In practical terms, secondary real estate investments are those which have one or more attributes which prevent them from being classified as prime.
The “defect”, if one can call it that, could be that the location is not a prime city or that it is not in the right spot in a prime city. It could be that the income is not stable due to poor covenants or short lease lengths. It could also be that the income is not capable of being replaced due to the property being over-rented. The definition changes depending on market conditions.
For example, there are areas of the North East that have become almost no-go zones, but which were classified as prime a few years ago. Secondary property as a label probably fits more properties than any other and there are sub-classifications from good to tertiary.
There has always been a price differential between prime and secondary property. This spread is a function of market conditions and more particularly, on the appetite for risk and availability of debt. Currently, the spread between prime and secondary yields is in excess 400 bps, which is over double the historical average.
The so called “yield gap” or price differential between prime and secondary property has become increasingly pronounced, creating opportunities for investors who know their markets and can make strategic acquisitions.
The consequence of this has been to put upward pressure on the price of prime property and to diminish the prospect of a good return. Logically, the next phase of the cycle will be for investors to look at the next tier of property which can generate better returns but this phase could be delayed by a lack of bank finance against such assets.
For those thinking of investing in secondary property it is advisable not to buy property assets that will become obsolete quickly. Obsolescence for retail can occur when the retail core in a location changes – often due to new development. For offices it is more to do with technology and working habits.
The key indicator to look for when considering a potential investment are cyclic factors that change the definition of the asset from prime to secondary. Eventually when the property cycle returns to a stable period, and risk is priced more sensibly, the right secondary properties will benefit disproportionately from a positive shift in value.
Mispricing has occurred in the UK property markets since 2008, specifically in relation to properties located outside London. While asset selection is key to a strong investment performance, the weight of funds targeting only London and South East real estate has produced a dislocation in valuations.
In 2012 two-thirds of all transactions have been in London leaving significant opportunities to be explored in the regions outside the capital, but this does not necessarily make it easy to get into the market, as it can be very hard for new entrants to be able to source and finance the right deals. A good way to get into deals is with a strategic partner who has the network of connections with agents banks and receivers.
This approach provides a platform for equity investors to invest in high yielding commercial property investments through Limited Partnership funds. By removing the barriers to entry to this complex market and providing an FSA regulated environment, sophisticated investors can benefit from the discounts associated with larger lot sizes. The scale of such funds allows high net worth individuals and family offices, looking to balance their investment portfolios, to invest equity from sums of as little as £100,000 per transaction.
While there is less competition in this niche of the market between £5m and £20m, bargain hunters need to be looking for value. If buying a bargain means buying a property that will increase faster in value than other seemingly similar properties then, yes there is such a thing, but as always asset selection is the key.
About the author
Bik Bhuptani established Greenridge with colleague Paul Simmons, in 1994, as a specialist counter cyclical buyer of good quality real estate, primarily located outside of London. The company’s aim was to build a reputation for excellence and to become known as a socially responsible organisation, which excels in providing market beating returns for its shareholders and investors.
Bik is a self confessed gadget freak and his interests include: photography, sandy beaches, snowy mountains, good wine, opera and modern art.
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