When we were examining the results from the Q2 CBRE Long Income Index, our focus initially was on the Q2 total return figure which had fallen to 0.0%, from 0.6% in Q1. This was disappointing, but of course it was far superior to the Mainstream market – the CBRE Monthly Index saw total returns of -2.4% over the same period – and in fact only one area of the Long Income sample saw negative returns (Sale & Lease Back, at -0.4%, versus Ground Rent at 0.4% and Income Strip and 0.8%). However, just as we were going to press, the news that inflation had plummeted in August suddenly moved a somewhat niche part of our analysis centre stage – the type and frequency of rent review mechanism in the sample.
Typically, Long Income real estate assets have long leases that are linked to an inflation index or (less often) a fixed uplift amount. This is attractive to liability driven investors whose outgoings are also linked to inflation, or who simply want a guaranteed hedge against inflation. But very few of the leases are pegged to inflation on an unrestricted basis. Most have a cap and a collar forming a range within which increases in income will fall; it will never go up above a certain amount nor will it go up by less than a certain amount. What was interesting about the low inflation numbers announced for August was the proportion of leases where the lower bound of increase (the collar) was now greater than inflation, meaning that investors would achieve greater than inflation increases in income, as shown in Figure 1.
Figure 1 - Collars in CBRE Long Income Index leases, weighted by rent passing
Source: CBRE Long Income Index, Q2 2020.
As of the end of the second quarter, 25.8% of Long Income leases (weighted by rent passing) had a collar at 1% or greater meaning that over a quarter of long income leases would see above inflation increases in income at the prevailing rate of inflation – August’s figures for RPI and CPI were 0.6% and 0.2% respectively. Sale & Lease Back and Income Strips had a slightly higher incidence of such collars, at 29.2% and 28.2% (weighted by rent passing) respectively. Should inflation fall further and dip below 0% then the vast majority of the sample would be protected; 87.2% of Long Income leases (weighted by rent passing) had a collar at 0% or greater at the end of the second quarter.
In the current environment therefore, Long Income is not just a defensive play based on the length of income stream (the Long Income sample has a WAULT of 38 years weighted by rent passing), it may also offer a rare opportunity for inflation-beating income growth – providing tenants remain in situ.
View the full Long Income Index Snapshot Q2 2020 here.