Time to Eye the U.K.’s Regional Retail Parks

After exiting three major developments in London, operating partner Quadrant Estates turns more of its attention to the U.K.’s regions and retail sector.

It’s not hard to see why London has been billed a frothy real estate market. With property transactions in the U.K. growing 16 percent in 2014 to a new post-crisis high of almost €70B, it was to London that half of that capital was destined.

Just like prime gateway markets the world over, London has seen significant capital flowing into commercial real estate investments, to the point where net office yields in the capital are now touching 5 percent—compared to 7.4 percent for the rest of the country, according to data provider Real Capital Analytics.

“We are back broadly to where we were at the end of the 1980s,” explains Tristram Gethin, founding partner of Quadrant Estates, the operating partner and development company that partners with the likes of KKR, Orion Capital Management, CarVal Investors, and BlackRock, among others.

In the 1980s, the capital source targeting the U.K. was primarily Japanese and Scandinavian. This time, however, it’s much more global. “What’s interesting is the geographic breadth of the capital,” says co-founding partner Christopher Daniel. “The capital is now coming from everywhere—the Americas, the Far East, Eastern Europe, Brazil. Yet the majority of those capital sources have a very narrow focus on what they want, which is usually central London.”

Those capital flows helped Quadrant Estates and its private equity partners exit around £500M ($742M; €682M) of deals in 2014, including the £211M sale in December of the office development Moorgate Exchange to Brookfield Property Partners, as well as the £157M disposition of the newly renovated Carmelite office complex on Victoria Embankment to LaSalle Investment Management. RCA data states an in-place cap rate of 4.6 percent for the Carmelite deal.

“A lot of capital has been prepared to pay a premium to get a position in the market, particularly investors who are new to the market,” says Gethin. “You see that a lot in London, but many of these investors are trying to preserve their equity and not underwriting any, or much, growth.”

With a focus traditionally on central London and retail parks nationally, Quadrant Estates—which acts as the operating partner for KKR’s U.K. retail strategy—sees greater opportunities within the U.K.’s regional retail sector, not least thanks to a lack of development owing to planning restrictions.

“The vast majority of retail parks are owned by U.K. institutions, and that market is only just coming to its full maturity,” says Daniel, explaining that retail centers developed 25 years ago are facing their first round of lease renewals. “Current owners will need to regear and reposition those assets, and that isn’t what a lot of institutions like doing. For parks coming to the end of their lease life cycle, there’s the prospect of being downgraded by valuers—and that gives us an opportunity, if we know the market well, to make an erudite assumption as to value.”

With expectations of deploying £150M of equity into U.K. retail in 2015, Gethin adds that even when focusing on the regions, assets still need to be prime. “You don’t do secondary assets. In the regions, secondary assets are not for the faint of heart.”