The positive pull of leisure
Despite the backdrop of economic doom and gloom the leisure property market is bucking the trend and providing canny investors with impressive returns, argues Mark Sheehan, managing director of Coffer Corporate Leisure.
A peculiar dichotomy has set in at Coffer Corporate Towers. On our daily travels to work, we are confronted by the doom-and-gloom stories and negativity that abound in the press, focused on the most challenging economic climate of our generation. But here at CCL Coffer Corporate Leisure our phones, emails and meeting rooms are humming with the gloriously enthusiastic tone of demand and positivity.
At times, it feels as though we ought to almost apologise for oozing positivity; but there is no getting away from it, the leisure sector is hot right now. In fact, demand for leisure property investments is at the highest level I have ever experienced in more than 20 years in the business.
Its not M&A I am referring to this is a property phenomenon. I am not, for a minute, suggesting that leisure is immune to the wider economic difficulties in the UK and globally, but there is certainly a feeling among property investors that the sectors operators are more robust and adept at growing amid these conditions and, crucially, that consumer demand remains stronger for leisure.
However, before merely gushing about the glories of leisure property, it is important to note that severe structural problems remain. Many investors assets remain significantly over-leveraged and many operators have legacy issues hanging over from historic, inflated sale-and-leaseback transactions, which will take some years to ride out to sustainable/realistic rental levels. It is this inflated scenario that has in part given sale-and-leasebacks a bad name.
In the heady boom days, many operators saw the opportunity to cash in on the properties they owned. By applying a new lease to their operating business and very high rental levels they could maximise the price they could generate from property investors chasing high income from the bricks and mortar. Pubs, hotels and other leisure/hospitality sectors were very popular. The problem was, these height of the market arrangements often comprised unsustainably high rent-to-EBITDA ratios, and built-in uplifts, which depended on sustained growth, often ignored capex requirements and, when we hit the financial crash, quickly became a suffocating liability for numerous companies.
The false rental market this practice created brought about a disheartening sentiment in the pub sector particularly. Many pub companies that carried out major sale-and-leasebacks possessed good-quality pubs in their portfolios, which, had they been let at a sustainable market level originally, would still be performing profitably. Unfortunately, the severe over-rented nature of these historic sale-and-leaseback arrangements has left many individual pubs haemorrhaging money: an unwanted scenario for both the landlord (whose property value diminishes with poor-performing occupiers and over-rented income) and tenant.
Over the past five years weve been advising on unwinding quite a number of such arrangements, involving the restructuring of businesses, rent renegotiations and, more recently, reconnecting the opco (operating company) and propco (property company) elements of businesses. Putting these businesses back together can add great value, just as separating them in the first place appeared to.
But sale-and-leasebacks are certainly back just with a very different slant. Fundamentally, the principle of releasing value from property in a strong market and using those funds on a core operating function remains sound.
If done sensibly there is attractive arbitrage between sales of property at yields of 4% to 6% and reinvesting those proceeds in operating businesses where you can achieve returns of 10%, 15% and even 25%-plus on certain capex or growth programmes.
In practice there should be no fundamental difference between a sale-and-leaseback and any other arrangement where the operator pays rent as the tenant. However, operators must learn the lessons from the recent past. It is absolutely crucial that the rent is set at sensible and sustainable levels in the long term and any potential uplifts must be capped or based on a model to protect the operating business.
Indeed, higher prices (or lower yields) are typically paid for rents that seem slightly lower than market value. The recent Marstons deal with LGV and Standard Life (35 to 40-year leaseback with fixed uplifts at sustainable rental levels) is a great example of a structure that benefits the seller with little risk and gives institutional property funds a guaranteed long-term return. That deal also demonstrates how some creative structuring can suit all parties in this case, the freeholds of the properties will actually revert back to Marstons at the end of the term.
Leisure is seen as a safe haven
So why is leisure in so much demand? The office market is, at best, flat. And the high street is littered with retailers that have found themselves on the scrap heap amid a massive decline in footfall and spend, due to the overwhelming superiority of online shopping. Industrial property also remains tough with the exception of core, prime locations.
Against this gloomy backdrop the leisure property market is booming and consumers continue to spend. The prices, premiums and rents paid for leisure property are as strong if not stronger than they have ever been. Leisure is now considered something of a safe haven, with few alternative assets showing potential for similar growth. With the changing face of the high street this will only increase.
Leisure also remains particularly attractive because it provides a long-term income stream. Unlike other forms of property, leisure still primarily relies on long leases often with explicit pre-agreed uplifts.
We are seeing capital values higher than the height of the market and the speed of transactions for investment opportunities is incredible: many even very large lots are being snapped up almost before they enter the market. Bidding wars are commonplace on a wide range of properties and businesses now.
What is driving this market surge?
It is the sheer weight of money. While in years gone by we could easily identify a potential buyer-type for an asset, today the variety of investors is diverse: we are seeing individuals from across the globe, including Russia, China, Malaysia, Ukraine, Greece and the Middle East, all keen to take advantage of the security the London property market provides. Private buyers understand leisure. They can visit and feel whether a restaurant or pub is successful.
But its not just London and its not just single assets.
Institutions, sovereign wealth funds and property companies from all reaches of the world, are aggressively buying assets throughout the UK. Many pension funds are forced to acquire assets because they are sitting on cash that they are required to spend. They have to split their asset allocation across several sectors and leisure is one of the relatively few secure areas for them to consider.
And leisure is seen as attractive for overseas opportunity funds, which cannot generate requisite returns from London alone and are buying secure property or portfolios in the regions.
A shortage of available stock has pushed prices and resulted in some very swift profit-taking. Purchasers are now taking more of a chance selling on property for much higher prices than they would have achieved less than a year ago. For example, we sold an investment in a restaurant scheme for £4.8m three years ago and have received an offer of more than £7m recently which has been rejected.
Weve recently completed two sale-and-leasebacks on behalf of Faucet Inn, selling assets in excess of what they were acquired for, at sensible rents and leaving Faucet with a very large property profit and an operating business virtually for nothing good business. Possibly this shortage of stock has pushed up prices too quickly; but the market is not driven by debt anymore cash buyers prevail.
And, it is clear that leisure is no longer a niche sector. The economic landscape has been seismically altered.
Growth cannot continue at such a pace and we will see interest rates creep up, which will affect yields. The demand for leisure may abate and the London market could pull back, which is why we firmly believe now is a perfect time to be capitalising on property holdings.
Over the past 12 months we have advised on the transaction of over £800m of leisure assets, involving more than 200 different properties. Leisure has cemented its place as the fastest-growing destination for money-into-property and will continue to blaze a trail as the economy recovers.
Mark Sheehan is the managing director of Coffer Corporate Leisure. Coffer Corporate Leisure is the only dedicated mergers and acquisitions advisor to the leisure industry, also advising on property investment transactions and unlocking property value from portfolios>
Article appeared in M&C Report, December 2013.