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?"

 

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

UK Retail Investment Opportunities

We are currently tracking a number of UK retail investment opportunities which are not yet available in the market.

With lot sizes of up to £1.25 million each investment offers an initial income return in excess of 5.5% from a long-term lease to a strong UK retailer.

Gearing of up to 60% is immediately available, and we expect total returns to exceed 10% per annum over the next five to seven years.

If you are interested in investing, please give us a call on the usual numbers.

Consequential Loss Claims from Swap Mis-selling

Only £5 m of additional consequential losses have paid out  by banks under FCA's IRHP review.

The FCA has recently posted some interesting information about consequential loss claims under the FCA approved review.

The 8% interest rate set by the FCA was designed, in part to provide redress for lost opportunities. Any claim for additional consequential loss has therefore to exceed that 8% per annum to be worth pursuing.

So far 2,965 claims have been received by banks and 1,535 of those have been assessed; with only 11 having resulted in a payout of more than £100,000.

Claims are complicated to put together and need not just legal advice, but real estate and financial know-how to restate accounts, assess losses and formulate strategy.

At Recept we have the necessary skills, and experience to help clients judge the chances of success.

You can see the FCA analysis here:

http://www.fca.org.uk/consumers/financial-services-products/banking/interest-rate-hedging-products/claims-for-consequential-loss.

This was first posted at ReceptConsult.blogspot.co.uk on 27th October 2014

UK Government commences outsourcing of immigration control.

The UK government today commenced a trial whereby landlords are required to undertake checks to ensure that potential tenants are not illegal immigrants. Any landlord failing to undertake the proper checks faces a fine of up to £3,000.

Thus, having failed to properly police illegal immigration at our national borders, politicians are making private citizens and companies responsible for the job instead.

Although some may argue that the private sector will do  better than the UK Border Agency, is it reasonable to fine offenders for failing to do a job that the government has failed to do itself?

The rules would also "act as a new line of attack against unscrupulous landlords who exploit people by renting out overcrowded and unsafe accommodation" said Securities Minister James Brokenshire. 

Am I alone in thinking that the unscrupulous and exploitive landlords referred to by Mr. Brokenshire are the very people who, having ignored existing legislation, will ignore this legislation also?

This was first posted at ReceptConsult.blogspot.co.uk on 1st December 2014

 

Fund raising lessons - No help from the helpers

I have spent a good deal of time in recent months talking to potential investors and to intermediaries who have claimed to be able to introduce me to potential investors.

My investment proposal provides a secure income return from UK real estate, with growth prospects and shows annualised returns of c. 12% per annum. The portfolio will be modestly geared (below 40%) and there is a potential upside from asset management and yield shift in a sector which is currently overlooked by investors.

So, what have I learned?

It is nearly ten years since Warren Buffet, in his annual shareholder letter treated us to an essay on 'How to Mimimise Investment Returns'. The letter is still available at http://www.berkshirehathaway.com/letters/2005ltr.pdf

From my experience the majority of investors have not read Mr Buffet's letter. They are a long way from the actual source of their investment returns and are often caught in a web of the 'helpers'; 'broker-helpers; and 'manager-helpers' described in the letter.

The majority of these 'helpers' have a financial or banking background and discuss at length the importance of the asset management, regulatory oversight and the value add that their involvement brings. In reality many just help themselves to a slice of the returns, without adding any real value over and above making an introduction. In many cases even the introduction has proved worthless because their fees have fatally damaged the economics.

Few if any of them have experience of direct real estate investment markets and how to manage the lifecycle risks of acquiring, asset managing, financing and selling real estate.

The investors that I have spoken to directly, have universally acknowledged the sense of my investment case, but many still expect high levels of return and low levels of risk. In fact one investor was looking for secure income double digit returns with no entry risk and a guaranteed exit!

So, I will bypass the helpers and continue to focus my discussions directly with investors. If you are, or you know of, an investor or investors who would be attracted by a secure income investment with upside potential, then please get in contact.