Commentary Papers
March 2023
Ribston: a further two and half years in the life (August 2020 – March 2023)
-
Our last paper was published in July 2020 so how might we describe the subsequent two and a half years?!
On one level, we’d say it was very similar to any other two year period since Ribston launched: never a dull moment! RPUT’s life to date has co-existed with the voting on and subsequent approval of Brexit; the arrival of Covid and all that went with it; turbulent UK politics (three Prime Ministers to date); the death of the Monarch; and Russia’s invasion of Ukraine – all big life events and a benign and regular year has yet to be experienced by Ribston. Perhaps there is no such thing as a benign and regular year, but the particular scale of recent global and UK events will no doubt enter historical records as ‘biggies’ to be studied for years to come.
Amongst all of this macro level chaos, UK industrial property charged on, ostensibly immune to any of the seismic events the world had to offer. The occupational market proved relatively indestructible throughout all of the global and UK turmoil. It strengthened never mind proved resilient as supply chains responded to the new world, perhaps shifting permanently so. Only now are there signs of any slowing in the rate of rental growth, albeit the direction remains positive.
The capital market operated at fever-pitch where the presumed baked-in nature of further and ever greater rates of growth played a large part in driving yields down to eye-watering levels ….right up to June/July 2022 when the heat finally and immediately turned down, or more accurately, turned off, predominantly in reaction to the end of an effectively zero base rate era.
The behaviour of the capital market over the past two or three years is a topic all on its own and worthy of wholesale analysis another time. A shorter assessment might be to simply describe it as frenzied; and frenzied madness in the closing six months before the balloon popped. We found ourselves running out of expressive adjectives when reporting that behaviour during our regular Quarterly updates to June 2022: “the industrial property sector continues to fire”, “appetite for industrial property seems to be insatiable”, “the sector is going gangbusters”, “the Spenders and trolley-dashers (distinct to rational Investors) remain in residence”, “the indiscriminate approach to industrial acquisitions remains intact” and “the appetite for industrial property is off the charts!” are all extracts from reports through that period. Had it kept going at the same rate of advancement we’d have needed to move to something like “Wacky Racers start your engines!”
We’d no doubt describe ourselves as naturally positive but cautious in our capacity as a co-investing manager, that disposition being the result of over 25 years of experience in the industrial sector. We were at the coalface long before, during and after the GFC for example, and have stayed there ever since. We are industrial specialists as opposed to generalists or chameleon-like operators flitting between sectors as time goes by.
This positive yet cautious approach is characterised in our own behaviour over the past two years (and before). Given the feeding frenzy that the industrial market was already becoming, we dropped anchor on acquisitions, and our last exposure to competitive bidding was in October 2021 where we agreed terms on three recently developed industrial estates. Pricing from the start of 2022 had evolved to what we considered to be unsustainable and the assumptions purchasers were compelled to make in order to ‘win’ the race lacked any semblance of credibility in our view. As the year tipped into its second half, that view was corroborated when the July jolt placed the property sector into yet a new style of confusion – initial panic resulting in an hiatus, where it has largely remained; and significant valuation based capital erosion across the sector.
As with the majority of our stock, our most recent acquisitions (completed in early January 2022) were pregnant with near term asset management initiatives that in turn were quickly captured and materially defended against the sector wide capital decline that was to follow. This culminated in an effectively flat total return across the portfolio at property level for the year. Others will not have fared as well in Q3 and Q4 2022 valuations and in fact they categorically didn’t by reference to MSCI’s All Industrial Index.
Depending on which property consultancy’s data you take, there were c.£10.1 billion of industrial acquisitions in the first half of 2022, much of which must now be underwater – perhaps some of it destined to be so for a very long time, particularly those assets starved of asset management opportunities within them.
Our own property level total returns present well against MSCI’s All Industrial Index outperforming across 1, 3 and 5 year periods to December 2022 (extremely so for 2022). This is particularly gratifying given the age of our Fund and its acquisition programme which meant we had acquisition costs to absorb and recover, particularly over 3 and 5 year periods, and which naturally dragged return until they did. On top of this we produced significant Index-beating income returns across 1, 3 and 5 year periods which led to healthy distributions to Unitholders throughout.
In the previous paper we introduced the idea of a universal league table of UK commercial property: each property having a rank in one hypothetical league, and every industrial property having been rewarded with a higher respective rank over recent years, deservedly so or otherwise. This notion reflected the evolved homogenisation of industrial property, or urban logistics or last mile etc (whether they were or not), and an artificially inflated position for some assets.
There have even been times in recent periods where the market adopted the view that Sheds equalled Good and non-sheds equalled Bad. This never made sense to us, and still doesn’t. A poor property is still a poor property, and a poor shed is still a poor shed. It might be less poor than another poor property. It might be higher ranked in the hypothetical universal league than another poor property, and in the case of industrial, might have even been ranked higher than a good non-shed property; but who wants poor anything?!
On the face of it lots did as the sector became crowded by indiscriminate buyers. Time will tell if the pursuit of poor/any/every industrial property at good property pricing (at all time record levels) was a sound strategy or not. We think not. As we predicted last time around, some sectors that had fallen out of favour during Covid like Alternatives would come back out of the shadows (they since have) and as a result those industrial properties swept up the rankings on a sector-wide wave will ebb back down the league again. This must now be naturally happening and is probably more pronounced in poor secondary and tertiary assets. A more acute slowing of the occupational market, or any signs of distress and reversing by it would exacerbate that fall in status, and the ever increasing significance of all things ESG probably exacerbates it alone. The level of capital decline through outward yield movement in September and December valuations was a function of capitalising passing rent and ERV at any property by the new-world yields. Less rent and/or lower ERV’s would lead to further decline even if new-world yields are now stabilised (which they may well not be).
We forecasted in our last paper that picking the performance winners would become increasingly important for investors if the thin veil of what had become regarded as close to guaranteed performance in industrial was lifted. We maintain these views, and having forecast that it would do, that veil was unceremoniously hoisted during the second half of 2022. We believe that the lifting will expose even more over the next twelve months. Naturally, we expect that our discerning approach to stock selection and management style will continue to be rewarded by out-performance through this next stage of the cycle.
In each of the previous papers we described our three initial tests to our acquisition approach, and proffered that a rigorous application of these tests promoted the best prospects for relative strong performance in both good times and bad. As a six year old fund of 49 assets, and now experience of good capital markets and bad, these projections have borne out. We did out-perform in the good times, and have materially defended against capital decline versus the Index in tougher times.
Part of this defence against material capital decline versus others is the original stock selection which was painstakingly assembled asset by asset; and partly due to the management approach (experienced, entrepreneurial and focussed). These two credentials have a symbiotic relationship where experience leads to buying assets that are likely to perform well and the same experience means that they do so at income and capital levels. A recent example of this was the RPUT’s income during Q4 2022 where the contracted rent increased by 5% over three months: great property attracted great levels of tenant retention and occupational interest; and great management expertise captured it.
Looking ahead, although the capital transactional market may currently be resting, many like us will no doubt be watching what is, or is not, going on with radars firmly on. The spectator sport of waiting for any evidence of liquidity and price discovery will turn into participation at some point of course. In the meantime, our energies are directed at maximising asset management initiatives within our own portfolio and forensically examining rental payment behaviours whilst staying calm. RPUT is in a healthy condition and the painstaking approach to asset selection combined with experienced attention when managing is proving to be a sound model. We continue to believe that model is a responsible approach to investing and expect to do more of that in the re-based pricing world at some stage in the future.
March 2023
July 2020
Ribston: another year and three quarters in the life (November 2018-July 2020)
-
The opening paragraphs of the first paper talked about our capital raising in 2016 – the year that Brexit was introduced to us all, was campaigned on, had a Referendum on, and had a shock outcome to that Referendum etc etc. Between then and the arrival of Covid-19 in March of this year, Brexit dominated the political and economic landscape, and formed the focal point of the snap General Election in December 2019.
We fundraised and launched in a period of UK-wide confusion; and confusion, or even chaos in very recent times, has prevailed throughout RPUT’s life. In the past year and three quarters we have witnessed the Tories securing a large majority following a snap election; we’ve learnt of a place called Wuhan; we’ve seen the temporary suspension of legislation for collecting arrears; and we’ve experienced the introduction (albeit temporary for industrial property) of a Material Uncertainty Clause in valuations for the first time since the GFC, to name just a few ‘surprises’.
We thought Brexit was a big topic, but the current Covid crisis and accompanying economic Recession has further advanced discussion in the Press and from Talking Heads, where hugely profound topics as far out as the existential risk of whole segments of the property sector are now debated.
Pre-Covid, the rhetoric included concerns over impending Brexit induced red-tape, impact on supply chains, costs related to importing/exporting, labour markets etc. Presumably that discussion will pick up again as we approach the year-end and Brexit comes back into the near ground; only this time against the new backdrop which will presumably incorporate the current topics of the day like whether the High Street and Shopping Centres have gone forever; what the future role of Offices is; how long will social distancing exist (perhaps permanently in some form), and what impact does that have on leisure, hotels, and indeed all property?
‘Beds and sheds’ was an often used strap-line in 2016, but even that appears to have been diluted to Sheds in the present, where language such as on-shoring, de-moorage and shortened supply chains is now used day to day.
This paper does not intend to address those profound discussion points nor offer Sage-like opinion on macro-property. We will leave that exercise to the experts. What is clear to us however is that as a country, and globe, we remain in a general state of confusion with much water to run under the bridge before general clarity materialises. For us, the upshot of this is that in the context of Returns, Income is key (as it usually is across most periods across recent decades). If anyone even needed the stark reminder we’ve all just been given, then Industrial property is an attractive proposition when realised income is the fundamental driver of return over longer periods, and particularly so in a low returning environment.
RPUT today
Amongst all the confusion/change over the last year or two, RPUT has experienced its own constitutional change since the last paper. In December 2019 we re-structured the fund to an Evergreen from the closed end vehicle it was launched as. This came with further equity commitments from Unitholders, including ourselves, and these new funds have started to be deployed into new acquisitions that continue to shape RPUT into the vehicle we want it to look like.
Rental income collected for Q2 amounted to over 93% of rent demanded where most of the residual is expected to be collected down life’s road. Q3 has started positively and using our own tenant base as evidence there is clearly a strong resolve in British business (at least in the industrial sector) to battle through this period.
October 2018 Backdrop revisited
The paradox of values increasing in what on the face of it had been a confused state (Brexit) continued from the time of the first paper right up to the arrival of Covid. This capital growth was largely driven by the strength of the occupational market and prospects for rental growth; and also perhaps concerns from investors about other sectors, most notably retail. This situation led us to be conservative in asset selection and that approach prevailed for us.
We continued to grow the fund on a piecemeal basis, ignoring the temptation to deploy large amounts of capital through portfolio acquisitions. As individuals who have operated in the sector for over two decades we are well aware of examples of poor assets that drag overall performance and that have been passed around in portfolio sales over the years. Whilst it is more painstaking to build up the fund asset by asset, we still like every property we have acquired into RPUT, and would have bought them all again.
We still refer to industrial as industrial! We remain of the view that not all industrial is ‘urban logistics’ nor ‘last mile’. It patently isn’t, or at least it isn’t if common sense is used to define ‘urban’ or ‘last mile’ - last mile to what?!
We remain of the view that it doesn’t matter that all industrial doesn’t fit neatly into those two fashionable definitions. In our view it is true that on balance a great urban asset has better prospects than a great non-urban asset; and it might also be true on balance that a poorer urban property has better prospects than a poorer non-urban property; but at a single asset level that simply cannot be a de facto rule. A poor asset is a poor asset. If one’s strategy is focus rather than world domination then the prospects for that particular asset (set inside the wider fund) must be the driving influence to own, rather than the badge it can loosely display.
It is true that our acquisition programme has created a portfolio of properties that are in places that most people have heard of, and also that most of them are genuinely ‘urban’. They are however not exclusively ‘urban’ in the strictest definition. We have some properties on motorway junctions and others on established industrial estates like Trafford Park (perhaps that is considered urban these days). We have other quasi-urban properties that are securely let but display strong alternative use prospects and which sit neatly in an Evergreen structure.
The point is we have continued to assess each prospective acquisition on its own merits applying the following two income tests:
Is the asset well placed to capture rental growth in a world that is on the up; and
Does the asset have sufficient defensive qualities to prove resilient in a world that is not on the up?
If an asset doesn’t pass both of those tests we don’t want to own it. Assuming the prospect does pass both of those tests, then the barriers to exit test has been applied:
What are the barriers to a clean, efficient and profitable exit in a full range of future market conditions. If there are any specific barriers, we don’t want to own the asset.
Looking back on the 39 properties in the fund, they would still pass all three tests. Some have obviously performed better than others since their respective purchase; some are still relatively early into their business plans; and some are navigating the bumps in the road created by Covid. Overall however the disciplined application of the three tests at purchase has proven to be a good thing and the Fund is in good shape. Looking ahead, all further acquisitions will continue to need to pass these tests as a mainstay of our approach.
The Ranking Discussion
During a recent internal team discussion over a prospective acquisition we arrived at an interesting concept. If every single UK commercial property: industrial, retail, office, leisure, BTR, student accom, hotel etc had a ranking in one comprehensive league table from best to worst before Covid, had the subject property moved up the league, stayed in the same position or gone down? This does not mean ‘is it worth, or value, more, the same, or less than before?’. That is an entirely different question and separate discussion, but the contemplation provoked good debate.
The property in our case was undeniably promoted in the hypothetical universal league table, and materially so. A.n.other industrial property might have moved up the universal rankings to a lesser, or even greater, extent. We landed on the conclusion that probably all industrial property has been rewarded with a higher position than it had before as a function of Covid, at least on a temporary basis. However, in our view this does not mean that all industrial properties are a one-way bet nor will they retain their new position in the ‘universal league’.
The hypothetical league table is an exercise in relativity, and a large or small part of any promotion is also a function of another property’s demotion. For example, as clarity improves around the future role of Offices as an investment class, driven predominantly in our view by human behaviour eventually presenting itself, then another material re-ranking could take place.
The same could be said for Alternatives who, having grown to the extent they are now fully reported on by MSCI as a discreet sector alongside the three traditional sectors, appear to be a little out of favour currently, but may well come back out of the shadows at some stage.
Perhaps this means that some industrial properties, having been swept up the rankings on a sector-wide wave, will ebb back once the world settles down. We think so, albeit we don’t attempt to numerate value shift nor impact on returns. We will continue to focus on those properties that we believe have the strongest prospects for, in effect, retaining, or further improving, their league position; and our three tests probably fit neatly into that exercise in any event.
Looking ahead
We believe we are in the ‘right’ sector. It is evident that an increasing number of investors in the pursuit of resilient income share that view. New entrants continue to arrive in the sector having reinvented themselves as industrial specialists. The upshot of this is there are a lot of players on the pitch and competition for stock is high.
This dynamic is obviously more significant than a simple observation, but in itself is not a dramatic concern for us. It means we will continue to be as discerning in stock selection as we have been to date. It means we will continue to heavily due diligence assets before arriving at a decision whether or not to pursue. It means we will inevitably continue to dismiss more ideas than we progress, but if something meets our particular requirements we will diligently and aggressively pursue it.
In an ongoing confused world (Covid, Recession and Brexit) the future looks good for industrial property in a relative sense. Picking the winners so they perform in an absolute sense will become increasingly acute for investors if the thin veil, of what in recent years has largely been assumed for industrial by many as offering close to guaranteed performance, is lifted.
July 2020
October 2018
Ribston: a year (and three quarters) in the life - AKA ‘what we have learnt’
-
· Measured, deliberate and considered versus indiscriminate asset accumulation
· Heavy due diligence and approach focussed on individual assets
· Aversion of barriers to exit
· Income – must have dual characteristics: sustainable and progressive but also defensive
· Capex must be accretive and not simply shoring up existing value
2016 turned out to be a year of ebbing and flowing of fundraising momentum. The introduction of the BREXIT concept in February and then the surprise outcome in June both impacted on progress, but the year was a success as we launched with £75m of equity provided by Real Estate Multi-Manager accounts run by Indirect Fund Managers Alistair Dryer and Catriona Allen at Aviva in the December. Having now invested that capital together with subsequent allocations of £42m from the same investment house the fund is in a good place – of a size that can still benefit from management influence; but also of the scale that has repeatedly proven attractive to portfolio purchasers. A debt facility with Barclays has been entered into and will allow the fund to release equity from our existing portfolio to make further acquisitions and enhance returns through a moderate level of gearing.
The measured approach we have taken to deploying our equity is entirely consistent with what we intended to do, however the 30 properties have been acquired to date in 29 transactions which is even more granular than we might have anticipated. The nearest we have got to acquiring something that resembles a portfolio is buying two properties at the same time from the same vendor. A further five properties currently in legals across four deals continues the theme.
Backdrop
Received wisdom at the time concluded that the surprise outcome of the Referendum would lead to a softening of pricing. Instead, whilst there was an immediate negative reaction in Q3 of 2016 (prior to our fund launch) it proved to be short lived. Retail funds led the sell-off which moved pricing out for a period but by the turn of the year ‘normal service’ had resumed.
The well documented issues of the retail sector, investor appetite for "sheds and beds", and the genuine prospects for rental growth in the industrial sector has maintained pricing and in fact seen yields hardening, and the general trend for industrial assets in terms of sentiment and pricing remains positive.
In spite of this we have chosen to continually challenge these macro-headlines and opted to be selective. Whilst rental growth is real; and investor appetite appears to be sustainable; and the continued absence of material development in the multi let space does nothing to meet demand; the paradox of prices increasing on all industrials in what should be a confused state (Brexit) leads us to be conservative in asset selection.
We do not subscribe to the widely publicised rhetoric that seems to be now enshrined as fact. We do not believe there is a single rule for industrial. Unlike a growing number of commentators, we still refer to industrial estates as ‘industrial estates’ notwithstanding the fact what businesses are carried out on them is eclectic (it always was!). At the risk of being controversial we would say:
· That not all industrial is ‘urban logistics’…and it doesn’t matter that it isn’t…and even if something is that does not define its prospects in isolation.
· Not all urban industrial is ‘last mile’…and again it does not matter that it isn’t…and again whether an asset actually is or not will not definitively shape its prospects.
It may well be the case that we have entered a new paradigm in the way property is used (most notably the metamorphosis of retail and industrial property), who will use it, the way we act as consumers etc. Time will tell whether it has changed forever but in any event, our view is that not all industrial property will permanently benefit from this trend or shift. Some inevitably will, but our view is that poor property, be that in any sector, is poor property and the best prospect for long and sustainable performance is to avoid it.
In spite of any new and ostensible permanent shift in the sector’s occupational and capital role, property has always been cyclical and we expect that trend to continue. We believe that in the event of any softening in occupational demand or investor sentiment then those poorer assets are less well positioned to defend against capital decline.
Stock selection
The Ribston Property Unit Trust (RPUT) was launched as a nimble and dynamic vehicle – big enough at full investment to have scale; but small enough for each asset to contribute to performance, and manageable enough to be properly diligenced by an onward purchaser down life’s road (whenever and whatever route(s) that takes).
This over-arching philosophy has driven the approach and attitude to stock selection and the economic and political backdrop has generated even more focus. We have not sought to price-up every opportunity that we have reviewed. Ours is not a strategy of aggressive asset accumulation where every property has its price; it is a strategy of assembling a portfolio of properties that complement each other and which in any permutation presents opportunity for performance and efficient, straightforward and profitable exit when the business imperative arises.
Income test
From launch of the fund we have sought properties that have, or are capable of quickly having, strong running yields. Income, and the ability to grow that income, is crucially important to pension funds, the mainstay of our investor base; and in assessing all opportunities we have applied what we consider as being two equally important tests:
Is the asset well placed to capture rental growth already inherent, and is it set fair to capture future rental growth in a world that keeps performing? AND
Does the asset have sufficient defensive qualities to prove resilient to any change in the economy, sentiment towards the property sector generally and any future downward trend of the industrial occupational market?
If an asset fails either of these tests it has been immediately dismissed. If it passes both tests it has had a further test applied to it:
Barriers to exit
3. What are the barriers to a clean, efficient and profitable exit in a full range of future market conditions in due course?
The answer to this third question for any particular asset might conclude there to be fundamental barriers. Alternatively, there might be issues that can be addressed and rectified during the ownership period.
For example, we would regard a short geared leasehold as a fundamental issue. Addressing it, or purifying it, is outside the long leaseholder's control and the prevailing market conditions at any given time would naturally narrow one's exit options to a very small pool of buyers or, in certain markets, perhaps no buyers at all.
Conversely, some 'barriers' (using our definition for the word) can be addressed through the life of the hold period, for example through undertaking capex. A barrier as we see it is something that limits the range of prospective buyers at exit. Our aim has been to establish a portfolio that is as attractive as possible at any given time to as wide a pool of investors as possible - institutions, PE houses, property companies using debt, and privates; both on a portfolio, or sub-portfolio, or individual asset sale basis.
An example of this sort of barrier might be asbestos-clad buildings. Whilst fundamentally a property's characteristics might be strong, we believe that institutions and banks might become increasingly averse to owning/lending on assets that are clad with asbestos. To that end, a well located and well configured property may prove to be of no interest/less interest to a large tranche of the prospective purchaser pool in the future and in turn might impact on pricing, profitability and efficiency of exit. In this example, a programme of capex through the ownership period might be planned to be undertaken.
A fair proportion of the stock we have seen over the last 18 months has been in need of capital expenditure; costs which arguably should have been addressed earlier and probably would have had the general market not provided performance to even passively held assets. In the current environment where it is debateable whether yields can harden much more, the need for inherent deficiencies to be dealt with becomes more pronounced. Whilst a strong occupational market can carry a property’s shortcomings, a less strong market might not. This has led to us dismissing some opportunities and only pursuing those in need of capex that both (a) can be dealt with quickly within business plan, and (b) add value rather than simply maintain value.
Having addressed this third (barrier to exit) 'test', anything that has a fundamental or economically insurmountable issue has been dismissed. Anything with a barrier that can be despatched through the life of ownership has continued to be due diligenced prior to making a decision whether to ultimately pursue or not.
· The upshot of applying these tests as a discipline is that:-
· Many more 'opportunities' have been dismissed than pursued since launch.
· Our acquisition profile has been very granular. We have not acquired any portfolios because we have not wanted to own any properties we fundamentally do not like, nor pay a premium for doing so. Instead we have chosen to deploy capital in a piecemeal manner acquiring assets on an individual basis.
· A function of not being seduced into acquiring portfolios is that we now have a portfolio of assets, all of which we genuinely wanted to own!
What we have bought:
· Properties that we believe are capable of making the most of the strong occupational market that the sector has experienced during RPUT’s life to date; BUT that are also defensive in nature and well placed to guard against any shift in sentiment or demand from occupiers.
· Locations that everyone has heard of. Our portfolio is characterised by city centre properties in Leeds, Glasgow, Birmingham, Bristol, Cardiff etc. and in established locations like Trafford Park and near motorway junctions.
· Properties that have been diligenced on a site specific basis i.e. we have not simply acquired in a particular location for pure bulking-up reasons. Each asset must bring something to the table both as a stand alone investment and as a component of the fund.
· Where a capex requirement has been identified pre-bidding then that investment must be value enhancing and not merely shoring up value or seeking to defend against value decline.
· Properties across all lot sizes up to £20m and where 24 properties are under £5m and six are over £5m.
· Properties at gross acquistion prices substantially below their replacement costs.
· Properties that as a fund at full investment are projected to deliver an annual income distribution in excess of 5%.
What we have not bought:
· Portfolios. We do not need to acquire every property we see nor has our strategy been a race to launch Fund 2. We have resisted the temptation to deploy large amounts of equity in a single slug, preferring to create our own portfolio of properties that are all assets that we have wanted to own. This piecemeal effort means we have not acquired make-weight properties within portfolios or assets that are incapable of making the return objectives.
· Tertiary property, save for one example which is single let on a long unexpired term to a financially very strong tenant who has been in occupation for many years, and which has annual fixed rent increases and, crucially, alternative use prospects in the future.
· Short or geared long leasehold interests.
· Properties in locations with swathes of homogenous stock in terms of age, specification, layout and more often than not with components of construction that are approaching the end of their economic life. Experience tells us that whilst we currently have a strong occupational market if/when that softens then these sort of locations generally regress quickly. Where the only differentiating factor between properties is price, then it can be a race to the bottom on rents and where there is at least one competing owner under duress then the general downward spiral is exacerbated.
Time will tell if our very selective and prudent approach turns out to be especially rewarded but we remain of the view it is the best way ahead.
October 2018