Long lease real estate’s role in urban regeneration

Urban regeneration is a core focus of many local authorities, with previously bustling high streets and commercial centres having experienced significant structural changes – some of which have accelerated during the Covid-19 pandemic – in the way we shop, work and socialise in the 21st century.

A growing number of local authorities have turned to long lease real estate transactions as a potential solution to fund their regeneration plans. These arrangements could offer a predictable and competitive cost of financing, which moves in line with inflation, over multi-decade periods.

Income strips

While traditional sale-and-leasebacks (S&L) are well-established in markets such as the UK, more recently income strips have emerged as a funding method of choice for local authorities and other quasi-public bodies to fund key real estate projects.

As with S&L, income strips can release capital from the tenant’s existing real estate assets to use for investment. Increasingly, however, local authorities with long-term regeneration ambitions are using these instruments as a method of funding brand new real estate projects. These structures allow the development risk to be transferred away from the local authority, whilst also providing a competitive cost of funding over 30 years or more.

This is now becoming a well-trodden path for private sector funding from institutional investors to be delivered where it’s needed, whilst enabling local authorities to retain long-term ownership of their strategic real estate assets. Meanwhile, institutional investors, such as pension schemes or insurers, gain access to long-term inflation-linked cashflows from the lease agreement with the authority, which allows them to match their liabilities.

This puts real estate asset managers, such as M&G, at the heart of urban transformation, given our role in directing institutional capital to respond to the ongoing physical and societal changes impacting our urban centres. This is evidenced by the growing number of local authority regeneration plans our income strip transactions have helped to finance in recent years.

In Rochdale for instance, a large town in Greater Manchester, we have funded the £80 million Rochdale Riverside development, which is designed to reverse a long-term downward spiral of reduced footfall and consumer spending in the town centre that has led to retail closures and further decline.

Following its completion in April 2020, the council has estimated that the M&G-backed development will bring in an extra 2.1 million visitors and £150 million in retail expenditure each year. Meanwhile, the scheme is expected to generate £1.6 million of annual rates revenue for the authority, as well as a profit rent from sub-letting the scheme, which can be used to fund local services.

Overall, the development has created 1,450 local jobs and an estimated £22 million gross value added (GVA) per year for the local economy. Around 40% of construction labour was also sourced from the local borough.[SD1]

Environmental considerations

In addition to driving social and economic benefits, environmental considerations and impact are central to the partnerships between M&G and its long lease occupiers. Our developments are designed to have a low carbon footprint, and all of our projects aim to meet high BREEAM UK New Construction standards and Energy Performance Certificate (typically ‘A’) ratings.

We are also working with our occupiers to reach net zero targets by 2050. Given the partners for income strips are often public or quasi-public bodies, several of our tenants have targets much earlier than this.

As a reflection of our efforts in Environmental, Social and Governance-led (ESG) investing, our UK income strip strategy was awarded first place among 79 peers in the recent Global ESG Benchmark for Real Assets (GRESB) 2021 survey.

We believe the adoption of increasingly sophisticated approaches to ESG investment management recognises the importance of these factors in both traditional and alternative real estate asset classes. In turn, we believe investment opportunities that can benefit society and the planet could offer increased potential to generate long-term returns with stable cashflows for institutional investors.

The views expressed in this document should not be taken as a recommendation, advice or forecast. The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance.