What we’re seeing and hearing from others is a definite division of appetite away from the middle ground and towards both lower risk and higher risk real estate investments.
Those is the low risk category are wanting long leased properties where there is a healthy premium in yield over the tenant’s bond rate. We recently completed, with our equity partner, the acquisition of the FBI headquarters in Denver, Colorado. With more than fifteen years remaining on the lease and the undoubted covenant of the US Government, the purchase yield provided a very healthy premium over the equivalent US Treasury.
Meanwhile, those with an appetite for higher projected returns are looking at development transactions. Appetite for UK and US residential developments remains high, but we are also seeing increasing enquiries for the industrial and office sectors where very little has been built for the last 5 years or more. Whilst in some markets rents still do not support such new builds, making acquisition of the best of the last generation of properties a wise investment, other markets are seeing rents back to the previous highs as demand outstrips the paltry supply.
The logistics sector is one such market where the continued rapid growth of online retailing is fundamentally changing the quantum of demand for both large distribution warehouses and smaller parcel sorting depots. Similarly, office rents in major cities have returned towards the previous highs, but developers are finding it difficult to secure sites when competing with residential use.
International Islamic capital remains largely focused on the UK, US, Germany and France for the moment, but whilst these markets can of course provide plenty of opportunities, there are other markets including Scandinavia in the north of Europe that I believe currently provide very attractive deals. The tide of capital hasn’t fully swept up through Scandinavia yet, providing interesting pricing if you get in quick.
Whilst currency may be a concern for those venturing outside the core currencies of the dollar, sterling and euro, an increasing number of Islamic banks are now offering Shari’ah compliant hedging products that can eliminate or at least reduce such risk. Speaking of currency, whilst the pound was valued at more than $1.70 as the summer commenced, now falling back towards $1.65 has waylaid some fears that it may continue to rise. Similarly, you would have required 5.5 Malaysian ringgit to buy each pound in July, but now require just over 5.2. I guess we have the low UK inflation environment to thank for that.
Before the UK Government concluded its sovereign sukuk issue I was asked if there would be any negative impact if the Government chose not to issue. Whilst I responded that I didn’t envisage any, since the sukuk, secured on the income from Government properties, was oversubscribed many times over I’ve been trying to observe any positive impact. I’m sure that the UK Islamic banks’ balance sheets have been helped by the issue, but beyond that the positive impact is far more subtle. Maybe we’ll see sukuk issues based on other properties later in the year, but I suspect we may have to wait a little longer.
As the underlying finance rates inevitably start to come off the bottom either later this year or early next, investor thoughts turn to what impact a rising overall cost of finance, i.e. including the margin, will have. Thankfully, at least for investors, is that as economic confidence continues and Islamic banks increase their allocation to real estate finance we have seen the margins continue to fall and have still further to fall before they reach the lows seen in 2007.
All of which brings us to the question of when the next peak of the market will be. I try not to get involved in crystal ball gazing, but it seems to me that we have a good few years left to go, with low inflation, low finance rates and bank regulation keeping the lid on over exuberance. However, as we do with all the real estate transactions we undertake, we always ask the same question: How are we going to add value to this property? Sometimes it can be as simple as buying in a rising rental market, or as relatively complicated as getting planning and building the bricks and mortar itself, but when investors stop asking this question and simply buy to “go with the flow” is when trouble starts to happen.
Wishing you happy investing over the remainder of 2014.
Author Philip Churchill