In a volatile world is investing in index linked longer leases too good to be true?

Published May 13, 2020

Alex Price and Rupert Sheldon discuss Fiera Real Estate’s long income strategy and how it has been affected by COVID-19, paying particular attention to:

  • The benefits of investing in real estate assets with a long-term lease.
  • While long income strategies are difficult to execute
  • How long income real estate improves risk-adjusted returns on a diversified portfolio.
  • The current opportunities and the outlook for the remainder of 2020/2021.

Minty Brown: Good afternoon and Welcome to today’s Fiera Real Estate investor webinar. Thank you for attending.

My name is Minty Brown and I am part of the Marketing Team here at Fiera Real Estate. Before I introduce today’s speakers, I would like to just go through some general housekeeping regarding the webinar software and how to use it.

Firstly, today’s webinar is being recorded and your line will be on mute throughout.

A replay will be available 24 hours after the call using the same link you were provided for this call.

The webinar console you are looking at now can be completely customised; you can minimise and move any of the windows you have open and you can submit your questions at any time via the question and answer tab which is located at the bottom of your screen.

As a brief introduction for those of you who are less familiar with us, we are the UK division of Fiera Real Estate, an investment management firm with offices in Canada and the UK that globally manages over 4.4 billion US dollars of commercial real estate through a range of investment funds and accounts. We are the real estate arm of Fiera Capital, a leading global asset management firm with 111billion US dollars of Assets under management.

Here in the UK we operate a vertically integrated business model which has been achieved by backing ten regional property companies. This creates a pan UK platform of partnerships allowing investors to access some of the best deal flow.


On this call with me today, I have two of my colleagues, Alex Price Chief Executive of Fiera Real Estate UK and Rupert Sheldon Fund Manager of the Fiera Real Estate Long Income Fund UK.

After they have finished the presentation, they will try to answer as many of the questions that have been submitted in the time we have available.

So, without further ado, I shall hand over to them.

Alex Price: Hi everyone, this is Alex here. By way of brief introduction, before working in real estate, I served as an officer in the British Army and then worked in the investment banking division of Credit Lyonnais, a French bank. I joined what was then Palmer Capital seventeen years ago, initially creating our real estate investment management business, before becoming Chief Executive in 2008. That’s me, Rupert, over to you.

Rupert Sheldon: Good afternoon everybody, my name is Rupert Sheldon and I head up the core real estate investment management team here at Fiera in the UK. Like Alex, I’ve been here for a number of years, a little over 14 years to be precise, however unlike Alex, I didn’t start my career chasing tanks across Salsbury Plain, but instead learning the ropes in real estate; first in private practice, before moving to what was then Henderson Global Investors and now Fiera.

I’ve been managing open ended real estate funds for more 15 years, and more specifically long income for the past 5. Now back to you Alex to kick things off.

Alex: Thanks Rupes.

A little bit about Fiera: we are a Toronto listed asset management group focused on mid-market strategies across all the main asset classes. The firm is known increasingly for its focus on private alternative solutions, accounting today for around 10% of our AUM. Within the private alternatives group, real estate is one of the key components, and that’s split 2/3 in Canada and 1/3 in the UK.

Fiera is focused on its clients first and foremost, providing them with actively managed strategies run by dedicated and thoughtful investment teams all located in their own markets.

So, let’s talk about the markets to start with. The last decade has provided fantastic return in pretty much every asset class. Real Estate has been no exception driven by quantitative easing, pushing yields down and increasing demand globally, from population requiring somewhere to live and somewhere to work. However, this year, it’s all come to a grinding halt, with the UK commercial real estate valuations down around 2% in March for the quarter but, in reality, they’re probably much lower, but they’re masked by limited amount of transactions that are happening.

Last year we had $17 trillion US dollars of negatively yielding fixed income –investors seemly being forced from risk free return to accepting return free risk. This looks set, though, to get worse in the coming years as over $5trillion of liquidity and government support is injected globally to combat Coronavirus.

If falling yields wasn’t bad enough, there’s an ageing population as well that’s increasing the pension funds liabilities, and in the UK we’re suffering this demographic shift as with everywhere else.

It’s no surprise then that these two factors are conspiring to increase Defined Benefit pension fund deficits – they’re up nearly £10bn in March alone according to the Pension Protection Fund, and nearly 140 billion pounds in total.

Even normal run of the mill investors are starting to get concerned. They’re worrying about where real returns can be achieved if this liquidity leads to inflation.

Well, one answer might be to invest into real estate.


Well in terms of absolute performance, UK property has provided outstanding returns in the last few years relative to other main asset classes. The bar chart here showing you that. This is a £600bn commercial real estate market and a £7trillion residential market, that’s deep and liquid enough for enough for every cycle.

But it’s not just the return, it’s the fact it does this with low correlation to other asset types and a volatility that’s pretty similar to fixed income.

So, you can see why I am personally sold on real estate as a way to match liabilities today, and in the years to come.

The key, though, is to try to find assets within the real estate market that match the ever-lengthening liabilities.  And that’s where I’m hoping Rupert can come back in. Rupert, back to you.

Rupert: Thanks Alex.

So, before we go any further, let’s define what we mean by long income. Well, in the UK, Long Income is considered to be anything over 15 years. With 94% of UK commercial leases at less than 15 years, this is very much the exception rather than the norm. By point of reference, our Fiera Real Estate Long Income Fund, which goes by the catchy acronym FRELIF, currently has a minimum weighted average unexpired lease term of 16.2 years, placing it squarely in the long income space.

This definition of long income needs to be set against the wider market trend which has been moving to shorter leases over the past 30 years.  As can be seen from the chart, in the past 18 years the market has trended down from a little under 10 years to much closer to five and that ignores the many lease breaks that are commonplace within commercial leasing deals today.

As we move through 2020 and the potential ravages of Covid-19, we expect that trend line to continue down below six – a number only previously seen through the GFC years when occupiers sought maximum leasing flexibility for obvious reasons.

So, how in this backdrop of ever shortening leases can landlords secure 15 years plus leases on a consistent basis?  We’ll look into how this can be achieved later on, together with the challenges around execution, however, for the most part, long leased strategies tend to achieve enhanced lease duration via an overweight to Alternative sectors such as hotels, hospitals, car parks, leisure or even care homes.  In short, operating assets where the tenant’s and their activity is bespoke to the building and therefore a long lease offers operating business security and it’s seen by the occupier as an asset.

This is supported by the MSCI Long Income Index where constituent funds have an average exposure, as at March 2020, to these types of operating assets at 47%. This compares to the wider UK market at a little over 10%. The flip side being a lower exposure to traditional assets where lease duration is shorter.  This brings about its own issues which we will consider later….

So, Why Buy Longer Leased Commercial Real Estate?

Well, In recent years the case has become compelling;

Liability matching – where an average pension fund liability duration is give or take 20 years; here in the UK is the principal goal and long income indexed linked real estate can offer a good match, with its 15 plus year duration, as a bond proxy;

Over the life of a lease investment value will normally trend down to a vacant value – broadly on a straight-line basis; it therefore follows that a longer lease dilutes the annual impact of depreciation.  Long duration triple net leases where maintenance and repair obligations rest with the tenant as opposed to the landlord result in minimal capital investment from the landlord during the life of the lease;

This is key – in a low interest rate, low growth market a high degree of income security and minimal cost exposure helps optimise both income and total returns resulting in out-performance – that can be seen in the chart at the top right hand side, particularly during times of volatility such as those seen here in the UK in the last 3-4 years.

By way of comparison and to evidence this point the two charts at the bottom of the slide show the position at income rather than total return levels and as you can see there is an income advantage that can be enjoyed through averaging or smoothing long dated indexed income streams with a low tenant counter party risk or default rate, and low vacancy rates with minimal dilution from capital expenditure. This leads to a higher blended income return over a longer period, and a significantly higher Sharpe ratio as you can see from the bottom right hand chart. SO, on a risk-adjusted basis, long income comes out pretty well.

But not everything can be quite as simple as that, so what are the challenges to execusion?

Well the principle challenger has to be Access to Stock:

As we’ve seen only about 5% of the market offers qualifying stock, i.e. 15 years plus,  due to changing occupier requirements for shorter leases and increased flexibility;

This shrinking asset pool is dwarfed by increasing demand from liability matching investors, a point Alex has already picked up on

Stock levels are dominated by:

  1. i) Pre-let developments;
  2. ii) Sale & leasebacks; and

iii)         Operational assets.

As we’ve already seen, those operational assets make up almost 50% of the Long Income universe. albeit there are inherent risks evidenced by poor rental collection statistics in March where the Government enforced lockdown effectively denied businesses the ability to trade – ULTIMATLY, IF YOU CAN’T TRADE, YOU CAN’T GENERATE REVENUE AND AS WE ARE SEEING NOW, IF YOU’RE NOT GENERATING REVENUE YOU ARE UNLIKELY TO BE PAYING YOUR RENT!  Unlike offices, and we’re all remotely working at the moment, as evidenced by your attendance via laptop at home today, or retail where there’s an online substitute. If you shut down a restaurant or car park for example, there is no substitute to physical trade. Worse still there are long term implications – how many people will flock back to cinemas having discovered the joys of Tiger King or Normal People on Netflix and catch-up TV! Our low relative exposure at Fiera Real Estate to operational assets at around 13% of the portfolio has helped drive high rent collection stats in March and we expect to deliver resilience into our forward-looking income return.

The key to deal flow, is getting access to these specific areas of the market – particularly pre-let developments and sale & leasebacks, and this is where we at Fiera have an edge working closely with our local development partner network, as explained by Minty earlier, where we have first call on all longer leased deals generated, giving us a real and tangible USP.

Moving on, the next key area of risk or challenge is assessing and managing tenant counter party Risk:

Whilst it’s hard to underwrite corporate risk for 15 years+, this is where robust systems and processes come in.  For us this means a three-tier approach to credit underwriting on acquisition via:

  1. i) An independent third-party credit review; and
  2. ii) Both credit committee and investment committee approvals with each committee having independent third-party experts.

Ongoing monitoring and analysis of credit continues on a regular basis throughout the hold period.

This rigour has helped ensure a consistently high occupancy rate and low default rate for the Fiera Fund running at less than 0.45% or 0.1% pa of total portfolio rent over the past five years.

Whilst assessing and monitoring credit risk is front and centre of everything we do in the long income space, this is also supplemented by a focus within our investment strategy on:

  1. i) High grade modern buildings; and also
  2. ii) Strong underlying residual site values which help minimise depreciation and dilute tenant counter party risk should this deteriorate over time.

Finally, in the event of Armageddon, which for us would mean tenant failure, an ability to call on a trusted local asset management network across our 10 real estate businesses around the UK creates another in-built layer of protection.

Finally, Technological Change. We’re all very aware of that in our industries and our market places asset depreciation is accelerated by technological obsolescence which can also compromise ESG credentials – an increasingly important area for everyone;

Acquiring long leased new developments enables an element of future proofing at purchase on both of these key measures.  Close to 50% of our long lease portfolio comprises either sale & leasebacks or forward funding new development schemes sourced and delivered by one of the 10 FRE backed development companies.  This enables early engagement in key areas of design and specification and gives a head start in terms of future proofing at both a technological and ESG level.

I thought I would use an example to illustrate some of these processes that we work through in the long income space just to highlight a real-life situation. So, this is an asset we acquired in Q1 this year, it’s in Birmingham the UK’s second largest city, and in the west midlands conurbation which has the largest population outside of central London. This is a logistics asset, so in the much sought after logistics sector, and as you can see there a very visible, prominent site just along the A38 which connects the city centre to the M6 motorway network. Now the key for us here is the quality and longevity of the income, which you can see is 25 years, so a good covenant. But also the progressive nature of the income; we have an indexation linkage to the five yearly rent review pattern within a range of 2-4%. But supporting that important credit underwriting process we’ve also go the facet of strong residual site value. So because this is such a prominent urban logistics site and would be a great redevelopment potential going forwards we estimated on acquisition around about 65% of investment value was underpinned by the land upon which the building sits, so a really solid underpin, irrespective of whatever building sits on the land itself. Also, over the duration of the lease we have a minimum rental obligation from the tenant, which is almost 200% of the value of the investment at day 1 so we have some really solid fundamentals here. Not surprisingly, this is leading to a pretty attractive average income return over the lease of 7.5% and a terminal IRR of just over 7% which is effectively holding the asset down to a vacant possession value at the end.

So, these are really important parts of our underwrite but hopefully in this example you can see how it plays out in practice.

So, Summary Conclusions:

We’ve seen that long income investing space has outperformed through the cycle on a risk adjusted basis, but what are the key takeaways….

Rental indexation aligns the long income space very well, we believe, in a post COVID and potentially inflationary world – as you can see in the chart on the right-hand side, 78% of our income exposure carries that indexation or fixed uplifts.

A rigorous ongoing credit assessment process is key, and enhanced levels of tenant engagement will also help to maintain a low default rate and strong rental collection, both of which are facets of what we do in the long income space, again as you can see in the table to the right.

Futureproofing by new developments will remain key, and that also serves to get over the functional and technological obsolescence and help drive the ESG initiative. So, all of those things together minimise obsolescence and protect future capital values. Residual values of local asset managers are other key elements that we need to consider.

Finally, the key will always be, in this space; access to market. There is always going to be a challenge in that area so it’s important that you are able to get access to the market through the various channels I’ve explained.

Hopefully that’s a helpful canter through the long income space and what Fiera offers through that part of the market.

Minty, back to you.


Minty: Thank you Rupert and Alex. So, for the next section of the webinar we are going to have a Q&A. As a reminder you can submit your questions at any time via the web console. Please do so via the question and answer tab which is located at the bottom left of your screen. So, onto the questions. The first question we have is for Rupert:


Q: How do you best access stock as the market looks constrained?

A: Thanks Minty. So, I think hopefully as I outlined in the presentation, it is a dwindling asset pool and that isn’t going to change, in fact if anything it’s going to get smaller. So, the key is being at the front end. You’ve got to be there at the delivery channel end, and if you can be there at the deal creation end, whether it’s a development project, a pre-let development project or indeed a sale and leaseback where you’re using your corporate contacts to create deal opportunities. That’s where most of the stock will come. I think I touched on, in the presentation, operational assets. Clearly operational assets will carry meaningful value through the long lease structure but one has to be very careful, and if the COVID experience teaches us anything, it’s if you are going to buy operational assets, try and do so where you’re not in a position where the business is completely disabled by longer term lockdown. But I think the key is having that superior access to market; it’s down to relationships. It’s down to corporate relationships for sale and leasebacks or developer relationships for new pre-let developments. And our 10 Fiera backed Real Estate developers give us that superior access to market.

Minth: Perfect, thank you Rupert. So, the next one is for Alex.


Q: How has COVID affected your strategy for assessing tenant counterparty risk?

A: Thanks Minty. Before I answer that, please can I just offer a quick welcome to, just looking at the attendees, welcome to clients of ours from the UAE, from Kuwait, from Canada, and of course from the UK. It’s great to have you all on this call and thank you for taking the time.

In respect of how we look at counterparties, I think the process of how we underwrite won’t change. For us, that’s a three-stage process where, whenever we look at an asset, an initial independent third party credit review followed by a second stage; an internal committee which has external credit professionals on it and then the third stage; the real estate team looking at the asset. So, that’s not going to change. I also think the monthly way we monitor, we do a monthly traffic light as well as regular Dunn & Bradstreet alerts will remain the same. The kind of process bit isn’t changing very much, and to an extent, the way we engage with tenants isn’t really changing. We talk to ours and meet them face-to-face at least once a year and we talk at least once a quarter regardless of how long their lease is. So that’s not going to change and shouldn’t change. But what I think we have realised is that early and better communication with your customers will identify problems, however strong you think that person is, and however long the lease may be. On top of that, I think you realise that cash generation is important. If they’re not generating cash flow in their business, then they’re not going to be able to continue paying you that rent. And thirdly, as Rupert said, this could be a complete revelation if I’m honest about it, is recognising that if the property is the only access point for your customer to earn revenue then you’ve doubled down on that risk, because not only is your property not going to work for somebody else if the hotel industry is shut, but they’re not going to be able to pay rent.

So I think we’ve all learned that you need to underwrite your customers in a way that ensures they have the cash generation, they have the relationship with you that they can be open and honest, and that they’re not reliant on one source of access to market and to revenue. Minty.

MB: Thank you Alex. There’s another one for you here Rupert.


Q: what will be COVID’s impact on capital values and what is the realistic expectation for returns over the next 12-18 months?

A: Thanks Minty. Well, capital values have been and will continue to be impacted by COVID but disproportionately across the various sub sectors of the market, we feel. Retail is and will continue to bear the brunt, with COVID accelerating the demise of an already troubled sector in that respect. But, as always, there will be winners and losers. Food retail, for example, and value retail we expect to come out on the right side of the line and continue to buck the trend. Traditional high street retail is likely to bear the brunt of the current crisis. Our suspicion is that valuers will probably start to exercise a renewed caution across some of the operational assets where COVID has exposed this overreliance on the asset itself for the business to function and leading to an inability to generate any revenue. So, restaurants, cinemas and others like that may well carry some valuation scars when normality resumes, whatever the new normal looks like. Conversely, industrial and logistics, the more resilient sectors will probably come through in better shape.

Overall, we’ve probably sided with Capital Economics on this. They’re forecasting something in the order of 10% coming off values through the remainder of this year. We think that’s largely going to come off the riskier assets. Buy and large duration income, particularly 20 year plus, if anything there’s going to be a flight to quality. What the last the last few weeks and couple of months has shown us is that the inherent risks of carrying high-risk retail estate and indeed any high-risk asset class. We suspect long duration real estate will be much more resilient with much less valuation movement.

Minty: Perfect, thank you Rupert. So, we have another question. I think it’s best for Alex.


Q: Could you confirm more about the background to your ESG policies at Fiera currently and going forward.

A: Yeah. I think ESG has been an important part of every business and the way we look at it is that we look at each component slightly differently, and forgive me because I’m going to park ‘Governance’ the G, because to my mind that should be a given. That should be an entry level capability, and everybody should be addressing that,and I’m happy to speak about that separately.

But if we look at the environmental side and the social side. I think what’s happened during the course of this quarter hasn’t fundamentally changed the way we look at the environment. Climate change is an issue and we need to build buildings, green buildings, that are more energy efficient, better located requiring less energy for people to get to those buildings. So, for us, the environmental side of what we do hasn’t really changed. I think the social side, though, has changed slightly in the last few months. We’ve seen a huge wave of people have an interest in helping  society get through the Coronavirus. Now, I’m delighted to say that at Fiera Real Estate we have been able to donate Headley Court, which is the former Military of Defence rehabilitation centre. We bought that as it became vacant when the MOD moved, we’ve donated that and the use of that to the NHS for them to use during this coronavirus period. So that helps to deliver the capability, but it also means that for the underlying pension funds that are supporters of our business in the main of the UK, can see that we are being socially responsible. And we need to be. We’ve seen in the last 12 years is the growth in inequality as asset led-inflation has increased. Those who have, maybe leaving those who haven’t behind. That will potentially get worse in the years ahead. So, for us the social impact of what we do, and I could list off other projects that we’re doing in every community where our operating partners operate because they’re long term community participants, I can list off more, but the ‘S’ is something really critical and I think it’s something we want to focus much more on in 2020.

Minty: Okay, thank you Alex. I think we have time for one more question, so, probably back to you Alex.


Q: Can you talk about your view on the office sector? Do you expect a reduction in demand given the possible long-term shift to working from home?

A: What we expect, and actually have expected for some time, is overall a reduction in like-for-like demand in the office sector. We think that because people are becoming more flexible and remotely enabled. And you can see that office utilisation, per employee, has been growing for the last 10-20 years. And, indeed, buildings we’re building are space planned to be able to take 50% more people per area than they were 10 years ago. That’s not to say that we’re expecting more people to be crammed in the office, it’s just that we’ve put the capability of more loos, more lifts, more fire escapes to allow it to happen if that’s what a customer wants. So, I think we will continue to see buildings becoming more efficient in the way that they’re run, and the sector continuing generally to not grow like-for-like as the population and the working population grows. So, we won’t necessarily see a reduction in stock but it wont grow as fast as the workforce grows. What we are going to see, though, is more and more people wanting better and better quality offices. Not just our customers who are paying the rent who want to have offices that are capable of taking on their workforce if they all chose to come to work on the same day, but also people who don’t have to go to the office. So they need to be incentivised to go to the office by being at a place where they want to be, not by being at a place where they feel they have to be. We think that those central amenitised, well-connected, well-serviced office will continue to be the places where people want work and they’ll be close, probably, to where they live. We think urbanisation will continue as a theme and I do realise that business parks have a place, but actually getting everyone off the slip road to the business park makes it pretty difficult to have everyone working there every day. Public transport does allow that. Post Coronavirus we will continue to use public transport as the only environmentally stable way of getting to work. So, in short, offices will continue to grow but not as fast as the workforce, and the drive will be for good, modern, high quality, amenitised buildings.

Minty: Thanks Alex. That’s just about all we have time for today, but I’d just like to thank you once again Alex and Rupert, and thank you all very much for attending. For any further questions, please do not hesitate to contact either Rupert or Alex, whose details were shared at the beginning of the presentation. As a reminder, today’s webinar was recorded. A replay will be available 24 hours after the call using the same link used for this call.

Goodbye and have a good rest of your day.