Stability in long leases

Roxane McMeeken writes about the unique benefits of the British commercial real estate market. Despite its miserable weather and notorious cuisine, the UK has long been an attractive destination for European cross-border real estate investors. The opportunities presented by this market are undeniable. For example, longer leases make British real estate a particularly stable investment prospect. However, the UK should be approached with some caution. Potential problems, such as the abolition of the long lease tradition, loom on the horizon. Close Property Investment, a division of the Close Brothers Group, is betting on keen interest in UK real estate from around the world. The London-based firm, which manages Ł600m (E880m), is marketing a new fund of funds spanning a range of niche sectors in the UK to investors internationally. Anthony Wyld, managing director of Close Property, explains the attraction of the British commercial market. “We have longer leases in the UK. The average lasts 16.5 years and many go up to 25 years. This compares to an average of below nine years for the rest of Europe. One retailer is taking a 35-year lease with us.” Mr Wyld says that an investment in a building with a lengthy lease will be very stable, often providing protection over more than one economic cycle. Property fund managers investing in such steady ventures are strong candidates for loans. Gearing allows more money to be invested, potentially increasing profitability, particularly with interest rates at their current low levels. According to Close’s research, rental income can be increased by around 50 per cent through prudent borrowing. Another benefit of the UK market is upward only rent reviews. Uniquely in Europe, British rents never decrease. The UK’s “no break clause” also means that even if tenants decide they no longer want to occupy a building, they must remain guarantor. In these cases the tenant typically sublets the building. In addition, the UK has managed to carry relatively healthy growth throughout the global downturn. Close Property’s favourite UK niches are all in the new Property Investment Portfolio fund:

• Ground rents – investing in the ground on which buildings are constructed
• Specialist residential – buying empty flats in retirement homes
• Commercial property – sourcing shops, offices and industrial units where there is the potential to extend leases, renegotiate service charges, and increase rental income
• Development – investing in budget hotels, specialist care homes and leisure sectors alongside Close Brothers Venture Capital Trust
• Industrial property – acquiring steel framed buildings in business parks let to tenants in service and distribution sectors. Pitfalls to beware But the UK real estate market is not without pitfalls. London is currently suffering from its heavy reliance on dwindling financial services employment and a bulging supply. Nick Tyrrell, director at Deutsche Bank Real Estate, says that while the sharp falls in office take-up in the wake of September 11 were partly reversed in the early spring of 2002, “with the European economy still in limbo, few commentators are projecting a significant pick-up in occupier demand until the final months of 2003 at the earliest.” The British retail sector has been the least scathed by the present macroeconomic weakness and looks attractive on the surface. But Mr Tyrrell warns that “if the macro economy weakens further it will probably be due to a collapse of household confidence, which in turn would clearly impact the retail sector”. Finally, he expects the attractive lease structure in the UK to change “in the next couple of years”, under government pressure for more flexible leases. But even taking these concerns into account, the UK remains an appealing property market compared to the rest of Europe. Real gross domestic product growth last year was 1.6 per cent in Britain, compared to 0.9 in France, 0.2 in Germany and 0.4 in Italy. This year should see 2.5 per cent in the UK, 1.2 in France, 0.6 in Germany and 1.1 in Italy, according to Deutsche Real Estate.