Sarah Bate looks at the case for allocating capital to alternative real estate investments in the UK, from car showrooms to budget hotels

As the global turmoil and uncertainty continue, investors are struggling to find
a secure and lucrative home for their investments. Traditional safe bets have moved up the risk curve, and the fear of contagion to even the most robust economies has adversely affected market prices for the majority of asset types. Investors are becoming ever more risk-adverse as the realisation of sovereign and banking system defaults develop into a distinct possibility.

Against this backdrop, commercial property - with an initial yield of 6.4%, according to the Investment Property Databank (IPD) Monthly Index - is looking increasingly attractive. This compares with cash yielding 0.5%, 10-year gilts at 60-year lows of below 2.5%, and with the volatile equity markets yielding approximately 3.5%.

Consequently, the weight of money chasing high-quality core assets and the tight supply of stock, in spite of the weakness in the occupational markets across the UK, is protecting the market from capital falls. The uncertain macro-economic outlook undermining confidence in the UK economy weakens the case for rental growth across the key institutional-grade sectors of the property market - namely offices, industrial and retail in most parts of the UK, excluding London. It is a good time to consider alternative investment sub-sectors within the property more generally, which now represent approximately 5% of the IPD index portfolio.

A selection of alternative investment sectors within the property market includes car showrooms, hotels, student accommodation, petrol filling stations, nursing homes, healthcare, data centres, renewables, ground leases, short leaseholds, caravan parks, marinas, car parks, serviced offices, garden centres, factory outlets, agriculture, forestry, infrastructure, residential, self-storage and solar farms.

Some of these alternatives to mainstream property investment offer interesting opportunities. But when investigating alternatives, consideration should be given to the attractions of the long-term income some offer - an increasingly rare feature of the main commercial sectors - as well as the opportunity to diversify the income stream. As per the old adage, location is key. This is particularly the case for property with potential alternative land-use value locked away.

Performance in many of the alternative sectors is reliant on the success or otherwise of operating managers, thereby rendering an investment in such assets heavily weighted towards the management of a business, rather than pure property investment. Examples include areas of the hotel sector, healthcare, caravan parks, and so on.

More interesting opportunities lie where there is depth to the demand for a site or building from the sector currently operating from it. For example, although many car dealerships do not offer an undoubted covenant, having showrooms in the right locations is critical to the performance of car manufacturers, which will be reluctant to release their outlets to competitors.

At a time of market uncertainty and questionable rental growth prospects across most markets and sectors, it is prudent to invest in property with fixed uplifts. This is particularly relevant today when bond are yields low - and likely to remain so - and inflation is likely to fall sharply from recent highs. For this reason, index-linked uplifts are less attractive than absolute rental uplifts of, say, 3% per annum.

Many of these alternative sectors can be described as ‘emerging' markets and in any lease agreement an investor would not want to preclude themselves from capturing the market-driven growth at the earliest opportunity. So, the higher of market rent or a fixed minimum uplift is deemed to be the ideal lease clause, similar to a cap-and-collar agreement. Such lease clauses can be available when investing in petrol stations with forecourt convenience stores, an increasingly popular concept among retailers.

The budget hotel sector is another such market that is now expanding; with an element of private equity often financing the operators, considerable due diligence is required. However, those assets boasting sound property fundamentals can be an appealing investment prospect. One should consider ‘survivor' locations - sites should be prominent, have strong transport links and draw sufficient prospective customers to ensure the occupancy rate is healthy and steady throughout the year.

Essentially, one should be looking to take on the stronger covenants with a proven business plan and strong track record on a long lease with fixed uplifts, thereby underwriting the property risk, not the business risk.

Despite the scale of the residential market in the UK, institutional investors are rarely exposed to it. Investment in the residential market is becoming more attractive because of the socio-economic changes taking place across the UK. Just as banks are generally deleveraging and debt to commercial property is difficult to come by, so the personal mortgage market has tightened, such that loan-to-value ratios have fallen and first-time buyers are finding it increasingly difficult to get on the property ladder. Demand in the rental market is going from strength to strength at a time when new development is constrained and supply is therefore tight.

One good opportunity within the residential market results from the lack of bank finance for residential development, particularly in London. Returns of 25% or more can be obtained through the provision of ‘preferred equity' with profit participation.

The property market offers some interesting alternative options to investors outside the traditional sectors, and it is reasonable to assume that as these sub-sectors mature and become more transparent, they will become more mainstream.

A good example of this evolution is the retail warehousing sector - an immature market as recently as 20 years ago and now a key asset in any balanced portfolio.

Sarah Bate is director of research and investment strategy at Mayfair Capital Investment Management