Factory outlets’ short leases, turnover rents and active management offer institutional investors the chance to make money, argues Matthew Allen
Many UK institutional investors are not familiar with factory outlets. The sector is still immature in terms of occupiers and consumers, but offers attractive portfolio diversification for fund managers.
The outlet centres’ patrons, who are shoppers in search of discounted branded goods, suggest that the sector should be defensive in a recession. But little hard evidence supports this claim, because the market has not been around long enough to weather an economic downturn. The rationale of the retail concept is also based on the growing strength of branded goods.
The sector’s other unique investment characteristics, which complement those of conventional retail property, are its short leases and turnover rents. Income is receivable monthly in arrears, on a turnover basis. So, unlike traditional five-yearly reviewable cashflows, the income at outlet centres is not reversionary. The income receivable by the investor “captures” any growth in rents on a monthly or quarterly basis rather than five-yearly, as with conventional property.
For example, compare two cashflows analysed over a period of 25 years with rental growth of 5% pa. Using the same net present value and target rate of return, a comparable initial yield on a quarterly reviewable cashflow is about 0.5% higher than on a conventional basis.
The short leases outside the Landlord and Tenant Act 1954 are the antithesis of conventional property management. The factory outlet landlord’s objective is to ensure that underperformers make changes to improve sales densities and/or have their lease terminated. In most situations, the tenants are more likely to have their space cut back as a means of improving their pro rata sales figures.
Active partnership
Outlet centre landlords take a more active partnership approach with retailers in respect of the running of individual stores and the centre itself. The management team will typically consist of professionals with retailing and marketing backgrounds rather than real estate experience.
The centres’ patrons, for example, are different from those of traditional out-of-town shopping centres. They will spend, on average, anywhere from an hour to 90 minutes driving to the outlet centre and buy £80-£90 of goods per head, compared with £40-£50 in regional shopping centres, according to DTZ research.
But only limited direct institutional investment opportunities exist, because of the hands-on nature of the developer/ managers of these centres. The main operators have their own source of finance and their objective is to hold and manage the assets. The supply will also be restricted by national planning guidelines and by the dynamics of the occupiers’ market.
Factory outlet shopping centres now make up only about 1.5% of the total shopping centre stock in the UK, rising to 2% by the Millennium, claims DTZ. The demand from retailers or manufacturers is more dependent upon their ability to support an outlet unit (which is, in turn, reliant upon surplus stock and seconds that are generated by nearby stores and factories), and not by market share.
It follows that the tenants will seek the regionally dominant centres and the most influential operators. The major operators, such as BAA McArthurGlen, Freeport Leisure, and MEPC, are able to sign deals with specific tenants for four or five centres across the UK.
Three or four major operator-cum-developers are likely to continue to monopolise the sector. Their specialist management and dominant market share will make it difficult for new entrants.
Investment transactions have been limited to the sale of the Clark’s portfolio in 1996 to MEPC; the recent sale of shares in BAA McArthurGlen’s Cheshire Oaks near Chester, Bridgend and Swindon to consortium; and Hammerson’s recent acquisition of a share of Bicester Village.
But the limited partnership is a workable alternative investment route. The Cheshire Oaks sale offered institutions a chance to make a passive capital commitment through a vehicle in which the specialist manager was a co-investor. There seem likely to be more.
Matthew Allen is an associate director in the investment division of DTZ Debenham Thorpe
