Not all commercial property funds are the same. We reveal why investors should look beyond the traditional to something more long term

 

Investors pulled £2.8 billion from open-ended commercial property funds last year[i] as the topsy-turvy political environment contributed to the worst year on record for the UK High Street[ii].

As Brexit uncertainties persist and shoppers abandon towns and malls in favour of online alternatives, we have seen significant outflows from those commercial property funds with a reliance on short leases.

It is only fair then that some investors felt there wasn’t much to write home about in the commercial property market. However, venture beyond the High Street and there are long term opportunities still to be had.

Investment in commercial property need not be limited to short leases or indeed tenants based on the High Street. Commercial long income property funds offer an alternative for investors seeking income returns with capital growth prospects.

Long term relationships

The key difference between traditional funds and their long income counterparts, lies in the nature of the leases. Unlike traditional property funds that have average lease lengths of just seven years, by contrast average long income property leases are typically in excess of 20 years. Investors in long leases can be far more certain of their long term income, than those investors in traditional property funds.

The second advantage of investing in a long lease relates to the nature of the tenant and the property. The property is typically of strategic importance to their business and often where revenue is driven. For example, supermarkets and hotels rely entirely on their buildings to interact with customers; should they lose the property then effectively the business goes with it.

In return for providing such long term certainty to tenants, landlords receive regular income which may grow over time since rent rises are agreed at outset and are typically linked to inflation or pre-agreed reviews. Equally important, and under a ‘full repairing and insuring lease’, all costs are typically the responsibility of the leaseholder rather than the landlord.

Meanwhile traditional commercial property funds offer investors far less certainty of income since short leases mean more frequent changes in tenant. At the same time, rent reviews are linked to open market property values. This means that if a lease is near to expiry or a rent review is due at a time when there is less demand for commercial property or a macroeconomic impact – such as on the High Street at present – it will be more challenging for landlords to negotiate rent rises – and could suffer increased void periods or rent reductions.

Consistent income

Long lease commercial property is suited to investors seeking consistent returns for a lower level of risk and volatility. The chart below shows the differences in income streams between a traditional commercial property fund and long lease  fund. The important difference lies in the income streams.

The majority of the traditional property fund’s return is reversionary – that is the present value of the property once the lease has expired. In contrast, the long lease fund derives less of its return from the reversionary value of the underlying property itself since it will be occupied for such long periods. Instead, investors are rewarded with yields of 2.5-6%. Rent reviews typically are linked to inflation or other similar uplifts.

Ultimately the income from long lease property is more consistent and delivered over a longer term (as shown by the blue portion on chart below). Meanwhile, the traditional commercial property funds rely on short term rental income that is subject on renewal to the vagaries of the market (illustrated in red on chart one).

Relatively few managers offer access to long leases but TIME Investments has a proven track record in doing just that. TIME:Commercial Long Income, now in its sixth year and over £450 million in value generated a total return of 4.46% for the 12-month period to 29 February 2020. At a time when traditional commercial property funds were suffering investor exits and poor performance, the long income fund has enjoyed net inflows and continued positive returns, while continuing to add to its property portfolio through acquisitions. The fund has created a portfolio of commercial property made up of discount foodstores, budget hotels, logistic centres, student accommodation and car showrooms.

With so many uncertainties ahead – both political and economic – it might make sense for investors seeking consistent long-term income to consider a long lease commercial income fund.

Shoppers may be turning away from the High Street but there is still life in commercial property away from traditional property funds.

Benefits of investing in commercial long income property:

  • Greater income security through typical lease lengths of 15+ years
  • In contrast, traditional commercial property funds have typical average lease terms of <10 years with many leases expiring in the short term
  • More certain rental growth through regular, non-negotiable inflation linked or fixed rent reviews, while traditional commercial property leases have rent reviews typically linked to open market property values and are subject to negotiation
  • Potential capital growth
  • Relatively low volatility
  • Assets tend to be of strategic importance to the tenants creating the desire for longer leases
  • Low or zero void rates and fully repairing and insuring leases

 

[i] https://www.morningstar.co.uk/uk/news/199021/2019-fund-flows-revealed.aspx

[ii] http://brc.org.uk/news/2019/worst-year-on-record-for-retail/

 

Posted: 06/03/2020 Categories: Income, News, TIME:Commercial Long Income, TIME:Social Long Income