Editor’s Letter: Finding viable alternatives

Daniel Cunningham

Across many European real estate sectors, prime yields are unlikely to compress much more this cycle. For investors, enhanced return prospects are largely pinned on rental growth in undersupplied markets.

Investors chasing a bit more yield otherwise need to look outside the mainstream sectors of offices, retail and industrial to the so-called alternatives such as hotels, student housing or healthcare.

And yet calling these properties ‘alternative’ might seem old hat to some investors. Indeed, there have been plenty of converts to the benefits of ‘operating assets’ in recent years. In one indicator of this mental shift, the Urban Land Institute and PwC’s 2017 Emerging Trends in Real Estate report showed that 44 percent of investors surveyed intend to invest in alternative sectors.

Lenders have arguably taken longer to get comfortable with alternatives than their investor clients. Many banks have limited appetite, while alternative lenders, including debt funds, have made the most of early moves into some of the less bankable parts of the market. Today, however, an increasing number of lenders are aiming to diversify their loan books through exposure to non-mainstream property.

Alternative assets have their plus-points.They tend to benefit from longer leases which can be index-linked or subject to fixed uplifts. Depending on their location, value can be enhanced by a lack of supply. Also, long-term demographic trends drive some markets, rather than short-term economic factors. Healthcare facilities and retirement homes are required throughout cycles, for instance.

There are also additional risks. Property performance depends largely on the ability of the operating partner, markets can be illiquid, and with limited trading, pricing transparency can be lacking. While lenders may be tempted to edge up the risk curve and finance alternative assets, awareness of the nuances of non-mainstream markets is essential.

MIPIM draws crowds

The hunt for returns in a highly-valued market was one of the main topics discussed at this year’s MIPIM in Cannes, which took place last month.

On the surface, it was a positive MIPIM. More than 24,000 property people officially attended, up slightly on last year’s numbers, according to the organiser. There were the usual dinners in the old town, parties on La Croisette and champagne receptions on the yachts, but the general tone of the event was professional; attendees seemed more focussed on networking and discussing the big issues of the day than drinking with friends in the sun.

Finance specialists from across Europe argued that there is continued momentum in the underlying property markets and that lending still makes sense. Borrowers described liquid property finance markets throughout most European countries. It will be interesting to watch how far up the risk curve lenders are tempted to go as they aim to make the most of the remainder of this cycle – and to what degree alternatives play a part – with an eye on when the next correction might come.