Value creation in a transitional market

Published July 14, 2020

Alex Price, CEO UK, and Chris Button, Head of Value Add REIM UK, discuss how to create value in the low returning world we find ourselves entering,post-Coronavirus and post-Brexit. Some of the focus topics are:

  • The short term drop in property values
  • The benefits of UK real estate
  • The lasting effects of COVID-19 on the industry
  • Tips for a successful value-add strategy
Transcript

Minty Brown: 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.

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.

On this call with me today, I have two of my colleagues, Alex Price Chief Executive of the UK division of and Chris Button, Head of UK Value Add Real Estate.

After they have finished the 20 minutes presentation, they will try to answer as many of the questions that have been submitted in the time we have.

Without further ado, I shall hand over to them.

Alex Price: Good afternoon everybody. I am Alex Price. Before working in the real estate industry, I served as an officer in the British Army and then worked in the investment banking division for Credit Lyonnais, a French bank. I joined what was Palmer Capital seventeen years ago, initially to create our real estate investment management business, before becoming Chief Executive in 2008. Chris, over to you.

Chris Button: Hi, I am Chris Button and I am the Head of Value Add REIM at Fiera Real Estate UK. I have worked with Alex for the last 12 years and prior to that was a director of acquisitions at M&G Real Estate and LaSalle Investment Management. I am a Chartered Surveyor with over 20 years industry experience. Alex.

Alex: Thanks, just to start with Fiera Real Estate. We’re part of Fiera Capital, a Toronto listed asset management group focused on mid-market strategies with $110billion of assets under management across all the main asset classes. The firm is known for its focus on private markets solutions and with nearly £4bn of real estate assets, this is a key part of the Fiera offering, with assets split 2/3 in Canada and 1/3 in the UK.

Fiera is focused on its clients, providing them with actively managed strategies run by dedicated and thoughtful investment teams located in their own markets.   In the UK this is helped by owning 33% stakes in ten of the most active regional private property development companies, which give us access to off market deal ideas and entrepreneurial and aligned management teams.

The last decade, as you can see, has provided great returns in most asset classes if you look at the top left of this slide. Real Estate has been no exception and I would argue it has been in large part driven by the post-2008 Quantitative easing induced falling yields as well as increasing demand globally for somewhere to live and work, over 1 billion new people today than there were in 2008.

The falling yields meant that by the end of 2019 we had $17 trillion of negatively yielding fixed income – investors seemly being forced from risk free return to a return free risk. This year will see yields even lower as McKisey estimate over $10trillion of government support has been injected globally to combat coronavirus, that’s triple the amount post-GFC. The last decade saw asset price inflation running ahead of wage inflation, and only a brave person would bet this will not continue, making real assets the best show in town.

Real Estate does follow these falling yields, as you can see on the bottom left graph from JLL this month. However the scale of the fall is far smaller, and a corresponding increase in the yield gap from owning property over bonds. Property should be at a premium because of the risks, but as you can see bottom right the volatility over the last few years, for property, has made it look much more bond like.

In summary, we may see a fall in property values in 2020 in the short term, but there’s a long-term upward direction of travel over the next few years.

So, if we have talked you into real estate, but let’s discuss why the UK?

Well in with a £500billion investible commercial real estate market and a £7trillion residential market, this is a deep and liquid market for all cycles. It also helped by one of the fastest growing populations in the developed world as you can see top right and one of the densest countries in Europe. Real Estate has strong demand from this growing population but at the same time we’re lacking supply in the UK. In the last decade new office construction is down 45% according to JLL and the UK Government target of 300,000 new residential units per annum has been missed year since the GFC, the closest being about 75% of the target achieved.  Coronavirus this year has further delayed new starts will only make this worse in the coming years helping to drive prices as demand exceeds supply.

If that wasn’t enough opportunity, sterling has fallen by 20% post-BREXIT referendum and UK property has underperformed the rest of Europe by about 10% over the same period (as you can see from the graph at the bottom left). We believe therefore that the market has priced in the uncertainty of Brexit, and once this is dealt with them, we should see a corresponding recovery.

The cynic will say that this is all history and it the future we should worry about. That’s right but as the KPMG June forecast show the UK is going to be hit here and now by Coronavirus, pushing us into an economic recession, which will in turn create short term distress in many sectors. However, the UK should recover much of the lost ground by the end of next year, at which point it will have the advantage of its own currency, a G7 economy and, with a bit of luck, a free trade arrangements in place with most of our trading partners. So two lost years but no real change in the direction of upward travel.

Lenin said “there are decades where nothing happens, and there are weeks where decades happen.”. Today, we are in a world that has more change occurring than anyone in UK Fiera Real Estate team can remember, and we have long memories.

This year, it’s all been about coronavirus and its effect on the economies of the world, with the IMF predicting a global recession. We’re also seeing, though, from coronavirus, the health issues of the pandemic, but the start of acceleration of the technology enabled changes. We’re starting to see technology enabled shifts in our lifestyle.

Working from home is here to stay and will accelerating the need to create offices that people aspire to go to rather than modern day white collar work houses. That’s modern, efficient, well located hubs of creativity and collaboration.

We will also see the continued growth in online sales, Tesco reported seeing doubling of online grocery sales in 2020 alone. This will mean new supply chains, new store formats, being built to reflect this shift.

I also think we will see major manufacturing changes through robotics and 3d printing in the years ahead, meaning cross border transport becomes more relevant than access to cheap labour.

Looking forward at the end of 2020 in the UK, we will have the most fundamental change in our international trading arrangements in a generation as a result of Brexit. I am not convinced this is a good thing for UK economy, but I am convinced it will create a need for completely new supply chains to be built and an opportunity for on-shoring of manufacturing to meet a domestic demand.

Finally, let’s not forget a much more fundamental change of all – that of climate. If hasn’t gone away and will require us to address many of these assets. Some of them need to be relocated, many assets to be improved and all assets to be more resilient.

The result of all this change is that we think strategies that embrace change and can deliver far better risk adjusted returns than the traditional route of levered income or asset management because of income will fall as earnings fall, and obsolesces or depreciation is increasing in a changing world.

Because of the change, we think investors must focus on enabling asset transition to create value, that undertaking fundamental change to the asset not using financial engineering or leverage, as this is just outsourcing the value creation to the market whilst ceding control of your asset to a third party which isn’t smart if you’re uncertain about the business plan or there’s change involved.

We think the best risk adjusted returns will come from development of new asset to meet new needs, from a growing population and shifting technology.

We think re-purposing older and redundant assets to meet these needs is not only going to be financially attractive but will play an important part for society. We also believe that these types of project need boots on the ground, through an aligned local partner.

Before I get Chris to explain in detail what I mean, let me show you a promotional video on one scheme, Finzels Reach, that we have undertaken over the last five years.

I’d like to now put Alex’s themes into context in relation to the sectors we are targeting, together with some examples of projects. To take advantage of our USP we seek to combine the bottom up entrepreneurial approach to deal sourcing and asset management of our Operating Partners with a top down strategic and institutional overlay driven by the factors Alex has outlined.

So, what does this mean we are targeting? Firstly, the development of industrial and logistics assets which have been the best performing subsector for some time and are forecast to continue to experience rental growth as locational and functional obsolescence drives changes in the nature and location of manufacturing and logistics premises. The planning environment is relatively permissive, construction is usually straight forward and the timeframe to delivery is short, allowing an accurate assessment of competition and reduced exposure to construction inflation. Secondly, Grade A office development in regional UK cities where supply is relatively low and demand is forecast to continue to push rents forward, particularly if the pattern of ‘hub and spoke’ or decentralisation continues, or is in fact perhaps accelerated by Covid 19. Finally, whilst there is evidence residential house prices are experiencing downward pressure, we believe that demographic growth will have a positive impact over the medium term. House builders and residential investors are reluctant to take planning risk giving us an opportunity to bridge the gap by buying unconsented sites (but with a strong planning background), obtaining consent and resolving ‘barriers to entry’ like servicing and then selling or forward funding ‘plug and play’ plots to developers and BTR investors.

I’d like to delve a little deeper into the targets for those 3 broad strategies.

For residential single family land, it is sites for 50-350 units, capable of being sold to no more than 1 or 2 housebuilders in single cheque deals. We are not interested in buying long term strategic sites for new settlements. Sites must have a planning history, whether that is a lapsed consent, brownfield land or an allocation in a completed or emerging local plan. They must also be capable of a 2-4 year business plan so we can deliver investors an attractive return and we can measure supply and competition. An area we are increasingly targeting is the BTR sector where there is significant investor demand for product that we can help in delivering by buying sites unconditionally, obtaining planning consent, lining up a building contractor and then delivering on a forward funded basis. Generally our return requirements are 1.5 to 2x equity multiples for both strategies

For industrial and logistics are seeking sites on arterial routes on the edges of settlements or urban areas for schemes of 50,000 sqft to 250,00- sqft in units of 5,000-75,000 sqft. We are not seeking to compete with ‘big box’ developers/investors who can offer occupiers national or international logistics solutions. We will develop on a speculative basis as our track record tells us that occupiers for this size range want to see a spade in the ground before committing to leasing a unit and generally with 100% equity. We have found that due to investor demand for industrial assets, we will invariably be approached to sell the assets on a forward commitment basis with the purchaser taking occupational risk to achieve a modest discount in price.

For offices, it is all about developing best in class assets, preferably new and, if not, comprehensive Grade A refurbishments. Regional city centre locations, good transport links and amenity and technologically enabled buildings to suit current and future tenant requirements. We found post the GFC and during recent more turbulent times that these assets are the most liquid when tenants have choice and therefore offer investors the best risk reward returns. We also have a great track record in working with corporate owner occupiers to maximise their assets, reduce their liabilities and release value for their shareholders.

Of unquestionable importance in undertaking value add strategies is the underwriting, the risk mitigation and how assets are managed during their business plans.

At Fiera Real Estate we are fortunate to have 10 regional operating partners to joint venture our projects and the importance of that ‘boots on the ground’ presence is demonstrated by the positive impact on risk mitigation by our partnership.

For example, prior to acquisition we will undertake pre-application meetings with local planning authorities, employ political consultants who will understand local issues and pressures which may impact the planning process. We will employ locally based architects, engineers, highways consultants, cost and environmental consultants and occupational and investment agents to enable us to have a clear view as to the veracity of our business plan. Our joint ventures ensure all parties are aligned through co-investment and success-based incentive payments.

This approach, combining regional operating partner knowledge and expertise with the institutional investment management framework allows us to successfully investor our clients’ monies into a value-add strategy which can provide attractive returns with a controlled risk exposure.

I’d like to bring these thoughts to life by giving a brief summary of two recent realised projects within our value add funds that we have undertaken together with our operating partners.

The first is an office development in Bristol on a half-acre site which was acquired with the benefit of outline planning consent and is party to the successful 5-acre Finzels Reach regeneration at the former courage brewery, as set out in the video shown before. Once acquired, we obtained detailed planning consent focusing on clean, 150,000 sq ft floor plates, a substantial roof terrace and sector-needing environmental and technological credentials including a WiredScore Platinum rating, BREEAM Outstanding and Lead Gold Standard ratings. Our approach was rewarded with 85% of the accommodation being pre-let to professional and technology-based firms. We sold the asset to a UK institution at a market leading price during Q4 2019 achieving an IRR of close to 70% and an equity multiple of 2.3x.

The second example is in the residential sector where we acquired a 20 acre site which was allocated for residential use and formed part of the Forgewood allocation for a new district of Crawley ,in the Crawley local plan. However, housebuilders were unwilling to bid on the site without actually having a planning consent even though there was an allocation. This was particularly due to lack of clarity on access arrangements. We acquired the site unconditionally in Q4 2018. We obtained consent for 185 residential units and sold to a national housebuilder earlier this year at a number representing 37% IRR and 1.8x equity multiple within a 2 year period.

And now let’s hand over to Alex to sum up the presentation.

Alex: Well, I am hoping that this gives you some ideas for creating value in the low returning world we find ourselves entering.

Before you buy assets, factor in the increasing risks of deprecation, both in absolute terms as building life cycles shorten and as a percentage of a low level of income. Think about the asset types carefully, make sure they are underpinned by fundamentals and can create something fit for the future not the past.

Ensure your business plan, where planning, development or re-purposing, is a pathway based on adding asset value and effecting a transition that creates something positive for its local community, not on using leverage to replace missing capital or a bet on accelerating upward returns

Finally execute with a combination of a top down strategic vision with institutional process alongside local management knowledge and flair.

If you want to take away three things from today:

  1. Population and asset price inflation will ensure property performs well in the years ahead.
  2. As Retail becomes an alternative assets type, Residential will become mainstream and every investor needs to access the market, whether through land trading, multi family housing or single family housing
  3. The ability to create value through transitioning assets is critical and that’s what you should base your strategy on in the years ahead.

Bill Gates when talking about technology said “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten”.

Remember, Real Estate is a long-term asset class.

Minty: Thank you once again Alex and Chris and thank you all for attending. For any further questions please contact Chris or Alex, whose details were shown on the first page.

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