By Manish Chande and Martin Myers
A six-point checklist for perfect post-recession investment
After a bumper December, when investors enjoyed a record monthly increase in value of more than 3%, they were brought down to earth in January.
The question for investors — large and small — is whether there will be a rebound in the spring or has “the bubble burst?”
In favour of a more positive outlook is the fact that all cash institutional investors seem to be back in town and are acquisitive. Retail investors shovelled more than £3bn into funds in the last quarter of 2009, presumably looking for a yield and bullish on the back of consistently positive news throughout the autumn.
Also, interest rates continue to be low — five-year swap rates are just above 3% — and lenders now appear to be back in the market, looking at loan to values of 55%-65%.
There still seems to be a relatively good supply of investment stock, particularly in the £15m-£30m bracket, and there are opportunities. Where vacancy rates are 15%-25%, asset managers can increase returns. Indeed, some properties are even offered with surplus land for future development.
Nevertheless, there remains the nagging thought that the country could slip back into recession, the prospect of a hung parliament, a domino danger of European states facing non-viability, January’s dismal retail figures and the threat of zero or even negative rental growth this year.
Accentuate the positives
Despite the negatives, we remain optimistic. When making investment decisions, perhaps the emphasis should be “how much can we lose” rather than “how much can we make?”
In immediate post-recession markets of the last 30 years, the factor that links them all is the opportunity to create a strong, positive yield gap. We can predict that — with the exception of a few special cases — there will be no fresh stock coming out of the ground for at least three years.
As long as buildings are or can be made “best in class”, the uplift in rental values will drive capital growth to recover the replacement cost and beyond. So, for an office building that dominates a local market but is let at £20/sq ft, when the economy grows, rents rise to a level that starts to make office development attractive again, say, £30-plus/sq ft.
The emphasis should be to go back to fundamentals: location and building quality. A significant feature of this post-recession investment market is that, unlike the early 1990s and the dot.com crash, it is possible to buy good buildings at below replacement cost, even assuming the site is thrown in at nominal value.
As a downside, to alleviate risk — and achieve good loan support — borrowing should not be more than 75%-80% of vacant possession value.
Assuming UK plc will recover over the next two to three years, the dual advantage of a high positive yield gap and rents substantially below replacement cost might be an area where investors can make good returns. Carefully selected office, retail and distribution investments can offer good returns with active management opportunities.
Aspiring investors who do not to take advantage of a longer-term upside because of perceived short-term considerations, may lose out. Excuses have been made over the last 12 months as to why advantage was not taken of the market. At this price and this yield, and with these opportunities, we do not need to look to the upside. So what makes a perfect investment?
First, it must be “best in class” in its sector by way of location and construction. Second, it should be valued and the purchase price be at or below replacement cost. Third, some part of the building could be vacant, so leases can be rationalised through asset management. Fourth, it should be capable of 50%-60% leverage. Finally, the buyer should underwrite a four-to-five-year view. Happy hunting!
Article appeared in Property Week 5th March 2010