The significant optimism around the UK real estate market is being bolstered further with increasing interest and investment from private equity.
Analysts at investment bank Berenberg recently identified that more than three-quarters of the UK real estate deals struck or mooted in 2021 have involved private equity, with high-profile acquisitions including St Modwen Properties, Sigma Capital and McCarthy & Stone.
gunnercooke‘s Private Equity Partner, Sameer Huda, looks at the current trend and the legal considerations around private equity firms investing in UK real estate.
‘The saying “safe as houses” as traditionally been an anathema to many private equity funds. Their fee structure and appetite for higher returns meant that real estate has largely been left to the domain of only specialist private equity funds. In an era where there is an abundance of dry powder finding it increasingly difficult to extract higher returns, however, a larger mix of private equity funds have now moved into search for real estate opportunities. The need to deploy substantial amounts of capital and the willingness to adopt longer term horizons, together with the perceived low risk profile of real estate have altered the dynamics of private equity’s attitude to UK property.’
‘Although this a global phenomenon, the continued weak pound has led dollar-denominated investors in greater numbers to UK property, given the historical window of opportunity this discounted currency provides.’
‘The robust UK legislative environment also forms part of the attractive proposition for international private equity investors.’
‘Expectations of inflationary pressures being more transitory in the UK compared to other markets, partially due to anxiety over the longer-term effects of Brexit and other UK specific issues, mean that some private equity firms also expect UK interest rates potentially to lag those of other major economies. Nevertheless, given the overall uncertainty, some believe that this may be a good time to lock in debt at low rates. It is this overall picture that sums up private equity investors current attitude towards the property market in the UK.’
‘There is no shortage of demand within different property sectors either, or expectations of this in the future. The Covid-19 pandemic has further stimulated demand in the housing and rental market. Likewise, the lack of commercial space, such as warehouses for logistics businesses, has created clear investment opportunities for those with a medium-term horizon.’
‘Commercial and leisure property such as office buildings, and shopping centres have, though, taken a hit due to lower usage and footfall, but many think investing now may prove to be shrewd business over the long-term. Particularly if planning law changes make it easier to convert office stock to residential in desirable supply-restricted areas.’
‘With currently suppressed valuations of listed property assets and continued low interest debt finance, the sector appears to provide a strong investment opportunity with plenty of scope for optimisation and consolidation.’
‘Aside from the seemingly inexorable rise in the value of land, these assets also offer opportunity to scale and deploy capital via development pipelines, a proactive buy and build strategy and diversification into property services with recurring revenue streams.’
‘Private equity can also take advantage of well understood tax efficient strategies in their deployment of capital and use of debt, thereby maximising the efficient return of capital and income, all of which boosts a fund’s performance.’
‘But if everything was clearly as “safe as houses”, then private equity would have turned greater attention to UK property in the past. There are always clear risks still with UK property for each asset class. For example, with offices, Savills has reported that almost 90% of offices are below the “B” EPC energy rating which will be a statutory requirement by 2030. Any acquisition of an office now would surely need to take this into account, factoring both the cost and practical viability of achieving this, as a key deal term. In Germany, the backlash against large corporate landowners in Berlin led to a vote by residents to demand that they sell their portfolio properties. As rents increase and incomes are squeezed — and large corporate landowners move into the BTR and residential space — similar regulatory pressures are also likely to build in the UK. Private equity can be an easy villain sometimes to explain more complex, and so less understandable, economic forces at play. The emotional, political mix of high rents leading to some families, struggling with inflationary increases in the cost of living, losing the roof over their heads to a landlord backed by a private equity fund is a PR nightmare that private equity will want to desperately avoid.’
‘The biggest risk for private equity, however, is betraying the very tenement on which private equity is based and that is overpaying for a purchase by misunderstanding how valuation factors vary within different asset classes and geographies of UK real estate. Credible valuation assessments require specialist investment managers who have a long and clear track record, something that some private equity managers turning to UK real estate do not possess. Many believe that property is a simple asset class whose risk profile is largely straightforward in comparison to the complexities of other sector investments. It is this assumption of the beguiling simplicity of property as an asset class which could lead some to fall over a cliff that they cannot imagine exists.’
‘With the market showing little sign of slowing, private equity’s interest in real estate, however, is likely to continue to grow considerably which is going to create interesting dynamics as they come up against more established investors in this space.’
‘The role of advisors to private equity is to ensure that the hardest conversations and challenges occur at the outset, to ensure that a successful outcome is on the cards for all stakeholders. It is the awareness of some of these less obvious risks that will help eliminate, or at lease reduce, some of the potential risks to private equity in the UK property market.’
If you have any queries relating to your private equity investments in real estate, contact Sameer Huda, Corporate/Private Equity Partner at gunnercooke here.