Longer Leases a Boost for Weakening Markets, A Drag for Rising Ones

For the year ended September 2020, longer- and shorter-leased UK assets returned +1.5 percent and -2.5 percent, respectively.

U.K. Total Return by Remaining Lease Term

Source: MSCI
Source: MSCI

Investors often think of their real estate exposure in terms of property type and geography, but there are many other potential factors that may help explain performance. An analysis of the MSCI UK Quarterly Property Index shows that lease length has been one such cyclical factor.

Long leases provided a performance boost during periods of weakening rental growth–an insight that may prove particularly relevant in today’s economic environment. For the year ended September 2020, longer- and shorter-leased UK assets returned +1.5 percent and -2.5 percent, respectively.

During the global financial crisis, longer leased properties outperformed as it benefitted from contractual rental escalations.

Fast forward to 2013, shorter leased assets again came into their own as the UK economy posted its strongest growth since 2007. The trend was even clearer on a sector level where the rental growth of retail and industrial diverged. Since 2016, the rental growth of UK retail assets has been declining which saw the return of longer leased properties hold up better.

By contrast, the industrial sector delivered stronger rental growth which enabled shorter-leased assets to outperform as these assets could benefit from positive rental reversions upon lease expiry. With real estate now occupying a greater slice of multi-asset-class portfolios, investors have been looking beyond inherent property attributes such as sector and location as the key drivers of investment performance. There has always been a need to understand the drivers of risk and return in investment portfolios; but as investors face an increasingly uncertain COVID-19-impacted world, the more factors we can analyze to understand performance and help position portfolios, the better.

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