In February’s edition I talked about how niching could be the way to gain competitive advantage in your commercial property investing in 2021.  Niching can be done geographically or by sector (or both), and it is the latter that I’d like to explore further in this edition.  I think there are some incredible opportunities on the horizon, for canny investors, arising from current (and future) market conditions.

So just to recap, traditionally investment in UK commercial property has been in the three main ‘sectors’ – namely retail, offices and industrial. Investors have consistently stuck to these types of investment because they have had all the essentials that facilitate secure institutional-grade income – including solid tenant covenants, long leases, upward-only rent reviews and full repairing and insuring leases.  As a result, they have provided ‘guaranteed’ longer term income.  These types of investments have therefore generally been proven to be liquid in the market, due to the weight of demand from both UK and overseas investors.

Other, alternative (or ‘alt’), sectors have emerged over recent years but have been less popular, and generally less sophisticated markets, than the ‘Big 3’.  These ‘alt’ sectors have included purpose-built student accommodation (PBSA), leisure property, hotels, build to rent, amongst others.

However, one major asset class is no longer proving as attractive to institutional investors and this, of course, is retail – especially large retail such as shopping centres and retail parks.  As a result, many institutional funds are reducing their exposure to such assets (they are trying to sell it!) and looking to re-allocate the funds. 

Coupled with this, lease lengths are generally decreasing across-the-board, certainly on offices and retail properties, and lease terms are changing to include more flexible lease structures, break clauses and turnover rents.  These changes in the more traditional commercial property sectors are meaning that investors are looking to cast their net wider to invest in other types of real estate in order to diversify their portfolios, reduce risk and obtain better returns. 

The immediate reaction of large investors (pension funds and the like) has been to divert investment into the industrial sector – especially into logistics as this sector is proving to be future-proofed in the wake of the recent societal and economic upheaval caused by COVID-19.

Investors, however, don’t tend to want to be too heavily weighted within one sector as this increases their exposure to risk. They will have to look broader in future and start to invest in a larger range of property assets.  The question is, which sectors will they be diversifying into? This push for diversification is leading to emerging sectors.  These could be asset classes that were previously not deemed to be ‘institutionally acceptable’, or they could be new asset classes that are emerging as a result of the two generationally defining events that occurred in 2020.  As a result of COVID-19 and Brexit, existing trends have been exacerbated and new trends have emerged. New types of investors, new types of tenants, and new types of property asset classes will emerge. I anticipate that these will form the new institutionally acceptable asset classes of the future.

Why is it important for SME investors to understand these property trends?

Simply, if you niche your investing strategies, you will acquire a competitive advantage. It’s always worth drilling down into a strategy or sector to become the expert as is it narrows your focus and opens up more opportunities, especially if you are also following trends.  In addition, following the money is a wise thing to do. And the money in this case is still searching for alternative, institutionally acceptable assets as I described above – great tenants, long leases, full repairing and insuring terms and upward only rent reviews.

The holy grail for your commercial property investing is to obtain ‘yield compression’.  This involves buying a property at a higher yield (remembering that with commercial property the higher yielding properties are those that are less prime) and selling / refinancing at a lower yield, either as a result of your own asset management or because of positive market movement.  Simplistically this means that you want to buy property in sectors that will increase in value over the medium term in order to improve your selling price upon exit.  

Once some of these emerging ‘niche’ assets that I have described below become mainstream, I anticipate that they will increase in value as the mass market piles into them, providing much sought-after yield compression for investors.  This could be similar to the huge value increases that have benefitted those forward-thinking purchasers of industrial logistics buildings 10 years ago who have seen huge value hikes as these properties have become mainstream investments.

So what “alternative” types of assets might be riding the waves created as a result of the recent economic, social and environmental changes?  I’ve thrown out some ideas below as to some types of real estate that could be on the rise:

‘Later Living’

By 2025, 20% of the UK population will be over 65 and that demographic will own an estimated £800 billion of housing equity which they will be looking to downsize (Source: Pinsent Masons).  Later Living generally comprises destination housing villages for those over 55, with a variety of social amenities, plus care for the older occupants.  However, it could feasibly include any type of housing targeted to the older generation.  In the future, there should be many opportunities for both developers and investors within this sector. 

Alternative Energy Solutions

Although not specifically a property asset these do tend to have longer lease structures similar to institutional property assets, and include windfarms, solar farms and the like. Within this group of assets, we could also include electric vehicle charging (EV). With petrol and diesel cars being phased out and anticipated future government tax breaks, this is only going to be a growth sector. There is very limited infrastructure around this at present and the real estate potential is vast.

Dark Kitchens

There are some sub-sectors of industrial that will ride some of the current waves. Dark Kitchens is an example of this.  They are commercial (usually industrial) units that cater for online customers. This takes the pressure off restaurant kitchens and is only likely to be a growing wave.  In this category you could also include dark supermarkets.

Cold Storage

Cold Storage is used for storing fresh food, and other goods such as vaccines.  The industry has enjoyed a steady growth, driven by population growth and, more recently, the storage requirements of the COVID-19 vaccine.  This is one sector that is only going to increase in its size requirements, and investors are starting to take notice of the sector, realising the important role it plays.

Data Centres

Data Centres are a growing niche in an increasingly consolidated market.  As storage moves to the Cloud, the big players (Amazon, Google etc) are fuelling demand for large units in the UK, especially after Brexit and the different data jurisdictions between the UK and EU. 

Self-Storage

It’s not a sexy business, but one with growth potential.  The self-storage market in the UK is currently much smaller than that in Australia and the US.  Self-storage has largely not been considered institutionally acceptable to date because it comprises short leases to consumers.  This could change as funds cast their nets wider.

Car Parks

These investments work because the availability of parking spaces in certain areas in the UK is very limited.  It is also a relatively low-risk proposition if the demand for parking is high.  Car park operators tend to take longer leases and, in ‘normal’ times it can generate excellent revenue.  A number of institutional investors have set up car park funds, but this is still a sector that is not heavily invested in and, currently, the investments are not very liquid.  Could this change as the search for more ‘alt’ sectors continues?

Hotels

Whilst this sector is relatively established in the UK, it is still considered an ‘alt’ investment in real estate terms.  In the UK, operators have tended to take full repairing and insuring long leases and it is a sector that could still have some room for growth going forwards, post lockdown.  

Build to Rent / Co-Living

The UK market in this sector is far less developed and sophisticated than the Multifamily market in the US, meaning that there is some way to go before this becomes saturated.  The growth in investment in this sector is likely to be huge over the next decade due to the UK’s population continuing to expand, housebuilding failing to meet demand and the divide between earnings and house prices meaning that many who aspire to buy homes are unable to do so.  UK Pension funds have started to pile into this sector, and I would expect that to continue.

Purpose Built Student Accommodation 

This is an asset class that is relatively routinely invested in by pension funds.  Demand has been affected this year, but the market is expected to recover.  I would question whether this is becoming a saturated market in some areas of the country – although here are still opportunities to enter the market in some pockets UK wide.  

This list is by no means comprehensive but gives some flavour as to where the ‘next big thing’ may come from.  A combination of demographics, the ‘decline’ of some of the traditional investing sectors and changing trends, accelerated by recent events, mean that the ‘Roaring 20’s’ are very likely to herald the rise of the ‘alt’ sectors.  Already private equity is accessing these markets, and institutions are likely to follow suit.  Over the medium term this should lead to yield compression and an increase in capital values for those investors and developers who hop on the wave now and ride it out!  The trick will be to do your research, play to your strengths and pick your wave carefully.  Happy surfing!