A special opportunity in investing terms is an unusual event that can trigger the chance to buy in at an attractive level. The term applies to stocks and various other assets. The steadily rising and sustained increase in borrowing costs has created more of these special situations, but rebounds are not guaranteed. The rise in these type of opportunities in 2023 correlates with a 27 per cent increase in UK administrations, along with a 30-year high in corporate insolvencies.
Scratch the surface, and the outlook becomes even bleaker. That’s because the number of administrations fell away over the last quarter of the year, while liquidations were on the rise, suggesting that insolvency practitioners have struggled to optimise the value of distressed businesses. And little respite is in sight as the Bank of England has delayed cuts to the base rate, meaning that an ever-increasing number of businesses in the UK will be lumbered with higher loan repayment schedules when their existing credit arrangements expire.
Few areas of the economy have been feeling the pinch more than the commercial real estate sector, both in the UK and abroad. Global commercial real estate investment was down by 54 per cent in 2023, according to analysts at Knight Frank. Increased financing costs have suppressed activity in the sector, but in the post-Covid-19 era “uncertainty over occupational demand due to structural shifts” has also had a profound effect on volumes. Nonetheless, the Knight Frank analysis posits that “asset prices have likely reached the bottom” in the most liquid UK markets, so we are already seeing an influx of private capital “taking advantage of reduced competition from debt-backed purchasers”.
All this provides the backdrop for a planned £500mn initial public offering (IPO) of units in Special Opportunities Reit on the London Stock Exchange. Founder of Primary Health Properties (PHP), Harry Hyman, and former Workspace (WKP) chief Jamie Hopkins are leading the internally managed Reit, which comes with a projected total expense ratio of 0.6 per cent, together with a 7-8 per cent EPRA cost ratio (net overheads and operating expenses against gross rental income). Debt financing is not projected to exceed 25 per cent on the portfolio relative to its market value – a relatively conservative target and wholly understandable given recent history.
Around £275mn will be allocated towards a portfolio comprised of structurally underserved areas of the commercial real estate market, such as student accommodation and budget hotels, although that could conceivably stretch to data and logistics centres, depending on entry yields. The onus is on acquiring assets with passing rent significantly below estimated rental value. It is a buyer’s market as there is no shortage of motivated sellers. Property sales with a value estimated at £18bn are expected from defined-benefit pension schemes following insurance buyouts, while many over-leveraged local authorities are looking to balance their books via disposals. The trajectory of interest rates means that there are more property investors who need to rapidly de-leverage as refinancing is no longer viable.
Timing any market is a fool’s errand, but there are signs that commercial real estate could be approaching the bottom of the cycle, as Knight Frank thinks, at least in the UK – the situation in the US is rather more parlous. Special Opportunities Reit makes the point that over the last 50 years, “there has not been a sustained fall in inflation adjusted property returns for more than three consecutive years”. That might be tempting fate, but the point is that the Reit isn’t burdened by legacy assets, so it doesn’t have to make up the yawning valuation gap to net assets that is now a feature of the sector. It’s also worth remembering that Reits have historically delivered their highest returns during early stages of the real estate recovery cycle.
If it makes it on to the London Stock Exchange – the prospectus is due for publication on 20 May – Special Opportunities Reit, in common with industry peers, will benefit from any eventual reduction in the risk-free rate of return. Many Reits carry fixed-rate debt, although hedging via floating rate exposures has become increasingly common, but the real problem with the current interest rate environment is that it has resulted in steep negative revaluations across the industry. Yet the general fall-away in commercial real estate valuations provides the main opportunity where this Reit is concerned, at least theoretically. Doubtless, administrators at the London Stock Exchange will be hoping that the prospective IPO will herald a change of fortune on the admissions front, but the trust will have to overcome the resistance to the sector that has built up over the past couple of years.
