What do ghost trains, garden centres, drive-thru coffee shops and discount grocers have in common? Answer – they all form part of a compelling retail and leisure investment strategy from UK long income REIT LXi.
The UK-listed investor, which merged with peer Secure Income REIT (SIR) this summer to create a £3.9 bn (€4.56 bn) business with a diverse range of tenants, is largely sector agnostic – preferring to focus on assets with long-term leases, strong covenants, and low starting rents that are RPI-linked.
Other niches it has been investing in include budget hotels, car parks, educational facilities, logistics and life sciences – increasing its exposure to dynamic, growth sectors experiencing attractive structural changes and pricing.
What is does well is both identify key secular trends – such as drive-thru coffee shops – while relying on the unusually long-leases of extremely rare opportunities – including theme parks Alton Towers and Thorpe Park, which are leased for 55 years.
It also focuses on forward funding pre-let developments deals at a discount to investment values, which are less competitive for smaller developments, and those as large as £100 mln and even up to £200 mln, which means investing at a 5%+ yield.
When the takeover of SIR was nearing the closing line in July, LXi unveiled the strongest set of annual results since its initial public offering (IPO) on the London Stock Exchange five years ago.
For the year to 31 March, LXi managed a total net asset value (NAV) return of 18.2% including NAV growth and dividends. It has managed that while growing net assets by 66.5% to £1.3 bn during the 12 months.
Financial acuity
According to fund manager Simon Lee, the firm’s increased scale is set to open the door to more attractive equity and debt finance both for acquisitions and for re-financings.
But LXi also has another trick up its sleeve, after circumnavigating expensive debt markets with a £257 mln ‘income strip’ sale in September at a low 2.96% exit yield, which proved much cheaper than re-financing – while retaining the opportunity to repurchase the assets’ freehold for a nominal £1 in year 65.
Today, LXi’s size, inflation-linked rents and even more diverse portfolio post-merger look like just the ticket going into a 2023 which many fear could mean a tough ride for landlords.
Lee told RetailWatch: ‘The attraction for us in completing the SIR deal in the first place was scale, and the high-quality nature of the assets. It brought really long-term leases – with an average of 30 years to first break – and largely index-linked income, with good, strong tenants.
‘It also further diversified our portfolio, bringing some tenants that we didn’t have access to previously. Another attraction is that the property costs in doing an asset deal are upwards of 7%. But with a corporate transaction and listed company acquisition, you don’t pay stamp duty – making our overall transaction costs a really efficient 1%.
‘The merger also unlocks ongoing annual management fee and administrative cost saving of just under £9 mln, as well as having even more inflation linked-leases going forward. We’ve also acquired more uncapped inflation-linked rental uplifts, bringing further financial security, as we extend the lease portfolio that we have. Particularly in the current climate, having even more uncapped inflation-linked leases is a boon. Finally, scale in its own right is valuable.
In difficult times, as a listed vehicle, the bigger you are, the more liquid you are. The combined company also represents a good platform for growth, when growth comes back.’
Strategic choices
Turning to the company’s signature inflation-linked leases – isn’t there a risk that rent increases at this time result in more occupier defaults? Said Lee: ‘The vast majority of our inflation-linked assets have an average cap of 4% annually.
The tenants are under less pressure therefore and you also avoid a situation where your rents become decidedly out of kilter from market rent level. In any case, we invest in assets with low starting rents and only pick tenants with strong balance sheets and corporate guarantees. Further, a large proportion of our occupiers’ revenue is linked to inflation, such as grocery stores and budget hotels.’
It is unsurprising that a key conviction at this time remains budget hotels, which are full even in lean times and are able to price rooms in line with inflation. ‘Two of our main tenants are Premier Inn and Travelodge, which are UK leaders in the sector,’ Lee added. ‘We like them generally because they have very high barriers to entry – if you have a national brand, well it’s difficult to replicate that.
'They also really thrive in this type of climate, as these types of hotel room are priced relatively more cheaply. When times are hard, both business users and regular consumers tend to trade down – we’re seeing that again, just as we did in 2008.’
Lee adds: ‘In discussions with both those tenants, it seems like it is going to be a record year in terms of trading performance. The weakness of Sterling is possibly also playing a part, but we are also seeing more local stays and anecdotally, domestic travellers often use single night stops at budget hotels to split a journey when travelling the length of the country.’
Retail and leisure hot spots
To date, LXi has successfully wrung stable rents from a retail sector that has attracted as many bad headlines as good in recent years. But Lee underlines how picky they have been in terms of sub-sectors. ‘There are certainly retail assets that we’re not keen on – including department stores, shopping centres and high street retail. You don’t find long leases with these assets, and there’s an oversupply of stock,’ he said.
LXi does however have a strong track record with foodstores, often favouring discount leaders including Aldi and Lidl. Yet the firm recently had to back out of a £500+ mln deal to buy a portfolio of Sainsbury’s stores due to “unstable financial markets”. ‘But it was an interesting portfolio with lots of strong points,’ said Lee, ‘including omnichannel capabilities in prime locations.’
Despite this high-profile deal collapsing, the firm is still bullish on the foodstore-led sub-sector. ‘As we enter a recessionary period, non-discretionary food or less discretionary food is not a bad place to be. And in terms of available deals, there is still opportunity out there.
‘While many supermarket owners are institutional, and don’t need to sell at any price, a number of stores are held by open-ended funds which have seen quite a flood of redemptions in recent times. These funds tend to dispose of their most liquid assets first – which can include supermarkets. We think there will be some interesting price movement on grocery stores in the next few months.’
He added: ‘The downside of the grocery store market is that rents are too high across many assets, and they are often not in the best locations. But we are absolutely open to buying stores with omnichannel capabilities, low rents and good trading performance.’
Niche retail
Beyond grocery stores, LXi has gained a reputation for its ability to see the upside in niches that don’t usually spring to mind. ‘We have forward-funded 30 drive-thru coffee stores for the likes of Starbucks and Costa Coffee. Garden centres is another highly-performing niche for us.
We have five Dobbies Garden Centres – they did very well during Covid, and have good plots with open A1 planning consent. That saw Dobbies recently sign a deal to add Waitrose Essentials to many of their sites.’ Under the new plans, Dobbies hopes to add some 50 Waitrose food halls to its centres nationwide to boost its convenience store business in the wake of Sainsbury’s pulling out of a supply deal with the garden centre operator.
Finally, the leisure part of LXi’s portfolio includes high profile assets – including Alton Towers and Thorpe Park – which captured the headlines in recent months thanks to an innovative financial transaction from LXi. These unique assets – with 50+ year leases – prove that fun can be financially serious, after LXi successfully sold 30% of their income for a fixed period of time.
‘In this type of climate, where you are looking at much higher interest rates for the foreseeable future, engineering the income strip sale was effectively a refinancing,’ Lee said. ‘The debt on these assets was a lot more expensive.’
He added: ‘It has to be said, this kind of approach doesn’t work for many portfolios. What the buyer is looking for is a high-quality tenant and a long lease – 55-years unexpired until the first break in this case. The durability of these assets is also rare.
'Thorpe Park occupies 100 acres in Surrey, and Alton Towers has an equally impressive footprint. That kind of plot is likely to be a theme park for the next 50-100 years – and retains significant value beyond that. If you compare a theme park to an industrial unit, the latter might also have a strong tenant, but will need to be refurbished or even rebuilt in 10 years.’
He concluded: ‘We have eliminated the refinancing risk on those assets and at the end of the 65 years, the freehold comes back for nothing – and the yield was obviously incredibly appealing at 2.96%. We’d like to continue to be this imaginative with our portfolio and believe that thinking outside the box is key for the future.’
