Why the Institutions have an Insatiable Appetite for Pubs
October 1, 2018
Turmoil in the retail market and the UK pensions crisis have shifted institutional property investment to an alternative sector.
Investors have long looked to commercial real estate to provide tangible and secure investment opportunities. In contrast with asset classes such as equities and government bonds, real estate presents asset-backed opportunities to investors, whilst simultaneously providing long-term income streams. The institutions have invested in property for generations for its continuity and security. However, their view of the property market has changed in recent years, largely due to the pensions time-bomb that faces the UK. The World Economic Forum estimates that by 2050, the UK pension savings gap will reach £25 trillion if efforts are not made to increase savings levels. But what can pension funds do to bridge this gap? And what does it have to do with pubs?
Traditionally, investment in commercial property has been spread across three primary sectors; Retail, Office and Industrial. These sectors have been deemed more reliable due to the once abundance of strong covenants and continual consumer demand. Today, these sectors still command the highest transaction volumes, with c.63% of all UK commercial property investment stemming from the Big 3 in 2017 (Property Data). However, in the decade following the financial crisis, investment into so-called alternative property sectors has seen a dramatic surge. Alternatives, which include Leisure, Hotel and Healthcare assets, now represent over a quarter of UK commercial property investment. Institutional investors from both home and abroad are now allocating huge amounts of capital specifically to alternative assets. This comes as the desire for inflation-protecting income increases and some of the more traditional sectors becoming more risky.
Mass Exodus on the High Street
Take retail for example. The online revolution has transformed the way we shop. We no longer need to brace the High Street in order to purchase clothes, furniture, household goods or even pharmaceuticals. Retailers that occupy large high-street units can no longer justify the hefty rents they were paying in times of heavy footfall. Add to this the sheer volume of low-cost online competition and it is no wonder that investors are worried about the future of retail the structure of the market has fundamentally and permanently changed. Conservative investors such as pension funds, do not want to have to worry about their tenant’s ability to pay rent, potential operator CVA’s and the prospect of vacant property. Some of the U.K.’s biggest and most well-known retailers such as House of Fraser and New Look have been closing stores in recent months, and it is a clear reflection of the decline of the retail sector.
Pubs Glorious Pubs
One thing that can’t be bought and enjoyed online, however, is a pint. Good, well-run public houses rarely go out of fashion and that is why successful pubs have typically been successful pubs for hundreds of years. And probably will be for the next hundred. This is a classic example of why investors like leisure property. From a bricks and mortar perspective, these successful pubs come in the form of large, historic, attractive buildings, generally in prominent and strong trading locations. The underlying property value is often very strong, which gives risk-averse, institutional investors comfort.
The lease structures within the public house market can also differ to those of the big 3 property sectors. Changing retail trends, shared office spaces, less desire to be chained to a site, has meant that for the past 40 years, average retail, office and industrial lease lengths have typically been shortening. This can be good news for the tenants as it provides flexibility. But for the landlords it just adds an additional element of risk.
In the pub sector however, it is still common to see 25 year fully repairing and insuring leases. Investors therefore can rely on long-dated income without the hassle of heavy asset management.
Pensions in Peril Inflation Proofing
Not only does the average lease length tend to be longer for pubs, but the leases also often benefit from preferential rent review clauses. Commercial leases typically have rent reviews every 3 to 5 years to make sure that the rent of the property keeps pace with the market. These reviews are ordinarily set to market value which means there is often no uplift at all when there is a downturn.
With many pub leases, however, these rent reviews are subject to increases in-line with either the Retail Price Index (RPI) or the Consumer Price Index (CPI), often with a minimum percentage uplift. In today’s climate where pension liabilities largely outweigh the available funds, these index-linked rent reviews provide institutions with explicit growth and protect their pension deficit from getting even bigger.
This income protection is then combined with a tangible asset which gives investors further comfort when compared to equities and bonds.
What’s in it for Pub Occupiers?
If you are a pub operator owning your own freehold, you may be thinking how does any of this help me?. Pension funds urgent need to protect their income means that they are willing to pay over the odds to secure it. The pub investment market is achieving record yields at present, specifically for index-linked investments, with yields even dipping below 3% (over 30x annual rent) for the very best assets.
We are experiencing demand for pub investments from a whole variety of institutional investors including Aberdeen Standard Investments, Legal & General, AXA Investment Managers, CBRE Global Investors, British Steel Pension Fund, Local Authorities and many more. The demand in the market is unwavering and we are seeing yield compression not just in London but also throughout the regions.
To capitalise on the record prices, many owner-operators of public houses are opting for sale & leasebacks, in which they are signing new long-leases that are intentionally attractive to institutional purchasers, in order to achieve huge capital values for their properties.
The operator, by agreeing to indexed-linked rent reviews, benefits from knowing how the rent will grow in the future, as opposed to experiencing often large, unexpected rental increases via a market value review.
Coffer Corporate Leisure has transacted over £1 billion of pub investments since being founded in 2005. We’ve seen yield compression consistently over that time and almost every buyer of public house investments has seen substantial returns on their initial investment. The pool of buyers is bigger than ever and we expect to see high quality public houses set new price records. This is a market that is here to stay.