| Industrial market to gain most from e-commerce |
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| Shortened leases, changed covenant policy and internet share options in return for cabling are some of effects of the e-commerce revolution for property investors, writes Brian Turner. |
To date, much of the literature concerning the effects of e-commerce on the property market has focused on the occupier market. Relatively little has dealt with the effects on the property investment market. Yet there will be effects, both indirect - through the occupier market - and direct, which merit examination.
Firstly, let us deal briefly with the indirect effects on property investment, through the occupier market. There has been some talk about internet retailing spelling the end of the high street as we know it. This has been largely overplayed. Around two thirds of retailers in the prime shopping thoroughfares and shopping centres in Dublin are at low risk from internet retailing, with only around one in six in the high risk category. It is likely that any units in these areas vacated because of competition from e-tailing will be quickly re-occupied by other tenants. However, some secondary locations may be at risk from a consolidation in demand from some tenants. Hence, investors with secondary retail properties in their portfolios may wish to re-examine their relative merits.
Internet share options
The office market is less clear cut between prime and secondary tiers. Office space in high profile prime areas will remain in demand, but some occupiers will opt for less prime locations in a bid to reduce costs. One issue which is affecting owners of office space in the US currently, which may migrate to this side of the Atlantic, is that broadband cable providers are competing heavily for the rights to wire buildings to their networks. As a result, they are offering incentives such as share options in their companies to landlords who award them the contracts. Provided that these companies do well, this presents landlords with an opportunity to make substantial gains with little or no risk.
The industrial market is likely to be the biggest winner in the e-commerce revolution. Demand for storage and distribution space will increase substantially in the coming years. In particular, well-located space, near transport nodes, will be sought after and will therefore prove sound investments in the coming years. There is likely to be a continuation of the recent trend away from standard sheds towards high-bay distribution warehouses and high-tech industrial units (often with high office content).
Covenant strength is key
Aside from performance, however, there are other, more direct issues which will affect property investors over the coming years. One of the foremost of these is the issue of covenant strength. In recent years, numerous high-tech start-up companies have been created. These companies all have space requirements but few, if any, of them would qualify as strong covenants for an institutional portfolio. A significant proportion of them are loss-making and are likely to remain that way for some time before they begin to make profits. Internet retailers, such as Amazon, also require storage and distribution facilities, but again are loss-making.
Hence, there may need to be a re-appraisal on the part of investors about covenant strength. Despite the poor balance sheets, a number of these start-up companies and internet retailers are likely to become profitable in the coming years and intuitively would make sound tenants. The traditional assessment criteria for covenant strength may not necessarily be applicable in these cases, therefore, and this needs to be taken into account.
Lease length to shorten
Furthermore, lease lengths in Ireland and the UK are amongst the longest in the world (see chart). Typical office leases here and in the UK are 15 years, compared with a standard five years in the US and Canada. Elsewhere, leases vary from three to 10 years, with the regional averages all standing at around five years. These start-up firms are rapidly changing, both in size and in structure, and therefore their space requirements will change dramatically in a 15-year period. Hence, they would be reluctant to sign long leases such as those offered in this country.
These last two points highlight an opportunity for investors. Shorter, more flexible leases will be in demand from tenants who, although they would be sound, do not have the track record to prove their covenant strength. Investors who are willing to take on the higher risk with this type of tenant could benefit from a number of options. Firstly, they could demand premium rents, improving their capital growth. Secondly, they could receive share options as part of a lease agreement, which, with prudent selection of tenants, could prove very profitable indeed.
Hence, the e-commerce revolution that is upon us will not only affect the property market from the occupational side, but it also presents investors with new challenges and opportunities. These opportunities, if seized, could ensure enhanced property returns in the coming years. |
Brian Turner is head of research at Hamilton Osborne King
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| Article appeared in the May 2000 issue.
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