Alternative investments: the hottest new thing since… AI?

AI – artificial intelligence – is the hot topic on everyone’s lips right now, including in the occasionally tech-averse property sector. But there’s another AI that should be piquing real estate’s interests right now: alternative investments.

Alternative asset classes, which can range from car parks and hotels to more infrastructure-led investments such as energy generation assets and care homes, are of course not new to the market. However, recognition has grown among investors over the past couple of years as to the value they can add to diversified portfolios.

What’s driving the interest to investors?

Over the last two decades, commercial leases have significantly shortened across the traditional commercial sectors, reflecting tenants’ desires for flexibility and landlords’ responding needs to attract quality occupiers.

Alternative asset classes, however, frequently still benefit from these longer leases. They usually feature tenants taking secure leases to protect their operations as well as the often substantial initial investment they make in order to adapt the space to their specific needs. Minimum void periods can additionally serve to help investors with their portfolio weightings.

Further to that, particularly amid the challenging market conditions we’ve experienced over the past six to 12 months, investors are attracted by alternative assets’ income-producing potential. They tend to offer regular index-linked or fixed uplifts, as the operational sides of the business tend to track inflation.

All the above suggests that although interest rates have moved out (and yields have followed suit) continued volatility is ensuring that a ‘flight to safety’ remains at the top of some investors’ wishlists.

What investors need to consider

Of course, as with any investment, there are risks. But investors in alternative classes can follow some fairly broad rules that should ensure they’re best placed to keep the income steady.

There is risk associated with long-let investments in general, including alternatives, which include the potential that the tenant will default. What this demonstrates, however, is the importance of having a strong underlying operational business, which lessens covenant risk when compared to traditional long-income investments, with a depth of occupiers ready to step into a profitable business.

Understanding of the tenant’s underlying performance, whether it’s EBITDA or analysing rent cover, is critical to the ongoing sustainability of the income stream.

So where’s the money going?

In 2021, total alternative transaction volumes were £11.57 billion. Last year, total alternative deal volumes were at £15.15 billion – a 31% increase. As an asset class, alternatives accounted for approximately 31% of the total market of commercial real estate traded in 2022, an increase from 21% in 2021. With no sign of this trend slowing down, where should investors consider putting their money?

With Covid in retreat, consumers and travellers are once again packing hotels – and, because of the cost of living crisis, are also generally staying closer to home. Value brands in particular are enjoying low vacancy rates. There is improved sentiment on covenants with the likes of Travelodge, which had declared a CVA during the pandemic that subsequently made investors nervous about buying and selling, which are now again starting to rise in investor popularity if priced correctly.

We’re seeing a big increase in interest in car show rooms, with several investors speaking to us about these assets. Likewise, there is growing demand for care homes, driven by the UK’s ageing population. Research from BuiltPlace revealed that over 65s in the UK hold 47% of national housing wealth. If even a small amount of this wealth trickles to private care home providers, it will mean a buoyant outlook for the sector in the long-term.

Finally, among alternative investments that will see a pick-up this year are nurseries and childcare assets. Having already seen an uptick in investor interest, we’re now expecting a rise in demand following the government’s planned expansion in state-funded childcare. This will see the existing policy of providing up to 30 hours a week for three- and four-year olds expanded by September 2025 to include eligible households in England with children as young as nine months. The property ramifications of this are huge if funded correctly, and could see improvements in existing spaces, redevelopment of buildings with other uses, and new ones created.