Retail property in the year ahead should continue to offer investors a reliable source of income....
Retail property in the year ahead should continue to offer investors a reliable source of income.
Last year saw a continuation of the strong performance seen in the commercial property sector since 2011. During those five years, the St. James’s Place Property fund, which is run by Orchard Street Investment Management, has posted consistent double-digit annual returns.
“What we’ve been saying for some time is that property is all about income, and growth in that income, in the sense of rental values growing as tenant demand exceeds the supply of space,” says Philip Gadsden, managing partner at Orchard Street. “Last year was no different, and the next few years should likewise be typical.”
So it was that commercial property produced around 5% of income and rental values grew by around 4% over the course of the year. Primarily regarded as an income asset class, commercial property tends to be assessed in terms of its yield relative to gilts (UK government bonds).
“It’s still in the order of a three or four percentage point premium to that level,” says Gadsden. “In mid-2007, the gap between the two was zero; whereas, in 2009, the gap was at around 6%.”
Today, interest rates are low and are expected to remain low for a good while yet, which is why Gadsden expects income to continue to dominate returns, even though the total returns may be slightly lower. Moreover, as others have noted, this year carries its own particular pressures for the UK commercial property sector.
“Commercial property transactions are slow ahead of the EU membership referendum,” says Ewen Cameron Watt, chief economist at BlackRock.
The buoyancy of the market for commercial rentals is one of the reasons that Orchard Street made just over £450 million of new acquisitions in 2015. One of those was Wellbar Central, a rental space in the north-east.
“We bought a prime property in the middle of Newcastle, multi-let in the normal way that we like to buy things, with rents at around £20 per square foot,” says Gadsden.
“It’s quite hard for other folks to come along and build a new [rival] space when rents are at that sort of level, so we are reasonably well insulated from a supply point of view. It’s a property slap bang in the middle of Newcastle, between the shopping centre and the football ground – and there’s some interesting redevelopment going on nearby.”
The Exchange Buildings in Birmingham was another city-centre purchase that Orchard Street made in the final quarter of 2015. Its primary tenant is Premier Inn, which has a 140-room hotel on the premises, and still has another 22 years on the lease, says Gadsden. Grand Central, a major new shopping centre, opened next door in 2015.
But Orchard Street headed out of the city centre in the fourth quarter too, buying up a portfolio of garden centres scattered up and down England, from Newcastle to Leicester to the south-east.
“The critical elements for us were the length of the lease and the profile of the tenant,” says Gadsden. “These centres had 25-year leases and the tenant was Wyevale, the largest provider of garden centres around the country – the company has 151 stores. Wyevale has around four times more outlets than its next competitor and is owned by Terra Firma, a private equity house. We spent a lot of time analysing the financials of Wyevale and were happy that they could afford to pay their rent.”
Gadsden points out that there is little need for tenants to invest much in garden centres, as the building deterioration rates are low. Rent is reliable and, longer term, Gadsden believes the real estate value could rise significantly.
Well-timed investment and prudent asset management – which sometimes means refurbishing existing properties – can often boost the performance of acquisitions. Thus, having spent around £40 million on acquiring an office building in Old Jewry, in the City of London in 2012, Orchard Street spent a further £2.5 million on a 2014 refurbishment. What had in 2013 been the worst holding in the portfolio was last year’s best performer.
Please note that past performance is not indicative of future performance. The opinions expressed are those of Ewen Cameron Watt of BlackRock and Philip Gadsden of Orchard Street and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
Simon Higginbotham DipPFS Cert CII (MP)
Wealth Manager, Franklyn Financial Management Limited
Senior Partner Practice of St. James’s Place Wealth Management
Tel: 01260 291825 or 07718 753228
The Partner Practice represents only St. James’s Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products. The ‘St. James’s Place Partnership’ and the titles ‘Partner’ and ‘Partner Practice’ are marketing terms used to describe St. James’s Place representatives.