One of the special moments of every auction is analysing results from the day. I always start with yield – what has broken the 5% threshold, who bought it and why?
With finance costs at something around 4 to 4.5%, buyers paying better than 5% are leaving themselves very little in the price for any risk premium, and by implication they must consider these purchases will either have immediate growth potential, or that they are firmly in the “widows and orphans” category of long term safe homes for their cash.
At the other end of the spectrum, where finance is not available, the yield paid has to accommodate the notional cost of finance, risk premium and a healthy dose of opportunistic hope value which is likely to take the yield well into double figures.
The ever increasing income risk between the best and worst assets is why the disparity of yields is now probably higher than it has been for at least a decade.
Two themes have come out of my most recent trawl through the 146 sales at our October auction, and setting the filter on the spreadsheet at 5%+ is revealing.
What about an ice cream parlour in Hammersmith?
Lot 7, a freehold entirely let to a chain of Ice Cream shops in Kings Street, Hammersmith sold at 4.1% £1.59m and reflecting £648psft.
Why? The location, opposite Primark and outside of a major shopping centre must be one of the busiest trading positions on a Saturday morning – despite this not being Bond Street. The tenant, Creams, is a franchisee and whilst solid, is hardly a grade A retailer. Having talked to several prospective buyers, who told us they came to the auction just for this lot, the recurring theme was the quality of the tenant was not important, it was the location and the fact that the upper floors had not been converted into residential use. This opportunity to add value helped to drive competition on the day. The rate per square foot left a little margin if change of use to residential could be achieved, although this was not a given.
The new owner meanwhile bought it from his office in Hong Kong and one hopes that it offered him some value as well as a welcome distraction from their shocking street scenes of late. He bought three properties of the 146 sold, all in London and across three sectors. The yields of these purchases were not compelling, but the assets are secure and the income reliable, allowing the buyer some comfort to wait patiently for their returns to improve.
The retail sector is rarely famous for over-delivering to our clients on price, but a portfolio of eight sales mainly in and around London proved that yield can be almost irrelevant. The key is where the inherent value of the asset is tied up by an overriding lease, and essentially, the asset combines both commercial and residential value, and therefore opportunity. This portfolio of mixed use lots around London and the South East sold at an average of 5% net, the lowest yield being 3.1% for lot 2, a fish and chip shop and flat in West Drayton which sold at £430,000.
Whilst one assumes that the buyers will have a plan to drive the yield, with a lease in place the opportunity maybe not be realised straight away, and, if not, like our Hong Kong buyer, they will wait.
The largest lot at the auction sold at £1.7m, 4.4%, which was low yielding and is instantly recognisable as a long term hold.
Lot 43, NCP Motherby Street, Lincoln is an unremarkable 46-space car park, well let on a lease for a further 25 years with fixed annual increases of 2.75%, and a tenant being 50% owned effectively by the Development Bank of Japan. The magic dust was evident and it resulted in quite a bidding battle.
To answer why with this example is easier. It’s long let to a solid tenant and has a simple mechanic to increase the rent annually, such a rare commodity in the private investor market.
Whilst these assets are at the epicentre of our cash rich private investment market, with investors looking to protect their wealth and generate a reliable income, these very attributes work hard against the uncertainty of a high proportion of high street investments. In the absence of mixed use, or the option to create an alternative use, the buyer is solely exposed to the vagaries of a weak occupational market.
The once in a generation change of buying habits and consumer demand, regular negotiations and renegotiations of CVA terms have combined to force the risk premium of these assets to new highs.
The more remarkable fact is, that we have regular buyers for this retail stock as retail makes up 68% of assets sold. Whilst funds and private investors alike are de-risking their portfolios away from retail, provided the price is right, we are still seeing buyer appetite.
The key to understanding these two paradigms of demand is that these private investors are well informed, very experienced and have taken time to build a good spread of risk in their portfolios.
This allows them to take advantage of the low cost of borrowings across their assets and take on risk on an informed basis against a low and typically fixed cost of borrowing that will take them well into the next parliamentary term.
With Brexit around the corner, investors will continue to take opportunity to vote with their cheque books and build portfolios that will take them well beyond an EU trade deal. Real Estate has once again become the long game.
If you would like to get in touch with George, please contact him:
firstname.lastname@example.org or +44 (0)20 7543 6706