Hotels and healthcare lead investor appetite for UK alternatives
Lower yields in mainstream real estate markets are driving investors towards alternative sectors such as hotels and healthcare, according to a report by business property adviser Christie & Co.
The report, UK Alternatives Investment Index H1 2019, suggests investors are attracted by the security of commercial real estate and returns which remain in excess of those available from bonds and debt markets.
Darren Bond, managing director – capital markets at Christie & Co, says the compression of yields in mainstream real estate markets, such as retail, offices and industrial, has meant that investors are looking beyond these traditional markets. Some of the alternative subsectors investors are turning to include healthcare, childcare, medical, hotel, licensed, retail and leisure.
“An increasing sophistication of the type of operators and covenants available in the alternative sectors and more attractive returns has also increased appetite,” says Bond. “There have also been challenges in the high street retail sector and this has displaced some traditional investors into the alternatives sector.”
Most investors come from the local domestic market, although there are an increasing number of funds and investors who are now contemplating cross-boundary activity. For instance, there are several UK, French, German and US funds that consider investing across many European markets. Christie & Co has also seen some Asian investors enter the European market, however the activity has not yet reached the anticipated levels.
The most attractive sectors at the moment are hotels and healthcare. “Both have strong investment pedigrees and receive the greatest level of appetite,” explains Bond. “There is a pool of sophisticated investors who have been investing in these markets for many years. The attraction of leases to strong domestic, market-listed or global covenants provides secure income over 25 to 35 year terms.”
The report reveals the average yield on prime investments across UK alternatives as a whole ranged between 3.5 and 7.5 per cent in the first half of the year, although the picture was diverse between sectors. This year’s yields show a marginal compression on recent years as the alternative sector continues to mature. “Whilst London may have peaked in 2017/18, other provincial UK markets have continued to compress as more investors looked outside the capital,” Bond says.
The report also shows there is a shortage of institution-grade stock across most of the subsectors. Bond says the scarcity of land for development in the right locations, along with escalating build costs, has meant that supply has been constrained. This has been partly attributed to the compression of yields as there have been lots of investors chasing limited opportunities.
The supply shortage is expected to evolve over the coming years as the sector becomes more mature and appeals to a wider pool of investors. “Some investors will only consider hotels and healthcare as being ‘mainstream alternative’,” says Bond. “They would avoid looking at pubs and, say, children’s day nurseries, as these markets are less established in the investment space and the markets have different liquidity challenges.”
The maturation of the sector combined with tightening yields is encouraging some investors to take on greater levels of risk.
“If the hotel sector offers a yield of 4.5 to 5.5 per cent, then they are considering looking at the pubs sector, which is typically higher risk, and consider accepting a yield of 5.5 to 6.5 per cent. Again, this is often due to a shortage of supply and yields becoming too aggressive in the more established markets. They will first undertake a period of detailed due diligence on the market and the covenants,” says Bond.
Although there was a reduction in mergers and acquisitions activity in the first quarter, thanks to the political turmoil over Brexit, activity stabilised in the second quarter as investors became more confident in the opportunities presented by alternatives – namely, that some sectors represent good value. Strong economic fundamentals in the UK, reduced vacancy periods, stable income streams and ongoing supply side constraints have encouraged the deployment of both institutional and private capital.
“The UK is still considered to be an attractive market to invest,” concludes Bond. “The cost of borrowing remains at an all-time low and the drop in the value of sterling has made prices more attractive to overseas investors.
“Any potential fallout from Brexit will take a period of time to unravel and, for now, investors still have to place capital. In short, business will continue in the short term. There has been some strengthening in some European markets as a result of Brexit, and the German investment market, for example, has seen continued yield compression as investors seek a market for their capital.”