The era of ultra-cheap money has come to an end, inflation is in double digits, interest rates are rising and recession is waiting in the wings. But is it all doom and gloom? At a recent panel event we asked our property fund managers for their take on key sectors.
Industrials
Matt Howard
In looking at the industrial sector, we need to separate the capital from the occupational markets. We have seen some over exuberance in industrial pricing in recent times and to some extent what we are seeing now is a reversal of that process. Yields had reached record lows, supported by significant rental growth that had already or was expected to be realised. This record growth was driven by supply/demand dynamics and essentially a ‘catching up’ in rents.
For a number of reasons, the sector had missed its moment in various cycles which meant rental values remained relatively static for decades. This was principally driven by an oversupply in stock. This effectively created affordability headroom. Therefore, when occupational rates began stabilising in the mid-2010s the sector began a period of significant growth.
On a national level, occupancy is around 94% across the entire industrial sector, whereas for all units above 50,000 square foot it’s about 97% now, with voids at a record low. Rental growth in London logistics has averaged around 90% since 2015 and regionally it’s been around 40%. Not all of this would have been captured yet as you have to wait for lease events or reviews to occur which are typically on 5 yearly cycles. Therefore, the yields are partly driven by this reversionary income even before factoring further growth expectations.
We have strong reversionary potential in our industrial portfolio within the CT Property Trust and this has been proven through recent lease events, which is a good position to be when you’re in this relatively low growth environment. We only have one vacancy in our industrial portfolio, which became vacant in September because the logistics operator outgrew the unit, and we’ve already got another logistics operator lined up to take that space.
Where we’ve got lease events in the next year or two, we’ve actually got occupiers approaching us keen to renew their position in light of few alternate options due to the lack of supply, despite the high levels of development in the sector. Going forward, there are economic headwinds and you’ve got to keep a close eye on occupier businesses but I think we go into this difficult period with a very strong underlying occupational market. Therefore, our overweight position to the sector offers us resilience moving forward.
Retail
Richard Kirby
In the UK retail sector generally, there is too much capacity and so shopping centres will continue to be distressed. I also think that in many instances there will a significant repurposing of properties moving forward.
Personally, the retail that I like is warehouse parks that are underpinned by grocery – convenience and discount led retailing. The parks offering that type of tenant mix should be fairly resilient and remain attractive. Within BCPT we’ve got two such parks in Newbury and Solihull. Even with all the doom and gloom at the moment, all our units at Newbury will be let by the end of month which is really encouraging.
At St Christopher’s Place, all its attributes became negatives in an instant in the pandemic, being central London, a reliance on office workers, tourism, public transport, food and beverage, retail and residential. It became a real challenge so what we are doing there is trying to curate the tenant mix. We are increasing the food and beverage offering, which is really important to us. We’ve had some recent successes there with San Carlo opening last year and we got one or two exciting opportunities that we’re working through at the moment. We may also use a more innovative re-leasing strategy, sort of like pop up.
We’ve only just started to see the benefit of the new Elizabeth Line. The trains started stopping at Bond Street from late October and this is an important development for us given its proximity to St Christopher’s Place. So there are some encouraging shoots emerging.
Alternatives
Marcus Phayre-Mudge
I think the first point to make about alternatives is that real estate equities of course have a forward-looking discounting mechanism and that’s why we’ve seen share prices, in many instances, dropping by 30%, 40% even 50% in some cases, where the fundamental underlying market conditions haven’t changed at all.
Plainly the stock market is obsessing about the cost of capital, the cost of debt and the impact of these on the individual balance sheets of companies. But where you have a business which is financially sound, doesn’t have a lot of refinancing in the short term and very importantly, its underlying business model is robust and customer base strong, then there is every reason to be optimistic at these new prices.
I think crucially, it’s important to appreciate that the stock market may well have overcooked it on some of these names but that doesn’t apply to everything. It is true that there are certain sub sectors we are less comfortable with, for example senior living, where operators profit margins are very challenging. Tenants are struggling because so much of their cost base is personnel related and it is difficult to fill jobs at prevailing pay levels. That’s a particular issue in the UK where we have seen a lot of strike activity and upward pressure on wages.
All these things affect the consumer and in that segment we’re nervous about our hotels. They’ve had a good run as we’ve come out of the pandemic, with everyone wanting to get away on holiday, but I think hotels will have a trickier time next year.
On the flip side, self-storage has been remarkably resilient in many downturns and that should be the case again. As an example, the PE ratios of Big Yellow, Safe Store etc., have come down from the high 20s to low 20s. There has been a real re-pricing in many Continental European listed companies. Much of Europe is financially better insulated than the UK. Countries like Germany, in particular, have a deeper social contract with their citizens so that if you lose your job your rent will be paid. Most Germans rent, rather than own, their homes so when mortgage rates go up it doesn’t affect their pockets in the same way.
In Scandinavia, at the property company level it’s quite dangerous because there are a lot of very indebted companies. Conversely, the consumer is relatively better off than other European peers because there’s a lot of hydroelectric power in the region so the challenges arising from global energy shortages is less acute here.
