At one point a glut of funds hit the market as supermarkets, of which there are no shortage, proved the ideal partners for such arrangements.
Wright says: “Supermarkets are happy to sign up for [long lease deals] as RPI comes into what they are doing; they like an RPI-linked lease and they expect to be in the premises they use for 20 years at a time. They were happy to release properties into the market and the first few funds were heavy investors in those.”
Yet, excusing the pun, the shelf-life of these opportunities is shortening and fund managers need to be more inventive to find the next generation of long lease partnerships.
Wright says: “You can’t keep buying supermarkets now because the return is starting to get a bit low so fund managers need to think about broader areas to keep yield at the right level.”
M&G Investments is one of the largest players in the long lease field and has built up a secured property portfolio – an alternative name for long lease – comprising 34 properties, with total assets of £1.48bn as at 31 May 2013. In March the company struck a deal with developer be:here, a subsidiary of Willmott Dixon, and housing association Poplar HARCA, to fund the development of 233 residential units in east London. M&G acquired a 250-year leasehold interest in return for providing the development funding. Completion of the development will begin with a 30-year lease to Poplar HARCA, at an initial rent of £2,639,813, with annual rent reviews linked to inflation.
This was followed by a further announcement in June, which saw M&G tie in with Swansea University to finance the construction of new student accommodation. The manager acquired a long leasehold interest providing it with a 45-year rental income, linked to inflation. The fund manager was also behind funding for a Premier Inn at Gatwick Airport.
Ben Jones, manager of the M&G secured property income fund, says that in spite of the flurry of announcements, these kinds of opportunity are few and far between.
“I wouldn’t say they are abundant – like any assets offering good value they are difficult to source,” he says. Jones attributes M&G’s size and its length of time in the game as key factors in its ability to find new long lease deals.
“Big areas of success lie in using development funding capability. We are looking at opportunities where there are developers with sites attractive to potential tenants prepared to enter into the lease arrangements that we are after,” Jones says.
Super tenants
Attractive, or financially sound, tenants are of paramount importance to the success of long lease arrangements. The whole premise of long lease is the tenants’ ability to not only pay their rent but keep on increasing it year after year. Any default and income streams dry up and properties could even stand empty.
Blackrock’s Sperber says: “Covenant strength is absolutely critical. You need to protect [the investment]; you want to be sure that the credit isn’t going to go bad so we spend a lot of time with other parts of our business, including our equities groups and our fixed income and credit groups, looking at the credit worthiness of the covenants.”
The same is true at M&G where Jones, who has a credit background, taps into the resources available within the wider fund management group.
“We are not going to enter into a contract if we don’t think the tenant is going to be able to pay the rent for 25 years,” he says.
Long future for long lease
Long lease funds have not yet become the default choice as proposed by KPMG last year but they are certainly proving popular. The Pensions Trust’s Adkins says his scheme will continue to make incremental allocations to long lease investments, since they are such a good match for inflation yet offer better terms than traditional index-linked gilts.
“[Long lease] will never be our entire property portfolio but we do like it and if we add to property we add to that rather than the mainstream portfolio. We can’t afford not to hold index-linked gilts but if we can find other assets that do the job then we are quite happy to invest in that way. We would see long lease as one example of an investment that fits that category,” Adkins says.
The Mercer 2013 European Asset Allocation survey reveals a ‘broadly positive’ interest in long lease property funds, compared to respondents’ negative bias to core property allocations. The consultant says: “Given the extent of the monetary stimulus being applied by the world’s major central banks, there remains a desire to introduce a greater degree of inflation sensitivity into portfolios, without accepting the negative real yields available on index-linked government bonds. Investors are therefore increasingly considering income focused (long lease or ground lease) property mandates.”
However, supply will have to meet demand and Sperber says Blackrock already limits its secure income fund to £400m inflows every year.
Investors looking to access the long lease market will have to hope competition continues to grow and that suitable real estate opportunities keep pace.
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