02What makes a city attractive to investors?
Put simply, investors are attracted to a city if there are opportunities to make money. They will assess the attractiveness of a city’s opportunities by estimating their likely return or profit, and will be drawn to cities which offer them the best combination of scale, risk and return.
Cities are complex economies, so a huge number of factors impact this return. As a result, investors consider a wide range of city characteristics and behaviours when assessing the attractiveness of a city. This longlist includes:
- Growth rate of businesses and jobs
- Resilience of the economy to shocks
- Quality and affordability of infrastructure
- Skill-level of the workforce, and quality of education and research
- Trading relationships within and beyond the UK
- Sector make-up of the economy
- Quality of place-making, city environment, and liveability
- City vision
- Strategic plan to realise vision
- Attitude and consistency of leadership
- Quality of city management
- Information and data provision
Practicalities of investment
- Scale of the city, population size, and the number of jobs and businesses
- Amount and type of land/assets available
- Planning system, and other regulations
- Taxation and incentives
- Construction costs
- Access to finance
Box 2: Assessing individual commercial property investments
This report focuses on assessing the investment potential of a city, rather than a site. The impact of the city’s characteristics – listed above – on each individual investment is captured by site-specific statistics, used by investors to estimate the likely return of each site.
The yield provides an estimate of the annual return to a property investment, capturing the effect of many different factors on the investment, such as economic and political risks. It is calculated as the building’s rent divided by its capital value. If the rent holds constant, a fall in the yield – due to economic growth and increased demand – leads to a higher capital value, indicating lower risk and expected income growth.9 Given the higher risks they present, regional cities tend to have higher yields than London.
More specifically, three types of yield are used:
- Initial yield – expected on day 1 of the investment – measured using the current rent and capital value
- Reversionary yield – if the property was vacant – measured using the market rent and market value
- Equivalent yield – weighted average of the initial and reversionary – based on assumptions made by the investor or advisor about the expected reality of the investment
The actual, or passing, rent is the amount paid by the current occupier. This often differs from the market rent which is the rent expected if there is a change in tenant and the building is put on the market. Both provide the investor with vital information about the income they can expect to generate. In addition, investors and their advisors calculate forecasts of expected future rent, accounting for anticipated market shifts and fluctuations.
The vacancy rate is the share of total available space in the property which is occupied. This indicates the strength of occupational demand for the particular type of property, providing an indication of anticipated future cash flow and the time and effort required to find additional tenants.
Which characteristics do investors prioritise most highly?
Of the longlist of city characteristics, which are the most attractive characteristics, signalling to an investor that the city is a good location to invest in?
When asked this question, most investors and developers list the same priorities. Although the ideal conditions for an individual investment vary from site to site, investors have the same asks for the city as whole. They consider the most important city characteristics to be:
- A strong economy with growth potential
- Excellent transport connections
- Pro-growth city leadership
- A focus on delivery
From an investor’s point of view these are the four ideal qualities of a city. This section will discuss each trait in turn, defining them and exploring why they make a city an ideal investment location.
1. A strong economy with growth potential
A growing economy, providing opportunities to generate returns
A growing economy with an expanding population of businesses and workers demands more offices, houses and shops, and therefore demands investment.
Skills are critical
Investors are particularly drawn to cities with highly-skilled workers, such as Oxford and Cambridge, as these enable cities to attract productive, well-paid jobs in innovative, knowledge-based industries. A well-educated workforce is more resilient to economic changes, due to its ability to adapt, and has greater spending power and therefore a greater appetite for investment, than a low-skilled workforce.
“Investors are always keen to know how ‘porous’ the knowledge economy is and how well monetised the city’s innovations are. The presence of tech centres, innovation districts and quality colleges are regularly on the agenda; related to how well the city will do in attracting corporates – and therefore demand for space.”
Rosemary Feenan, JLL
A strong economy must be supported, not limited, by its infrastructure. Investors need to know their occupiers have access to quality housing and digital connections, which are now seen as a major pre-condition for investment.
Resilience to the economic cycle and external shocks
Economic fluctuations are inevitable but the change in demand they induce exposes investors to risk and unforeseen costs. A track record of relative economic stability, or of bouncing back fast from recessions, reassures investors. Resilience to external shocks, such as Brexit, is also important. Overreliance on one sector, employer or trading partner indicates vulnerability, increasing investors’ risks and deterring investment.
How do investors assess the strength of a city’s economy?
Investors use a variety of economic statistics to assess the strength, resilience and growth potential of a city’s economy, a selection of which are shown in Table 1.
Table 1: Measurements used by investors to assess a city’s economy
2. Excellent transport connections
Investors favour a well-connected city. Connections mean access to businesses, workers, residents and supply chains, reducing transactions costs, improving productivity and facilitating economic growth. Investors often seek opportunities right next to train stations or in city centres, placing the occupier as close as possible to transport links.
A well-functioning internal transport system
A city’s residents must be able to reach jobs and amenities. For fast-growing cities, like Bristol and Swindon, ensuring transport infrastructure keeps up with growing demand has to be a priority.
Excellent national and international connections
Occupiers and users must be able to access their key markets, though these will differ for each investment. For some a fast link to London is the priority, for others access to neighbouring cities is most important. International transport links are also valuable, hence the significance of Manchester’s direct links to San Francisco, China and Dubai.
Plans to improve transport to keep up with investment
New developments must be met with increased capacity, not congestion. To have confidence in the future quality of transport, investors need to see a forward-looking transport plan to enable the city’s development pipeline, backed by sufficient funds, or an innovative approach to funding such as the Milton Keynes tariff.10 But ambitious plans with no timetable for making final decisions undermines confidence in cities’ abilities to make the necessary trade-offs to press ahead with infrastructure projects.
Investors’ preference for connectivity is clearly visible by the way in which new transport schemes trigger interest. For example, the announcement of HS2 has been a catalyst for real-estate development, with Birmingham’s Curzon HS2 development masterplan making the most of this opportunity by focusing development in the area around the station.11
How do investors assess the quality of a city’s transport links?
Measures of the frequency and speed of connections are used by investors, as listed in Table 2, but quantifying connectivity is not straight forward. The multiple modes of transport and varying preferences of workers and residents means interpreting statistics is difficult. For example, longer commuting times could be due to traffic congestion or workers choosing to travel further to reach very attractive job opportunities.
Domestic investors are often familiar with the relative connectivity of UK cities. As a result they do not always use statistics, instead using their own perceptions of connectivity to guide location choices. So cities should promote new or improved connections, providing investors with information to ensure they are aware of changes.
Table 2: Measurements used by investors to assess a city’s transport connections
3. Pro-investment city leadership
The attitude and behaviours of a city’s leadership has a significant influence on investor decisions. Political and executive leadership which prioritises investment, as illustrated by Manchester and Barcelona, is an attribute that investors particularly look for. Leadership includes the senior management as well as the political leaders of the city.
Leadership prioritising city growth and investment
Investors are drawn to cities with ambitious, can-do leadership. This pro-investment attitude signals the city will be supportive and easy to work with, reducing the risk of delays and unforeseen costs. It is crucial this attitude is shared by the public, and city stakeholders, to further reduce resistance to investment.
Long-term consistency and clarity around growth opportunities
A sudden shift in policy could alter the return on an investment. A new leadership which is less supportive of growth could endanger the completion of developments. Having a track record of consistent leadership, beyond individuals and political cycles, is therefore favourable as investors can trust that the current leadership is indicative of future leadership, limiting the risk of unforeseen issues and costs.
“We operate across the UK and know the local authorities who are keen to work with us to deliver new homes in areas where people want to live. We have a long term plan for volume growth and inevitably focus on the areas where there is both demand for our product and the local leadership and commitment to help us deliver”
Philip Barnes, Barratt Development Plc
High-profile and prominent leadership
Being front-of-mind will increase the chance of making it onto an investor’s shortlist. The Mayor of London is a household name, contributing to the profile of the capital. A prominent, respected leadership can cultivate prestige, attracting investors seeking to promote their investment portfolio. But the higher the profile of the leadership, the more critically it will be assessed.
Ability to influence central government decisions
A healthy relationship with Whitehall will enable the leadership to have a say in policy matters which impact the city. This bargaining power also increases the chance of devolution of powers or funding to the city, as in Greater Manchester with four iterations of its devolution deal so far. This is favoured by investors as it can improve a city’s strategic thinking and spatial planning for the geography over which the city-region economy operates.
How do investors assess the strength of a city’s leadership?
Strength and consistency of leadership is impossible to quantify, so investors consider the leadership’s reputation and track record:
- Previous statements by, and actions of, the leadership
- Reputation of the leadership amongst others in the industry, especially those who have previously invested in the city
- Level of resources committed to economic development
- Public profile and credibility of the leadership
- Level, and type, of devolution to the city
4. A focus on delivery
For an investor to see the benefits of pro-investment leadership, the openness to investment must also be reflected in day-to-day decisions and processes. Investors prioritise cities which treat them as customers rather than adversaries, facilitating investment and ensuring it happens smoothly and easily. Not all cities are easy to work with, so this can give a city a way to stand out from the crowd.
A responsive planning system, open to growth
A reputation for slow, restrictive planning deters investors even if the city leader welcomes them, as hold-ups introduce sizeable costs and risks into an investment. Investors prioritise cities they know are likely to approve their plan, and without delay.
A team which understands private sector investment and development
Knowing the aims and requirements of each type of investor, such as their timescales and risk-return preferences, enables the city to facilitate this where possible. This expertise also gives investors confidence in the ability of the team. They want access to a dedicated contact who ‘speaks their language’, leading to the development of a personal relationship. An awareness of the viability of each investment is also crucial for working smoothly with the private sector.
A willingness to flex processes and provide incentives, where necessary
Knowing the city is willing to step in encourages investors to commit to investments. This could take the form of accelerating a planning process, sharing risk using a publicly-owned asset or providing funds. But incentives should only be used where absolutely necessary to facilitate investment.
How do investors assess how easy it is to work with a city?
Investors often use current levels of investment activity as an indication of ease of investment. High numbers of transactions suggest a responsive, supportive system, whilst small numbers signal a restrictive environment or a small market. Expectations of the city are also based on the experiences of others, shared by word-of-mouth through their network of contacts. So to attract investment, as well as being easy to work with, a city must ensure it has a reputation for being so.
Box 3: Known for something distinctive
Investors often speak of attractive cities having a distinctive reputation. For investors with so many potential locations to choose from, a city which stands out is more likely to attract interest.
It is difficult to precisely define this distinctive quality. This visibility could be based on a cultural or historical significance, such as Liverpool for the Beatles. Or the city could be associated with a particular industry, such as Aberdeen for the oil industry or Cambridge and Oxford for their universities. Prestige is also important, particularly for international investors, and not limited to the largest cities, as proven by San Francisco, Cambridge or Munich.
Though desirable, many cities do not have this distinctiveness and it is not something they can easily create. Having a distinctive reputation is not the same as having a brand. A brand is how the city wants to be viewed; a reputation is how it is actually viewed by the industry and this is what matters. Rather than spend time and money on branding, investors would prefer to see these cities focus on promoting their strengths and opportunities.
Box 4: Differences between types of commercial property
The above focuses on investors in aggregate, exploring the overarching city characteristics they prioritise regardless of the sector in which they invest. However, the weight put on each trait will vary according to the investment.
Office space is particularly sensitive to the city’s economic performance and the resulting demand for space from businesses. Operating costs are high, so vacancies can significantly cut into returns by incurring costs on the investor. As a result, expectations of the growth and resilience of the city economy are of particular interest to these investors.
Retail investments rely on the spending power of the population, so investors have a specific interest in demographic indicators and measures of disposable income. Footfall and retail sales growth statistics are also used to estimate demand more directly. Returns are often more stable than for office space, as retailers are slower to change location and leases tend to be longer.
Industrial investments tend to be smaller on average and require less management. As a result the operating costs can be lower than for other properties. Functionality, such as ceiling height, and transport connections, such as links to major road routes, are vital given the use of this property type for warehousing, distribution or manufacturing.