Non-traditional assets, such as marinas and doctors' surgeries, provide secure and diverse income, says Marcus Sperber
The current low yield and inflationary market environment is forcing investors to look beyond traditional sources of income. While mainstream property assets in the office, retail and industrial sectors offer a range of opportunities, institutional investors should consider looking beyond these into the non-traditional or niche real estate sectors to achieve a greater and more stable source of returns.
Non-traditional real estate assets can range from car parks, nursing homes and student housing to more unusual assets such as self-storage facilities and caravan parks. This sector also includes doctors' surgeries and marinas, which can deliver particularly attractive yields and act as effective diversifiers within real estate portfolios.
The principal benefit of including non-traditional assets in a real estate portfolio is diversification. Looking at the last three years to the end of June 2011, the average return on the mainstream commercial real estate market in the UK, as defined and calculated by standing investment in the Investment Property Databank (IPD) Quarterly index has been 1% per annum. By contrast, the average return achieved by alternative styles of assets, such as restaurants, hotels and schools, for example, over the same period was 3.1%.
There is also a healthy mismatch between potential yields compared with bond yields. The latest average initial yield on alternative-style assets, as measured by IPD at the end of June, was 6.3%, 330 basis points higher than the yield on 15-year gilts at the end of September of around 3%.
The diversification benefits are even better than this: the diversity of the income that can be achieved across the individual assets is also noteworthy. For instance, a typical marina will have over 500 berths, so the loss of one or two berth holders will have very little impact on revenue. Similarly, in the UK the National Health Service (NHS) generally guarantees the rental liability of the doctors' surgeries they operate on a multi-occupancy basis. These tend to contain more than one general practitioner, so the loss of one practitioner is unlikely to have a significant impact on the overall revenue.
There are added dimensions to investing in marinas that further improve their potential returns. Aside from the income stream from the berths, the surrounding land is often unoccupied and can present exploitable opportunities. Planning permission can be sought for commercial, leisure or residential developments, which can prove very valuable and can increase the value of a portfolio.
The security of income that many non-traditional investments provide is another factor in their favour. They can be less volatile than traditional assets and can be considered as an effective lower-beta play within the real estate sector. This means that allocations often behave more defensively in a downturn. In addition to secure and diverse income, they also offer alternative investment characteristics. For instance, the rents for doctors' surgeries are generally reviewed on a three-yearly cycle and for marinas on an annual cycle.
Some non-traditional assets can also be seen as alternative means of gaining exposure to mainstream markets. Marinas, for instance, can be a substitute for consumer spending. We also see some value in the fact that these assets are considered by investors as a niche investment. They are less-trodden paths where the full extent of income generation and the potential for growth that institutional investors seek are yet to be fully realised.
Non-traditional assets are not immune to downside risks and there are specific factors that need to be considered and assessed within each sector.
They are by no means impervious to a sluggish economy but are robust investments when demand is taken into account. The demand for marinas, for instance, is relatively inelastic, since the cost of berthing is small compared with the overall running costs of a vessel.
Furthermore, a year-on-year increase in berthing costs is unlikely to affect their use significantly, providing an opportunity for rental growth. The stability of income that this affords makes non-traditional assets a suitable core element of institutional portfolios.
However, each of these non-traditional sectors has its specific risks and, as with all assets, rigorous due diligence is extremely important to ensure investment is adequately rewarded.
In the case of both doctors' surgeries and marinas, the value-add in terms of achieving alpha lies in the ability to identify the opportunities that extend the length of the existing income while seeking out value-generating features within the portfolio. In addition to this, the ability to identify a suitable partner to seek out these opportunities can make a large difference to long-term performance.
Marcus Sperber is head of BlackRock's international real estate business