Several common themes have emerged when we have worked with clients on their investment process. One theme has been the adjustment of individual property required returns for leasing risk.

Individual property returns can vary widely as a lease expiry approaches or a tenant teeters on the edge of insolvency. These variations are specific to the property and exaggerated by changes in value ahead of the event as expectations switch from one outcome to another.

This type of volatility can be reduced by having an exposure to a large number of such tenants and so no additional return is appropriate for bearing these types of risks.

However, the value of a portfolio of short lease property will be more volatile than that of a portfolio of securely let property. This volatility is due to the sensitivity of returns to fluctuations in the market average level of tenant default, rollover rates, vacancy periods etc. For example, if the average expected vacancy period lengthens, the value of properties with lower income security will fall by more than the value of properties with higher income security. The required return for all properties with weaker income security is therefore higher. Long-income funds, targeting long leases, should produce lower, but less volatile returns.

The distinction is subtle, but makes a significant difference in the appropriate approach to risk management.