“It’s shaping up to be an interesting year – with the election behind us and a stable government in place we believe that some of the uncertainty that has clouded the UK market is likely to lift. The good news is that the majority of investors were rather more worried about the prospects of a Corbyn led government than of the ongoing agonies over BREXIT. So whilst the intricacies of negotiating trade deals have still to play out, Corbyn is a risk that is firmly behind us.
City of London offices are the property sector most exposed to ongoing BREXIT uncertainty, as a result of the preponderance of big international financial services occupiers in the City. But with City office deals often being very big transactions for hundreds of millions of pounds this is not an area of undue concern to small cap property investors.
Whilst the wider UK market is not entirely immune to the ongoing impact of BREXIT this area of the market is far more driven by the domestic economy and in our view this is a good thing for small cap investors.
As we all know the UK commercial property is cyclical and this has been a particularly elongated cycle. It is natural for this to give rise to a degree of caution but at the moment the fundamentals of the market (with perhaps the notable exception of retail) continue to look extremely good. Occupational markets have relatively low levels of supply and healthy demand whilst there is little sign of over heating in the debt markets.
So where do we at Active Value Capital see opportunity this year?
Firstly, we like multi let smaller industrial property particularly where it serves the last mile of retail distribution. Industrial is a sector which has had a strong run but recently we feel some of the hot money has come out of the market. We particularly like older and more secondary property where rents remain at sensible/affordable levels, as we expect to see tenants being displaced from the best schemes and locations where rents have reached eye watering levels. In Q3 2019 we acquired a 190,000 sq ft multi let industrial estate in Hitchin for £11.5m on behalf of private clients. Off rents of c£5/sq ft and a capital value per sq ft of only £62 we believe that such investments will continue to be appealing in 2020.
We also like multi let office buildings in the larger regional cities. Here we see relatively tight supply as a result of poorer quality older stock having been converted to residential, student accommodation and hotels. As in the multi let industrial sector good secondary sits at values less than the cost of building, a dynamic that is very supportive of ongoing investment. Many of the stronger cities like Manchester and Bristol have already seen strong performance, but those in the next tier down for example Sheffield and Cardiff now look attractive, as they have not yet seen the same level of rental growth.
Finally, and possibly surprisingly to some, we are starting to see some interesting opportunities in smaller retail warehouse schemes. This is a sector that has traditionally been dominated by large Property Funds and many of these are starting to reduce their exposure. Investment into retail warehousing requires careful stock picking as there is considerable over renting in the sector with some schemes being 100% over rented! Furthermore, there can often be substantial voids and in many instances there is no demand to reoccupy these units. This being said in those schemes where one can establish tenant demand, with ERVs in the low teens and where there is some form of under pin from alternative use values, we believe there will be some interesting opportunities to buy at yields in the high 7 to 9% range or possibly even higher.
And for leveraged investors, who whilst required to put in substantial equity, there is the opportunity to borrow at exceptionally low rates, providing the prospect of double-digit cash on cash returns. It remains challenging to secure debt for retail, but it is available selectively. Elsewhere there is generally competition to lend, although the banks do not seem to be making the mistakes that they made in the last cycle of lending at excessive LTVs. For the ongoing health of the market this must be a good thing!
If you are interested in accessing the small cap commercial property sector or have opportunities that you think may fulfil our buying criteria please contact David Wise (davidw@activevaluecapital.co.uk) or Philip Bach (philipb@activevaluecapital.co.uk).”