January 7, 2013
The news from the weekend that Axa Real Estate is looking to raise around £1bn to invest in buildings with very long leases has resparked the debate into what sort of lease represents the best value for investors and tenants in these uncertain times. The new fund will target commercial properties with minimum twenty year leases even though investors have to pay a premium for such properties and the majority of occupiers don’t want them.
What we do know for certain is that the appetite for long leases (and the concomitant demand for high quality tenants) has grown to such an extent that the market struggles to meet demand. The past year has seen investors from around the world targeting what they perceive to be the best investments in properties such as the headquarters of large corporate, especially in the City of London, datacentres and logistics hubs as well as hospitals, supermarkets, retailers and hotels. Investors are attracted by the longer leases which are more prevalent in the UK in comparison to other European countries as well as the fixed minimum rents associated with UK properties.
Nevertheless, according to a report from IPD, one of the main attractions of investments in long lease property is not to maximise returns, which are comparable across a range of lease lengths, but as a way of protecting capital and income streams. The capital values for long leased properties are now around 22 per cent lower than their 2007 peak, whilst those with standard leases are valued a third lower.
The tensions in the market are evident from the fact that the average lease length has fallen by a factor of three since 1990 to just seven years, according to the researchers while the increase in demand for long lease property combined with a comparative shortfall in supply has fuelled higher prices for these assets.
Even so, such investments only make sense when coupled with secure occupiers. Continuing uncertainty for the long term commercial prospects of the majority of tenants means that the average length of a new lease in the UK is just five years while the market for leases being targeted by the likes of Axa’s 20-year fund represents under five percent of the total market. This means that investors have the dual challenge of finding appropriate properties and appropriate tenants, which has the inevitable effect of adding to the premiums they need to pay.
Of course, long leases create their own particular problems in world that is not only uncertain but fast moving. Rapidly changing businesses may quickly find that their premises are not ideal for the size, location or nature of their organisation so committing to a 20 year lease can restrict the firm’s operation and development. So long leases are not necessarily a good idea for any business that doesn’t expect to be the same size and shape in the long term.
In addition, a report published by the British Council for Offices in conjunction with IPD last summer into the obsolescence of properties, found that very long leases are a primary cause of dilapidation because they actively discourage investment.