Real Estate Research
What's the alternative: five reasons to move away from the mainstream
Investing in alternative property is not a new idea; the composition of the UK property market has always been more than just a commercial trio of offices, retail units and industrial assets.
Investing in alternative property is not a new idea; the composition of the UK property market has always been more than just a commercial trio of offices, retail units and industrial assets. From students to seniors and bowling alleys to bingo halls, exposure to a tenant base outside of the mainstream has never been completely off the radar of institutional investors. This paper makes the case for investing in these assets and outlines five reasons for why investors should look to move away from the mainstream.
Investors have been rewarded by long-term outperformance
Demand for alternative property assets from institutional investors has increased over the last 25 years, with the weighting towards ‘other’ in the IPD Annual Index rising steadily from 1% in 1988 to reach 8% in 2013. Historically, those prepared to take on the additional risk inherent in these assets have been rewarded with outperformance. As illustrated in Figure 1, total returns from the sector have exceeded the market average over three, five and ten years. The absence of any yield impact illustrates how performance has predominately been derived through the market fundamentals of income and rental growth as opposed to a shift in pricing.
The alternative market underperformed the all property benchmark in 2013 (total return: 8.9% v 10.7%) as investor sentiment towards the core sectors improved, overseas capital targeted London assets and the recovery continued in the mainstream occupier markets.This is clearly reflected in the re-pricing of the commercial sectors, where the average equivalent yield ended the year at 6.66%, down from 7.01% at end 20121
We believe that over a medium and long-term horizon alternative properties should outperform once again, particularly on a risk-adjusted basis. Detailed below are five reasons why this dynamic and diverse sector should be on every investor’s radar.
1. Alternatives are not as risky as you think they are
Investing in any property market exposes the purchaser to a range of risks, such as obsolescence, over-renting and illiquidity. Whilst there is additional due diligence required on alternative assets, such as the regulatory requirements of a medical centre or the reputational risk associated with a care home, the fundamental drivers behind this sector make it less risky than it would first appear.
Perhaps of most interest to prospective landlords is the stability of the rental cycle, which is a result of exposure to demographic and social structural forces that make the sector counter or even anti-cyclical. The alternative tenant base is largely composed of GPs, students and care home residents and thus is relatively decoupled from the usual economic drivers that fuel, and reduce, demand for commercial property. In addition, the latest economic cycle has also engendered long-term behavioural changes that have benefitted the sector. For example, in the face of fiscal austerity there has been increased footfall at local leisure attractions and chain restaurants as consumers economised on luxury goods and services. This is illustrated in Figure 3 where rental values did not depreciate to the same extent as recorded in the commercial sectors during the latest downturn.
The ability of the alternative sector’s rental cycle to withstand economic fluctuations ultimately feeds into the stability of investment performance. This can be seen in Figure 2, where the volatility of returns from different groups of alternative assets is lower than those from traditional commercial property. Returns from student accommodation, GP surgeries and care homes all exceed the all property average and are closer to the y axis, providing more consistent – and thus less risky - returns. Whilst the performance histories for the segments are relatively short compared to the core markets, we do not believe this is just a statistical anomaly.
1 Annual Digest 2013’. IPD, 2013
The views and opinions contained herein are those of Eleanor Jukes, Senior Property Research Analyst, Schroders and Nick Barker, Head of Alternatives, Property, Schroders and may notnecessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
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