Best assets lend long lease of life to an ‘uninspired’ market


IPD’s 2.7% UK 2012 return masks strength of London and long-leased assets, writes Jane Roberts

IPD’s 2012 figures underline a headline story for UK property last year: the striking outperformance of long-leased property.

Presenting the results of the Quarterly Index on 31 January, much earlier than previous years, IPD’s UK managing director, Phil Tily, said the “relatively uninspired” 2.7% total return for UK property in 2012, down from 7.8% in 2011, masked very varied performance for different kinds of assets.

02.13 IPD fig 1 p10It wasn’t just central London that stood out: alternative assets such as student accommodation, ground leases and leisure, which are usually let on long leases, performed far more strongly than most retail, office and industrial property. Long- leased property was clearly the place to be.

Long-income funds did more than 4% better than the 2.7% quarterly benchmark, with a 6.9% average return, against just 0.2% for all balanced funds (see fig 1).

“Balanced funds took the brunt with hefty writedowns in net asset value,” Tily said. “Funds that did best invested in alternatives, with long-term income. It demonstrates how varied the market was last year.”

02.13 IPD fig 2 p10Of the traditional sectors, retail “clearly has a lot of challenges”, he added. The sector has previously made up 50% of many institutional portfolios and with a much bigger negative yield impact and rental value contraction eroding returns it was the worst performer last year, although supermarkets were the exception, returning 7% (see fig 2).

A highly polarised market

London offices’ strong rental growth continued to counteract regional falls; West End offices returned 9.8%. As offices are a far larger sector by value than alternatives – termed ‘other’ by IPD, which performed best – taking them out of the 2.7% 2012 total return leaves a total return of just 0.4%. “It’s hard to remember a time when the market was so polarised [between London and the rest of the UK]”, Tily said.

02.13 IPD fig 3 p10The other polarisation, between prime and ‘secondary’, is less clear cut. Under IPD’s definition, long-leased secondary returned 3.6%, compared with 2.7% for short-leased prime assets (see fig 3). Tily said this again reflected a risk-averse market: “Long leased, better-let properties are what people wanted.”

Malcolm Hunt, IPD’s UK client services director, said it was no surprise that 2012 was another favourable year for big insurance and pension funds, REITs and family estates, which have big London office portfolios and relatively more longer-let income (see fig 4).

Charlie Walker, Legal & General Property’s business development director and manager of its UK Property Income Fund, says: “Last year, if you didn’t have central London and long-leased property you had to do something special to keep pace with the index.”

His boss, Bill Hughes, says LGP has invested £1bn in long-leased investments since mid 2011, mainly, but not exclusively, on behalf of the property team’s in-house annuity client. “These investments have seen 10% capital growth,” Hughes says.

Tily: “Funds that did best last year invested in alternatives, with long-term income. It shows how varied the market was”

Can this outperformance last? Or will it tail off and better value emerge from shorter-leased, value-added assets at last? The panel at IPD’s London results presentation was not ready to switch out of long-leased property yet.

Tim Francis, TIAA-CREF Asset Management’s senior director of strategy and research for global property, said: “Property income has performed very well, including retail, and has not fallen off. I can’t stress enough the strength of property income alongside long leases and its attractiveness to investors.”

Paul Richards, pension fund consultant Mercer’s head of European real estate, agreed: “Property’s attraction is always income compared with other asset classes. Our [defined benefit pension fund] clients are looking for inflation-linked income, which is why there have been huge inflows [into this type of assets]. There have been discussions about whether values look very high, but compared with gilts, they don’t.”

Richards added that changes in the retail sector, with internet shopping reducing the number of stores, “were interesting… But despite all these concerns, there is no reduction in the attractiveness of property.”

Income return still impressive

In a tough economic climate, property’s income return was impressive, Hunt agreed. In the past five years, 95% of the direct UK portfolios IPD analyses produced a 5%-plus income return; over a three-year rolling basis all produced positive cash flow.

02.13 IPD fig 4 p11With tough occupier markets but proactive management, Hunt questioned whether that feat could be achieved in the next five years – and if it would be enough for investors.

BlackRock managing director Marcus Sperber said a fixation with 5% income returns was “a red herring. If bond yields blow out, 5% may not be enough.” But he thought the yield itself was sustainable.

He was not surprised by alternative assets’ better performance. “They are an alternative to retail, frankly,” he said. “It’s where people are still spending money, on leisure, for example, and that sector needs property.”

Sperber expected to see pricing differentials in the market tempt investors to edge up the risk curve this year. “There has been a ‘risk-off’ environment but I am seeing a ‘risk-on’ environment again,” he said. “Twelve months ago, you were rewarded in results for being risk averse in property. There will be a bit more risk and good rewards for it.”

Fall in values adds a negative twist to property’s positive income story

Income return remained steady at 6% in 2012, the IPD index shows, welcome evidence that supports property’s positive position with regard to yields compared with other asset classes.

But capital growth of -3.1% for 2012, after four consecutive quarterly falls, pulled down the 2012 total return to 2.7%, from 7.8% in 2011. The fall in values was mainly due to 0% rental growth and a -2.7% yield impact.

02.13 IPD fig 5 p11However, at -0.7% by Q4, the rate of fall in values slowed slightly from earlier in the year – a trend also reflected in the monthly index’s January 2013 figure – so looking back, Q2 2012 was the low point of the second dip in total returns.

IPD UK managing director Phil Tily said rents “have been pretty much static for the past 2.5 years”. So no progress there yet.

Some 25% of portfolios did not produce a positive return, but 95% showed a positive income return (see main copy). Over a longer term, 50% of portfolios were in negative territory over five years, but a majority were positive over three and 10 years, averaging an annual 8.4% and 6% respectively.

Some investment houses are more optimistic about 2013 returns. Legal & General Property, for example, expects prices to be stable compared with 2012’s 3.1% fall.

The audience at the London presentation were less optimistic: in a vote, 59% expected 2-5% returns, while 21% voted for 0-2%.