Joint SPR-IPF Rent Setting - Rent Index Webinar
Tuesday, 6th October 2020

More to rental growth than meets the eye

The presentations at this seminar were a breath of fresh air – no mention of pandemics or the C-word – said moderator Vanessa Muscarà of Europa Capital in her introduction.  But she did admit that the outcome of rental events is becoming an increasingly important topic given the premium on cash-flow resilience in current market conditions.

Market rental indices are often presented as if they are relevant to any rental event – say a rent review or lease expiry – but this kind of blanket approach can be misleading, suggested Steven Devaney of Henley Business School, opening his presentation of new data on rental events, which went on to showcase an innovative ‘transaction-based’ rent index for UK commercial property.   For one thing, the data from this study showed that new lettings tend to see significantly less favourable income growth outcomes than lease renewals, particularly if the new letting has been triggered by a tenant default.  Lease expiries and exercised break options have also tended to produce worse outcomes than re-lettings, though to a smaller degree.

Devaney noted that these differences were not constant over time but varied depending on the state of the market, and were most evident in downswing periods, particularly 2008-12.  The unique data source for this analysis was compiled from around 5000 units held across 10 management houses as a ‘lease consortium’ assembled by Real Estate Strategies.  Joining the meeting as a panellist, Malcom Frodsham of RES noted that the research could also have implications for non-UK lease scenarios, given that different lease formats do seem to lead to different tenant behaviours. The UK upward-only rent review had not in practice helped to compensate for depreciation as intended, whereas continental CPI-based leases made rental uplifts much more dependable.

This kind of variation between the outcomes of rental events was one of the main reasons for producing a ‘transaction-based’ rental index, Devaney explained in the second half of his talk. The desirability of overcoming the smoothing and lagging inherent in valuation-derived rental indices was another.  This problem is less widely recognised than for return indices, but can still be significant due to the use of historical and aggregated rent information.  The new transaction-based indices showed similar trends for headline and effective rents across all UK property, but both were significantly more volatile than the MSCI rental growth index, although all three indices shared similar turning points.  If new lettings are isolated, effective rents show a somewhat greater sensitivity to market changes than do all rental events taken together, as one would expect from the analysis of the underlying data that was presented earlier.

Frodsham summarised the ultimate objective of the new indices as doing what the valuer does – i.e. bringing together evidence of rental transactions in order to reach an estimate of market rental value – but in an automated way. Muscarà suggested that this called for the industry to provide more data, which would allow for greater granularity in the analysis, e.g. in comparing rental trends for lease renewals alone – where the data is currently limited – to those for new lettings.

Tim Horsey