Alternatives is an unfortunate choice of term to describe property sectors as diverse as student accommodation, healthcare and the private rented sector. It implies that these areas are somehow a bit of a marginal, left-field choice. The reality is quite different, as JLL’s second annual survey of these sectors demonstrates. Of the 52 fund and asset managers surveyed, 90% said they were going to expand their investments in these areas, with allocations moving from the current level of 23% to 32% in five years’ time. If this rate of growth is achieved, then alternatives will represent a quarter of all capital markets volumes by 2019.
These figures look quite high, but reflect the presence of private equity and specialist investors in the sample. However, the major institutions – which comprised just under half of respondents – said that they would move from a 9% exposure today to 16% tomorrow, a more significant increase than the overall trend. Given the size of some of these funds, and the five-year timescale, this implies a huge movement of capital into these sectors.
Indeed, based on this prediction, and recent patterns in investment, volumes in these sectors should almost double from £11.2bn today to £20.3bn in 2019 – meaning that in five years’ time, they will represent 25% of capital flows, compared to 20% today. Hopefully, by that time, there will be a new phrase to describe what will then be clearly part of the mainstream.
Our survey also explored why there was so much interest in these sectors – and there were some clear themes that cut across what are actually quite different areas of operation:
- Good Supply / Demand dynamics
- Most of these sectors are characterised by undersupply despite rising demand. The Private Rented Sector (PRS) is perhaps the most obvious, but it applies to other areas such as healthcare and student accommodation. This strongly suggests that pricing will rise over the next few years.
- Given their links to essential needs (health, shelter) these sectors are likely to behave more acyclically than, for example, the office market. Furthermore, while some properties with conventional leasing structures are available, incomes are often indexed or tied to the EBITDA of the occupying business. This adds to the acyclical ‘balancing’ role that can be performed by many of these sectors.
- Higher Returns
- Yields are generally (but not always) higher than for conventional commercial real estate, particularly as competition for prime assets has pushed up capital values significantly. This is particularly attractive for pension funds looking to fund their long-term liabilities, but it also demonstrates the all-pervading search for yield in a world that increasingly appears to be on a lower growth trajectory.
- Increased transaction volumes and the entry of many more experienced overseas investors is helping to prove the increasing maturity of the market. Transactional evidence is building, making markets more transparent.
- Structural / Demographic changes
- Increasing concerns over structural change in sectors such as secondary retail are pushing investors to diversify into other sectors. Also, areas such as healthcare and the PRS are supported by demographic shifts – the ageing population and the growing number of single-person households respectively.
- A stable, long term income stream
- Many assets in this sector are let on very long term leases (sometimes as much as 25 years) – an undoubted advantage given the pressure on lease lengths in some conventional sectors. Meanwhile, the fact that many are indexed to inflation is a benefit for pension or life funds looking to match future liabilities.
Our survey also asked which sectors would prove most attractive (alongside ‘conventional commercial property’ as a control). Our respondents seemed to be indicating that student accommodation, hotels, healthcare and the private rented sector would also see stronger growth than many areas that were hitherto seen as ‘core’.
However, the PRS appeared to polarise respondents the most, with strong enthusiasm for a large increase in investment – but with a large minority saying that they would never invest.
There are still some barriers to overcome – ranging from the need for more data, transparency and liquidity to the lack of expertise among funds, particularly given the greater need to understand the operational businesses compared to, for example, offices. Low yields and competition from private investors are a particular issue for the growth of the PRS. However, when we repeat the exercise again next year, it will become even more evident that these sectors are not alternatives – rather, they are the new mainstream.