Niche sectors benefited in the boom years as the mainstream became saturated. In the downturn niche have held up well compared to mainstream sectors and some boast excellent long-term prospects, as Lynn Strongin Dodds reports
Niche segments came into their own during the last boom and have proven their mettle as durable, counter-cyclical investments. The diversification benefits, steady income streams, low vacancy rates and reasonable relative returns are appealing but as with any asset class, caution is the watchword.
Andrew Appleyard, head of UK specialist property funds at Aviva Investors, notes: "There is nothing that is immune from the current financial crisis. Capital markets have an influence on the ultimate returns in property but certain sectors have performed relatively well. Nursing homes, for example, have proven to be robust, while student accommodation in certain areas, as well as leisure, have held up relatively well."
David Batchelor, senior director at CB Richard Ellis also believes that niche sectors in general could outperform their traditional counterparts over the long term. "For the last few months, all the talk has been about value in the mainstream but once those markets stabilise, there is greater future potential in the alternative sectors because of the opportunities for improvement in the underlying businesses. I do not think double digit returns are out of the question. There will be a lot of restructuring in the economy and we see opportunities in two to three areas - nursing homes, gaming and self-storage."
The UK, which has had one of the severest price corrections of any European country, seems to be attracting the most attention although there is a dearth of activity across the entire real estate spectrum. Institutions continue to bide their time, waiting for prices to slide further, while banks remain in a lending holding pattern. When the ice does break, student and senior housing are expected to top the list.
As Patrick Carr, director of investment at Cordea Savills and portfolio manager of its student hall fund, says: "The secure and robust income streams offered by some of the specialist sectors of the residential market are increasingly being accepted by institutions as mainstream investment opportunities. One of the main attractions in student housing is the strength of the underlying occupier demand which contrasts with weakening occupier market in the mainstream commercial property sectors. The counter-cyclical nature of the sector continues to underpin rental growth, irrespective of the state of the UK economy.
"There are very few funds on the market but the asset class is a good diversifier within any balanced portfolio. The focus for the investor must be on targeting those areas with the strongest supply/demand imbalance and detailed research underpins the strategy for our fund - at the moment we're keen to gain exposure to London which has very strong demand levels, but particularly constrained supply and therefore offers the best opportunities for growth."
According to a recent study by Savills, the average rents for purpose-built student housing (PBSH) grew by 5% between 2007/2008 and 2008/2009, with London enjoying a 7% spurt. Figures from Unite, the specialist student accommodation provider, also reveal that only 52% of first-year students in London can find a place in student halls, compared to 85% outside of the capital city. Unite chief executive Mark Allan, believes that in future "there will be a greater gap between the stronger and weaker universities where student numbers will drop. London is one of our main areas of focus but we also target cities like Manchester, which has two strong institutions - Manchester University and Manchester Metropolitan."
In terms of performance, funds have been hit but not as badly as traditional properties. Allan says: "Our fund has fallen by 11% in the two-year period between June 2007 and June 2009 but rental growth rose about 14%, which offset the 25% expansion in yields. This is a far better picture than commercial property which has dropped by about 40%."
Senior housing has also proven resilient with performance down about 20% compared to commercial property's 40% in 2008. Long leases coupled with strong rental growth and demographics are the main drivers. The latest statistics show that by 2020, one-fifth of the population will be aged 65 years or older, and almost 2m people will be aged 85 years or older. The biggest challenge, according to Appleyard, whose fund runs the Quercus healthcare fund, is understanding the regulatory and operator side of the equation. "The operator is being paid by the local authority to provide a service and you have to make sure that it is running a viable business. There were a few operators that expanded rapidly and there has recently been consolidation in the business."
The strength of the operator is also an important factor in the leisure end of the market which covers gyms, cinemas, bowling allies and restaurants. People may have scaled down their pursuits, but eating out and going to the cinema remain popular. In fact, cinema audiences are at all time highs across the EU. "The main attraction of leisure is the long leases of up to 20 years and steady rental income," according to John Danes, head of UK research and investment strategy at Aberdeen Property Investors. "At the moment some of the restaurants in these complexes are suffering but strong cinema attendance is helping to offset these losses."
As for other promising markets, Ian Chappell, fund manager of AXA's Alternative Property Income Venture at AXA Real Estate Investment Management, points to motorway service stations. "This is particularly true in the UK which has had the sharpest price movement and assets are now at historical lows. The exchange rates are also making them look attractive to European investors. There are opportunities in motorway service stations because people are still travelling and they need a place to stop. Also, the quality of new outlets is impressive and barriers to entry are high in this sector. The one area I would avoid is car showrooms because of the fragile state of the auto industry."
Invista Real Estate Investment Management, on the other hand, is extolling the virtues of self storage after buying the Asian property fund management arm of Babcock & Brown, which owns the Asian Big Orange Self Storage Fund. Chief executive Duncan Owen says: "Our main objective when looking at a niche sector is its ability to develop into a mainstream asset. We believe that the Big Orange, which has units in the large Asian cities, has that potential because of the increasing demand from these economies and in densely populated cities. People are also willing to pay premium prices for best of class and secure storage services."