After the lull
John Humberstone of Orchard Street discusses recent commercial property investments made for St. James’s Place following the post-referendum lull.
After the surprise result in last year’s referendum, stocks on the FTSE 100 quickly recovered – and then soared. More fundamentally, economic growth didn’t miss a beat, calming fears of a slowdown immediately following the vote to leave the EU. Yet there was an important exception to the rule: the commercial property market.
“Commercial property funds had more than their fair share of headlines, and immediately after the referendum there was huge uncertainty in all property markets,” says John Humberstone of Orchard Street, manager of the St. James’s Place Property fund. “Some of the funds saw hundreds of millions of pounds coming out in a few days and they simply didn’t have the liquidity to deal with that.”
In fact, Humberstone points out, the fundamentals hadn’t changed. Tenants continued to pay their rent and commit to longer-term plans. The sell-off reflected short-term market sentiment rather than deeper fundamentals and was driven by large institutional investors selling big stakes in retail commercial property funds. In contrast, the St. James’s Place Property fund is owned only by individual private investors, and therefore not subject to such bulk transactions, which Humberstone identifies as a crucial differentiating factor.
“I think that has had a big part to play in the huge difference between the outflows of the other commercial property funds and the relatively tiny outflows that St. James’s Place saw,” says Humberstone. “I’m aware of one property fund that had a single £100 million redemption in one day, which is very difficult to manage from a cashflow perspective.”
Yet if it was the period after the referendum that provided the pyrotechnics, it may have been decisions made during the lead-up to the referendum that had the greatest impact on investment outcomes.
“In the period leading up to the referendum, we were really quite cautious on investment, primarily because there was a big uncertainty on the near horizon and the pricing in the market didn’t reflect that,” says Humberstone. “Immediately after the referendum, the property market – like many other investment markets – paused to let the dust settle, and there was very little trading done in the month after the referendum. Since then, however, activity has picked up. Even though it was a quieter year overall in 2016, there was still £50 billion invested in the UK commercial property markets.”
The lull only lasted for the summer. As of September last year, having expressed caution in the run-up to the referendum, Orchard Street found itself in a strong position. In consequence, the fund has invested more than £270 million since the referendum across seven properties that span all the main commercial sectors. One major acquisition was an office in Great Pulteney Street in London’s West End.
“It is an absolutely grade-A specification office, fully let to multiple tenants, and is probably one of the best streets in London at the moment. I think the rental prospects for this property over the medium term are really very good,” says Humberstone. “In addition to that, we bought two retail parks: one in Derby and another in Christchurch in Dorset. Both are fully let to major national retailers and both are dominant in their local catchment area.”
Local dominance is a key quality that Orchard Street looks for in its retail acquisitions – Humberstone argues that there is no point buying a town’s third-best retail park. Moreover, it is retail parks which tend to be the favourite among retailers, because the rents are significantly lower than on the High Street. However, there are two further key approaches Orchard Street employs in its due diligence process.
“What we do when we are analysing these investments is speak to the tenants,” says Humberstone. “Moreover, because we’ve got billions of pounds invested in retail property, we’ve also got very strong relationships with the major retailers, and we’re able to get quite a good line of sight as to where they trade well and where they don’t.”
Occasionally, however, there are opportunities to upgrade the tenants in a retail park. When the fund acquired Junction One Retail Park in Rugby, one part of the site was underutilised and so Orchard Street applied for planning permission to add two new units. One was pre-let to B&M Retail, “to de-risk the project” – as one of the major discount retailers, it is a great generator of footfall. Having now built the units, Orchard Street should be in a position to let them both out in the coming weeks.
Redevelopments, extensions and refurbishments comprise one major part of Orchard Street’s asset management process, but the company also adopts a far more granular approach to focus on day-to-day management.
“Since the referendum, we have done new lettings, lease renewals, and lease re-gears on 575,000 square feet – and that encompasses a total of £7.7 million of rental income,” says Humberstone. “The cumulative effect is very significant indeed, which is why we attach so much importance to asset management work.”
Looking back over 2016 provides a reminder that commercial property can behave very differently from other major asset classes. Over the longer term though, it remains an important diversifier within a portfolio, providing investors with the potential for a steady income stream and some capital appreciation.
Orchard Street is a fund manager for St. James’s Place.
The opinions expressed are those of John Humberstone of Orchard Street as of May 2017 and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.