APL discussion finds today’s alternative sectors are tomorrow’s core, writes Alex Catalano
The UK Association of Property Lenders’ annual seminar lived up to its billing of “opportunities in NOIR” – real estate that is Not Office, Industrial or Retail.
“These are everyday assets in our lives, typically counter-cyclical, where cashflow is naturally recurring,” said Rory Hardick, a founding principal of private equity group M3 Capital Partners. “You don’t have to worry about large cliff-edge renewals, which can decimate core investments.”
Barclays’ head of real estate Brendan Jarvis added: “A lot of today’s alternative real estate is tomorrow’s core; the private rented sector and student accommodation, definitely.”
Wider economic trends are driving the demand for alternative property. But panellist after panellist stressed the need to drill down, not just into local supply and demand dynamics, but the businesses and the expertise of the property occupiers.
“Alternative assets are not vanilla investments where you can sit back,” CBRE’s chief economist Neil Blake warned. “Their performance will succeed or fail depending on how good the operator is and the owner’s relationship with the operator. If the operator fails, the property fails.”
Jarvis said: “In the 2005/06 opco/propco world, grown up people, with good spread sheets, were seduced into thinking they were entering great transactions. They weren’t really focussing on the core of the proposition: where’s the cashflow coming from? What’s its quality? Do you understand what the operator is doing – is it alchemy?”
Both lenders and investors were badly scarred when some boom-time deals went seriously wrong; UK care homes, for example. “A lot of the things that have gone bang cyclically have been on bad structures, as opposed to bad fundamentals,” Hardick argued. “Banking can protect itself by digging down to underlying business assets.”
AXA Real Estate typically puts senior debt on its alternative assets, but “we look for leverage and covenants that can withstand markets with strong economic volatility”, said senior fund manager Olivier Astruc.
Not hunting with the pack
Omni, a non-bank lender with an alternative and central London residential focus, prides itself on keeping a step ahead of the herd. “We don’t hunt with the pack – that just ends up in high leverage, more risk and low returns,” said partner Dan Smith. “A lot of lenders have come into the bridge space in the past four years – there are now 20-30 people driving down prices.”
Jarvis agreed that “pricing is coming down across the board. Generally covenants are starting to creep in a bit as well. But we’re not seeing leverage go up that much, which is good.”
“We can expect yields to come down, particularly with new entrants seeking the stable income profile delivered by some alternative assets,” said Astruc.
In selected sub-sectors, such as hotels, new international capital has driven down yields. The search for yield is also pushing traditional institutional investors into specialist assets. But the consensus was that alternatives were not yet in danger territory.
Blake said: “There’s a benign economic climate; the recovery is spreading out and a property boom is some way from a peak – I don’t think we are at 2006-7 levels. Lending margins over risk-free rates have slumped – it is quite a good time to borrow for property investment.”
AXA follows the trends to build £2bn niche property portfolio
From a standing start, AXA Real Estate has amassed a £2bn portfolio of alternatives over the past 15 years: hotels, senior housing, petrol stations and data centres. “Big trends underlie our investments,” says Olivier Astruc, senior fund manager, alternatives.
The EU hosts 1.1bn tourists a year and the figure is rising; they need hotels. Its population is ageing, requiring senior housing and healthcare. Students also need accommodating.
“London has six of the top 20 universities in the world and has been going strongly for the past 20 years, especially with the arrival of non-EU students,” says Astruc. “It is about providing the right space — not just student housing but potentially educational space, which is evolving quite a bit.”
Astruc highlights the age of buildings in Europe’s older cities, where most office stock is more than 20 years old: “There’s been a lack of capital expenditure since the credit crunch and many properties are unfit for the evolving demand. There are opportunities to transform stock to alternative use.”
AXA takes on developments and refurbishments: for example, a trophy hotel in Amsterdam and the turnkey acquisition of German care homes. The latter “provided the yield we wanted and also had a spread of risk we liked for our portfolio”, says Astruc.
“A key risk with development is not being in the right product,” he notes. “ You don’t want to be the first person to build a new type of care home or leisure facility, or student housing in a new market. You want other people to try it, then you pick up their experience and apply it on a larger scale.“
Motorway service areas get an Extra twist
ExtraMSA’s chief executive Andrew Long calls his £760m of UK motorway service assets “necessity retail”. Extra has pioneered the concept of competition among site tenants to drive high operating standards.
Unlike other motorway service area (MSA) operators, Extra is mainly a landlord, owning or controlling most of its sites and “multi-letting” them to a select range of tenants, rather than operating the facilities itself.
Long says: “MSA assets can provide stable, high, predictable cashflows with long-term visibility, minimum guaranteed rental income, plus regular rises due to ‘upwards only’, performance-driven rent reviews.”
This appeals to lenders: Extra’s 18 MSAs produce annual net rental income of around £47m, mainly secured on long-term leases.
In January, Extra placed a £220m, 10-year bond with institutional investors, with a fixed annual coupon of just under 3.7%. It was backed by nine multi-let MSAs, including two of the UK’s busiest: M40 Beaconsfield and M25 Cobham.
Last September, Extra refinanced its Ulysses portfolio of nine older MSAs: single lets to Welcome Break, the UK’s second largest MSA operator. RBS, Aalto and Santander provided a five-year, £170m facility. “The loan-to-value ratio is only 47% and there is strong interest cover ratio headroom,” says Long.
‘No limits’ to M3’s alternative ambitions
“Nothing is off-limits for us,” says Rory Hardick , a founding principal of private equity group M3 Capital Partners.
The list of M3’s investments backs Hardick’s claim. The $6.3bn of assets its investment partnership, Evergreen Real Estate Partners, owns are definitely alternative: four self-storage companies; Urbanest student housing in the UK and Australia; three housing/land-
related companies, including UK private rented housing provider Essential Living; UK motorway services specialist Extra (see panel above); and “most esoterically”, Northstar Memorial Group, the seventh largest funeral facilities provider in the US.
Hardick calls alternative property “assets that form part of everyday lives”, but notes that institutional investment accounts for a small bite of the £19bn UK sector.
“The complexity of underwriting is a key attraction for us. It keeps the competition away, gives a pricing advantage and higher free cashflow yield.
“Our heaviest underwriting focus is on occupational demand and capacity for rental growth. The second is management partners and business structure.”
M3’s underwriting checklist includes what cashflows can service on a risk-adjusted basis and regulatory risks. Hardick says: “We spend little time worrying about investment demand. We are a long-term owner with partners and not looking to trade assets.”
M3 advises listed developers, mainly in Asia, on their capital requirements and has itself looked to the bond markets for finance.
Hardick says: “We bought a Japanese self-storage company 22 months ago and put in a long-term debt facility. Strong management coupled with quantitative easing in Japan is driving rents crazy and debt rates ever lower. With the yield spread you can get from this financing arbitrage we are able to make a significant dividend distribution.”
CBRE shows confidence in non-core assets
“We haven’t seen these levels of consumer confidence since 1997,” CBRE’s chief economist Neil Blake told delegates at the Association of Property Lenders event.
Blake pointed to the “double whammy of rising real incomes and rising employment” that is hitting the UK economy, as well as rising job security. “Put it all together and we have a very happy consumer at the moment, which bodes well for retail and other consumer services,“ he added.
The “economic feel-good factors” are moving beyond London and the south east and out of the traditional sectors, said Blake. “It is spreading through the rest of the country and away from offices and high-end retail to other property sectors, too.”
With the upturn, investment in alternative property sub-sectors is surging, accounting for 24% of total UK property investment last year.
“Past the big trough when the recession hit, we’ve seen some very impressive numbers,” Blake said. “Hotels doubled, healthcare is up 400%. This is not a fringe area; this is something attracting a lot of attention.
“However, the point is that it is cyclical,” Blake warned. “It won’t go on forever, but I think we still have a couple of good years to come.”
Omni finds sweet funding spots for Candy
Omni Capital finances high-end London residential real estate and alternative assets such as care homes, hotels and private rented housing.
“Traditional assets attract traditional lenders — it’s very competitive, and that drives down returns,” says Dan Smith , Omni’s head of structured finance. “We look to do things others try not to do.”
Set up in 2010, Omni is an unregulated lender: the financial services brand of CPC, the Candy brothers’ glitzy property development and investment company.
“We’re happy to provide short duration, 12-18-month loans,” says Smith. “Borrowers often can’t get this from debt funds, because they have income and recycling targets. For banks, it might be a smallish deal that is too much trouble for too little return. How much can they make off it in the short term?”
Omni provides short-term bridge loans at higher leverage (up to 80% LTV levels) on high-value, central London assets, at 75bps to 1.5% upfront and 75bps to 1.5% per month, “returns that are achievable”. It also lends to wealthy investors with prime central London private rented portfolios at up to 75% LTV ratios; banks are reluctant to go over 50%.
Omni finances smaller, £5m-50m London developments in zones 1 to 5, lending 70-75% of final gross development value. “We’ll look at a scheme’s complexity and end value,” says Smith. “We have a unique understanding of central London and access to skills in CPC and Candy & Candy.”
Construction funding includes £30m of revolving credit for LNT’s development of care homes and a £25m facility to resume building the Hilton hotel at Ageas Bowl, Southampton, after the original developer went bust.
To date, Omni has lent £700m in over 300 deals and has seen four insolvencies and no capital losses, says Smith. “We seek higher returns without necessarily taking on what we perceive as proportionally higher risk.”