A generational buying opportunity for investors: How to create value in UK real estate

Why UK Real Estate?

Market Size

• The UK is one of the largest, deepest and most liquid markets in the world with over £700bn of investible commercial real estate and £7trn of residential real estate.

Population

• The UK is the fastest growing and densest population of any major European country bar one, that makes land valuable and drives demand. The population continues to grow at 350,000 people per year yet lack of developable land, strict planning laws and shortage of construction has meant that the the government target of 300,00 new homes per annum has been missed by at least 25% every year for over a decade[1].

Technology

• The UK is home to the world’s third largest online retail market in ecommerce sales, and the already-deep demand has exploded in 2020, with online sales now accounting for 26% of all retail sales[2].
• This growth is moving the retail supply chain away from the traditional high street into warehousing in urban areas becoming the last physical link. Knight Frank forecast a need to grow the 500m sq ft+ warehousing market by another 90m sq ft to meet this demand. [3]
• In the office market, remote working means offices must allow for ‘flexi working’ in the future, with the space they have meeting the needs of an ever more demanding workforce.

Income Yield

• The collapse in yield in 2020 has continued a trend started in 2008 of low return from lower risk assets such as fixed income. Investors are conversely finding liabilities are growing as the population is ageing, creating a widening gap. Whilst in the last decade the yield on real estate has fallen in many sectors, the relative yield gap between real estate and fixed income has grown, which will shrink in the years ahead as investors chase income.

Inflation

• The adoption by central banks of an average future inflation target and the carry forward of the historical undershoot in inflation, means we will see far higher inflation being both allowed and encouraged in the years ahead. Investors will suffer significant negative real returns and real estate will become increasingly attractive as it provides protection against this inflation.

Why 2021?

COVID-19

• The economic effect has begun to dramatically shrink GDP in most economies, although this has been muted by unprecedented global stimulus, well over $10tn which is 3 x GFC and 30X Marshal Plan[4]. The overall result will be higher government borrowing, lower for longer interest rates and an accelerated recovery in the UK in the next few years as it catches up lost GDP.
• The overall effect will be to accelerate change, and what would have taken a decade will happen in 12 months. Changes like increased remote working and more online sales are permanent and consequently some assets have become functionally obsolete almost overnight. At the same time, the reward for creating and owning grade A stabilised assets will increase quickly with lowed rates of return and many of the assets we need to meet these changes don’t exist, such as logistics space.

Brexit:

• Since the UK voted to leave the EU in 2016, the UK has been off the radar for most investors. Over the last few years GBP is down c. 20% versus USD, FTSE is down c. 20% from its peak and London offices have flatlined whilst similar assets in Paris and Frankfurt are up 40% and 70% in USD terms. Relatively speaking the UK looks cheap in today’s market.[5]
• A Free Trade Agreement looks there to be had, and it will require new manufacturing and service related supply chains to be built, creating opportunity from this need, and allowing investors to access these assets at what in year to come will be a historic discount.

Why Develop to Create Value?

• Fiera Real Estate believe development of new logistics, new residential (both for rent and for sale) and, very selectively, some grade A office assets in regional cities is a smarter way to deliver returns through levered income on older asset that may become obsolete.
• Development is addressing a space shortage in certain areas and so these assets can only be developed as they don’t exist today despite the rapidly emerging demand.
• When you are developing new you are also better able to deliver what your customer wants, this is unusual for real estate but at the heart of pretty much every other industry.
• With the effects of climate change likely to be increasingly felt in years ahead, the quality, location and build resilience will not just demand a premium, without these facets being addressed an asset may just be unsaleable.

How to buy income?

• Investors need to find the right level of risk to meet the required return. Not everyone wants or needs higher IRRs, and cashflow will always remain key – whether creating or owning it.
• If you own income in a changing world then the longer leases, with secure cash flows best mitigate the risk of obsolesces, as these are muted through the duration of the lease and the fact that residual site value is a lower component in the discounted cash flow.

Why Fiera Real Estate?

• Fiera operates a part owned UK network of developers embedded in their local communities combined with a REIM platform that selects the best risk adjusted opportunities from the network.
• Fiera has a track record of success in development and adding value has led to attractive financial returns, which has been driven by the underlying culture of attention to social and environmental factors.
• Over £250m of assets in 14 separate transactions have been sold in 2020, all bar one of these exits have been at or above the business plan despite COVID-19.

[1] https://inews.co.uk/news/business/uk-housebuilders-missed-government-target-new-homes-394719

[2] https://www.ons.gov.uk/businessindustryandtrade/retailindustry/timeseries/j4mc/drsi

[3] Knight Frank Market Report, 2019

[4] https://www.mckinsey.com/business-functions/sustainability/our-insights/how-a-post-pandemic-stimulus-can-both-create-jobs-and-help-the-climate#

[5] KPMG, October 2020