Actuarial Investments

1
Actuarial Investments

• Shane Whelan
• L527

2
Description of Key Markets

• - The Property Market
• I of III

3
Property Market - Terminology

• Covenant a legal agreement that attaches to the
  lease of land or property, often restricting its
  use/alteration.
• Covenant means the quality of the tenant (in
  ability to pay the rent). Important, especially
  in recessionary times.
• Easement specific rights over property by
  someone other than tenant or owner.
• Freeholder the absolute owner in perpetuity.
  Every property in our isles has a freeholder.
• Ground rent rent to the owner in respect of a
  ground lease granted to a developer who has the
  right to develop the land (who may then include
  it as liability in terms of purchase of
  property).

4
Property Market - Terminology

• Lease an agreement which allows the leaseholder
  the use of the land or part of the building for a
  specified period in return for rent (the property
  is said to be leasehold).
• Marriage Value the value-added when all the
  separate interests in a property are combined,
  (especially in the sense that the leaseholder and
  freeholder are the same).
• Prime property most attractive sort of property
  when viewed by location, age condition,
  covenant of tenant, lease structure, size, other
  properties in area.
• Rack rent rent achievable if able to rent on
  market today.

5
Property Market - Terminology

• Reversion interest interest of a longer term
  leaseholder to whom poprety reverts to an expiry
  of lease.
• Void vacated property with no rent paid to
  owner.
• Years purchase factors PV of unit rental
  income on property. So either a unit perpetuity
  or a unit annuity certain.

6
Characteristics of Direct Property Investment

• Lumpy investment big investment in any one
  property which requires specialist management.
• Each property is unique hence valuation
  problems. Not a transparent market.
• High on-going expenses of management and very
  high dealing costs ensures relatively low
  turnover. It is a long-term investment.
• Return on property can be expected to rise with
  inflation as it is a real asset.
• Leases tend to have periodic rent reviews once
  every 5 years is common and may have a rent
  upward only clause. Hence income tends to come
  in a series of increasing steps.
• Running yield varies but generally above equities
  and below gilts.
• Marketability very low. It takes months to
  sell, dealing costs are high, and sometimes
  market is all one-way.

7
Characteristics of Direct Property Investment

• Risk better than equity in company (as rent is
  prior charge on profits) but voids are expensive.
  All depends on the covenant of tenant and lease
  structure.
• Capital values are volatile but valuation
  methodologies tend to understate short-term
  volatilities.
• Valuation by professional valuers at infrequent
  (annual?) intervals subjective values.
• Obsolescence land is indestructible (site
  value) but building will date.
• Investment characteristics can be altered by
  ownerincluding release of marriage value.
• Political risk planning controls, rent
  controls, etc.
• Expected return higher than index-linked gilts?

8
Types of Property

• Offices
• Shops
• Industrial
• Other
• This is a traditional classification but maybe
  not best as property returns might be more
  correlated by region than function.
• Also multi-purpose buildings give option to
  convert to other usage at a future time.

9
Offices Specific Characteristics

• Tenant covenant generally good with rents a small
  part of their outgoings.
• Large market of possible tenants (compared to
  other types of property).
• Large and diversified market for offices.
• Multi-let office spreads default risk, smooths
  income steps, and helps rent review process.
• Leases generally of 25 years with 5 year rent
  reviews. Also, if full repairing and insuring
  lease (which is common), management costs are
  low.

10
Offices Specific Characteristics

• Market split into capital city (or financial
  centres) and provinces with rents higher in
  former maybe up to 10 times.
• Yields on prime offices lie between the low
  yields of prime retail and high yield of prime
  industrials.
• Prime office easily accessible by car and
  public transport, well-appointed, and generally
  attractive to best tenants.
• Many comparables to help in rent review.
• Depreciation as require occasional refurbishment.

11
Shops (or Retail)

• After offices, shops are the second major
  category in an institutional portfolio.
• Average value is less than for offices. Small can
  be beautiful a small shop can be regarded as
  prime.
• Reasonably flexible in use many different
  tenants possible.
• Macro indicator for this sector is consumer
  expenditure.
• The pitch is key to tenants turnover and hence
  rent also foot-fall, frontage, ground floor,
  neighbouring shops. Supply is naturally more
  limited than offices.

12
Shops (or Retail)

• Prime shops can yield as low as equities.
• Shops have lower running costs than other
  property types. Low depreciation as site value is
  high proportion of total value. Building is the
  basic shell the retailer fits out the interior.
• Rent is large proportion of total costs of
  retailer hence retail growth tied to
  profitability of tenant (and whole retail sector)
• Many comparables.