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Hosts: Colm Lauder and Andrew Teacher
PropCast host Andrew Teacher grills his former IPD colleague and renowned market analyst Colm Lauder on the future for listed property stocks and private investors.
Lauder, a leading real estate investment banker, debates how real estate’s “operation game” is becoming an increasingly vital part of the mix, and the duo explain why investors need to stop being so obsessed with NAV.
Colm Lauder’s career is firmly rooted in the listed sector. It was during a six year stint at MSCI, then IPD, where he and Andrew Teacher first met and collaborated. Subsequently, Lauder established and ran the real estate practice at Goodbody, the investment bank covering the listed sector in the UK and Ireland. As Teacher puts it, Lauder’s “been crunching data and analysing real estate businesses for 15 years now.” This horizon and perspective mean the pair are uniquely placed to review the state of the real estate market and chart its trajectory.
Lauder says that signifiers of performance are less clear than they used to be. The listed sector used to be seen as a leading indicator of the real estate market, but this is no longer the case. Teacher agrees, saying: “Typically the markets are seen as smelling what’s coming, reacting quickly, and everybody else gets into line… often more quickly than the valuers. But that has flipped on its head.” This gap highlights the market’s quicker reaction to changes, often ahead of formal valuations.
Teacher concludes that there is a fallacy in reliance on periodic net asset valuations of real estate companies. Often such valuations are treated as the only barometer of the health of a real estate company. As he puts it: “The valuation of the businesses might be at X. The markets are saying, ‘Well, actually they’re half X.’”.
Amid conflicting messages between the market and valuations, Lauder says it is more sensible to look at the underlying operational performance, since there have been “considerable turnarounds through improvements in operational levels in larger UK property companies in the last six months”.
Turning to offices in particular, London’s role as a commercial centre is clearly undergoing evolution. Lauder explains: “The office market has evolved so fast that a modern office being built now is almost unrecognisable compared to what’s held in most legacy portfolios.” Modern offices now include amenities like gyms, auditoriums and cafés, as well as bundled services beyond a simple desk and a chair, which significantly change the cost and value dynamics.
Shortening lease lengths, too, are affecting the cost structure of the sector. Teacher says: “When you and I started out, the average lease length was over 10 years. Now, lease lengths have significantly shortened, impacting turnover costs and operational strategies.” This shift has sparked the appearance of “traditional landlords acting like flexible office providers”, including GPE, Landsec and British Land. Meanwhile, more flexible specialists like TOG, Fora and Regus are offering “enterprise products for big corporates”. Lauder agrees that, “landlords are certainly moving to a more operational office model.”
Yet, with shorter leases come more input, lettings and turnover costs, as well as operational costs such as the fit-out in a full-service flexible offering. This means that while headline rents might look attractive in an investor prospectus, the cost of achieving those rents is higher. Lauder cautions that such rents are, “not comparable remotely with historical or legacy rents, because there are big costs cut into them.”
Lauder says that there are challenges for lenders in adapting to a shorter leasing environment: “Banks remain cautious about lending on short-term leases, preferring the security of long-term income streams”. This cautious approach creates an imbalance, with some parts of the industry advancing while others lag.
The importance of operational performance is also true of retail. Companies such as Hammerson may have subdued share values and experienced falling valuations and vacancies in the last few years, but “retail values have broadly stabilised and there are healthy levels of rental growth.” The key point, Lauder says, is that “yields are stable, there’s a good income stream and operationally Hammerson is solid.”
Lauder points to issues that perhaps had exacerbated the decline of some older and secondary retail shopping centres where they had effectively been managed as “a passive property fund”. Teacher agrees: “The property skill sets in a lot of institutions had filtered away. The result was assets being run down over the duration of longer leases.” Unifying the story of the office market and retail for Teacher is “the good assets that can support premium occupiers are recovering. The wrong asset off the beaten track or those that are badly maintained won’t recover.” Lauder observes that the bifurcation in retail is perhaps more acute: “There’s probably a dozen to maybe 15 strong destination-style shopping centres across the UK, which are performing well with low vacancies.”
For Teacher, there are takeaways for real estate owners that are moving to operational models. The paradox is that there is a good story to tell for many listed businesses by exposing their operational excellence. They might, “a) start to claw back some of the value that has drifted in the last 2–3 years and b) be able to reach that holy grail of generalist investors.” Yet, the annual results press release from many listed firms tends to lead with a focus on net asset value. Changing the narrative on firm performance, says Teacher, will involve company boards being more forthcoming about operational performance and find a way to relate a narrative of value and performance that matches reality.
Turning to industrial properties, Teacher suggests that the asset class’s long-promised day of rental growth has arrived after over a decade of waiting. Yet, in spite of the sector piling in, Teacher warns that electrification of fleet presents obsolescence risk for logistics, threatening to “change the dynamic of where assets sit” based on power supply availability. A lack of critical utilities infrastructure to provide capacity and long queues for new connections would mean that greenfield sites are unlikely to lend themselves well to new industrial buildings, as well as data centres. For Lauder, this presents an opportunity for “those landlords that have older sites that are well serviced”. These might include former heavy industrial sites and those that have good proximity to transport termini for road and rail freight, such as those owned by Tritax and Harworth Group.
On the prognosis for residential, Lauder is cautiously optimistic. He sees potential in sectors like multi-family PRS (private rented sector) and student housing, which have shown resilience despite broader market challenges. “Multi-family (or PRS), and the single-family space, have been extremely dynamic,” he says. Teacher argues that “institutional investors with a long-term mindset” are one of the only remaining options to build housing at scale given the large-scale demise of local authorities as housebuilders.
Housing in the UK, as well as in Lauder’s home market of Ireland, remains a key political battleground. Lauder warns of political risks for institutional investors involved in housing delivery amid public misperception that investors are contributing to the problem. In the UK, Lauder fears that politicians may react by introducing rent controls, which could in turn impact investment flows and market stability. To those politicians, Lauder urges a note of caution: “Capital now is so international, but it’s also very fleeting.” The introduction of rent controls in countries such as Scotland, Sweden and the Netherlands had served to “spook investment”. The UK Government would do well to learn from the experiences of introducing rent controls overseas, he argues. Simply put, frighten away investors and the government will have little by way of a solution to the housing crisis.