE OF THESE TENANTS IS NOT ONLY THEIR GLOBAL PRESENCE BUT ALSO THE FOOTFALL THEY ENJOY IN LONDON FROM VISITORS FROM ALL OVER THE WORLD."
Firstly, despite the notoriously cyclical nature of the commercial property market, prime central London buildings have tended to yield stable returns from long-term leases to strong global brands. These include the major retail brands in London's West End and financial institutions and professional firms in areas such as the City of London and Docklands. And a key aspect to the trade of these tenants is not only their global presence but also the footfall they enjoy in London from visitors from all over the world.
Secondly, the big institutional investors are also looking for capital growth. Yield and capital growth combined have the potential to produce the sorts of 'inflation proof' investment returns that they seek. So the question for private investors is how to follow suit and gain similar steady income streams for their portfolios.
One route might simply be to buy directly into commercial property. That is, to seek out freehold shops, offices, factory or light industrial units wherever they may be. And indeed some do. In most cases however the prime locations have already been snapped up by big funds and specialist property investors.
In many depressed areas of the country assets may be available at bargain basement prices, especially as lenders dispose of their distressed stock. But this is a high-risk strategy. It may involve committing substantial sums of money to property which may have been deteriorating for some time, left vacant by tenants who have long since departed. It also requires knowledge and experience in real estate investment and an appreciation of the dynamics of property investment. The very long-term investor may be able to afford to take such risks but it would not be for the faint hearted.
The FTSE All Share index Real Estate Investment Trust (REIT) sector includes firms such as the Big Yellow Group; the self-storage and related services business, Hammerson; the investor and developer that specialises in shopping centres, retail parks and offices, and SEGRO; a manager and developer of industrial property and offices, principally those on its Slough Trading Estate to the west of London. These and other REITs hold sizeable portfolios of properties and buying shares in them enables the small investor to benefit from their expertise, the spread of risk in the portfolio, and a share in their revenues.
REIT shares rise and fall in price like all other quoted stocks depending on performance so dividends may also rise and fall and indeed may not be paid at all. REITs do have the advantage that their REIT status requires them to distribute at least 90% of their taxable income to their investors: good news for the shareholder. So, all told, REITs could be worth considering as an easy and typically liquid route into the commercial property sector.
While quoted REITs are 'closed ended,' meaning that they issue a specific number of shares that can be traded much like equities, open-ended property funds operate like mutual funds. Investors buy units in the fund and the more money the fund manager attracts, the more he or she has to invest in property. The price of the units may, of course, go up or down.
These funds can be country specific or international, invest in specific types of property or be more general in nature. The investor's challenge is to try and gauge how good the fund manager is and whether the level of risk and return is appropriate.
The significant range of available funds should enable the private investor to gain exposure to the commercial property sector and, in some cases, alongside the very wealthy, highly influential sovereign wealth, private equity and pension funds, but it's important to consider the risks of investing in the wake of the smart money.
During the years of the financial crisis following the collapse of Lehman brothers, many large property investors lost money. Properties they invested in failed to produce the returns they expected and in some cases they lost a considerable amount of their capital. Moreover where institutions invested in specially constituted funding vehicles, often domiciled in offshore locations for tax efficiency, they found that they suffered from lock-ins that prevented them from withdrawing their funds when they wanted to do so.
These investors have learned their lessons. They may now insist on greater levels of liquidity for their investments, being able to sell on the holdings or exit as and when they wish. In addition they now insist on higher degrees of transparency. They look for more frequent and more granular reporting from fund managers as to how their funds are being deployed, what the net asset values of the properties are, and how the funds are performing. Moreover, as we saw from the example of the Norges Bank investment at the top of this article, they may prefer to co-invest with a small number of known, highly expert partners who represent a degree of insurance.
"RESEARCH CARRIED OUT BY REAL ESTATE SERVICES AND INVESTMENT MANAGEMENT COMPANY JLL REPORTED THAT CENTRAL LONDON OFFICE INVESTMENT VOLUMES WILL EXCEED £18.5BILLION IN 2015.3"
The small private investor cannot expect this degree of security when, for example, investing in a REIT as a shareholder or buying units in funds alongside thousands of other small investors. But he or she can draw some investment wisdom from watching what the big investors do.
First and foremost, consider carefully whether there is a sufficiently acceptable level of transparency in reporting on a fund's property holdings. How are the fund's properties being managed and let? Is the level of return adequate? How often does the fund report to its investors? How liquid are they – can investors sell their holdings as and when they wish, or are there onerous lock-in terms?
In addition remember, as with all markets, commercial property is cyclical. The people who tend to make money are those who buy when assets are cheap and when others are, often quite correctly, fearful. They then sell when prices have been driven up by demand from other investors.
A prudent route for the private investor to follow could be to carefully choose those funds that offer the most consistent, stable returns from the highest quality properties, while continuing to watch what the big players are doing. If they start to sell, it may be time for the small investor to take a view. At the end of the day, risk management in terms of investing in commercial property, comes with the territory for the private investor, just as it does for the big boys.
Past performance is not an indication of future performance and cannot be relied upon. The value of investments and the income from them can go down as well as up and cannot be guaranteed.
Contributor Richard Willsher has been published in The Financial Times, The Wall Street Journal, The Times and The International Herald Tribune. Views expressed by all contributors are their own. All information is correct as at 21 December 2015.
Any views expressed by Lloyds Bank Private Banking are our current in house views as at 21 December 2015 and should not be relied upon as fact and could be proved wrong. Views expressed by contributors are their own. All information correct as at 21 December 2015 .
1. Norges Bank press release 13/01/11 www.norges-bank.no/en/om/publisert/pressemeldinger/2011/pressemelding-13-januar-2011/
2. DTZ “Money into Property UK 2013 – Mounting evidence of recovery” 01/05/13
3. Central London office investment expected to exceed £18.5 billion in 2015”, JLL, 21/12/15
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