Sunday Trading Reform - A mess waiting to happen

George Osborne is set to announce a consultation on changes to Sunday trading laws.

Apparently he intends to leave it local authorities to decide policy. That means, for example, that Dartford Council could allow Bluewater Shopping Centre to open for longer hours on Sunday whilst across the Thames, Thurrock Council could refuse to allow extended opening at Lakeside.

I can only imagine the employment difficulties that retailers would face with such a piecemeal policy.

What is easier to understand is that the ability to trade longer on Sunday in certain locations could improve the attractiveness of those locations to retailers which in turn could lead to higher rents and higher capital values.

New Property Fund

Over the next three weeks Stephen and I are road-showing to potential investors to raise equity for our first major real estate fund. Our aim is to raise £90 million of equity, to which we will add £60 million of debt to give a total initial capacity of £150 million.

After an initial investment period of about 18 months we expect to show a cash on cash return of c.7% with a target IRR in excess of 10%.

Investments will be made in a sector where Stephen and I have long experience.

This is an exciting next step in the evolution of Recept and I hope to be able to share more details with you in early September.

Professional Negligence Claim

It is perhaps inevitable that the downturn has led to an increase in the incidence of negligence claims against valuers. In one high profile case last year the High Court found against Colliers in a claim worth €32 million.

Although not on that scale we took the first steps last week in a claim against a firm of valuers for an amount of nearly £2 million in respect of the valuation of an office building in Birmingham in 2010.

We hope to achieve a sensible financial settlement without resorting to litigation; however we have prepared the ground with lawyers and expert witnesses so that, if necessary, we can commence proceedings. We have taken detailed advice on issues such as the application of the statue of limitation, our duties to mitigate and how to quantify the amount of any loss.

Although we hope to settle by negotiation we have, of necessity, put aside a substantial fighting fund to meet the costs of the litigation. 

For now we are keeping silent about the identity of the valuer, but should we commence proceedings that will undoubtedly become public. Let us hope that this can yet be dealt with amicably, and out of the public eye, and without incurring unnecessary legal and other costs.

Tenancy Fees - Is Ed Miliband right?

Some years ago, before the financial crisis I can remember getting into a somewhat long and complicated debate about the fees charged by rating agencies to provide credit ratings to companies issuing bonds.

It seemed to me at the time to be wrong that the issuing companies paid those fees, rather than the investors who benefited (or not) from the ratings. I accepted that if investors were to pay then it was likely that the costs would in some way be passed back to the issuers, perhaps by way of pricing on the bonds, but the fact that the investors did not pay for the rating left a gap in accountability.

That gap in accountability was dramatically exposed by the financial crisis.

I found my thoughts drifting back to that debate today, when I read about Ed Miliband's latest proposals to address perceived problems in the residential lettings market.

There is of course much that many landlords, including me, will dislike or disagree with in those proposals; and I am sure (if they are ever enacted) that the law of unintended consequences is likely to come into play.

However, I find myself thinking that, in respect of the tenancy fees element of his comments that Mr Miliband is right. Letting agents are instructed by landlords and not by tenants and the agents' responsibility is to the landlords. It is clearly the landlords that gain the benefit from credit checks, inspections and other administration for which fees are commonly charged.

As with the rating agencies, I think that responsibility for fees should rest with the party who benefits from the service provided which, in the residential lettings market, is the landlord. Otherwise an accountability gap exists that could well contribute to problems that we have yet to fully foresee. Additionally as the landlord is not paying there is no 'market' control on the level of the fees. In most cases the tenant will have to just accept the charges, whereas if the landlord were paying he could compare total lettings costs much more easily.

Of course the tenant may ultimately bear the cost by way of an increase in rents, but if all lettings were undertaken on that basis then it would be easy for the tenant to compare different options.

There is no doubt in my mind that were such a control imposed, the additional costs charged by agents would fall dramatically over time leading to a better overall deal for both tenants and for landlords.

THIS PIECE WAS ORIGINALLY PUBLISHED ON 3RD FEBRUARY 2015

Tesco property values - Still not adding up

Tesco has today announced that, as part of its programme of rebuilding trust and transparency, it is providing 'increased disclosure, including additional details on property valuation and ownership'.

So what has Tesco told us?

It has told us that the estimated market value for its fully owned property was £22.9 bn. Note please that this is an estimate not an external valuation notwithstanding that Tesco later says that "This valuation represents an estimated surplus of £2.7 bn over the year-end net book value".

Tesco also tells us that the £22.9 bn represents a reduction of £7.6 bn year on year. By my calculation that is just short of a 25% reduction in value. That reduction is described by Tesco as 'driven mainly by a significant weakening of the UK retail property market....'

I'm fairly confident that the UK retail property market didn't fall by 25% last year nor did the supermarket sector. In respect of the latter, the latest figures (to 30th Sept 2014) from British Land showed its superstore portfolio growing by 3.1% year on year.

Notwithstanding Tesco's claim of improved transparency, it seems to me that something still does not add up.

Birthday

Thanks to those of you who took time out of your busy mornings to wish me Happy Birthday on LinkedIn, Twitter, email, snail mail (thanks Mum); and in Spanish (Carlos)!

Morrisons

I was interested to see that among yesterday's senior management changes was the departure of Gordon Mowat.

There has been much focus at all the grocery retailers on trading performance, but the problems are exacerbated when trading is from the wrong size stores in the wrong locations.

It is easy to blame the 'retail' teams for that, but the reality is that Morrisons, along with its competitors has long needed a property function that is at the heart of the decision making process.

In recent years, far too many retailers have been badly affected or even ceased to exist because their property strategy was too inflexible, (think HMV, Clinton Cards).

Mr. Potts is clearly taking action early to change the business and he should not hesitate to replace Mr. Mowat with a real estate professional who can properly capitalise on the Morrison's largely freehold portfolio, which remains a true competitive advantage for the business.

A Parliament for the Whole UK? - continued....

In my blog of 21st January 2015 - A Parliament for the Whole UK? - I suggested that a wholesale move of the government from London to the regions should be considered against the background of the ageing and costly government estate in London and in particular the Houses of Parliament.

The BBC reports this morning on a speech by John Bercow in which he said, amongst other things that

Parliament may need to decant in order to undertake necessary repair work; that

If MPs and peers were to temporarily move out, locations outside London should be considered; and that

"once you are out it can be very difficult to get back in".

Putting all of those things together suggests that a permanent move might well be the better option, and that such a move should be to the regions. The only thing stopping a serious contemplation of that idea seems to be an emotional attachment to the building, but in my view that conflates the physical building with the ideal of a parliamentary democracy.

What is best here is abandon emotion and the money pit that the government's ageing estate is guaranteed to become. I am not alone in this thought and there is already an e-petition here.

I urge you to sign it too.

Correlation, Causality and Cockroaches

In his recent letter to shareholders of Berkshire Hathaway, Warren Buffet said that

"In the world of business, bad news often surfaces serially: You see a cockroach in you kitchen; as the days go by, you meet his relatives."

Quite apart from the unfortunate use of a cockroach analogy when talking about a food retailer, I wonder about the point that Mr Buffet was trying to make. He appears to provide a causality link by saying

"The company's market share fell, its margins contacted and accounting problems surfaced."

There is of course a temptation to think that because one thing follows another that the first is the cause of the second - a fallacy otherwise known as 'post hoc ergo propter hoc'.

But there is a significant difference between correlation and causality.

It seems to me that there is a significant correlation here, but not necessarily causality; for that we may well be better looking at something else that Mr Buffet said

"In 2013, I soured somewhat on the company's then-management...."

and that may be the real lesson here.​

Could deflation lead to rent increases?

Inflation has generally been considered a positive for real estate as prices and rents tend to rise and one might therefore conclude that deflation would be a negative.

However, following yesterday's inflation report, Retail Economics posted an update which suggested that deflation would allow retailers to rebuild margins as the costs of goods fall.

If that is correct, could those improved margins also allow more scope for rent increases?

That sounds counter-intuitive - what do you think?

"Cities may set Stamp Duty and keep revenue"

reports a Times newspaper headline today, quoting Danny Alexander the chief secretary to the Treasury.

There are some compelling arguments marshalled in favour of such a change but what would it mean for real estate investment in those cities?

On the face of it, a city with a lower SDLT rate ought to be more attractive to real estate investors and it would certainly lower the purchase costs; but would there be an increase in the volatility of stamp duty rates?

Uncertainty has always been a problem for investors in long-term relatively illiquid assets. Property valuations are affected by changes in stamp duty even when properties are not sold, a stamp duty increase can reduce values overnight so increased volatility could be a problem.

And, what of the boundaries? We do not yet know where any lines might be drawn but is it possible that the metropolitan areas of Liverpool and Manchester might benefit when Blackburn and Preston don't?

What is sure is that any differential in rates would affect investment decisions and almost inevitably create winners and losers.

Implementation of any such changes remain a long way off, but consideration must be given to not skewing the field against towns and cities that need and deserve investment.

Not so much 'Factoid' as 'Fractoid'' #fractoid

The Sunday Times today reported an oft repeated 'fact' that the closure of 43 unprofitable Tesco stores would result in the loss of 2,000 jobs.

There is a temptation to describe this as a factoid. Oxford Dictionaries defines a factoid as

"An item of unreliable information that is reported and repeated so often that it becomes accepted as fact"

I am not sure however that the Sunday Times report strictly meets that definition because it is highly probable that the closure of those 43 stores will actually result in that many job losses.

What is not in any way described however is that the store closures are caused by increased competition from other retailers, in particular Aldi and Lidl who have themselves announced the intention to significantly increase staff numbers over the next few years. In fact with the UK grocery market set to continue to grow over the next few years the sector is likely to see net job creation rather than job losses.

It seems to me therefore that the job loss numbers are what I might term a fractoid, defined as

"An item of information that is reported and repeated so often that it becomes accepted as relevant, even though it isn't."

In other words the statement includes only a fraction of the information required to be truly helpful.

I would be interested to hear from you with other fractoids.

Monday News

There were a couple of apparently unrelated items that caught my eye this morning.

Firstly, the news reported in The Times that "supermarkets and discount retailers are expected to enter the race to buy BHS".

Despite the fact that many of these stores have planning to allow the sale of food I doubt that the location, size and tenure of the BHS stores will make more than a handful of them attractive for convenience food stores without substantial investment.

I would expect Aldi and Lidl to show most interest. Tesco and Sainsbury less so as they will already be represented in many of the towns where BHS trade. Morrisons may show interest in some if the price is right.

However, in my view a trade sale is the more likely outcome.

The second item was the Q3 IMS from LondonMetric with Chief Executive Andrew Jones highlighting the "greater alignment to the growth of eCommerce through retail led distribution assets and the convenience of click and collect...."

Click and Collect is still strongly preferred by many customers and existing retail locations, close to transport links or houses themselves will continue to benefit from that.

Andrew is right to highlight the benefit of Click and Collect, but the question remains open about how to value that, both for occupiers and for landlords.

If there is an eCommerce value in the BHS trading locations then perhaps these two items are not as unrelated as they first appear.

A Parliament for the whole UK?

Imagine the agents brochure, for sale a couple of well located terraced houses with gated access, close to Horseguards parade, and a large residential conversion opportunity with clock tower and excellent river views?

Notwithstanding a noble history the current Houses of Parliament building is in a poor state of repair and, even fully refurbished would be barely fit for purpose. That refurbishment is likely to cost the taxpayers in the UK up to £ 5 billion.

There is no particular reason why parliament needs to sit in London, which is now one of the most expensive cities in the world. Surely it would be much better to move it,  and the other major institutions and departments of government to one or more of the regional centres; Manchester, Birmingham and / or Liverpool for instance.

The savings from not refurbishing the current building, and releasing it and other Westminster buildings to the private sector would more than cover the costs of the new buildings required (even allowing for the propensity of civil servants to overspend on such projects).

The removal of the government from London would free up infrastructure capacity and allow private sector investment into some of London's most iconic buildings. More international air traffic would be diverted to Manchester relieving congestion at Heathrow.

As the BBC has already proved a move to Manchester is perfectly possible and think of the signal that such a move would send to domestic and inward investors to the northern half of the UK. A move timed to coincide with the completion of HS2 would allow for the significant additional capacity that would be required for such a move.

In my view this is exactly the type of bold strategic thinking that is required to ensure that the UK and London remain one of the best places in the world to live, work and invest.

I fear however that I might wait a long time to see that agent's brochure.

UK Infrastructure

I'm in Glasgow this morning, having flown up from Heathrow. I find that flights are always a good opportunity to reflect on some of the wider issues that are driving the general economy and real estate markets.

As I am presenting my IPF short paper on real estate debt at lunchtime, this morning my thoughts drifted to the fact that occupier demand remains a key driver of real estate values.

One of the important factors in that occupier demand is infrastructure, and more specifically transport. The evidence of demand for (and the increasing value of) commercial and residential property close to Crossrail stations is a clear manifestation of that.

The comparison between King's Cross and Gare de Nord Stations provides another example of the benefit of investment in first class facilities. The same applies at Heathrow T5 and the new T2.

The Centre for Cities published research earlier this week which highlighted the continuing North / South divide in terms of new investment and jobs.

That divide is a problem for everyone in the UK because capacity in London and the South East is limited and therefore without a stronger North, new jobs and investment will inevitably drift towards the continent and away from the UK.

In my mind that means that HS2 is certain to provide a catalyst for investment (if it goes ahead) and the important question is not if it is necessary (it is) but how it can be delivered at a sensible economic and social cost.

That is a question which will never be able to be answered definitively (at least in advance) but I do have a few thoughts on that so, watch this space for my follow up piece - "Does London need the Houses of Parliament?"

Zombie Loans: Fact or Fiction

The IPF published an article in its Focus journal last week based on the short paper that I produced about UK real estate lending.

Here is a pdf of the article.

Aldi and Lidl - Widening the Moat

We have heard much in the media about the threat posed to Tesco, Sainsbury and Morrisons by the rise of the discount retailers.

It is obvious that the annual sales growth that we have seen of 22.6% (Aldi) and 15.1% (Lidl) cannot be sustained without opening a very significant number of new stores. Both businesses have ambitious plans in that regard but opening 30, 50 or 100 new stores per year in the UK will be very challenging.

What strikes me most however is the manner in which both companies talk about the future. Without the pressure of a stock exchange listing and a daily judgement from the market Aldi and Lidl each look to the longer term. Aldi aims to move from 550 to 1,000 stores in the UK by 2022. Ronny Gottschlich of Lidl talks of there being room for up to 1,500 Lidl stores but refuses to be drawn on a time-scale.

That is not to say that Tesco and the other grocers do not have longer term plans, indeed the focus on internet and convenience suggests that they do but the market's focus on quarterly trading performance reduces the scope for true longer term investment.

I am reminded of Warren Buffett's thoughts

"We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted."

Perhaps the listed grocers' inability to widen the moat explains Mr Buffett's recent decision to sell his stake in Tesco and suggests also that the rise of Aldi and Lidl in the UK is set to continue.

Superstore Yields and Rents

Following the recent news flow from Tesco and the increasing competition in the grocery sector, I have been asked a number of times recently about my views on yields and rents.

There has been a noticeable outwards shift in the bond prices of the securitisations that are secured by Sainsbury and Tesco stores, with Tesco's in particular suffering from the downgrade of its rating by Moody's.

Clearly, tenant quality is a factor, but the more important drivers of yield are, in my view, the underlying fundamentals of the property. For that you need to look at demographics, competition, and of course actual and market rental levels.

With retailers starting to scale back new openings (and even exit from existing stores) it is certain that the demand dynamics in the market are changing which will almost certainly have an affect on rental levels. Given that there has always been a shortage of market rental evidence in the sector it is difficult to know exactly how that will feed through. The picture for future rental growth remains unclear, the reduction in supply caused by the reduction in new schemes could be a positive, yet that is also a symptom of reduced demand.

In my view continued price deflation and the consequent margin erosion is likely to put downward pressure on rents, and that is almost certain to have an impact on yields. Investors in RPI linked lease income will need to start to consider the impact on value if indexed linked increases outstrip market rental growth.

Innovation through Experience

We are today launching our new website and I thought that it would be a good opportunity to explain why I chose the name Recept, and what Innovation through Experience means to me and my colleagues.

Some months after I formed Recept in  July 2010, I was asked in a meeting where the name had come from. Before I could reply one of the colleagues of the questioner said "It's obvious, it's an anagram" and before I had time to form the question "of what?", he went on to say "of Peter C".

Actually, when trying to decide on a name I was looking through an old dictionary that I inherited from my grandfather, at words that began with RE (for Real Estate). Recept (a word that has fallen out of common use) was defined in that dictionary as "a new idea formed in the mind by the repetition of similar percepts, as successive percepts of the same object."

That definition, phrased slightly differently is Innovation through Experience.

To me therefore what Recept means is that in a rapidly changing world, new ideas and new ways of doing business are vital to success. The trick however is is knowing how to evaluate and choose which of those new ideas will work, and efficiently discarding those that won't; and that is where experience is so important.

Throughout our careers the Recept team and I have been at the forefront of innovation, in financial structuring; in the use of joint ventures; in asset and property management; in corporate responsibility and customer service; in systems and process management; in the sustainable design and operation of buildings and in developing the value in new asset classes.

So Innovation through Experience is at the heart of what we do and although it may be have been unintentional, I am proud to have my name so closely associated with the Recept brand.

Citylink

Can we please, please stop with the outright castigation of Better Capital and John Moulton.

It is widely accepted that when Citylink was bought for £1 from Rentokill that it had been loss making for some years and, in the absence of another bidder a closure and subsequent redundancy of staff would have been the only alternative.

Better Capital have clearly put significant time effort and money into trying to turn the business around but have not succeeded. In the meantime they have paid staff wages and kept thousands of people in employment.

They have chosen to shut the business at a time which causes least overall disruption, and that also is apparently a reason to take them to task, but imagine what would have happened if they had closed the business two weeks earlier in the middle of the Christmas delivery rush.

Perhaps the critics in politics, the media and the unions should take a step back and attempt to better understand the reality rather than the headline.

Peter Clarke Director Recept Consulting Limited