Copyright: David Lawson – appeared Property Week Jan 1998Home page
Poor Prudence. The last few months have turned Britain's biggest financial institution from a distinguished old lady into a nervous wreck. And livid bitemarks from the Financial Services Authority watchdog over pension misselling do not create the best atmosphere for the Prudential to tout investment skills.
But while tempers fray in the fund's distinctive Gothic fortress at London's Holborn Bars, the mood is altogether more buoyant in a more anonymous block a few hundred yards up the road. Here, the property team has been doing its own cleanup - although this involves collecting profits rather than filling financial black holes.
While other funds twittered and whined about falling returns a couple of years ago, the Pru made an inspired tactical move across the Atlantic. It spent 350 dollars on property ranging from a regional shopping centre to giant office blocks. That has already generated profits of almost 90m pounds, raising total returns on the 4.5bn portfolio by 1% this year - a handy weapon for managers selling investment services to smaller funds nervous about the recent bad publicity.
Such swift success - particularly in a market which has savaged so many other investors - is a reminder that not all big funds are over-cautious behemoths, following the herd ten steps behind nimble entrepreneurs. It also shows the value of good research.
The same approach could now shift to other undervalued parts of the world - maybe even South-east Asia. 'We avoided the region when everyone else piled in, but with prices down 30-40%, there may be opportunities now,' says Paul McNamara, head of property research.
Mainland Europe is currently under the magnifying glass. But a shock could be waiting for surveying firms hoping to benefit from the new interest. Nick Thompson, chief property investment officer at Prudential Portfolio Managers, points out that much of the US success hinges on a radical approach to fees.
Advisers La Salle and Wendy Luscombe, the well-known UK expat, will reap rich rewards from the ???m pounds worth of property sold over the last few months because of incentives built into their contracts. 'But there were also penalty clauses if income streams did not live up to promises,' warns Thompson.
The Pru is considering a similar system if it pursues European purchases. There is no suggestion yet about using this technique in the UK, but further successes would inevitably lead to pressure for advisers to put their money where there mouth is. This trend is already emerging: one of the main reasons why Richard Ellis went looking for a rich partner was to raise funds for co-investment.
The Pru had no hidden plan for changing the structure of investment advice when it crossed the Atlantic, however. It was simple logic, according to Thompson. 'We were looking for more property; prices were too high in the UK; and the US economy looked promising,' he says.
A crucial factor was the influence of Hugh Jenkins, then in overall charge of Prudential investment. He and Luscombe had made a killing over there in the Eighties for the Coal Board Pension Fund by getting in and out quickly. He returned from a business trip in 1993 with a suggestion that the time could be right to move in again.
But the Pru, for all its lightness of foot, does nothing without intensive investigation. McNamara spent a year researching markets before allowing any move. 'We were also lucky to be offered a US portfolio to act as a measure,' he says.
Assets were cheap at that time because US funds were out of the market with liquidity problems. The Japanese had burned their fingers badly after pouring in billions for several years. But there were still strict criteria to meet the Pru's needs. Firstly, real returns should be 1% above the 6% produced in the UK, merely to justify the extra hassle of buying abroad. Assets also had to be easily liquidated.
'The window of opportunity was relatively small. We bought assets we felt happy holding for five to ten years, but we wanted to be sure we could get out more quickly if necessary,' says McNamara.
That meant sifting out anything but 'pure vanilla' property - straightforward investment which required no massaging, but would gain by floating up on the general tide of recovery.
Apartments and hotels were too radical a departure from normal investment. Industrial wallowed in environmental complications. Booming real estate investment trusts were a major reason why Jenkins had recommended a new look at the US, but the liquidity and pricing was wrong at the time.
That left offices and retail, and these had to be in portfolio chunks rather than individual lots. Intensive research of long-term cycles and local markets narrowed these down to regional malls and offices in specific cities like Atlanta. La Salle trawled the market for possibilities meeting these criteria but Luscombe still rejected 75% before they even reached Thompson's desk.
One major difficulty was the extra margin demanded over domestic competitors. 'Another was that our name meant little at the start. We would lose out in tenders merely because we were an unknown player,' says Thompson - a lesson tucked away for future overseas campaigns.
The time taken on research and careful choice was costly - not least because the market began to move. Thompson aimed to have 10% of the Life Fund property portfolio in the US but had to settle for half that as prices recovered during the selection period.
But the care paid off. 'Since we bought good assets in good markets, these have recovered even more quickly than expected,' says McNamara. And the markets left behind are now among the first showing signs of being overpriced.
A 40% uplift has yielded around 90m profit - and there is a shopping mall in Los Angeles still to go. The capital uplift is still not sufficient to justify selling it, although Thompson is happy to hold when the income return is around 7%.
McNamara is plainly cock-a-hoop that the gamble of entering such a dangerous market paid off - although he would argue that the amount of research reduced the odds considerably.
'We are pleased with the outcome and that others were too sceptical or not geared up and have missed a trick,' he says. Lessons about issues like performance fees and presentation will last a lot longer than the champagne, however.
If the country's biggest property investor decides to change the rules at home, this small US campaign could have a fundamental impact on the future of the UK industry.
The original $350m portfolio comprised ten assets split around 70% offices and the rest in retail. Total sales of $313m have been agreed so far, producing gross profits of $76m. They include:
Platinum Tower, a 28,400 sq m (305,000 sq ft) block in Atlanta, Georgia, bought in early 1996 for $32m and just sold to a German Investment company for more than $41m
Lakeside Square, a 36,250 sq m (390,000 sq ft) office block in Dallas sold for $57m
Other properties in Prudential's US portfolio include suburban office buildings:
1600 Duke Street. Alexandria. Virginia
Fair Oaks Plaza, Fairfax, Virginia
North Creek, Colorado Springs. Colorado
122 West Carpenter Freeway, Los Colinas, Texas
The retail asset is Fashion Square, at Sherman Oaks, California, a two-level enclosed regional mall on a total of 29 acres. The total retail area is 823,000 sq ft with 125 mall stores. These were approximately 90% let when purchased and produced a gross rental income of approximately $16m.
The locational split was: Mid Atlantic (15%), Mid West (6%), South Central (34% ), Mountain (7%), South East (9%), Pacific (29%).