article title

Once the subsector favoured by private equity houses and specialist property companies, alternatives have evolved into a mature market sector, one now highly sought by UK institutional investors.

In 2008, alternative transaction volumes were just £2bn but, last year, alternative deal volumes rose to £17.9bn — a 795% increase over ten years. As an asset class, alternatives now account for 29% of the total market, representing a meteoric rise in just a decade.

So why has the face of balanced property portfolios seen such a fundamental shift towards alternative investment?

Over the last two decades, commercial leases have shortened across most of the traditional commercial sectors. Tenants want more flexibility in a fast-changing world, leading to a rise in serviced offices and co-working space. Even large corporate behemoths are wary of committing to long leases, preferring to opt for the flexibility of shorter leases, so they are better able to adapt to changing business, technological, economic and political headwinds.

“Alternatives tend to be operational assets”

However, alternative assets have bucked this trend and are one of the final bastions available to investors searching for long index-linked income. Alternatives tend to be operational assets — properties from which businesses are run, such as a hotel, care home, or pub — and often require a significant initial outlay from the tenant. So, it is in the occupier’s interest to have the security and protection that comes with longer leases, to safeguard its operation and investment.

Understanding of the tenant’s underlying performance, be it EBITDA or analysing rent cover, is critical to the ongoing sustainability of the income stream. This is because investment committees have become increasingly focussed in this regard and these matrices are cast under a major spotlight.

Having a strong operational asset also lessens covenant risk. An example being, if you have a profitable hotel or pub and the tenant goes into administration, there will be a plethora of similar operators who will step into their shoes. If you have an office tenant that goes bust, it is more troublesome and there are potentially long voids and high capex requirements.

Alternative assets tend to offer index linked or fixed uplifts as the operational side of the business tends to track inflation. The general consensus is that we are late on in the current property cycle, exacerbated by the current economic and market uncertainty that has been brewing since the EU Referendum. In a market where there are so many unknowns, investing in long index-linked income is, in my opinion, an astute strategy.

It is hard to see the occupational markets in the traditional commercial sectors outperforming the Retail Price Index, particularly if we have a harder form of Brexit or ‘no deal’. So, it is little surprise that pension funds have flocked toward this asset class in a bid to maintain a long, secure income stream and minimise void periods.

The market for long index-linked income is likely to continue strengthening, driven by the flood of long-income funds currently being raised. Whilst yields look reasonably low already, it seems likely that these will be compressed further due to increased market competition.

Over the coming months, as we get closer to the Brexit deadline, we anticipate that the market share of alternative investments will only increase.

View our long Income / alternative market update