Income strips

An income strip is a long-dated, usually index-linked lease structure in which an institution buys the income and the occupier retains a right to reacquire the asset at expiry for a nominal sum. It separates the secure income of a building from its residual value, allowing a liability-matching investor to buy a long, bond-like cash flow while the occupier secures very long-term use of the asset and the option to own it outright at the end.

Income strips sit within the family of long-income structures and are frequently paired with forward funding on newly developed public sector, university and long-let commercial assets. This page explains how they work and where they fit. For the delivery structure that often precedes them, see the anchor guide to forward funding.

How an income strip works

An income strip splits a property investment into two parts, the income and the residual value, and sells only the income to the investor. The lease is typically 30 to 50 years or longer, with rent reviewed by reference to an index such as RPI or CPI, often within a collar. At the end of the term the occupier, or a party it nominates, can reacquire the asset for a nominal sum, commonly one pound.

Because the residual reverts to the occupier for next to nothing, the investor is not paying for the building at expiry; it is paying for the stream of index-linked payments over the term. That makes the cash flow behave like an inflation-linked bond secured on real estate, which is exactly what a pension or annuity fund matching long-dated, inflation-linked liabilities is looking for.

Why institutions buy income strips

Long-income and liability-matching investors buy income strips because they convert a building into a long, secure, index-linked cash flow that matches their liabilities better than conventional property. The appeal is duration and security rather than growth.

For the investor, the attraction is a predictable, inflation-protected income over decades, secured on real estate and often underpinned by a strong occupier covenant such as a government body, a university or a housing association. For the occupier, the strip provides long-term certainty of occupation, an efficient cost of capital, and the right to reacquire the asset cheaply at the end, which can be attractive to public bodies and institutions that want use of a building without tying up capital in ownership from day one.

Pricing and the link to gilts

Income strips are priced off the security and duration of the income and move with long-dated index-linked gilt yields as much as with property yields. Because the investor is buying a bond-like stream rather than a reversion, the pricing reference is closer to the gilt market than to conventional property pricing.

The stronger and longer the income, and the tighter the indexation, the keener the yield. A strip let to a government-backed covenant on a 40-year index-linked lease will price very differently from a shorter strip on a weaker covenant. As with all long-income pricing, the figures are sensitive to the rates environment and should be treated as indicative and date-stamped rather than fixed.

Income strips and forward funding

An income strip is often the end state of a forward funded development, with the forward funding delivering the asset and the income strip defining how the completed income is owned. Agreeing the strip terms at the outset allows an investor to forward fund the construction of a building it will hold as long income, which is common in primary care, public sector pre-lets and long-let logistics schemes. Those long-income sectors sit within the wider sector coverage.

The two structures answer different questions. Forward funding answers how the building gets built and who carries the development risk; the income strip answers how the long income is owned and priced once it exists. If you are developing an asset with a long, strong, index-linked income and want to understand how an income strip would price it, get in touch.