Alternative investment: not on the high street

“I’ve never had an experience like this in my career and I hope never to repeat it… it’s certainly been the most harrowing week of my life.” These are the words recently uttered by Luke Johnson, executive chairman of Patisserie Valerie, upon discovering the listed bakery chain was close to insolvent amid a black hole and suspected fraud. If ever there was a salutary lesson needed about the risks, dangers and challenges of Britain’s high street then this is surely it. Even the covenant of Patisserie Valerie – a former darling of London’s AIM market whose shares soared from 170p at flotation in 2014 to 429.5p before its stock was suspended – cannot necessarily be relied on. While the drama unfolding at Patisserie Valerie may be an extraordinary situation, it has delivered yet another blow to a British high street already reeling from a host of high-profile failures this year, including Toys R US and House of Fraser. The growing sense of gloom is not only manifesting itself on the high street but has been feeding a palpable nervousness about high street investments in commercial auction rooms. “There are fewer buyers [for retail] now and people are naturally nervous so the depth of bidding is different with lots of things selling just above reserve,” observed one regular trader after October’s Allsop and Acuitus sales. [caption id="attachment_950030" align="aligncenter" width="847"] Travis Perkins, Melton Mowbray, sold for £1.4m[/caption] Matthew Oakeshott, chairman of OLIM Property, which regularly sells at auction, says there is no doubt that retail is in a “pretty bad place now”. “Most high streets outside the most prosperous parts of Britain are in terminal decline and rents are collapsing. The penny is now dropping that valuers have not been facing up to reality,” he explains. “Ten years ago we had about 100 shops [in OLIM’s portfolio] and we have cut that down to less than 10. We have been steadily selling most of those shops at auction but it has been getting harder and you have to be very realistic on price to get it away.” Meanwhile, private investors are increasingly looking for alternatives to pure retail assets, particularly those less exposed to the high street and intense online competition. Everything from funeral homes, GP surgeries and vet practices to nursing homes, petrol stations, law firm offices, private schools, public libraries and even golf courses are in hot demand. In teh first half of this year Allsop sold more than £85m of non-retail assets, accounting for about a quarter of its total sales at auction. And competition has been fierce: a portfolio of seven solicitors’ offices in the North West, for example, sold at a keen average yield of 5.95% with a low of 5% – hardly the norm for secondary or tertiary offices in the North West. Let on new 15-year index-linked leases to the 12 partners of an established Lancashire law firm, they ticked all the boxes for private investors looking for a lower risk option to the high street.  Allsop says that, in general, properties occupied by tenants with business models that are perceived to be “internet resilient” are attracting a price premium of about 20% in the auction room. Partner George Walker adds: “We have to be realistic that private investors are not going to be chasing down retail assets for at least the next two to five years and if they can get a bit of internet-resilient, non-retail exposure then they are very keen.” Richard Auterac, chairman of commercial auctioneer Acuitus says assets such as doctors’, dentists’ and veterinary practices are popular as they are often held on long leases with tenants who are generally loathe to move. “A lot of the investors at auction also tend to be doctors, pharmacists and dentists so they often know and understand the underlying business.”  Similarly, properties in the wider healthcare sector, such as health assessment centres or care homes run by local authorities, are in hot demand, particularly as many can be let on 20-year leases with inflation-proof income. Kwik Fit car servicing roadside sites, popular for at least the past decade, also remain highly sought-after. Auterac says Kwik Fit sites have been selling “incredibly well, with yields of sub 5% on them”, largely as many still have at least 10 years left on the lease with fixed uplifts. The trend for looking at alternatives to pure retail was clear at Acuitus’s October sale, when a Travis Perkins trade counter in Melton Mowbray sold for £1.4m, a yield of 4.38%. With nine years unexpired on the lease and no break options, the investment currently produces rental income of £65,000 pa. See also: Investors broaden scope at Acuitus commercial sale Even pubs – a sector that left many a private investor with a terrible hangover in the last financial crisis – are still considered attractive. A pub let on a long lease to a large group, such as Enterprise Inns, in London in a top location could be in the 2% yield territory. Similarly, gastro pubs or country establishments with associated land are also highly desirable as there is the potential for alternative use if the existing tenant fails. These are only a smattering of the types of alternative assets most in demand from investors. PJ Thibault, chairman of CBRE’s small cap team, says “alternative” properties are fast becoming mainstream assets.  “The concept of the ballroom auction room [typically dominated by retail assets] is still a relatively small part of the market compared to the total volume of small lots trading in the market,” he explains. “For us, alternative assets are much more important. Student and leisure property is much bigger than retail, for example.” Last year, CBRE launched Deal Flow, a global online listing platform for all investment property and portfolio sales, in the UK. Thibault says this platform, first used in the US, has resulted in an explosion of interest from overseas investors looking at all types of UK properties. He says it is a positive sign for a market where, apart from a few big deals, overall day-to-day trading had been hugely down. Deals are being transacted online too: Neil Singer, founder of Clicktopurchase, a platform that carries out private treaty and auction transactions online, recently took just eight days to sell a funeral home in Trowbridge, Wiltshire, let to The Co-operative Funeralcare. It sold at the asking price of £255,000, reflecting a net initial yield of 6%. However, deciding to venture into the world of alternative assets is not for the uninitiated. Andrew Groves, head of capital markets at Bidwells, says careful consideration must be made before any investment, even the seemingly bullet-proof doctors’ surgery. “There are a mix of pros and cons to a doctors’ surgery as the leases are often only internal repair and not full repairing leases and sometimes there is little movement for rent reviews,” he explains. “Surgeries leased to local authorities might have a stronger covenant than those leased to three or four individual GPs – the covenant strength of doctors’ surgeries is not always as strong as investor might think.” Groves says these and other specialist use assets could require substantial long-term capital expenditure to keep them fit for purpose or to convert for alternative uses. “If you are buying alternative assets you should really seek advice so you know what you are buying,” he says. “Some investors just see a 15-year lease as a bond-type investment and think it [the end of the lease] is tomorrow’s problem.” He believes the most interesting part of the market currently is properties with mid-term lease lengths of 5-10 years, for example, a Texaco petrol station on a mid-term lease generating a yield of about 6% compared to one on a longer lease at a keener 5%. “The investor does not have to take on very short-term risk, so even with a few bumps in the road in the next two or three years [such as Brexit] you should be carried over that and yet you’re not paying a big price for a long term lease,” says Groves. While most auction room investors are more than sophisticated enough to weigh up any risks, the biggest challenge they are likely to face now as they seek out alternative assets is one of supply. Acuitus’s Auterac says that demand is easily exceeding supply at the moment, particularly for ‘prime properties’, but adds that there is always a market for even the most difficult assets: “I don’t believe there is a sector that won’t sell. At the end of the day it’s about investment grade properties, cash flow and yield and if that stacks up then it will sell.” Alternative routes to accessing the commercial property market It is no secret that it is difficult for the average person to access the commercial property market. PJ Thibault, chairman of CBRE’s small caps team, even goes so far as to liken the industry to a near-impenetrable black cube for those on the outside trying to get in. “The commercial real estate industry has not done a good job of making the market accessible,” he says. “It is pretty difficult for the man in the street to get into commercial real estate and the main reason is because you need quite a lot of cash – you probably have to have at least £1m and how many people have that?” This explains why in recent years there have been a host of initiatives aimed at finding ways for regular punters and smaller investors to access commercial real estate. From club investment deals to crowdfunding opportunities, there are now a wide range of options. Cogress, founded in 2014, is one such platform, offering investors the opportunity to participate in commercial, mixed-use and prime and multi-unit residential development opportunities. “We allow investors to come together, pick and choose property development projects and take an equity stake or provide mezzanine lending,” explains Rachel Stark, investor relations director. Investors can invest from £20,000 upwards in the Cogress platform, which is regulated by the Financial Conduct Authority. It has 7,000 registered users, of which about 10% are actively involved. Cogress carries out all the due diligence on a project before presenting it to the investment club. So far, it has funded 51 developments with a gross development value of more than £1bn, using £170m of equity. Stark says only about one in every 30 projects it assesses are presented to investors. Those that do succeed have about 70% bank debt, with Cogress funding 90% of the balance and the developer making up the difference. Cogress underwrites the projects so a developer with a project that passes muster will secure funding from the platform. However, one downside is that it is an illiquid investment as any return is only generated at the end of the project. Stark says investors are made very aware of this and because of the higher risk profile, Cogress only deals with high-net-worth individuals, defined as someone with an income of £100,000 a year or assets, excluding their principal home, of £250,000 or more. Returns can average from 13-16% on mezzanine debt lending and 15-20% on equity investments. Cogress is far from the only show in town. Rival platforms include Brickvest and Property Partners. Brickvest allows investors to participate in closed club property deals but tends to focus on exceedingly well-heeled investors able to make a minimum investment of $5m-10m to access lucrative institutional-quality transactions. Its rating team is headed by Remi Antonini, the former European head of real estate at Goldman Sachs and Exane BNP Paribas. Brickvest also allows secondary trading of units on its platform, which it claims brings “unprecedented liquidity to a traditional illiquid asset class”. Property Partners, for a one-off 2% fee, allows punters to simply choose a property on its platform and decide how much to invest. It says it has more than 90 investment opportunities across the UK, telling investors: “You can build a portfolio to suit your own criteria and easily diversify across different types of property assets”. These new platforms are jostling for prominence alongside more established and tried-and-tested methods for accessing property indirectly. Clearly, the oldest and most common route to access property is buying shares in a listed company. It is a well-regulated, well-understood and typically liquid market and can provide easy access to companies, such as Landsec or British Land, with a wide range of commercial assets. Another established route is investing in a property unit fund, such as those sponsored by Scottish Widows or Legal & General. Investors can buy units in a fund backed by a variety of property assets, and generally take comfort that the fund is managed by a big, established fund manager. The pitfalls of this type of investment – high management fees and potential liquidity restrictions when redeeming units – are fairly well known, and assuming an investor is comfortable with those restrictions, it is generally a solid investment.  CBRE’s Thibault says there will always be an issue with real estate because of liquidity restrictions but says he believes “robust, well-regulated platforms with big names” provide the safest indirect route for private investors. He is less of a fan of the newer investment platforms, particularly those syndicating investment deals. “Some of the property syndicates set up before the 2008 crisis went pop overnight and the promoters disappeared, leaving thousands of investors out of pocket,” says Thibault. “I would never invest in these collective schemes. When it is all going well it is great, but they can be disastrous.” George Walker at Allsop says platforms such as Brickvest or Property Partners attract different types of investors to those frequenting commercial auction ballrooms. “Our investors get hesitant when they have to give absolute control through to a third party,” he says. “They are sophisticated investors who like to take risk.” Could a pub be a good alternative? “Pubs are a difficult market for private investors. There is a long-term trend of pub closures and pubs have lost about 50% of their beer trade to supermarkets in the past 30 years,” says Tim Martin, founder and chairman of pub operator JD Wetherspoon. “Pubs pay 20% VAT on food sales, while supermarkets pay almost nothing. Pubs pay business rates of about 20 pence a pint and supermarkets pay about 2 pence. This enables supermarkets to subsidise the price of alcoholic drinks. “The biggest investors in pub freeholds – Punch and Enterprise – ran into trouble in the last downturn when tenants defaulted en masse. “The rent review system based on comparables (“what Jamie Oliver paid last year”) means previously profitable pubs and restaurants often become marginal or unprofitable, contributing to widespread CVAs in the industry. “Add to that a significant amount of fraud, as seen in  Wetherspoon’s 10-year legal battle against our former agents Van de Berg and others, I’d have to advise potential investors to proceed with extreme care. It’s probably not a market for the uninitiated.” In 2009, JD Wetherspoon was awarded almost £8m in damages after it successfully argued its former retained agent, Van de Berg & Co, had fraudulently diverted freehold properties to third parties, while recommending Wetherspoon take leases on them, thereby boosting the value. Picture: WestEnd61/REX/Shutterstock This article appears in the November edition of EG’s Property Auction Buyers’ Guide, out on 24 November