As people cut holidays will they turn to their local leisure facilities instead? The sector's future potential relies on optimising the product offering, as Lynn Strongin Dodds reports

There has been little activity on the leisure property front. However, this niche holding may grow in stature as other segments of the property market suffer in the post credit crunch fallout. While few assets are immune to an economic downturn, industry experts are split as to whether leisure parks, particularly those offering reasonably priced entertainment activities, are in a better position to weather the economic storm.

Last year, the asset class surprised the market by turning out a 0.7% return in one of the most difficult trading environments for years, according to the International Property Databank (IPD) figures. Although the figure seems anaemic, it looks almost robust compared with the IPD All Property Share index's negative performance of -3.4%, which included -6.1% for retail and -0.5% for offices.

The UK's only two leisure funds - Capital & Regional's X-Leisure and Legal & General Leisure Fund - both outperformed the IPD index. The former, which was started five years ago, has £970m (€1.23bn) of assets under management and ended 2007 with a 3.2% return. The latter, launched in 2002, has accumulated £280m AUM and turned in a 1.9% performance last year.

Robin Goodchild, European director of strategy and research at LaSalle Investment Management, notes: "Returns in leisure property last year held up slightly better, relatively speaking, to other parts of the market. It is a bit spurious, though, as the yields did not move out as far as in the office and retail sectors, mainly because there was no transaction evidence. I would not look at leisure as a safe haven because weaker consumer spending will have an impact; we could see as many receiverships in leisure as in retail. There is a place for the asset in a diversified property portfolio but I would not be overweight because I mistakenly believed it would be more resilient to an economic downturn."

While all industry participants agree that leisure should only constitute a slice of an institution's real estate portfolio, some are more optimistic about the asset's future prospects in a faltering economy. As Andrew McGregor, director of Savills leisure group, points out: "The focus will be on value for money and many of these leisure parks offer just that. Figures from the Department of Agriculture show that nearly 40% of the total annual food budget in the UK is spent on eating out and I do not think this will change dramatically. What we will see is a polarisation in the market with people who can afford to eat at the higher-end restaurants, while those on lower incomes will turn more to the family-style restaurant or chain. It will be those in the middle who will be squeezed."

PY Gerbeau, chief executive of X-Leisure, owned by Capital & Regional Fund, with Hermes as fund manager, echoes these sentiments. "People may cut back on the number of holidays they take but they will still want to go out and enjoy themselves. The main attraction of leisure parks is, for example, that a whole family can have a meal for less than £60, or go to the cinema or bowling for less than £10 a head, or even spend a whole day out with activities such as climbing, skiing, flying for less than £100."

Leisure is also an attractive property proposition because of the steady income flow and rental growth. "Occupiers typically take 20-year leases and there is an element of indexation linked to the retail price index," says McGregor. "The other benefit of these properties, particularly the out-of-town centres, is the flexibility of their design. They can be broken up and reused for other purposes."

Leisure parks, which are a UK phenomenon, are often anchored by a cinema and filled with family-style restaurants, pubs, bowling and health and fitness clubs. Pubs and nightclubs also feature, but they are typically more prevalent in city centres where there is strong transportation links. Out-of-town centres, which typically have car parks, are not thought to be suitable because of the fears of drink driving.

By contrast, continental Europeans tend to view leisure a as a sub-set of retail property, according to Goodchild. "This is mainly due to the different planning processes which have resulted in UK leisure properties being more specialist while European sites are usually a mix of retail and leisure. One of the main challenges is that cinemas are not as strong anchors as they were in the past due to competition from home multi-media entertainment systems."

Things are slowly changing, according to research from Savills. It found that many new shopping centres in the UK are set to include a substantial leisure component with their retail offering in an attempt to attract more consumers. Over 70% of the schemes which opened in 2007, or are due to open this year, - comprising over 11mft2 of trading space - are anchored by cinemas, and all of them will house five or more restaurants.

The biggest challenge, according to Duncan Miller, fund manager of Legal & General's Leisure Fund, "will be to enhance continually the appeal and attraction of the leisure offer. Our main focus this year is on restaurants because of the opportunities for growth and expansion. We are also reviewing further investments that are available and we are careful to ensure that any expansion of the fund would enhance the returns."

The Legal & General Leisure Fund holds seven prime leisure assets which are geared towards family entertainment, such as cinema, bowling and the casual dining experience. "The fund benefits from a strong income stream. Of the fund's income, 45% is subject to minimum fixed uplifts and the average unexpired lease term is 16 years. This provides a solid base from which we believe we can again outperform the index in 2008."

Gerbeau. who will also be concentrating on enhancing the asset mix in its 19 leisure properties, is no stranger to challenges. His previous job was trying to save the ill-fated Millennium Dome in 2000 and he cut his teeth at EuroDisney in the early 1990s when UK housing prices were plummeting and interest rates soaring. The lessons have held him in good stead for today's volatile conditions.

Gerbeau says: "Based on my 17 years of experience in the leisure and tourism market,
one shouldn't adjust pricing strategy to generate more business. Our philosophy has always been to encourage outstanding value for money, and we are doing the same with our leisure schemes. We will grow through asset management initiatives as well as some developments, and continue to constantly improve the tenant mix, giving more variety and answer the end customer demand and trends. The consumer has become more sophisticated and demanding, and we have to meet their changing requirements. We have business plans for each property and if they no longer meet our investment criteria or no longer have asset management potential then we will sell them depending on market conditions."

Last year, X-Leisure benefited from a capital infusion of £200m from the restructuring undertaken by Capital & Regional of its leisure division. The move was designed to increase the size as well as strengthen the structure of the investment fund to make it more attractive to investors. The group transferred ownership of its Xscape snowdomes in Castleford and Milton Keynes from its own books into the fund, which boosted the value of the fund from £723m to almost £900m.

Ideally, Gerbeau would like to look for opportunities, but the credit crunch has put a damper on any immediate purchases. "It is a difficult time to be acquisitive and we need the markets to come back before we can play again. We do not have the cash. In the meantime, we will add value to our existing properties and wait for things to improve."

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