Paul Till, Head of National Business Space at LaSalle Investment Management, talks to Warehouse & Logistics News.
The industrial market has evolved dramatically over the last few decades, with tenants now demanding shorter leases and investment asset managers intensively managing their clients’ portfolios to align with a substantially shorter income profile. Shorter lease terms are not ideal for pension funds or other institutional investors, which typically work to a 30 year plus time horizon, in terms of matching their investment strategy to their payment liabilities, and therefore require delicate handling by the fund and asset managers.
In the 1970’s and 1980’s, a leasing profile typically involved 25 year lease terms with five yearly upward only rent reviews which was aligned to a pension fund’s strategy. In other words, property was a great match for these investors – and it was also regarded as a hedge against inflation.
With shorter leases, fund managers need to focus on the key fundamentals that make an investment worthwhile and acquire buildings that encourage tenant stability, keeping them beyond break and expiry, thus stabilising investor clients’ cash-flows so they have as few holes in them as possible.
The success of a portfolio is now monitored by performance benchmarking, which would typically compare an investment manager’s performance against an agglomeration of funds or ‘industry averages’. Although these are usually annual, investment managers have been encouraged to ensure that their short term, year on year, performance meets or beats the benchmarks, despite the fact that the clients are seeking to meet medium to long term liabilities. Average performance is no longer good enough – benchmarks are set to be beaten.
It could therefore be regarded as monumentally unhelpful that industrial tenants have meanwhile moved away from long term leasehold commitments. In fast moving and dynamic markets, they crave flexibility to match their business needs and contractual commitments as well as changing and evolving markets and economic circumstances. Typically therefore, tenants will demand break clauses in their leases at five yearly intervals or in some cases even more frequently. During the recession, landlords had little option but to accept the tenants’ requirements. Although industrial buildings receive six months exemption from paying empty rates, landlords would rather have a confirmed tenant during the down turn rather than risk having to pay the contingent losses such as insurance costs, service charges and post six months, empty rates.
The upshot of the above is that the balance of power in the landlord and tenant relationship has shifted towards the tenant. The occupier is king and desperate landlords have had to reach for their cheque books or offer generous rent free inducements to persuade tenants to take space as void levels increased through the recession.
However, a change is coming. As the economic cycle moves into recovery phase, occupational demand is rising and long vacant stock is being re-let. This is set against a backdrop of little new development of any commercial real estate during the recession so availability will become short with more and more requirements chasing fewer and fewer properties, applying upward pressure to rents as demand outstrips supply. It is likely that landlords will start to build speculatively in areas of acute shortage and demand pre-lets for 15 years or more where market supply is short..
A further outcome of the rebalance of the relationship between landlord and tenant will be that leases will start to lengthen, helped by increasing business confidence as entrepreneurial anxiety is replaced by more bullish and confident sentiments. Inflationary pressures have all but subsided so the ‘upward only’ rent review has simply become a mechanism for protecting against the downside.
So what can we do? LaSalle Investment Management’s role sits at the fulcrum between the investor and occupier making us a vital part of the investment process. We think like tenants and buy and refurbish property according to market demand whilst always adopting the following key fundamentals:
• An asset manager is a relationship manager. Gone are the days when a tenant is viewed as a cash cow to be milked for all they’re worth. Landlords need to understand their occupiers by listening to them and engaging with them. This will help landlords provide tenants with a product that meets or, even better, beats their occupational requirements
• Stock selection. We buy property in great locations, whether it be close to motorway junctions or intersections or close to conurbations which generate markets and sales synergies. These properties will always attract huge interest from tenants in the logistics sector
• Obsolescence. Holding back the tide by wise investment, well thought through refurbishment and careful re-positioning of the property versus its competition is second nature at LaSalle. It is something of a cliché but kerbside appeal is important. If an MD or FD (typically both) is undertaking a property search, don’t lose them before they have even got out of their car! The property needs to be clean, tidy, in good decorative order, well sign-posted and well landscaped – in other words tightly managed.
• A happy tenant is a sticky tenant. If a building meets an occupier’s needs they are not going to move when the break opportunity arises or the lease expires. Our asset managers spend at least one day a week on site. They need to be out and about talking but even more importantly, listening to the tenants to find out their intentions, requirements, likes and dislikes. Losing a tenant to a competing scheme is almost a crime at LaSalle!
None of these fundamentals are rocket science but many would be surprised at how many asset and investment managers don’t take the time to visit their stock or do the extensive research required to make an investment work for the institutional investors. Proof of this strategy is provided by our latest review of retention rates, for the industrial sector in 2012. As a house, we retained 67.1% of our tenants at expiry, over double the IPD average for the same year (31%).
LaSalle Investment Management
Tel: 0207 852 4000