Urban Regeneration

Property Investment and Development

J.N. Berry, N.G. Deddis, W.S. McGreal

• Publisher: Taylor & Francis
• Year: 2013
• ISBN:
  9781136738845
• Edition: 1
• Topic: Architecture
• Subtopic: Urban Planning & Landscaping

This book provides an in-depth analysis of the role of property investment and development in the urban regeneration process. It relates the physical, economic, financial and environmental aspects of urban change and development to the realities of particular cities by case studies drawn from Britain and Europe.

PART ONE

PROPERTY FINANCE
AND INVESTMENT

1

Parameters for
institutional
investment in inner
city commercial
property markets

P. McNamara

The focus of urban regeneration policy in the United Kingdom since the Second World War has evolved slowly from a concentration on environmental quality in the 1950s, through an emphasis on social policy in the 1960s, to a clear and lasting focus on economic issues in the 1970s and beyond (Healey, 1990). In the 1980s, emphasis was given to the stimulation of commercial confidence and environmental transformation through property development. In particular, considerable attention was paid by the Government to the involvement of major long term financial institutions and property companies in the United Kingdom in this process. Specific emphasis was given to the role of insurance companies and pension funds in supporting the property development process, deemed by many as a block on economic development. However, given their immense financial resources, there have been expressions of disappointment at the level of activity in which the long term financial institutions have engaged.

This chapter outlines the criteria which influence the investment policies of long term financial institutions and, in that context, examines the features of the inner city land market vis-ä-vis those of other land related investment opportunities. In conclusion, it examines areas of policy that have not yet been fully explored by policymakers which, if implemented, should begin to place inner city land markets on an even playing field with other segments of the market and attack the continuing problem of ‘hope value’ which stultifies many development initiatives in the inner city. Emphasis is placed on property development. However, this is done in recognition that such investment is only one of many possible forms of investment that long term financial institutions might make to support inner city regeneration.

1.1FINANCIAL INSTITUTIONS, CONSTITUENCIES AND INVESTMENT CRITERIA

The prevailing pressures that affect the nature and composition of the investment portfolios of long term financial institutions vary. Different forms of institution service different forms of clients or constituencies. In nearly all instances some form of payment, in the form of contributions, premia or investments, is made to the financial institution concerned in the expectation of return at some later date, either when or if some prespecified event occurs. Insurance and assurance companies therefore have responsibilities to policyholders; depending on whether they are public companies or mutual companies they may also have responsibilities to shareholders. Similarly, pension funds have responsibilities to provide for existing and prospective pension holders. In the implementation of their investment policy, they also have responsibilities to current employers and employees in terms of minimizing the level of extra contributions required to meet promised pension commitments.

Given these constituencies, long term financial institutions such as pension funds and life insurance companies should not be seen as entirely free agents in terms of the investments they can make. They are restricted in their ability to take risks. They must select assets which not only produce returns in a manner that broadly matches the incidence of the liabilities to which they are exposed but, in the case of life insurance companies, there is strict legislative control to ensure that the companies are secure from insolvency. It is imprudent and, in some instances, illegal for such institutions to expose themselves to undue risk.

Life insurance companies compete with each other for market share in the same way as companies do in any other industry. The performance of investments will influence both the scale of eventual policy payouts and the level of dividends paid to shareholders. To perform poorly would risk losing policyholders to other life companies, poor share performance and limiting the level of capital for reinvestment in the company. Hence, in brief, such investors are concerned with both the absolute and the relative performance of their investments.

There are, therefore, two major concerns facing long term financial institutions when purchasing investment assets with the prospect of future liabilities and payouts. Competitive levels of return are required. However, undue risk has to be avoided. Long term financial institutions are under a duty to respect these parameters. The options available to them are briefly reviewed here.

Increasing flows of information, improving technology and liberalization in terms of the movement of money across international boundaries mean that financial institutions now have a wider array of assets in which they can invest. A simple classification of investment types open to institutional investors in the United Kingdom would identify company shares, derivatives (options and futures), government and corporate bonds, and property. There is the opportunity to invest in any or all of these across the world. Each of these different forms of asset has a unique potential for income or capital return, or both; each has a unique profile of attendant risk attached to it. In short, each can be characterized by a different risk/reward profile. The investment community will review the risk/reward profile of this universe of assets and calibrate the price it will pay for each asset in a manner which reflects its perceived risks.

Without seeking to enter a detailed debate about investment theory, this idea can be explored a little further by way of example. The Government in the United Kingdom periodically raises money by issuing bonds. Investors purchasing such bonds usually receive a steady income and a final lump sum payment. Returns on the bonds are guaranteed by the funds raised by the Government through taxation and other means. If the returns from investing in bonds are fixed (i.e. they are the same each year), then unanticipated bouts of inflation will undermine the value of those assets. (An anticipated level of inflation will have been incorporated in the original pricing of the assets by the investor.) Hence, they are said to carry an ‘inflation risk’. However, if returns from such bonds are index linked (i.e. they rise to take account of inflation), then the investor has a doubly secure investment. In some ways such an asset could almost be considered ‘riskless’.

The concept of a riskless asset is an important foundation to how investors review different asset types. Clearly, on a like for like basis, an investor would pay more for an asset that is guaranteed against inflation than one that is not because there is no risk that income and final payments will be eroded by unanticipated inflation. The investor is therefore demanding a premium for investing in an asset that exhibits risk. This will come in the form of a higher rate of return and will be achieved by reducing the price for the asset until it will give sufficient return to compensate for the perceived risk of the asset.

The corollary of this is clear. An investor considering an asset that exhibits risk will naturally require a higher return from that asset (i.e. will adjust his purchase price downwards) compared to a riskless asset. Risk in this context can be seen as receiving less than was anticipated from the asset. The vast majority of investment opportunities open to investors, including financial institutions, exhibit risks of one form or another. Manifestly, returns from company shares depend significantly on how a company will perform. If economic conditions have been poor or the management of the company has taken bad decisions, or both, company dividend payouts and corresponding returns from such investments will be poor. The price of company shares is, therefore, adjusted by investors to try and best reflect not only the anticipated levels of return from those shares, but also the level of risk attached to that ‘central estimate’ of returns.

Explicitly or implicitly, investors considering investment in commercial property as a whole, or individual properties in particular, will similarly adopt a central view of returns from the investment and then adjust the price (or establish the risk premium) to take account of the many different forms of risk to which properties are exposed. As with company shares, economic conditions may prove worse than anticipated, making rental growth from properties less easy to achieve; tenants may even go bankrupt leaving a period of no income. More longstanding risks exist for commercial property. For example, new work practices or technological advances may render certain types of property obsolete.

Given that the risks of different types of asset, whether they are company shares, government bonds or different types of property, relate to different economic pressures, an investor can reduce risk by constructing portfolios of different asset types. This investment equivalent of ‘not placing all one’s eggs in one basket’ means that, typically, long term financial institutions would have an exposure of 10–20% of their assets in commercial property.

Hence, in summary, when considering an investment a financial institution will want to consider both its risks and return profile. When considering commercial property, a risk premium will be added to the expected returns from riskless assets to establish a ‘target’ rate of return. This will be the level of return which an investor will need to receive from investing in an asset of given characteristics. When combined with a view about how the income from the asset might grow, this helps to determine the price that the investor will pay for that asset. It is in this context that investment in inner city properties, either as standing investments or in the form of development projects, must be considered. The following two sections consider the return prospects for properties in the inner city and the risk profile of such properties.

1.2INNER CITY PROPERTY: PROSPECTS FOR RETURN

The total return from an investment relates to both the income received from the asset and to changes in the capital value of the asset. Clearly, with changing economic conditions both the income and the capital value will vary over time. Rents will be influenced by the relative balance between the demand and the supply of a given form of property in a given location. This balance will vary over time. Rents will also tend to rise naturally with inflation.

Likewise, the capital value of an asset is influenced by a range of factors. Brett (1990) suggests that there are two main factors which influence capital values. Firstly, if future rental growth prospects increase, capital values increase because the yield at which the current rental income is capitalized decreases. A second factor is the relative attractiveness to investors of commercial property compared with other asset types. If investors as a group consider that commercial property is, in general, attractively priced in that it will deliver target returns or above, then a ‘weight of money’ from the institutions will attempt to enter the commercial property market putting upward pressure on property prices (or downward pressure if the opposite circumstances apply).

Given these two features of return, it is pertinent to assess realistically the characteristics of commercial property in the inner city in terms of what it offers to long term financial institutional investors. The evolution and current situation concerning the problems of the inner city have been documented elsewhere (Lawless, 1989). However, in essence, the general perception of the cycle of decline faced by inner cities in the United Kingdom relates to a number of mutually reinforcing economic, environmental and socio-demographic processes. Inner city areas, being the historical locus for industrial activity, have a much higher than average number of traditional industries, often producing increasingly obsolete products using increasingly dated and uncompetitive techniques. Not surprisingly, it is therefore the inner city which has experienced the greatest impact of industrial decline throughout the post-war period. These economic structural problems have been exacerbated by many other firms finding expansion difficult on landlocked sites and resolving their growth problems through relocation (Fothergill and Gudgin, 1982). Furthermore, as economic activity has graduated from an urban to a regional, national and international scale, the natural location for industrial activity has moved to the edge of urban areas rather than in difficult to access inner city areas. This has rendered inner city locations increasingly obsolete per se.

Historically low standards of concern for environmental conditions have meant that these inner city areas have tended to suffer from poor environmental conditions. Factories and housing have located cheek-by-jowl in some instances since the industrial revolution. This situation has been exacerbated as companies in financial difficulties have had less and less to invest in the upkeep of properties and diminishing enthusiasm to respond to initiatives to combat general environmental decay. Failed firms have left a legacy of derelict sites, sometimes corporately vandalized to avoid rate liabilities, and often contaminated with deleterious by-products from the production process. Many inner city areas are traversed by major infrastructure corridors linking city centres with suburbs and beyond. All of th...

Table of contents

• Cover
• Title Page
• Copyright Page
• Contents
• Contributors
• Preface
• Part One: Property Finance and Investment
• Part Two: Regeneration Policy and Practice
• Part Three: Regeneration Mechanisms
• Index