Out of town retail investment
If investment is the engine of UK property growth and retail its fifth gear, then out of town retail investment is 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. Around £1.3bn parks were transacted over the last year according to CBRE with both the average lot size (£35.9m) and the average capital value (£301.71 / sq ft) rising by around 20% last year. Rents grew nearly 6% providing the sort of income certainty most investors can only dream of. And prime initial yields for an average rack rented property hardened to 5.2% squeezed by nearly half a percentage point. All in all a vintage year for retail warehousing investment.
But it is that prospect of further yield compression that is raising a few eyebrows especially over secondary stock. While some are still extolling the virtues of growing revenue on secondary out of town retail parks, many funds managers including Arlington, Henderson and ING are now stating a strong preference for open A1 consent parks, over the less popular bulky consent parks.
Despite this yields for bulky consent parks are widely the same as those with open A1 consent so have some investors got caught up in the feeding frenzy?
There are also question marks over consumer spending. The faltering housing market will undoubtedly slow down the sale of bulky goods and a shift in the nations perceived wealth. And while the threat of further interest rate rises may not hurt investors – with five year swap rates already pricing in a rise this may further derail consumer spending.
Put together and it could be quite a turbulent ride for retail rents with forecasters predicting a rather modest rise of 5.3%.
Without careful selection of stock some could get caught out believes Mark Ridley, head of Savills Manchester office. “Some rent review settlements are going to be disappointing,” he says, “retailers are trading fine but it not staggeringly well.
“It is implied that retail warehousing is going to grow, but some parks are ex-growth.”
Institutions remain the dominant player in the marketplace this year. But while many institutions and funds are still underweight in the sector there is a greater deal of caution over what is being bought.
“People are starting to overpay for stock,” says Mike Dickinson director at CBRE, “we are probably seeing the danger signs of a strong market look at the dotcom bubble in the stock market that market was overheated.”
Dickinson is not predicting a similar cataclysmic crash with many funds looking to work secondary stock in order to enhance returns. But he adds : “It is difficult to understand 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 propostion 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.” Winslow says from a yield in the “low fives” investors could look at a reversionary yield of at best 5.5-5.75%. Is this worth the risk? “No I doubt it, probably not,” says Winslow.
As consumer spending continues to slow taking its toll on rental growth returns will be nearer a cooler and argueably more comfortable 13-14%, says Winslow. “That’s a significant slowing as we are looking at london and midtown offices begin to match and outperform out of town retial 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 ERV 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 they are much more vunerable,” adds Friend. The warning signs are already he believes. Twelve months ago Friend says product was sold within weeks, with bidders lining up to invest. “That’s dwindled in the last three months to one-on-one sales,” he adds, although he admits most of these are properties in smaller towns with less flexible planning.
Some properties have traded quite quickly says Friend, “because of the mispricing on the secondary stock there has been an element of pass the parcel noone wants to be left holding the stock when the music stops,” he says.
But investment is nearing the top of the market, last year’s activity showed anything but signs of slowing. Retail warehousing account for nearly a fifth of all capital invested in UK property. Nearly a tenth of the market by number of transactions were investments of £55m or more. The sale of Fosse Park, Leicestershire from Pillar Property to REIT Asset Management was undoubtedly the largest in the last year at £308m. But there several others of note including Fforestfach Retail park in Swansea which changing hands from Hammerson to Henderson for £90m reflecting a net intial yield of 3.7%, and an equivalent yield of 4.9%. This was closely followed in the final months of 2004 by transactions including Wycombe Retail park in High Wycombe bought by BP Pensions from Thames Water; and Telford Bridge Retail Park sold 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,” he says with the safest paper delivering a return of 4.95% “and that’s all you get, if interest rates go up a quarter of a percent the yield on a bond is so small a quarter point movement wipes out your return for that year.”
Whittock places retail warehouse rental growth at 4-5%. Equivalent yields at around 4.5%. “in very crude mathematical terms you are looking at 9% return,” he says. Most investors have a hurdle rate of return of 5%, so this return is more than acceptable, Whittock adds.
That is not about to stop anytime soon, believes Whittock. Stripping out the bulky goods sector which he belives 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 and as they are included in the indices 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 is a sentiment echoed by Fraser Bowen, associate director at Jones Lang LaSalle. He believes that 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 that 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 get probably be held more tightly than ever, and forsees that this year yields could get as low as 4.5%. ” There may well be some profit taking but if investors do this the fact that it is not replaceable is weighing on people minds.”
As a result funds will have to “bite the bullet” and look at more mixed use sites a the edge of town, “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%”
PK: Stock is going to be held more tightly yields are hardening 5.5% to 5 this year 4.75 could get 4.5.
Then there is the issue of capital gains tax. Savill’s Ridley points to capital returns of 10% made by some investors. “Many will look at the income they are getting and they will look at the tax bill they will foot and they will be reticent to sell,” he says.
