As opportunistic investors seek to realise profits from their early-cycle investments, they will require a willing pool of buyers.
There is a much-reported “wall of money”. Buyers are plentiful. But are they the right type of buyer? Could the wrong type of buyer delay the train?
The classic business school text on investing states that before buying anything, you should identify your end buyer. You realise a profit only when you sell well.
The shopping centre market has weathered a harsh credit-crunch winter and raced rapidly into spring. With yield compression of 200bps+ and rental growth starting to emerge, there is now an opportunity for the brave folk who invested in 2010 to 2013 to realise a profit through selling.
Many investment papers written in the past five years use the words “having added value through (delete as appropriate: intensive asset management/construction/letting vacant space), we intend to exit to an institutional investor in an improving market”.
The “institutional investor” is a mythical creature that delivers bountiful profits: a unicorn with deep pockets. The institutional investor is a generic description of the permanent or quasi-permanent capital vehicles that own UK real estate as a long-term investment rather than for short-term capital gain. This grouping would include pension funds, insurers and REITs.
In theory, as the investment cycle evolves, ownership of assets should transition from high-risk investors to entities that are more risk-averse but will accept lower returns.
However, this model has not yet developed in the shopping centre sector. With the exception of the best regional malls, the depth of institutional interest remains thin. Savills reports that institutions have accounted for only 13% of shopping centre acquisitions of less than £100m in 2015.
Does this matter and what does it tell us about the market and the cycle generally?
There has been a strong rally in shopping centre yields over the past 18 months. Other than a general repricing of all real estate assets, the main drivers of this yield compression have been:
• a rapid increase in the availability of debt financing at higher leverage and lower price;
• an increase in the number of bidders for shopping centres;
• burn-off in over-renting as tenants have renegotiated down rents at break, lease expiry or corporate restructuring (genuine or contrived); and
• a resurgent consumer economy that is boosting tenant demand and will deliver rental growth in sustainable locations.
Of these value drivers, the positive change in the debt market has been the most powerful. The availability of high-leverage, cheap debt makes the acquisition of higher-yielding assets compelling. But it is relevant only to leveraged investors; it is irrelevant to most institutional investors, who remain very conservative in their use of leverage.
The increase in the number of bidders reflects the attractive yields and high potential returns offered by shopping centres. Yet almost all these investors seek a 15%+ IRR. Thus, the field of bidders is crowded by opportunistic investors that look similar to one another.
The elimination of over-renting, the increase in tenant demand and the potential for rental growth are property fundamentals, rather than financial factors, that should attract institutional investors. However, shopping centres remain a source of nervousness for many. Savills says that institutional investors are showing more interest in shopping centres, but this has not yet fed into transactional activity.
As such, opportunistic investors seeking to realise profits have to sell to a universe of investors that look much like themselves. This presents challenges. Firstly, no one likes to sell to or buy from their competitors. Secondly, buying a property where much of the value add has been achieved is less appealing to opportunistic investors.
In order to be rewarded fully for the value that has been created, you need an investor that is happy to be less speculative and is willing to pay a premium for a stabilised rental stream. If this buyer does not exist, a seller is unlikely to realise their pricing or return ambitions.
We are transitioning from the early to the mid-point of the investment cycle. Greater appreciation of the fundamentals is likely to see institutional investors re-enter the market, which would prompt further yield compression. Until this happens, pricing is unlikely to evolve further, frustrating sellers but offering a buying opportunity for an institution willing to be the first mover.
Morgan Garfield is managing director at Ellandi
