IF ever one needed a lesson about why excessive leverage is bad, particularly in the retail arena, Nick Sanderson, finance director of FTSE 250 property investment and development business Great Portland Estates, has experienced it first-hand. The investment banking veteran was at Lehman Brothers at the time of its collapse, having joined the bank to develop its Europe and Middle East real-estate business.
The lesson – having experienced what doesn’t work to learn what does – is pertinent, given how Great Portland operates at a lower end of the sector’s leverage level. The business, which owns more than £3.2bn of real estate, maintains a consistently strong balance sheet and conservative financial leverage with a low-cost, diversified debt book.
Gearing was cut to 25.2% in the past financial year. Such a conservative position, coupled with a diverse debt portfolio, helps to provide downside protection against the cyclical nature of Great Portland’s core property markets and maintain the business’s financial flexibility when new investment opportunities arise, Sanderson explains.
“Because we went into the downturn in a relatively strong position, the business was able to exploit the opportunities that emerged. Since the summer of 2009 we have bought just under 60% of the portfolio we own today,” he tells Financial Director.
In the mid-3% range, Great Portland continues to have lowest cost of debt of any of the UK real-estate investment trusts and has successfully placed convertible bonds with the lowest ever coupon for a sterling convertible. Nevertheless, Sanderson says it is the real-estate decisions that come first and the business “never has the balance sheet dictate what we can do”.
The bulk of GPE’s debt funding is provided on an unsecured basis – at 31 March 2015, 54% of its debt was from non-bank sources, with 78% borrowed on an unsecured basis – something Sanderson believes is “really valuable”.
“If we want to go and buy a building tomorrow, we don’t need to ask the bank for permission. We can draw on our £450m in our current facility and because the funding is not going to be secured on the asset, we can move very quickly,” he says. “We have a good spread of debt funding sources. It means we have always got options and it gives us a pricing benefit.”
Just as important to Great Portland’s success is its ability to predict the property market cycle. Its portfolio is almost entirely focused on London’s West End – 82% of its portfolio, to be exact – with the bulk held in office space. Operating in the central London property markets, one of the most cyclical markets in the world, it is critical that Sanderson and his team read the cycle effectively and flex the business’s operational risk in tune with it.
That requires close contact between the finance, development, property management and asset management teams, as well as a deep knowledge of the market and extensive analytics capabilities. While GPE is a relatively big business in terms of asset base, it is quite small in terms of people: about 90 people, all on one floor.
“We are all in each other’s pockets,” Sanderson says. “Because the strategy is as clear as it is – ie, we are not thinking about whether we should be investing in Leeds or Manchester or Paris – we can spend our time on making sure we get best execution and reading the cycle.”
On a monthly basis finance prepares a dashboard of lead indicators with regards to the economy and the property market, right down to the granularity of the level of development, building starts, completions and what is going on in real-estate capital markets and the availability of debt funding.
As a team, finance spends a lot of time trying to use what Sanderson calls small data. “The best source of small data is the intelligence that we get from our tenants. If you want to know what is going on in the central London economy, go back to the people who are in the buildings,” he says.
In practice, Sanderson, along with one of his board directors, will meet all of GPE’s top 20 tenants every year to understand how their business is going and what their real-estate needs are. “More widely, our asset managers are required to meet with every tenant twice a year and we take that information and use that to inform the business,” he says.
On a more bottom-up approach, finance pulls together the data so that management can re-review the business plan for every single property every quarter. “We run through the business plan of each asset and examine the forward look returns and that helps inform us as to whether it should be a hold or sell. That is core to our strategy, in that every asset has to earn its position in the portfolio,” explains Sanderson.
Having read the cycle – which Great Portland breaks down into three phases (acquisition, execution, de-risking) – the next step to managing such a closely situated group of assets is to flex the business’s operational risk, such as the level of buying and selling and the level of development activity.
Today, the market is “firmly in the execution phase” which effectively means repositioning assets to drive rental growth.
“Rather than deploy our capital to buy new assets in an incredibly competitive market, we are using our capital to invest into our existing assets through development. The best way to leverage the opportunity from the rental growth opportunity we see is through developing and so we are very aggressively developing at the moment,” Sanderson explains.
By contrast, the business was “buying really aggressively” in the financial years ending March 2010, 2011, 2012 and 2013. That spending spree was helped by the nature of GPE’s downturn compared to those of its peers. While no real-estate company had a great downturn, GPE read the cycle better than many others. In the two years leading up to Lehman Brothers going down, Great Portland had been a net seller.
“We had turned off our development exposure to the point that when Lehman went down, we had less than £10m of future capital commitments, but we also maintained financial leverage at relatively low levels. At the point Lehman went down, our loan-to-value (LTV) was – we understand – the lowest of any listed property company in western Europe,” he says. “We are really big buyers when able to find good value in the market and one of the key things we look at is what the forecast IRRs of the assets are, and also whether we are able to buy buildings at a discount to replacement cost.”
At some point, GPE will move from the execution phase into the de-risking phase, which means it will be both a big net seller and will greatly curtail its development. In the past financial year, GPE was a net seller as it crystalised profits, recycling capital into its development programme. Its sales of £344m included 79% of the apartments at Rathbone Square, W1 and the forward sale of its pre-let development at 12/14 New Fetter Lane, EC4, delivering an ungeared IRR of 55%.
“We are always reappraising the forward look returns on each asset and where it doesn’t deliver an appropriate level of premium to our cost of capital, the asset will find its way into the sales programme. We are always de-risking individual assets through the cycle. While we have been a net seller for the past two years, that has been more than offset by the level of capital expenditure into the development programme,” he concludes. ?
IN BLACK AND WHITE
2011 – present Finance director, Great Portland Estates
2010 – 2011 Head of real estate corporate finance advisory, Deloitte
2008 – 2010 Managing director, head of UK real estate investment banking,
2005 – 2008 Executive director, real estate investment banking, Lehman Brothers
2000 – 2005 Director, real estate investment banking, UBS Investment Bank
1995 – 2000 Audit manager, Arthur Andersen