Rupert Sheldon, Head of Core REIM UK, talks through the main takeaways from our webinar on Long Income Investing.
Welcome to the Fiera Real Estate UK Long Income Webinar. I’m Rupert Sheldon, Manager of the Fiera Real Estate UK Long Income Fund and I’d like to share with you some key observations on this increasingly important segment of the market here in the UK
So Firstly, What do we mean by the term Long Income in UK commercial Real Estate
- Long income is considered to be anything over 15 years;
- With 94% of UK commercial leases at less that 15 years this is the very much the exception rather than the norm;
- By point of reference, our Fiera Real Estate Long Income Fund [FRELIF] currently has a minimum weighted average unexpired lease term of 16.2 years which places it very much in the long income space;
Why Buy Longer Leased Commercial Real Estate
- In recent years the case has become compelling;
- With long income indexed linked real estate offering a good match as a bond proxy;
- Key attributes include a lower level of asset depreciation per annum when spread over a longer term; and
- lower costs of repair and maintenance which rest with the tenant on triple net leases. This, combined with lower vacancy rates, mean less dilution to returns from capital expenditure and cost leakage;
- All of this adds up to stable total returns when measured against the wider market, disproportionately attractive income returns and a resultant higher relative sharp ratio – a universally accepted measure of risk v. return.
SO – HAVING BUILT THE CASE FOR INVESTMENT, WHAT ARE THE KEY CHALLENGES TO EXECUTION?
Challenges to Execution
- Access to Stock:
- As we’ve seen only 5% of the market represents qualifying stock due to changing occupier requirements for shorter leases;
- Managers therefore need to find a way of cracking this code to open up deal flow.
At Fiera Real Estate the solution is to source and execute through our unique platform of 10 regional operating development partners, all of whom are active developers of long income real estate, future proofed in the key areas of technology, sustainability and ESG therefore reducing occupational and functional obsolescence; and
- A second challenge is underwriting Tenant Counter Party Risk over the longer term:
- This is where robust systems and processes come in at Fiera, ensuring a consistently high occupancy rate and low default rate across FRELIF.
- This process is supplemented by an investment strategy focussed on:
- High grade modern buildings; and
- Strong underlying residual site values both of which help minimise depreciation and dilute the effects of any deterioration in tenant quality should this occur over time.
We thought it would be helpful to illustrate how some of these key factors play out with an example of a recent acquisition for FRELIF in Q1 this year…
- Off market sale & leaseback transaction in Birmingham, the UK’s second City with a population of 1.3m;
- The property occupies a prime site in the resilient & favoured logistics sector and benefits from;
- Long duration income, low tenant counter party risk and inflation linked five yearly rent reviews making the asset a perfect liability match;
- The minimum income commitment over the life of the lease is 200% of day one investment value and the cleared site value alone stands at 65% of purchase price.
- These are really sold fundamentals which underpin a strong average income return and IRR for what is essentially a low risk project.
- We’ve seen that long income investing has outperformed through the cycle on a risk adjusted basis.
…So moving forwards what are the key takeaways….
- Rental indexation should align well in a post Covid world where inflation must surely follow – For us 78% of FRELIF is currently hedged should that happen;
- Secondly, rigorous ongoing credit assessment will be key to maintaining low default rates and strong rental collection as seen in the stats to the right.
- Acquiring new developments which are future proofed for both technology and ESG will minimise obsolescence and protect capital values
- Keep an eye out for strong residual site values as these should continue to underpin asset acquisitions.
- But overall, the key will remain gaining access to best in class stock as the investible universe shrinks over time. Fiera’s “secret sauce” of securing consistent deal flow from its 10 part owned regional development partners provides a clear USP.
- And finally….following the fund opening up to third party investment in March, there is unit availability and a strong investment case as we move through the current cycle. We would love to talk to you about investment on behalf of any of your clients