If investment is the engine of UK property growth and retail is its fifth gear, then out-of-town retail investment has been travelling at warp speed. The sector showed total returns of 23.4% last year against an all-property return of 18%, earning it the top-performer spot in the IPD annual index.
According to CBRE, around £1.3bn of retail parks were bought and sold over the past year. It says the average lot size (£35.9m) and the average capital value (£302 per sq ft) rose by around 20% last year. Rents grew by nearly 6%, providing the sort of income most investors can only dream of.
Prime initial yields for an average rack-rented property hardened to 5.2% – a contraction of nearly half a percentage point. All in all, 2004 was something of a vintage year for retail warehousing investment.
But it is the prospect of further yield compression that is raising a few eyebrows, especially over secondary stock. While some still have faith in growing revenue on secondary, out-of-town retail parks, many fund managers – including Arlington, Henderson and ING – are now stating a preference for open A1 consent parks rather than the less popular bulky consent parks.
Feeding frenzy
Despite this, yields for bulky consent parks are generally the same as those with open A1 consent. So, have some investors got caught up in a feeding frenzy?
There are also question marks over consumer spending. The faltering housing market will undoubtedly slow down the sale of bulky goods. And while the threat of furtherinterest rate rises could not hurt investors – with five-year swap rates already pricing in a rise – this may further derail consumer spending. So, it could be a turbulent ride for retail rents, with forecasts predicting a modest increase of 5.3%.
Without careful selection of stock, investors could get caught out, believes MarkRidley, head of Savills’ Manchester office. “Some rent review settlements are going to be disappointing,” he says. “Retailers are trading, but not particularly well. “It is implied that retail warehousing is going to grow, but some parks have very little growth in them.”
Institutions have remained the dominant players in the market this year. But while many institutions and funds are still underweight in the sector, there is a greater degree of caution over what is being bought.
“People are starting to overpay for stock,” says Mike Dickinson, a director at CBRE. Dickinson is not predicting a dot.com-style bust, but he says: “It is difficult to understand the market when you see strong prices being paid for secondary stock, and I think we are probably going to see retail warehouse returns come into line with the market average.”
Simon Winslow, head of Arlington Asset Management, agrees. The value proposition is still out there for the best bulky goods parks with the best retailers, but he warns: “If these two criteria are not met then I would be very cautious of the bulky goods market.”
Reversionary yield
Winslow says that from a yield in the “low fives”, investors could look at a reversionary yield of at best 5.5-5.75%. “I doubt if this is worth the risk,” says Winslow.
As consumer spending continues to slow, the retail market will cool to a more comfortable 13-14%, says Winslow. “That’s a significant slowing, because we are looking at London offices beginning to match and outperform out-of-town retail over the next five years.”
Even with the most generous forecasts for estimated rental values (ERV), it is difficult to see the value.
Pointing to yields, which have shifted 80 basis points, and ERVs, which have grown around 6%, Andrew Friend, director of property retail warehousing at Henderson Global Investors, says: “These are massive, baffling numbers. We haven’t gone past fair pricing yet for the best stock, but I really do fear for the secondary products because they are much more vulnerable.”
The warning signs are already here, he believes. Twelve months ago, Friend says product was sold within weeks, with bidders lining up to invest. “That’s dwindled in the past three months to one-to-one sales,” he adds, although he admits that most of these are properties in smaller towns, which have less flexible planning regimes.
Some properties have traded quite quickly. “Because of the mispricing on the secondary stock, there has been an element of pass the parcel,” says Friend. “No one wants to be left holding the stock when the music stops.”
Even if investment is nearing the top of the market, last year’s level of activity shows no signs of slowing. Retail warehouses account for nearly a fifth of all capital invested in UK property. Nearly a tenth of the deals were investments of £55m or more.
The sale of Fosse Park in Leicestershire by Pillar Property to REIT Asset Management was undoubtedly the year’s largest at £308m. But there were several others of note, including Fforestfach Retail Park in Swansea, which changed hands from Hammerson to Henderson for £90m – a net initial yield of 3.7%, and an equivalent yield of 4.9%.
This was closely followed at the end of 2004 by the sale of Wycombe Retail Park in High Wycombe to BP Pensions from Thames Water, and Telford Bridge Retail Park’s disposal by LXB Properties to Arlington Investors.
Ian Whittock, head of research and forecasting at ING, remains bullish about the retail warehouse investment market. “Retail warehousing kicks the pants off anything else. There is no value in the bond market.”
Still profits to be made
Whittock places retail warehouse rental growth at 4-5%, and equivalent yields at around 4.5%. “In very crude mathematical terms you are looking at a 9% return,” he says. Most investors have a hurdle rate of return of 5%, so this is more than acceptable.
That is not about to stop anytime soon, says Whittock. Stripping out the bulky goods sector, which he believes could be eroded as the housing market slows, Whittock adds: “We are still riding a structural shift in retailing, and retailers are still much more profitable and efficient at trading from out-of-town locations.”
Pointing to Pillar Properties, Whittock says: “The big specialist funds have pushed up their weighting. They are included in the indices, so that puts pressure on other managers to push their weighting up.”
ING’s current fund target is a 30% weighting for retail warehousing. Whittock says its direct fund is “slightly lower” than this, but like so many funds they are “still chasing product”.
That sentiment is echoed by Fraser Bowen, associate director at Jones Lang LaSalle, who believes there is a case for prime open consent yields to move in further. “The difference between prime open and prime bulky is minimal,” he says, “but we are not saying the bulky sector is going to move out. If anything, some of the real dominant prime open could come in even further.”
That means more deals and even higher prices. So could there be a degree of profit taking? Yes and no. Despite a flurry of activity at the start of last year,
Patrick Knapman, investment partner at Cushman & Wakefield Healey & Baker, believes stock will probably be held more tightly than ever, and foresees yields falling as low as 4.5% this year. “There may well be some profit taking, but if investors do this, the fact that it is not replaceable is weighing on people’s minds.”
As a result, funds will have to “bite the bullet” and look at more mixed-use sites on the edge of towns. “They have liked to compartmentalise their investments, but with planning changes they are going to have to accept this and look at yields of 6.5%.”
Then there is the issue of capital gains tax. Savills’ Ridley points to capital returns of 10% made by some investors. He says: “Many will look at the income they are getting, look at the tax bill they’ll foot and won’t want to sell.”
