Why investors need to look out of the window…
Shortening lease lengths and the diminished security of income that they cause is making property investors look at a whole new raft of data that was once rarely considered.
It already feels like the stuff of myth and legend: commercial buildings let on 25-year leases with five-yearly upward-only rent reviews, all tied up in a package that left the occupier responsible for repairing and insuring the property – and even returning it in the state in which they took it on.
Aside from the specialist requirements of some hospitality operators who are looking to amortise huge capex expenditure, the long lease is increasingly the dodo of the property jungle. In the golden post-war decades when landlords largely held the whip hand, the other myth perpetuated in our industry was that to be in successful in property all you needed to do was understand ‘location, location, location’.
What that meant in practice was understanding where there was scarcity or demand and how that would push up values. The truth has been that landlords for decades have understood little about the economic and demographic landscape surrounding their assets. They didn’t need to: the bond-like nature of property looked after them.
By the end of 1992, 60% by value of the property assets which made up the main Investment Property Databank universe were let on leases which had over 15 years to expiry and a many were let at rents which exceeded the prevalent open market value. By the time we emerged blinking from lockdown in 2023, data from Re-Leased showed that the average office lease length in the UK had dropped by 34% from 52 months in Q1 2019 to 34 months in Q1 2023.
Today, in the core retail sector, if you can get someone to sign a lease for five years there’ll usually be a tenant’s break option in year three. Among the core property sectors, the honourable exception is logistics which can still achieve double-digit lease lengths.
But for most investors faced with portfolios where the weighted average unexpired lease term is shrinking in alarming fashion, how should they prepare themselves for the future?
Well, in property we have never been great at literally ‘looking out of the window’ at what’s happening in the local economic and demographic neighbourhood. If you’re going to be faced with a growing number of assets that need to be relet or repositioned you need to understand the dynamics of the location which may define that process.
It’s fascinating to sit down with a US private equity house and understand just how big a part non-property data now plays in this sector’s assessment of assets. They want to see data about what’s driving a local economy around an asset and what that may mean for real estate demand.
Below is a chart relating to a piece of analysis that we did last year on the trajectory of active UK tech businesses across a sample of locations. The spike in Brighton represented the effect of people moving out of London after the pandemic and setting up on the south coast. It represented 133 new businesses that had started trading and had an implication for the provision of appropriate tech space.
The wider point is that whilst we may all think we’re aboard the ‘good ship UK plc’ and sailing in the same economic direction, we’re most definitely not.
Macro and micro economies across the UK respond in different ways to periods of economic stress and opportunity. The chart below showing the economic vitality trajectory of London, Birmingham and Manchester from 2011-2024 shows the variance across these major cities.
Interestingly, it also illustrates how the c£400bn of fiscal support that the Government provided during the pandemic lockdown did underpin the UK economy. In contrast, when the Russia-Ukraine war escalated and the cost-of-living crisis deepened, no such ‘safety net’ was available and the impact on economic vitality was stark.
This type of analysis shows the ‘economic direction of travel’ of locations, but it gets even more pertinent when you are able to identify the types of businesses that are powering an economy, how they are changing over time and what that means for the relevance of current property and the provision of new space. Many of us may still think of the West Midlands as a cradle of manufacturing but it’s been a decade since it was overtaken by the Entertainment & Leisure sector in terms of the proportion of active businesses.
Looking at assets in terms of location does not seek to replace the essential property metrics which define the commercial operation of our market. Instead, it puts them in a context which helps shape the strategies that can enhance the resilience of an asset and its relevance to the market.
(This article first appeared in the summer 2024 edition of Property Chronicle)