Back to bricks and mortar?
August 2009
Andrew Allen considers property's position as a core asset class within a charity's portfolio
During a downturn the importance of income to charities becomes even more acute. Returns from investments decrease, legacy values decline as house prices fall, and there is pressure on fundraising income. At the same time, beneficiary need is increasing and many charities are trying to do more work with less money.
So where will the returns needed by charities come from? There is a view that cash is the safe option. However, what at first appears to be ‘no risk’ investing is not actually without risk. With such low returns on cash right now, other assets have to work that bit harder, and perhaps take more risk themselves, to deliver the income desired.
Historical reasons for property inclusion
Charities have found property to be an attractive asset class for a number of reasons. Firstly, it adds diversification to a portfolio, especially as it is not highly correlated with any of the other major asset classes. Rental income, for example, may provide insulation against market volatility due to lease structures and upward-only rent reviews. It is one of the highest yielding asset classes and has produced consistently high income returns over a number of years.
It is important to remember that active management of properties can enhance asset values. It has always been the case that property needs to be managed to maximise value but this is especially true in tougher conditions. Therefore investors directly managing properties can preserve income and add value by focusing on property management fundamentals. Market timing can be used to maximise rental values. And in a downturn, property owners limit losses through flexibility, for example, by offering shorter terms, lower rents and break options to their tenants.
The property market has high levels of transparency. There is robust performance analysis data available, for example, from IPD (Investment Property Databank), and investors can both view individual properties and measure tenant quality. Finally, property offers the potential for both income and capital growth, a powerful motivator for charity investors.
While equities do have the advantage of answering investor concerns over liquidity, they are subject to more significant volatility, so there is a risk trade-off. Generally, property is regarded as a long term investment in which case liquidity should be less of a concern. Besides the general positive strengths of property as an investment for charities, there are a number of characteristics of the current property market that suggest that, despite recent malaise, now might be a good time to invest.
Current market conditions
One concern investors have is about whether
the market has bottomed out. While there has been a sharp repricing and a 40 per cent plus decline in the value of property, this means that there are significantly higher discounts available currently. The question for investors to ask is whether the pricing is sensible. Yields on property, according to recent figures, stand at 7.8 per cent, which compares favourably to other asset classes (see figure 1 below).
the market has bottomed out. While there has been a sharp repricing and a 40 per cent plus decline in the value of property, this means that there are significantly higher discounts available currently. The question for investors to ask is whether the pricing is sensible. Yields on property, according to recent figures, stand at 7.8 per cent, which compares favourably to other asset classes (see figure 1 below).
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It is also worth remembering that property may be better value than the figures suggest due to a time lag in valuations used for IPD yield measurement. The gap in pricing between prime and non-prime properties is returning, which suggests a return to a more rational market.
Inflation/deflation
One other factor that adds to the attractiveness of property is deflation. It is thought that the UK economy is on the brink of deflation, although analysts predict RPI to be positive in 2010 especially if VAT rate restored to 17.5 per cent. It is unlikely that there will be 1970s style inflation and it would be bad news for all asset classes if there was. But looking at historical investing data reveals that commercial property has inflation proofing characteristics that make it particularly attractive compared to other sources of income (see figure 2 below).
Deflation and the market corrections explained above combined with the fact that UK property may be at a historically low relative price, means that it is worth charities considering property as an investment subject to making the right choices. But where are the best opportunities?
Property sector issues
The retail sector is suffering cyclical and structural impacts, yet there has been a huge repricing of some assets such as retail parks, which could now be attractive. There is a danger of interpreting strong overall retail figures as an indication of health on the high street as food retailers are taking trade away from the high street. One also has to consider the proportion of sales that are online and it is difficult to break down and measure. However, there are signs that the high street is adjusting and not all units are empty.
In the industrial sub-sector, although there is a reduced global demand for manufactured goods, currency weakness benefits exporters which could offer opportunities. The logistics sub-sector is seen as the ultimate safety play for the property investor because it delivers good solid returns with low volatility. Despite worries over limited export demand and a declining domestic distribution business, its lower risk characteristics remain with opportunities, particularly around the M25 and M4.
There has been a significant downturn in rental levels for offices yet there remains global investor interest in key UK markets led by London which is already proving to stabilise the capital values and indeed in some cases provide evidence of price increases. But one other area that presents significant opportunity for investors is residential property where properties let on long leases to robust tenants can be acquired. Whilst standard housing affordability is a challenge there is a material growth in opportunities amongst senior housing and student housing, underpinned by resilient and growing occupier demand.
Looking outside the UK, what is the situation in Europe? The mainland European economy was in denial over the seriousness of the economic downturn for a long time but now it is biting, countries that previously may have been attractive to investors, are no longer so.
The fractured nature of Europe means it is difficult to take a pan-European view. There are huge regional disparities in data, commonly due to differences in the nature of leases agreed and additionally variations in how property is valued. Property investment volumes in mainland Europe collapsed in quarter one 2009, and with yields still rising there has been no sign of the flattening seen in the UK. Therefore analysts predict that 2009 will largely be a time of security but risk loving investors may move back into the market. While there are risks ahead across Europe, the UK is the best prospect for property investors going forward, especially if the recovery favours service sector economies and those which went into downturn earliest.
Outlook
Generally, it is inappropriate to say that all property is either a good or bad investment, but opportunities prevail for investors who know what they are doing. Charities have a need for income that ‘no risk’ investing will not provide. With its attractive diversification characteristics, historically consistent returns, and proven strength in deflationary markets, property could deliver that all-important income while also offering growth potential, in the testing months ahead.
Author: Andrew Allen
Andrew Allen is director of research and strategy at Cordea Savills, property manager of the Charities Property Fund. The fund has over 850 investors and a portfolio of approximately £200m by value (as at June 2009).
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