An Update on things Craigard - The Bizarre Bubble has not Burst
An update from the Craigard frontline as we have turned the half year and sadly the days start to shorten once again.
Most of you will be aware that in April we made a second acquisition for the Craigard Select Model – an industrial building at Tamworth. This represents our single success this year despite an enormous amount of leg work with a dozen or more bids submitted on a variety of assets to suit all risk models – the more conservative Craigard Select, the considered risk and return and the higher risk/reward scenarios. We have been selective with our targets so we have usually been competitive, but unfortunately we have found that there have been buyers so desperate to acquire assets, they have driven the pricing to a level, we no longer consider the deal has much upside remaining ... and we are mindful of an increasing potential downside should over time the currently hot yields move out once again.
Typical is a four-unit retail park at Frome – a nice little piece of modern real estate alongside Sainsbury’s, Homebase and Halfords and perfect for Craigard Select where we are looking to nurture an income stream but protect and hopefully enhance capital without excessive risk taking. Partly over rented and complicated by a soft lease renewal done by the selling institution on an estate with rather unusual upward and downward rent reviews. The income stream therefore had fragility and could reduce at the next reviews. So therefore you would expect a slight discount on pricing, hence the attraction. Given that this was to be a relatively steady and sensible investment, we felt able to drive the required IRR down to about 10-11%, but even then we found ourselves £150,000 off the pace in a distant second place. In respect of the more aggressive plays, we worked on a large site at New Addington which had an old industrial building with a short term lease and medium term redevelopment potential. The initial guide price was about £3.3m and we could convince ourselves to pay £3.6m but the eventual closing price was north of £4m. The most active buyers seem to be mainly High Net Worth individuals and Local Authorities – neither of whom seem to be overly savvy in their analysis. Propco’s such as ourselves, which are generally more measured in their approach, are less able or willing to compete. See the link to the article below which makes fascinating reading:
The market pressure is primarily due to weight of money given low interest rates and lack of returns in shares and cash. This year to date there has seemed insatiable appetite - despite Brexit. And it still seems ongoing despite the unsettling election result as last week we learnt that a multi-let estate in Gloucester has gone under offer at 6.5% (long term median pricing probably c.7.5%). In the last week or two there has been a stream of distinctly average industrial asset sales launched and still at punchy numbers - a particularly popular asset class the depth of which will be tested. There is a little more headroom in the office sector (particularly where the income stream is tender or cap ex is required) and retail seems less popular - although the auction houses seem ever busy.
This is all whilst tenant demand remains distinctly patchy due to Brexit and political uncertainties. Craigard syndicates have only modest exposure to vacant property but in all scenarios we are not seeing many enquiries – space in the broader market is still shifting, but it is very selective and driven by those who need to move due to lease events or downsizing/up sizing. The space we have on offer is all competitively priced and fundamentally good product – but demand is not anywhere near levels we saw pre-referendum. Conventional town centre retail seems a particularly downbeat market just now.
So the bizarre bubble continues for now.
Our appraisals are now therefore reflecting a longer void period and whereas 12 months ago we certainly expected rental growth to be coming through, that is probably now less immediate. We also feel we should maintain a requirement for a minimum 10% IRR for steady stock (the market generally seems content to come down to 7-8%) and mid to high teens for riskier deals. You will see from the attached article from Property Week that The Bank of England agree with us! Market commentary suggests that property is only 10% over valued, which would still be significantly less than equities. That may be the case on historical analysis but the current driver of low yields are low interest rates and weight of money - not property fundamentals. Further market-driven yield compression seems inconceivable (as opposed to creative asset management) so income yield remains a key defensive ingredient to whatever we buy until confidence and the elusive rental growth comes through to add the further value.
Positives are that the stock of available warehouses/industrial premises remain historically very low. Supply of office space seems to be increasing slowly, albeit not dramatically. We still feel reasonably confident that as soon as we turn the corner from all the current economic uncertainties, tenant demand will recover and it is then going to be very much a landlord’s market - and potentially quite quickly. Interest rates are likely to stay low for some time so there is unlikely to be forced selling as in 2007/8.
So the message from us here at Craigard is that we are still actively in the marketplace, but equally we are cautious not to chase prices currently being paid if that might lead to an undue risk of a future market correction wiping out significant value. It has to be acknowledged that there are no longer any bargains out there but we do expect to find assets with credible business plans. Purchases will be fewer and further between than we have been able to deliver in recent years - but we are confident workable assets will be identified with a patient and considered approach. We remain positive about underlying fundamentals in our market if you look through the froth - we are just slightly more conservative on our modelling. We have three possibilities under evaluation at the moment - a single long let industrial in Tewkesbury, a short lease office situation in Cheltenham and a long leasehold industrial asset in Basingstoke. But we shall see where the bidding takes us and whether these assets can be bought sensibly.
Those invested with us will be aware that there is a lot of activity on the existing portfolio. Much of that is very positive, albeit there are a couple of tricky situations due tenant defaults/lease events.
More to follow - and having sent a cautionary note deals will probably now follow like London buses!