The Rent Review Specialist
Commercial Property Insurance - Part 2
23/12/2014
Whether lawyer or surveyor, we professional advisers to landlords and tenants have a dual-role in the field of business tenancies: to help clients to abide by and comply with the law, and where the client has not sought our advice beforehand to find legitimate ways to wriggle out of liabilities and responsibilities. For further reading please visit LandlordZone.
Commercial Property Insurance - Part 1
10/12/2014
Amongst the thorny issues in the relationship between landlord and tenant is the building insurance premium. For further reading please visit LandlordZone.
Expectation for Commercial Property Growth
27/11/2014
Unlike residential property, the factors that determine prospects for commercial property growth are much more dependent upon specific tenant demand, rather than demand and supply generally. For further reading, please visit LandlordZone newsletter issue 30 - click here
Commercial Property and Free Advice
05/11/2014
The recent ruling on why landlords cannot rely upon general advice from HMRC is a timely reminder of the perils of free advice generally. For further reading, please visit LandlordZone, click here.
Appraising High Streets
24/10/2014
My work takes me travelling all over England and Wales so, apart from work for regular clients, I never know in advance where each new instruction might be. Long-distance travelling is not as demanding when… For further reading, please visit LandlordZone - click here
Commercial Propery Pension Plan
23/10/2014
The object of a pension is to provide an income during retirement. A pension is an accumulation of money that has been saved over the years. For further reading, please visit LandlordZone newsletter issue 29 - click here
Rent Review Increase
09/10/2014
On grant of leases, there are two types of landlord. The landlord for whom the property has always been an investment, and the landlord that previously occupied the property for his own business but is selling up and simultaneously granting a new lease of the property to the buyer. For further reading, please visit LandlordZone.
(Please note: this article is an abbreviated version of "Open Market Rent Review".)
(Please note: this article is an abbreviated version of "Open Market Rent Review".)
Open market rent review
09/10/2014
A feature of investing in commercial property is the rent review. With residential BTL, rents can be increased but usually only at the end of the term if the existing tenant would pay more or on a new letting if the market is up to it or, as with ground rents, to pre-set incremental increases. With commercial property, rent reviews can occur at regular intervals throughout the term because the duration of a commercial property letting is often for years: 3 to 5 years is not uncommon, 10 is typical, 15-25 years not unusual, and with ground leases 75-125 years or more. At present, I dealing with a ground lease rent review where the contractual term was extended from 80 years to 150 years.
There are various types of rent review: fixed increases, percentage uplifts, formulaic reviews such as inflation-adjusted index-linked, ground rent reviews geared to open market rent, turnover rent review comprising a base figure plus a percentage of the turnover of the tenant's business, and open market reviews where the rent is assessed by reference to the open market. Turnover reviews are common in factory outlet centres and shopping malls that are owned by a single landlord; in isolation turnover reviews are for the private investor harder to administer, let alone finding a tenant who'd agree. (The turnover is before VAT: in case-law, a tenant got clobbered a while back through overlooking the impact of VAT on the wording of the review and was obliged to pay more rent when the VAT rate went up to 20%.) Fixed increases, common during the 1960s/1970s, are rare nowadays because the amount of increase requires a leap of faith at the onset. Formulaic reviews tend to be found with sale-and-leaseback and where investors are offered a certain or easily calculable income stream, akin to an annuity. Ground rent review is where the land is let, the tenant constructing the building in consideration for which the landlord gets a percentage of the rental value of the building.
Open market review is the most common. The principle is that the rent would be adjusted to the market rent assuming (hypothetically) the premises would be available to let in the open market at the review date or valuation date if different. For the hypothesis, there are matters to be assumed and disregarded and whatever is to be taken into account is to be found in the wording of the rent review clause. There are no set guidelines: it all depends upon what was agreed when the lease was granted and any related documentation. The interpretation the guidelines is another matter entirely which is why to assume literally whatever the review clause says can be a mistake.
For open market review, the rental valuation approach is evidence-oriented. There has to be evidence of a higher rent elsewhere for the rent of the premises under review to increase, either that or informed opinion. Informed opinion is not the same as working out what the actual tenant should be able to afford: that the tenant might be able to afford, for example, ten times more doesn't in itself mean that the rent should increase.
On grant of leases, there are two types of landlord. The landlord for whom the property has always been an investment, and the landlord that previously occupied the property for his own business but is selling up and simultaneously granting a new lease of the property to the buyer. Where the lease is being granted in conjunction with the sale of the business, it is common for the initial rent to be set by reference to what the business could afford. Where that rent is higher than the market rent, it is essential for the wording of the rent review to enable an increase, otherwise all that will happen is that the market rent would prevail. That does not matter if the market rent were higher than the initial rent but, all other factors remaining constant, often it's not. In such cases, the rent currently payable could result in over-renting in the context of the open market rent.
Frequently, I am consulted by landlords who, having granted a new lease in conjunction with sale of their business as a going concern, approach the rent review in the same way of thinking as with the initial rent. A well-advised tenant is likely to opposite any increase on that basis.
The landlord for whom the property has always been an investment will usually agree whatever rent the incoming tenant will agree to pay. Since that rent would normally be based on the asking rent, the agreed rent is likely to reflect the open market rent at the time, presupposing the terms and conditions of the lease reflect that rent.
Unlike the new letting where the landlord can bide his time waiting for an acceptable offer, the open market rent on review is at a fixed date, the valuation date which may or may not be the same as the review date depending upon what the lease says. Regardless of the type of landlord and how the initial rent was set, both become subject to the terminology of the open market rent on review, in particular the valuation basis.
In outline, the leases contains two leases: the lease and the hypothetical lease. The hypothetical lease only applies at rent review. The terms and conditions of the hypothetical lease can be the same as the lease or differ, that's a matter of drafting and approval when the lease was granted. Of the three methods of valuation, the contractor's or costs method, the profits test, and the comparable evidence, the latter is the most common. The profits test may not be admissible evidence: the information would have to be in the public domain and limited to the particular property, rather than the tenant's other interests. The contractor's method tends to be used for buildings that are rarely on the market and for which there is no evidence. The evidence method, based on comparable evidence, is the method in widespread use because the opinions that can cloud the contractor's and profits' method do not apply.
Evidence is what another tenant has agreed to pay for their property. The property may belong to the same of a different landlord. The weight that would be given to the evidence for use as comparable is likely to vary according to the facts and circumstances.
What happens if there's no evidence. The short answer is no increase. Does that make sense? Yes and no. Yes if you accept without question the valuation basis for the rent. No if you wonder why you should lose out just because there's no evidence.
Perhaps it has always been thus but in recent years I've noticed a trend towards reliance on evidence regardless. I suspect it's a product of tenant-resistance to increase. Tenants and surveyors are well aware of the need for evidence for justification. It may not be necessary to give reasons but in the event of dispute it is. In dispute, which is the parameter upon which all reviews are based even if referral were not initiated, the tenant's approach is to require the landlord to justify the proposed increase with supporting evidence. To the inexperienced landlord, it is wearing, often frustrating that the tenant will not play ball. Despite the lease stating the parties are to reach agreement, rarely if ever does the lease prescribe how agreement is to be reached. The landlords thinks the tenant can afford more, the tenant thinks why should he offer more. This is unyielding combat, a battle of wits.
Frequently, I am instructed to take over negotiations where the landlord having reached the end of his tether doesn't want to take the next step of referral but wants me to work wonders. To force the pace, the cost of referral is not a step to be taken lightly. One step at a time maybe but the starting price is £369 for referral to the RICS. After that, the minimum fee could be £500/£750 plus anything between £180 and £350 an hour plus VAT and disbursements merely to get the tenant to concede. Lining the pockets of third parties is not how it should be, but is the price of venturing into the property system.
The standard form of rent review clause to open market rent is rarely thought out in the context of the actual property. In my opinion, there is no benefit to a landlord in going to the expense of a rent review clause drafted if there is any possibility the rent might not increase. To assume that merely because there is a rent review and an open market that the two combine to support an increase is a nonsense. At rent review to open market, a landlord is not in a position to insist upon an increase, nor is there is any justification for an increase merely because at the last rent review there was no increase. In a matter I was dealing with earlier this year, where my instructions were withdrawn despite the landlord concurring with my opinion that the rent would not increase, the fact that it takes time to procure an increase when none is justified seemed to be lost on the landlord. as far as the landlord was concerned merely because I advised no increase, but have a go, and the tenant's surveyor concurred with me did not mean the rent should not increase. You may think the landlord off his rocker but the failing is that the rent review clause to open market was drafted on the assumption that there would be evidence in the open market to support an increase.
Psychologically, the implication in 'upward-only' rent review is that the rent must increase and that if the landlord cannot procure what he wants through his own efforts a surveyor ought to be able to do better. Tough, it's not like that. Sometimes the rent that the parties could agree between themselves would be higher than if surveyors are involved. Hardly surprising therefore that landlords are keen on dissuading tenants from involving surveyors!
There are various types of rent review: fixed increases, percentage uplifts, formulaic reviews such as inflation-adjusted index-linked, ground rent reviews geared to open market rent, turnover rent review comprising a base figure plus a percentage of the turnover of the tenant's business, and open market reviews where the rent is assessed by reference to the open market. Turnover reviews are common in factory outlet centres and shopping malls that are owned by a single landlord; in isolation turnover reviews are for the private investor harder to administer, let alone finding a tenant who'd agree. (The turnover is before VAT: in case-law, a tenant got clobbered a while back through overlooking the impact of VAT on the wording of the review and was obliged to pay more rent when the VAT rate went up to 20%.) Fixed increases, common during the 1960s/1970s, are rare nowadays because the amount of increase requires a leap of faith at the onset. Formulaic reviews tend to be found with sale-and-leaseback and where investors are offered a certain or easily calculable income stream, akin to an annuity. Ground rent review is where the land is let, the tenant constructing the building in consideration for which the landlord gets a percentage of the rental value of the building.
Open market review is the most common. The principle is that the rent would be adjusted to the market rent assuming (hypothetically) the premises would be available to let in the open market at the review date or valuation date if different. For the hypothesis, there are matters to be assumed and disregarded and whatever is to be taken into account is to be found in the wording of the rent review clause. There are no set guidelines: it all depends upon what was agreed when the lease was granted and any related documentation. The interpretation the guidelines is another matter entirely which is why to assume literally whatever the review clause says can be a mistake.
For open market review, the rental valuation approach is evidence-oriented. There has to be evidence of a higher rent elsewhere for the rent of the premises under review to increase, either that or informed opinion. Informed opinion is not the same as working out what the actual tenant should be able to afford: that the tenant might be able to afford, for example, ten times more doesn't in itself mean that the rent should increase.
On grant of leases, there are two types of landlord. The landlord for whom the property has always been an investment, and the landlord that previously occupied the property for his own business but is selling up and simultaneously granting a new lease of the property to the buyer. Where the lease is being granted in conjunction with the sale of the business, it is common for the initial rent to be set by reference to what the business could afford. Where that rent is higher than the market rent, it is essential for the wording of the rent review to enable an increase, otherwise all that will happen is that the market rent would prevail. That does not matter if the market rent were higher than the initial rent but, all other factors remaining constant, often it's not. In such cases, the rent currently payable could result in over-renting in the context of the open market rent.
Frequently, I am consulted by landlords who, having granted a new lease in conjunction with sale of their business as a going concern, approach the rent review in the same way of thinking as with the initial rent. A well-advised tenant is likely to opposite any increase on that basis.
The landlord for whom the property has always been an investment will usually agree whatever rent the incoming tenant will agree to pay. Since that rent would normally be based on the asking rent, the agreed rent is likely to reflect the open market rent at the time, presupposing the terms and conditions of the lease reflect that rent.
Unlike the new letting where the landlord can bide his time waiting for an acceptable offer, the open market rent on review is at a fixed date, the valuation date which may or may not be the same as the review date depending upon what the lease says. Regardless of the type of landlord and how the initial rent was set, both become subject to the terminology of the open market rent on review, in particular the valuation basis.
In outline, the leases contains two leases: the lease and the hypothetical lease. The hypothetical lease only applies at rent review. The terms and conditions of the hypothetical lease can be the same as the lease or differ, that's a matter of drafting and approval when the lease was granted. Of the three methods of valuation, the contractor's or costs method, the profits test, and the comparable evidence, the latter is the most common. The profits test may not be admissible evidence: the information would have to be in the public domain and limited to the particular property, rather than the tenant's other interests. The contractor's method tends to be used for buildings that are rarely on the market and for which there is no evidence. The evidence method, based on comparable evidence, is the method in widespread use because the opinions that can cloud the contractor's and profits' method do not apply.
Evidence is what another tenant has agreed to pay for their property. The property may belong to the same of a different landlord. The weight that would be given to the evidence for use as comparable is likely to vary according to the facts and circumstances.
What happens if there's no evidence. The short answer is no increase. Does that make sense? Yes and no. Yes if you accept without question the valuation basis for the rent. No if you wonder why you should lose out just because there's no evidence.
Perhaps it has always been thus but in recent years I've noticed a trend towards reliance on evidence regardless. I suspect it's a product of tenant-resistance to increase. Tenants and surveyors are well aware of the need for evidence for justification. It may not be necessary to give reasons but in the event of dispute it is. In dispute, which is the parameter upon which all reviews are based even if referral were not initiated, the tenant's approach is to require the landlord to justify the proposed increase with supporting evidence. To the inexperienced landlord, it is wearing, often frustrating that the tenant will not play ball. Despite the lease stating the parties are to reach agreement, rarely if ever does the lease prescribe how agreement is to be reached. The landlords thinks the tenant can afford more, the tenant thinks why should he offer more. This is unyielding combat, a battle of wits.
Frequently, I am instructed to take over negotiations where the landlord having reached the end of his tether doesn't want to take the next step of referral but wants me to work wonders. To force the pace, the cost of referral is not a step to be taken lightly. One step at a time maybe but the starting price is £369 for referral to the RICS. After that, the minimum fee could be £500/£750 plus anything between £180 and £350 an hour plus VAT and disbursements merely to get the tenant to concede. Lining the pockets of third parties is not how it should be, but is the price of venturing into the property system.
The standard form of rent review clause to open market rent is rarely thought out in the context of the actual property. In my opinion, there is no benefit to a landlord in going to the expense of a rent review clause drafted if there is any possibility the rent might not increase. To assume that merely because there is a rent review and an open market that the two combine to support an increase is a nonsense. At rent review to open market, a landlord is not in a position to insist upon an increase, nor is there is any justification for an increase merely because at the last rent review there was no increase. In a matter I was dealing with earlier this year, where my instructions were withdrawn despite the landlord concurring with my opinion that the rent would not increase, the fact that it takes time to procure an increase when none is justified seemed to be lost on the landlord. as far as the landlord was concerned merely because I advised no increase, but have a go, and the tenant's surveyor concurred with me did not mean the rent should not increase. You may think the landlord off his rocker but the failing is that the rent review clause to open market was drafted on the assumption that there would be evidence in the open market to support an increase.
Psychologically, the implication in 'upward-only' rent review is that the rent must increase and that if the landlord cannot procure what he wants through his own efforts a surveyor ought to be able to do better. Tough, it's not like that. Sometimes the rent that the parties could agree between themselves would be higher than if surveyors are involved. Hardly surprising therefore that landlords are keen on dissuading tenants from involving surveyors!
Supermarkets at War
29/09/2014
The Tesco bookkeeping announcement on 22 September 2014 is a useful reminder of what can happen when a retailer becomes so big that the cost of keeping up appearances might lead to all manner of shenanigans. For further reading, please visit newsletter 28 on LandlordZone
Is most commercial property ex-growth?
25/09/2014
Successful investment in commercial property is all about art and timing. The art, which might be described as judicious choice, is the skill needed to discern whether the particular property is likely to continually head in the same direction as the market. For further reading, please visit LandlordZone.
Guarantor or Rent deposit
01/09/2014
The ideal for any landlord is for the tenant to have a guarantor and provide a rent deposit. But which is better when the landlord has to choose? For further reading, please visit LandorrdZone
Everyone's an Expert in Property
28/08/2014
Amongst the subjects in which everyone thinks themselves an expert are politics, sport, psychology, marketing, and property. For further reading, please visit LandlordZone newsletter issue 27 - click here
Summertime Blues
11/08/2014
Seen through London eyes, much of the property throughout the rest of Britain is relatively inexpensive, cheap even. Anthropocentric perhaps but, to an extent, London has every right to think itself the most significant. For further reading, please visit LandlordZone.
Auction and Guide Prices
01/08/2014
In July 2014, the Advertising Standards Authority upheld a complaint brought against Auction House Ltd (“AH”) whereby the complainant argued that several properties sold at auction by AH had had reserve prices higher than the guide prices and so could not have been bought at the guide price. For further reading, please visit LandlordZone
“Where are the customers’ yachts?”
31/07/2014
For most people, a state pension is quite possibly the opposite of what they’ve experienced throughout most if not the whole of their working life, presupposing an employee and not running their own business. A pension is other people paying you. For further reading, please visit LandlordZone.
Froth and Reassurance
15/07/2014
Now that the property market has steamed ahead for quite some time, in many cases prices up to pre-2008 crash levels, the pundits are now telling us that everything in the garden is rosy and we shouldn’t be concerned. Talk of good value for money and why prices should continue to rise, any flaws in their reasoning explained away, is, at least in my opinion, rather worrying. For further reading, please visit LandlordZone
s25 and s26 notices - The landlord's perspective
03/07/2014
… you can find out about section 25 and section 26 notices respectively in more general terms, but here I talk about some of the ways the 1954 Act notices and procedures may be used tactically by landlords… For further reading please visit LandlordZone
Are banks a safe bet?
26/06/2014
Not that long ago, one of the best ways to invest in a bank was through stocks and shares. As well as a slice of the action, you became a part-owner of… For further reading, please visit LandlordZone
What's in a word?
16/06/2014
As I say on my website, ”anyone can read a lease, but knowing what to look for is what really counts”. Words have meanings, but words attract positive and negative connotations so… For further reading, please visit LandlordZone
How to Appraise a Shop Investment
02/06/2014
The short answer to how to appraise a shop investment is that everything about the proposition is reflected in the level of Zone A rent. For further reading, please visit LandlordZone
A Refreshing Change
29/05/2014
Becoming, being a landlord will change you. In the driving seat, no longer a passenger, will shift you into a different state of mind. Investment does that to people: the feeling that others are paying you is …For further reading, please visit LandlordZone newsletter issue 24 - click here
"Upward only" rent review
12/05/2014
Contrary to popular belief, ‘upward-only’ rent review does not mean the rent must increase. For further reading, please visit LandlordZone
Safety in Numbers
02/05/2014
Physically outwardly people are different and different nationalities each have their own cultures but, other than gender, human beings are basically inwardly the same. For further reading, please visit LandlordZone - click here
Sentiment v Technicalities
23/04/2014
With commercial property rent review and lease renewal when practical help from a surveyor is sought, as distinct from seeking advice, there are two types of client: …For further reading, please visit LandlordZone newsletter issue 23 - click here
Location, location, location
12/04/2014
Investment performance despite any resistance by the tenant. Why would the tenant resist? …For further reading, please visit LandlordZone - click here
April Fool or Successful Investor
01/04/2014
Successful investment is about judicious choice and timing: what to buy, how much to pay, how to manage, when and how to sell…for further reading, please visit LandlordZone - click here
Investment Psychology
27/03/2014
Psychology occupies the middle-ground between who you are and who you want to become, and all that that entails. To become something you have to invest. Investment is about becoming better off than you are now. How long it takes to become better off depends upon a combination of two factors: the practical and the psychological. … For further reading, please visit LandlordZone newsletter issue 22 - click here
Valuation and Over-Paying
01/03/2014
I want to dispel a widely held notion, the strong belief in which leads to investors overpaying for shop property. It is a notion that has contributed to substantial over-valuation (along with over-mortgaging by the banks and other lenders) of shop property investments for more than three decades.
When you buy a shop property for investment, you are not buying into the existing or proposed tenant's business: the only thing you own is the property itself. That is all. How the tenant chooses to run its business, the prospects for the business including the market sector the tenant's business serves, are nothing to do with you. You are buying the property and whether it is the entire building or part of a building, that is all. Therefore, the identity of the tenant makes no difference whatsoever to the value of the property. The only relevance of what is known as the 'covenant' of the tenant that makes a difference is the chances of rent on time and other requirements of the occupancy honoured throughout the term of the lease. Therefore, if you pay a higher price because the shop property is let to a well-known covenant, then that 'premium' adds to the risk and may not be recoverable when you want to sell.
To understand why even though there is no link between the value of the property and the tenant's covenant nevertheless a strong connection is made, it is necessary to go back to events in the shop property market during the mid-1970s. In 1972, all Asians were expelled from Uganda by Idi Amin, the president of Uganda at that time. Those holding British passports came to Britain. Many had been businesspeople in Africa and rebuilt up their lives in Britain. Some became retailers while others found suitable employment.
An explosive growth in demand for shops and retail businesses led to a widespread change in attitude. Before the immigration-influx, I think it fair to say many 'white' shopkeepers were living off their laurels, for example half-day closing during the week was the norm, trading times out of kilter with an increasingly cosmopolitan society. Asian shops, the ubiquitous 'Mr Patel', opened longer hours, closing at 10pm rather than 5.30pm, and extended the shopping week to include all day Sunday. Prices obtainable in the market for selling going-concern businesses also rose. In the newsagent, confectioner, tobacconist sector, ("CTN"), it was said a 'white' buyer would pay ten times turnover, but an 'Asian' buyer would pay fifteen times turnover. The difference in price was accounted for by removing staff costs and so on, because the Asian family would work in the shop. Strictly, it shouldn't make any difference to price payable that savings can be made from being more operationally efficient, but I do not think that was the agenda. It was not so much about wanting more income, so much as wanting more capital. By modernising the business, turnover could be increased and the business re-sold for a profit. It also gave the Asian family an opportunity to establish 'roots' in the wider community.
(The presence of Asian shopkeepers in Britain was by no means new. The earliest origins of settlement of South Asians in Great Britain is uncertain, perhaps the Middle Ages. By the late 19th/early 20th centuries there were approximately 70,000 South Asians in Britain and following World War II and the break-up of the British Empire, immigration increased throughout the 1950s and 1960s as citizens of Commonwealth countries and former Caribbean colonies moved to Britain. Following restrictions on primary immigration, much of the subsequent growth in the British Asian community has come from the births of second and third-generation Asian Britons. As time passes, the formation and development of community can alter the demographics. Southall, in north-west Greater London, for example, is a case in point. In 1950, the first group of South Asians arrived in Southall, reputedly recruited to work in a factory owned by a former British Army officer. With the closeness of expanding employment opportunities such as Heathrow Airport, nowadays over 55% of Southall's population of 70,000 is Indian/Pakistani, Southall has one of the largest Sikh Temples outside India and Southall contains the largest Asian shopping centre in the London area.)
An attraction of English property law is freehold ownership. As the ultimate owner of the property, freehold provides both physical and emotional security. Owning shop property freehold can contribute to status in community and business. As anyone that has tried to buy shop property for investment will testify, it is not an easy step. The first hurdle is convincing commercial property agencies you are serious! It's not that surveyors were impossible to deal with, simply they have regular buyers and saw no reason to give newcomers a bite of the cherry. Also, many established surveyors can't be bothered with inexperienced investors. Then there is a question of credibility. Unless you pay the asking price or your offer is very close, you risk being considered a time-waster. Similarly, if you mess about and delay exchange of contract and/or fail to complete. Moreover, there may be a language barrier. Even if you fulfil the criteria, there is no certainty of being offered anything with potential. The solution is to buy at property auctions. Property auctions lend themselves to anonymity. Property auctions have long been popular with people of all nationalities, but before the mid-1970s there was a greater tacit understanding of shop valuation methodology. What the new wave of investors did not appreciate (or at least not give an impression) was that, in principle, a high yield suggests a shop property where little or no capital growth is expected, conversely a low-yield offers prospects for growth. In any event, because the cost of borrowing money is the same nationwide, it made no sense to be able to buy a shop property investment yielding say 12% for a lower price pro-rata than a shop property showing 7%. Hence, what began to happen and rapidly gathered steam, until the influence of the change in approach became the 'norm', was for shop properties having little or no growth prospects to go up price which in turn led to an increase in price for properties with growth prospects.
Finance plays a pivotal role in the commercial property market. It is said that property investment is more about finance than property. When a buyer wants to mortgage an investment property, or needs a mortgage in order to buy the property in the first place, ways to repay the mortgage include the borrower's other sources of income and whether the yield on the property exceeds the instalment for payment of the mortgage. Whilst a lender will assess the credit-worthiness of the borrower, a lender is not normally interested in the prospects for the investment: all a mortgagee cares about is whether the borrower could honour the requirements of the mortgage, or in the event of default the property could be sold to repay the loan. The fact that high-yielding investments are more risky is of no consequence to the lender, and may in fact be considered more secure simply because of a higher yield. In effect, thanks to their mortgage criteria, what the banks have imposed on buyers of shop property is the equivalent of a business plan, whereby never mind whether the shop property constitutes an investment, all that matters is that the financial side of things stack up.
What stemmed from inexperience became the 'norm' thanks to mortgage valuation surveyors. The task of a mortgage valuation surveyor, often a chartered surveyor, is to give an opinion of the market value of the property. However, the market value of a property is only the value of the property itself. It is not the value of the investment. The investment comprises the property and any existing or proposed 'tenancy' involving that property. So, since the value of the investment can vary depending upon terms of the tenancy, arguably a valuation surveyor should make that clear in the report, otherwise there is the risk the banks could be misled into thinking lending on the property is more secure than it is.
The fact that a layer of variable value can be added to the intrinsic value of a property is not something lost on sellers. The marketing of commercial property for investment involves very sophisticated and shrewd techniques. For example, one of the most obvious ways to maximise the price is to create an investment that is readily mortgageable. When selling a shop property investment, the seller is not interested in the value of the property as such, but how much the property and all that comes with it is likely to fetch in the market. It is the existence of that subtle difference for which the inexperienced investor can pay a hefty price. Selling a shop property for investment is no different to any other form of selling. Dress it up to look its best and hope the buyer doesn't spot what's wrong. Any complaints afterwards can be met by caveat emptor: the buyer alone is responsible for checking the quality and suitability of goods before making the purchase. Moreover, unlike products and services where the seller might be concerned to safeguard reputation for future custom, a seller of shop property is unlikely to care a jot about goodwill.
Although the seller of shop property is unlikely to care about goodwill, the seller's agents are mindful of their reputation in the market. To maximise the selling process whilst attempting to minimise the repercussions of overpayment, auctioneers have, for some time, highlighted the financial status of the tenant in the auction catalogue, for example the retailer's number of branches, latest turnover and profit figures.
Covenant and early review lots are guaranteed to fetch top prices. In the details, much emphasis is given to the date of review, with the estimated rental value suggested, either by having issued the rent review notice quoting a very high proposal, or by stating the vendor's opinion of rental value, or by citing a brief mention of a nearby new letting.
Pre-occupation with quality of covenant has driven investment yields down to levels which, for the type of property, is more commonly expected for prime propositions, offering assured long-term growth!
Consequently, what has happened is that not only has the way shop property is valued disconnected from fundamental principles, but also the banks and vested interests have create a market that is completely divorced from the reality of property itself. The test of that claim is easy to pass, for example: imagine two shop properties, next door to each other, both shops identical size, layout, etc, both let for 20 years at the same rent with rent reviews at five yearly intervals. One shop is let to a national multiple retailer with dozens of branches, the other to a local shopkeeper with just that one shop. Both properties are offered for sale by auction on the same date by the same auctioneer. What's the betting the shop let to the multiple retailer would fetch a higher price?
In my opinion, it is not up to valuation surveyors to insist banks lend only on the value of the property, as distinct from the market value of the investment. That decision is for the banks alone. However, I do consider valuation surveyors have a duty of care to ensure the banks understand there is a difference which might not necessarily be allowed for in the 'forced' sale valuation. A definition of 'forced sale' valuation is "the highest price which a property can reasonably be expected to bring, if offered for sale without the consent or concurrence of the owner by virtue of judicial process, in what may be a restricted market place, within a restricted time frame, to a prudent, willing and able purchaser who may have limited knowledge about the property, its uses and capability." If the forced sale valuation is a percentage of the market value of the property then in my opinion the mortgage is likely to be more secure, than if the forced sale value is the valuation of the investment.
When you buy a shop property for investment, you are not buying into the existing or proposed tenant's business: the only thing you own is the property itself. That is all. How the tenant chooses to run its business, the prospects for the business including the market sector the tenant's business serves, are nothing to do with you. You are buying the property and whether it is the entire building or part of a building, that is all. Therefore, the identity of the tenant makes no difference whatsoever to the value of the property. The only relevance of what is known as the 'covenant' of the tenant that makes a difference is the chances of rent on time and other requirements of the occupancy honoured throughout the term of the lease. Therefore, if you pay a higher price because the shop property is let to a well-known covenant, then that 'premium' adds to the risk and may not be recoverable when you want to sell.
To understand why even though there is no link between the value of the property and the tenant's covenant nevertheless a strong connection is made, it is necessary to go back to events in the shop property market during the mid-1970s. In 1972, all Asians were expelled from Uganda by Idi Amin, the president of Uganda at that time. Those holding British passports came to Britain. Many had been businesspeople in Africa and rebuilt up their lives in Britain. Some became retailers while others found suitable employment.
An explosive growth in demand for shops and retail businesses led to a widespread change in attitude. Before the immigration-influx, I think it fair to say many 'white' shopkeepers were living off their laurels, for example half-day closing during the week was the norm, trading times out of kilter with an increasingly cosmopolitan society. Asian shops, the ubiquitous 'Mr Patel', opened longer hours, closing at 10pm rather than 5.30pm, and extended the shopping week to include all day Sunday. Prices obtainable in the market for selling going-concern businesses also rose. In the newsagent, confectioner, tobacconist sector, ("CTN"), it was said a 'white' buyer would pay ten times turnover, but an 'Asian' buyer would pay fifteen times turnover. The difference in price was accounted for by removing staff costs and so on, because the Asian family would work in the shop. Strictly, it shouldn't make any difference to price payable that savings can be made from being more operationally efficient, but I do not think that was the agenda. It was not so much about wanting more income, so much as wanting more capital. By modernising the business, turnover could be increased and the business re-sold for a profit. It also gave the Asian family an opportunity to establish 'roots' in the wider community.
(The presence of Asian shopkeepers in Britain was by no means new. The earliest origins of settlement of South Asians in Great Britain is uncertain, perhaps the Middle Ages. By the late 19th/early 20th centuries there were approximately 70,000 South Asians in Britain and following World War II and the break-up of the British Empire, immigration increased throughout the 1950s and 1960s as citizens of Commonwealth countries and former Caribbean colonies moved to Britain. Following restrictions on primary immigration, much of the subsequent growth in the British Asian community has come from the births of second and third-generation Asian Britons. As time passes, the formation and development of community can alter the demographics. Southall, in north-west Greater London, for example, is a case in point. In 1950, the first group of South Asians arrived in Southall, reputedly recruited to work in a factory owned by a former British Army officer. With the closeness of expanding employment opportunities such as Heathrow Airport, nowadays over 55% of Southall's population of 70,000 is Indian/Pakistani, Southall has one of the largest Sikh Temples outside India and Southall contains the largest Asian shopping centre in the London area.)
An attraction of English property law is freehold ownership. As the ultimate owner of the property, freehold provides both physical and emotional security. Owning shop property freehold can contribute to status in community and business. As anyone that has tried to buy shop property for investment will testify, it is not an easy step. The first hurdle is convincing commercial property agencies you are serious! It's not that surveyors were impossible to deal with, simply they have regular buyers and saw no reason to give newcomers a bite of the cherry. Also, many established surveyors can't be bothered with inexperienced investors. Then there is a question of credibility. Unless you pay the asking price or your offer is very close, you risk being considered a time-waster. Similarly, if you mess about and delay exchange of contract and/or fail to complete. Moreover, there may be a language barrier. Even if you fulfil the criteria, there is no certainty of being offered anything with potential. The solution is to buy at property auctions. Property auctions lend themselves to anonymity. Property auctions have long been popular with people of all nationalities, but before the mid-1970s there was a greater tacit understanding of shop valuation methodology. What the new wave of investors did not appreciate (or at least not give an impression) was that, in principle, a high yield suggests a shop property where little or no capital growth is expected, conversely a low-yield offers prospects for growth. In any event, because the cost of borrowing money is the same nationwide, it made no sense to be able to buy a shop property investment yielding say 12% for a lower price pro-rata than a shop property showing 7%. Hence, what began to happen and rapidly gathered steam, until the influence of the change in approach became the 'norm', was for shop properties having little or no growth prospects to go up price which in turn led to an increase in price for properties with growth prospects.
Finance plays a pivotal role in the commercial property market. It is said that property investment is more about finance than property. When a buyer wants to mortgage an investment property, or needs a mortgage in order to buy the property in the first place, ways to repay the mortgage include the borrower's other sources of income and whether the yield on the property exceeds the instalment for payment of the mortgage. Whilst a lender will assess the credit-worthiness of the borrower, a lender is not normally interested in the prospects for the investment: all a mortgagee cares about is whether the borrower could honour the requirements of the mortgage, or in the event of default the property could be sold to repay the loan. The fact that high-yielding investments are more risky is of no consequence to the lender, and may in fact be considered more secure simply because of a higher yield. In effect, thanks to their mortgage criteria, what the banks have imposed on buyers of shop property is the equivalent of a business plan, whereby never mind whether the shop property constitutes an investment, all that matters is that the financial side of things stack up.
What stemmed from inexperience became the 'norm' thanks to mortgage valuation surveyors. The task of a mortgage valuation surveyor, often a chartered surveyor, is to give an opinion of the market value of the property. However, the market value of a property is only the value of the property itself. It is not the value of the investment. The investment comprises the property and any existing or proposed 'tenancy' involving that property. So, since the value of the investment can vary depending upon terms of the tenancy, arguably a valuation surveyor should make that clear in the report, otherwise there is the risk the banks could be misled into thinking lending on the property is more secure than it is.
The fact that a layer of variable value can be added to the intrinsic value of a property is not something lost on sellers. The marketing of commercial property for investment involves very sophisticated and shrewd techniques. For example, one of the most obvious ways to maximise the price is to create an investment that is readily mortgageable. When selling a shop property investment, the seller is not interested in the value of the property as such, but how much the property and all that comes with it is likely to fetch in the market. It is the existence of that subtle difference for which the inexperienced investor can pay a hefty price. Selling a shop property for investment is no different to any other form of selling. Dress it up to look its best and hope the buyer doesn't spot what's wrong. Any complaints afterwards can be met by caveat emptor: the buyer alone is responsible for checking the quality and suitability of goods before making the purchase. Moreover, unlike products and services where the seller might be concerned to safeguard reputation for future custom, a seller of shop property is unlikely to care a jot about goodwill.
Although the seller of shop property is unlikely to care about goodwill, the seller's agents are mindful of their reputation in the market. To maximise the selling process whilst attempting to minimise the repercussions of overpayment, auctioneers have, for some time, highlighted the financial status of the tenant in the auction catalogue, for example the retailer's number of branches, latest turnover and profit figures.
Covenant and early review lots are guaranteed to fetch top prices. In the details, much emphasis is given to the date of review, with the estimated rental value suggested, either by having issued the rent review notice quoting a very high proposal, or by stating the vendor's opinion of rental value, or by citing a brief mention of a nearby new letting.
Pre-occupation with quality of covenant has driven investment yields down to levels which, for the type of property, is more commonly expected for prime propositions, offering assured long-term growth!
Consequently, what has happened is that not only has the way shop property is valued disconnected from fundamental principles, but also the banks and vested interests have create a market that is completely divorced from the reality of property itself. The test of that claim is easy to pass, for example: imagine two shop properties, next door to each other, both shops identical size, layout, etc, both let for 20 years at the same rent with rent reviews at five yearly intervals. One shop is let to a national multiple retailer with dozens of branches, the other to a local shopkeeper with just that one shop. Both properties are offered for sale by auction on the same date by the same auctioneer. What's the betting the shop let to the multiple retailer would fetch a higher price?
In my opinion, it is not up to valuation surveyors to insist banks lend only on the value of the property, as distinct from the market value of the investment. That decision is for the banks alone. However, I do consider valuation surveyors have a duty of care to ensure the banks understand there is a difference which might not necessarily be allowed for in the 'forced' sale valuation. A definition of 'forced sale' valuation is "the highest price which a property can reasonably be expected to bring, if offered for sale without the consent or concurrence of the owner by virtue of judicial process, in what may be a restricted market place, within a restricted time frame, to a prudent, willing and able purchaser who may have limited knowledge about the property, its uses and capability." If the forced sale valuation is a percentage of the market value of the property then in my opinion the mortgage is likely to be more secure, than if the forced sale value is the valuation of the investment.
Dispute Resolution Costs
01/03/2014
In my opinion, and I'm not alone, the fees required and charged by surveyors appointed by the RICS to act as arbitrators or independent experts are often out of touch with reality and, in many instances, obscene.
For example, I am dealing with two matters at present, for different clients, where the rents are likely to end up at around £14,500 pa. In each case, the independent expert wants to charge around £250-£300 an hour, with a minimum fee of £3500 + disbursements and VAT. Now if the agency side of the firms of which those experts are partners were instructed to let the property then chances are the commission would be 10% of the first year's rent (ignoring any rent-free) subject to a minimum commission of £2000 plus VAT.
In another case, the appointed independent expert's hourly rate is £200 an hour + disbursements and VAT. Okay, maybe that's par for the course (or at least it used to be), but the surveyor has run up a bill of almost £1000 + VAT, etc just on dealing with preliminary communications. Also, at a different office of same company, where another person has been appointed, the charge is (only) £175 an hour which, considering it's the same administrative structure, suggests to me some sort of target approach to revenue.
I don't know where such people think the money comes from to pay their fees but frankly if that's the way they carry on then it's hardly surprising so many surveyors are suffering intense competition.
It's always been the case that where the parties have no choice the adviser will charge as much as they possibly can. You get that with legal costs and surveyor's fees in connection with tenant applications for licences to assign, sub-let, do alterations, and with schedules of dilapidations. I think the same principle is being applied at review referrals. Once appointed, the surveyor has a general duty to proceed and although that can be stopped by agreement what the parties have little or no control over is how much the surveyor will charge.
Personally, and I've said this all along, I think there should be a fixed fee, possibly on a sliding scale according to the level of passing rent, (with adjustment if the passing rent is a ground rent, for example), for independent expert determinations and arbitrator awards at rent review. The old argument it's impossible to know what will be involved doesn't hold water. When I take on a rent review for a client, I don't have the luxury of being able to charge whatever I like: I quote a fee at the start and no matter how long the job takes or what's involved, I stick to what has been agreed and no more.
An open-ended 'blank cheque' approach exposes both landlord and tenant to the risk of having to pay a disproportionate amount to a third party, which let's face it, particularly with an independent expert, expects most of the job done for them.
I should like to set up a low cost referral service where, for example, one would charge in the region of £1000 + VAT for expert determination assuming the matter straightforward and maybe the same for arbitration. I could set up such a service and rely on the provision in many leases where the parties can appoint a surveyor without having to go through the RICS. What you think? Would you like me to?
The advantage of a fixed fee is that you know where you are the start. You can tell the client it would cost 'x' to go to referral and that would it. At present, I can only estimate and having to say that the total costs could be in the region of £3000-£5000 + VAT, etc is a really frightening figure for most people, even if their share would only amount to half of that.
The RICS has set up a low-cost referral service but the parties have to agree to give up certain rights before the procedure can be used. Otherwise, since one function of the RICS is to provide a source of revenue for its members, the RICS won't get involved but I think they'd have to sit up and take notice and do something about it if more and more landlords and tenants were to register their disapproval and clamour for a lower cost system. As it is, I think landlords and tenants are being taken for a ride.
For example, I am dealing with two matters at present, for different clients, where the rents are likely to end up at around £14,500 pa. In each case, the independent expert wants to charge around £250-£300 an hour, with a minimum fee of £3500 + disbursements and VAT. Now if the agency side of the firms of which those experts are partners were instructed to let the property then chances are the commission would be 10% of the first year's rent (ignoring any rent-free) subject to a minimum commission of £2000 plus VAT.
In another case, the appointed independent expert's hourly rate is £200 an hour + disbursements and VAT. Okay, maybe that's par for the course (or at least it used to be), but the surveyor has run up a bill of almost £1000 + VAT, etc just on dealing with preliminary communications. Also, at a different office of same company, where another person has been appointed, the charge is (only) £175 an hour which, considering it's the same administrative structure, suggests to me some sort of target approach to revenue.
I don't know where such people think the money comes from to pay their fees but frankly if that's the way they carry on then it's hardly surprising so many surveyors are suffering intense competition.
It's always been the case that where the parties have no choice the adviser will charge as much as they possibly can. You get that with legal costs and surveyor's fees in connection with tenant applications for licences to assign, sub-let, do alterations, and with schedules of dilapidations. I think the same principle is being applied at review referrals. Once appointed, the surveyor has a general duty to proceed and although that can be stopped by agreement what the parties have little or no control over is how much the surveyor will charge.
Personally, and I've said this all along, I think there should be a fixed fee, possibly on a sliding scale according to the level of passing rent, (with adjustment if the passing rent is a ground rent, for example), for independent expert determinations and arbitrator awards at rent review. The old argument it's impossible to know what will be involved doesn't hold water. When I take on a rent review for a client, I don't have the luxury of being able to charge whatever I like: I quote a fee at the start and no matter how long the job takes or what's involved, I stick to what has been agreed and no more.
An open-ended 'blank cheque' approach exposes both landlord and tenant to the risk of having to pay a disproportionate amount to a third party, which let's face it, particularly with an independent expert, expects most of the job done for them.
I should like to set up a low cost referral service where, for example, one would charge in the region of £1000 + VAT for expert determination assuming the matter straightforward and maybe the same for arbitration. I could set up such a service and rely on the provision in many leases where the parties can appoint a surveyor without having to go through the RICS. What you think? Would you like me to?
The advantage of a fixed fee is that you know where you are the start. You can tell the client it would cost 'x' to go to referral and that would it. At present, I can only estimate and having to say that the total costs could be in the region of £3000-£5000 + VAT, etc is a really frightening figure for most people, even if their share would only amount to half of that.
The RICS has set up a low-cost referral service but the parties have to agree to give up certain rights before the procedure can be used. Otherwise, since one function of the RICS is to provide a source of revenue for its members, the RICS won't get involved but I think they'd have to sit up and take notice and do something about it if more and more landlords and tenants were to register their disapproval and clamour for a lower cost system. As it is, I think landlords and tenants are being taken for a ride.
Landlord Proposals
01/03/2014
Years ago, an institutional landlord, a well-known insurance company, whom I found myself acting against on numerous occasions, used to include £500 pa margin in its proposals for rent review which struck me as ambitious but in most cases nevertheless insurmountable. Thinking I'd like try the same approach, I experimented by recommending a nominal margin for a proposal on behalf of a landlord-client. My client's reaction was perhaps only to be expected. In his view, tenants would expect the margin to be considerably more and would want a substantial reduction. A small margin would allow me little room for manoeuvre.
The size of the margin I told him was of no consequence to me. The client was happy with my recommended rent, it was my task to achieve it. Despite trepidation, the client allowed me to go ahead. To cut a story, I achieved the rent I was after.
Unlike that insurance company, whose £500 margin seemed to be the norm, I tailor my recommendations to suit the circumstances so if you're a tenant and on the receiving end of a proposal from my landlord-client there's no certainty the margin would be the same in each case.
The point, however, is whether possible to negotiate based a small margin. The answer to that, I suggests, depends upon one's attitude at the onset.
For example, let's assume the passing rent is £28,000 and market rent £30,000 a year. A proposal including 10% margin would be £33,000 pa but there's a risk that if the difference between the proposal and the passing £28,000 is not that much then that could invite the feeling that the landlord isn't expecting any increase. In bartering psychology, therefore, it would be better to inflate the proposal to £35,000 on the assumption that the tenant would offer at least £30,000 to start with.
My only experience of unrepresented landlords is when acting for their tenant, and vice versa my experience of unrepresented tenants is when acting for the landlord. Generally, unrepresented landlords like to barter and expect their tenants to do likewise but actually there is no reason for a tenant to barter if that would result in agreeing more than necessary. Bartering is not the same as negotiation, or at least not the same where the terms and conditions of the lease are taken into account as would happen when the tenant is represented. Consequently, bartering can come unstuck when faced with a refusal to play the game.
In my experience, unrepresented parties tend to focus on the rent to the exclusion of all else. But that can be to their disadvantage because the terms and conditions of the tenancy have a bearing on the rent and there may well be something in the 'small print' to one party's advantage.
The size of the margin I told him was of no consequence to me. The client was happy with my recommended rent, it was my task to achieve it. Despite trepidation, the client allowed me to go ahead. To cut a story, I achieved the rent I was after.
Unlike that insurance company, whose £500 margin seemed to be the norm, I tailor my recommendations to suit the circumstances so if you're a tenant and on the receiving end of a proposal from my landlord-client there's no certainty the margin would be the same in each case.
The point, however, is whether possible to negotiate based a small margin. The answer to that, I suggests, depends upon one's attitude at the onset.
For example, let's assume the passing rent is £28,000 and market rent £30,000 a year. A proposal including 10% margin would be £33,000 pa but there's a risk that if the difference between the proposal and the passing £28,000 is not that much then that could invite the feeling that the landlord isn't expecting any increase. In bartering psychology, therefore, it would be better to inflate the proposal to £35,000 on the assumption that the tenant would offer at least £30,000 to start with.
My only experience of unrepresented landlords is when acting for their tenant, and vice versa my experience of unrepresented tenants is when acting for the landlord. Generally, unrepresented landlords like to barter and expect their tenants to do likewise but actually there is no reason for a tenant to barter if that would result in agreeing more than necessary. Bartering is not the same as negotiation, or at least not the same where the terms and conditions of the lease are taken into account as would happen when the tenant is represented. Consequently, bartering can come unstuck when faced with a refusal to play the game.
In my experience, unrepresented parties tend to focus on the rent to the exclusion of all else. But that can be to their disadvantage because the terms and conditions of the tenancy have a bearing on the rent and there may well be something in the 'small print' to one party's advantage.
Chasing Rainbows
20/02/2014
Unlike investing in stocks and shares where the volatility of share prices and uncertainty of dividends can lead to long term buy and lose, investment in property offers two advantages: … For further reading, please visit LandlordZone newsletter issue 21 - click here
Sub-Lease
01/01/2014
Multiple retailers, particularly, with premises that are surplus to requirements frequently sub-let rather than assign the leases. Why? There are many reasons. For example:
1) the risk of assignment is that in the event of assignee default, the lease could revert to the assignor at any time. [Although leases containing Authorised Guarantee Agreements only revert to the assignor in the event of assignee default, older leases are subject to the original rules of privity of contract, so would revert to the original tenant, regardless of how many assignments have taken place, and with the assignor having no rights to reoccupy the premises.]
2) The financial standing of the assignee might not satisfy the freeholder's criteria.
3) Once assigned, it would not normally be possible for the assignor to take the premises back were the assignor to want to re-occupy the premises in future.
4) Any use to which an assignee or future assignee might put the premises could, assuming no restriction in the lease, risk creating a competitor for the assignor's business in the locality.
On balance, sub-letting is an opportunity to charge a profit rent, and enables the tenant to keep control of the lease. The risk of sub-tenant default or delay in paying the rent still exists, but the tenant would control what to do, rather than the landlord.
Generally, where a lease allows the tenant to sub-let, the required outline terms and conditions of any underlease are stated in the lease. Although modern leases may require any under-lease to be outside the Landlord and Tenant Act 1954, often older leases do not. That means that provided the under-lease would qualify for renewal rights on expiry, and assuming the under-lessee wants to renew and the superior landlord does not oppose renewal, the under-lessee would become the direct tenant of the superior landlord.
Regardless of the conditions required by the lease, on grant of under-lease, it is not unusual for strictures of full repairing and decorating obligations to be eased by a schedule of condition or similar. In such cases, the under-lessee should be aware that, unless the underlease is worded correctly, the commercial value of a schedule of condition will end on expiry of the contractual term of underlease, and not continue into any statutory continuation or holding over period. Furthermore, provided the under-lessee is in occupation of the premises on expiry, (and the superior landlord does not oppose renewal, and renewal rights are protected), it should be possible for the terms and conditions of the underlease to be reflected in the terms and conditions of the renewal lease. So, the renewal lease could also contain a schedule of condition.
The risk/cost of managing surplus estate and onerous leases can mount up to become a noticeable provision on the balance-sheet, so retailers like to be rid of the commitment by assigning them, either to third parties, or more likely to their under-lessees. Where an under-lease contains a schedule of condition, the lessor/assignor will normally agree to indemnify the under-lessee for the cost of compliance with the difference between the full repairing covenant and the schedule of condition so that, in practice, the underlesee/to-be-assignee is in no worse a position.
However, unless careful consideration is given to the long-term and wider consequences, the position could be a lot worse. The under-lessee should ensure the indemnity covers any statutory continuation or holding over period of the lease. Also, the under-lessee should note that, on expiry and renewal, it would be the terms and conditions of the lease (assigned) that form the basis for the valuation aspects of s.34 and s.35 Landlord and Tenant Act 1954, and not the terms and conditions of the underlease. In other words, by taking over the lease, the under-lessee would be losing the right to renew on the same terms and conditions of the underlease, the schedule of condition not carried forward.
The total cost of putting a property in a state of repair and decoration as envisaged by the lease can be considerable. It is not only the actual expense for the works but also the attendant costs and fees payable to lawyers and surveyors for the landlord, as well as the tenant's advisers.
1) the risk of assignment is that in the event of assignee default, the lease could revert to the assignor at any time. [Although leases containing Authorised Guarantee Agreements only revert to the assignor in the event of assignee default, older leases are subject to the original rules of privity of contract, so would revert to the original tenant, regardless of how many assignments have taken place, and with the assignor having no rights to reoccupy the premises.]
2) The financial standing of the assignee might not satisfy the freeholder's criteria.
3) Once assigned, it would not normally be possible for the assignor to take the premises back were the assignor to want to re-occupy the premises in future.
4) Any use to which an assignee or future assignee might put the premises could, assuming no restriction in the lease, risk creating a competitor for the assignor's business in the locality.
On balance, sub-letting is an opportunity to charge a profit rent, and enables the tenant to keep control of the lease. The risk of sub-tenant default or delay in paying the rent still exists, but the tenant would control what to do, rather than the landlord.
Generally, where a lease allows the tenant to sub-let, the required outline terms and conditions of any underlease are stated in the lease. Although modern leases may require any under-lease to be outside the Landlord and Tenant Act 1954, often older leases do not. That means that provided the under-lease would qualify for renewal rights on expiry, and assuming the under-lessee wants to renew and the superior landlord does not oppose renewal, the under-lessee would become the direct tenant of the superior landlord.
Regardless of the conditions required by the lease, on grant of under-lease, it is not unusual for strictures of full repairing and decorating obligations to be eased by a schedule of condition or similar. In such cases, the under-lessee should be aware that, unless the underlease is worded correctly, the commercial value of a schedule of condition will end on expiry of the contractual term of underlease, and not continue into any statutory continuation or holding over period. Furthermore, provided the under-lessee is in occupation of the premises on expiry, (and the superior landlord does not oppose renewal, and renewal rights are protected), it should be possible for the terms and conditions of the underlease to be reflected in the terms and conditions of the renewal lease. So, the renewal lease could also contain a schedule of condition.
The risk/cost of managing surplus estate and onerous leases can mount up to become a noticeable provision on the balance-sheet, so retailers like to be rid of the commitment by assigning them, either to third parties, or more likely to their under-lessees. Where an under-lease contains a schedule of condition, the lessor/assignor will normally agree to indemnify the under-lessee for the cost of compliance with the difference between the full repairing covenant and the schedule of condition so that, in practice, the underlesee/to-be-assignee is in no worse a position.
However, unless careful consideration is given to the long-term and wider consequences, the position could be a lot worse. The under-lessee should ensure the indemnity covers any statutory continuation or holding over period of the lease. Also, the under-lessee should note that, on expiry and renewal, it would be the terms and conditions of the lease (assigned) that form the basis for the valuation aspects of s.34 and s.35 Landlord and Tenant Act 1954, and not the terms and conditions of the underlease. In other words, by taking over the lease, the under-lessee would be losing the right to renew on the same terms and conditions of the underlease, the schedule of condition not carried forward.
The total cost of putting a property in a state of repair and decoration as envisaged by the lease can be considerable. It is not only the actual expense for the works but also the attendant costs and fees payable to lawyers and surveyors for the landlord, as well as the tenant's advisers.
Rent Review
01/01/2014
The purpose of a rent review (and where the basis is market rent) is to enable the landlord to obtain the market rent for the premises at the review date (or valuation date if different) and for the tenant to ensure it is not paying any more or less.
The open market is made up of different ‘affordabilities’, so, in linking the review to 'open market rent' ("OMR") ‘open’ means everyone and anyone. [In valuation, the word ‘open’ is superfluous. ]
As comparable evidence, a new letting to an inexperienced first-time tenant at a rent that might amaze is as valid as any hard-driven bargain by a company with dozens of branches. So, since rents in the commercial property market are unregulated, any tenant committing to a review to OMR is exposing its business to all manner of risks beyond its control (a situation that can strain compliance with the Turnbull report on internal control and risk management, to safeguard shareholders’ investment and the company’s assets). Similarly, since, in the open market, different landlords are likely to have different investment strategies, risks also apply to the landlord’s investment. Hence, the only way the actual landlord and actual tenant can have any control over the direction of the rental relationship is by recording their requirements in the lease, per the rent review guidelines.
In the market, rent is a product; it does not occur naturally, as in, ‘this is the rent for the premises’. To value rent, all terms and conditions of the tenancy must be known, stated in advance or defined. But, since the rent on a new letting is often agreed before the lease is drafted and/or approved, it is possible for a completed lease to contain terms and conditions that could produce a different rent to what was agreed. The test of efficacy is whether the rent would be identical if there were a rent review on the same date as the term commencement.
A rent review might be thought of greater benefit to landlords but, essentially, benefit is equal. A review ensures the tenant is not subsidised. Of course, tenants do not necessarily see it like that; and, for many, the only way the business can remain profitable is when costs are below the going rate.
With the gap widening between those that have what customers want and those that do not, tenants not on the receiving end of profitable demand are often fighting to preserve an outmoded business model. The tenant’s reaction to a proposed increase is likely to be emotional, than dispassionate, but a tenant’s failure to adapt its style to changing circumstances cannot possibly be something for which the landlord should be expected to share responsibility. It is not a fault of landlords that rents have become uneconomical for some tenants, but a function of the market, and that includes competition from other businesses, valuation methodology, and tenants straying from review guidelines.
It is pointless for a tenant to agree what it can afford because that could vary over the years: to pay more than necessary when business is booming can mean that rent fixed for the term, regardless. Because terminology is fashionable, guidelines vary from detailed to vague - terms and conditions of a tenancy cannot be changed, except by rectification by the original parties, or mutual agreement - but, whether the intention of the original parties is clear or interpreted, the guidelines are intended to be helpful: to enable the tenant to apply market circumstances at the valuation date to the level of rent.
A rent review is objective: not how much the actual tenant would agree, or the actual landlord would want, but what a hypothetical willing landlord would reasonably expect and a hypothetical willing tenant would pay; such parties may include the actual landlord and actual tenant. So, in addition to procedure for operating the review, time for agreement, method and cost of dispute resolution, and timing of payment and rate of interest on any back rent, the guidelines define the valuation basis for the terms of the tenancy between the hypothetical parties.
There is no such thing as an ‘upward-only rent review’ as such. Upward-only is a cushion for the rent payable and nothing to do with the market rent. So, if the lease contains an “upward-only” review clause, then that does not mean the rent must go up; but that the rent payable after the review cannot be lower than before. Even so, when the landlord expects an increase, that feeling can rub off on the tenant, so the tenant’s first thought is likely to focus on the proposal, rather than how to agree a rent that accords with the guidelines. Landlords can prey on inexperience and unsuspecting - for example, an increase for inflation, or encouraging avoiding the expense of appointing surveyors - so when landlord and tenant communicate directly, it is not unusual for such tenants to settle for a quiet life. But, whereas avoiding confrontation may sometimes be commercially expedient, it makes no sense, at least to me, for a tenant to ignore the guidelines, by thinking that could upset their landlord, when the guidelines are designed to be helpful.
If you are acting for the tenant and do as the tenant asks, but the landlord is unyielding, then for you and/or the tenant to reckon no real likelihood of a surveyor doing any better should, I suggest, be put to the test. It does not follow just because you and your client are not making any progress that a surveyor's experience would also get nowhere. To a landlord (whether represented overtly by a surveyor), a tenant, when negotiating themselves, or through a solicitor or an accountant, is often regarded a ‘soft touch’. Calling a landlord’s bluff - for example, threatening to instruct a surveyor, or referral to ‘arbitration’ - will only work when the landlord is fearful of the prospect. A landlord will wait to see whom the tenant has instructed, before deciding whether to enter into combat.
Although lowest rent is important, it may be all the more where the lease contains a tenant’s option to buy the freehold for the price valuation formula is based on the rent.
In my opinion, things go wrong in the landlord and tenant relationship when negotiations become subjective, and wider consequences for the actual landlord and tenant dominate. It is not simply a clash of personality or viewpoint. Costs can figure largely, the tenant baulks at the expense of referral, angles are not spotted or explored, so a new rent does not reflect the market at the valuation date, but is a product of the past, based almost solely on other rent review and lease renewal agreements. The cumulative effect can take its toll.
To quote from Wallshire Ltd v Aarons [1988] “second best are rent reviews which are negotiated between valuers, because although their aim is to achieve the same end-result of deciding what the market rent is, their decision is not tested by the market; their decision, their agreement, is based on their conclusions about what the market would decide. Negotiated settlements therefore can be unreliable because of the possibility of error piled on error. They need … an occasional window of reality provided by open market decisions. ”
The difficulty for a solicitor, when acting for a tenant, is their advisory role differs from that of a surveyor. Solicitors act only on client instructions, whereas surveyors can act off their own bat. When the tenant tells you the landlord’s proposal is excessive, or such like, and wants to reply with a counter-offer of what he could afford, how the response is received by the landlord is likely to be construed as an outburst, merely letting off steam. While some landlords do overstate, the proposal may in fact be close to market rent. Generally, particularly when substantial increase is proposed, the tenant’s reaction is anticipated. A emotional plea is unlikely to cut any ice. Since a review is a function of tenancy management, the tenant may forget, or not realise, the process is nothing personal.
It is also important to realise the review process is not only about rent, but also whether the review can be implemented and/or the proposal negotiated. Implementation often requires some notice to be given, the notice must be valid, and time-limits adhered to. Similarly, it may be necessary to serve a counter-notice. It is vital to respect the guidelines. Bellinger v South London Stationers Ltd [1979] is an example of what can go wrong: “we would hardly need to add that we do not accept your revised figure” was not considered sufficiently specific to be a counter-notice.
Where many tenants go wrong is not consulting a surveyor. It’s all very well wanting to save on fees by tackling the landlord themselves, or getting their solicitor or accountant to write, but, at rent review, as with anything involving a business tenancy, it’s not simply a matter of the tenant agreeing what it can afford, but what others would agree for the same situation. Anything the tenant agrees by themselves could end up backfiring on them at a later date. Whether through a solicitor or an accountant, a tenant trying to negotiate a rent review without involving a surveyor can leave the tenant with the feeling the cards are stacked in favour of the landlord but, in my experience, how negotiations are handled from the start can make a difference to the outcome.
The open market is made up of different ‘affordabilities’, so, in linking the review to 'open market rent' ("OMR") ‘open’ means everyone and anyone. [In valuation, the word ‘open’ is superfluous. ]
As comparable evidence, a new letting to an inexperienced first-time tenant at a rent that might amaze is as valid as any hard-driven bargain by a company with dozens of branches. So, since rents in the commercial property market are unregulated, any tenant committing to a review to OMR is exposing its business to all manner of risks beyond its control (a situation that can strain compliance with the Turnbull report on internal control and risk management, to safeguard shareholders’ investment and the company’s assets). Similarly, since, in the open market, different landlords are likely to have different investment strategies, risks also apply to the landlord’s investment. Hence, the only way the actual landlord and actual tenant can have any control over the direction of the rental relationship is by recording their requirements in the lease, per the rent review guidelines.
In the market, rent is a product; it does not occur naturally, as in, ‘this is the rent for the premises’. To value rent, all terms and conditions of the tenancy must be known, stated in advance or defined. But, since the rent on a new letting is often agreed before the lease is drafted and/or approved, it is possible for a completed lease to contain terms and conditions that could produce a different rent to what was agreed. The test of efficacy is whether the rent would be identical if there were a rent review on the same date as the term commencement.
A rent review might be thought of greater benefit to landlords but, essentially, benefit is equal. A review ensures the tenant is not subsidised. Of course, tenants do not necessarily see it like that; and, for many, the only way the business can remain profitable is when costs are below the going rate.
With the gap widening between those that have what customers want and those that do not, tenants not on the receiving end of profitable demand are often fighting to preserve an outmoded business model. The tenant’s reaction to a proposed increase is likely to be emotional, than dispassionate, but a tenant’s failure to adapt its style to changing circumstances cannot possibly be something for which the landlord should be expected to share responsibility. It is not a fault of landlords that rents have become uneconomical for some tenants, but a function of the market, and that includes competition from other businesses, valuation methodology, and tenants straying from review guidelines.
It is pointless for a tenant to agree what it can afford because that could vary over the years: to pay more than necessary when business is booming can mean that rent fixed for the term, regardless. Because terminology is fashionable, guidelines vary from detailed to vague - terms and conditions of a tenancy cannot be changed, except by rectification by the original parties, or mutual agreement - but, whether the intention of the original parties is clear or interpreted, the guidelines are intended to be helpful: to enable the tenant to apply market circumstances at the valuation date to the level of rent.
A rent review is objective: not how much the actual tenant would agree, or the actual landlord would want, but what a hypothetical willing landlord would reasonably expect and a hypothetical willing tenant would pay; such parties may include the actual landlord and actual tenant. So, in addition to procedure for operating the review, time for agreement, method and cost of dispute resolution, and timing of payment and rate of interest on any back rent, the guidelines define the valuation basis for the terms of the tenancy between the hypothetical parties.
There is no such thing as an ‘upward-only rent review’ as such. Upward-only is a cushion for the rent payable and nothing to do with the market rent. So, if the lease contains an “upward-only” review clause, then that does not mean the rent must go up; but that the rent payable after the review cannot be lower than before. Even so, when the landlord expects an increase, that feeling can rub off on the tenant, so the tenant’s first thought is likely to focus on the proposal, rather than how to agree a rent that accords with the guidelines. Landlords can prey on inexperience and unsuspecting - for example, an increase for inflation, or encouraging avoiding the expense of appointing surveyors - so when landlord and tenant communicate directly, it is not unusual for such tenants to settle for a quiet life. But, whereas avoiding confrontation may sometimes be commercially expedient, it makes no sense, at least to me, for a tenant to ignore the guidelines, by thinking that could upset their landlord, when the guidelines are designed to be helpful.
If you are acting for the tenant and do as the tenant asks, but the landlord is unyielding, then for you and/or the tenant to reckon no real likelihood of a surveyor doing any better should, I suggest, be put to the test. It does not follow just because you and your client are not making any progress that a surveyor's experience would also get nowhere. To a landlord (whether represented overtly by a surveyor), a tenant, when negotiating themselves, or through a solicitor or an accountant, is often regarded a ‘soft touch’. Calling a landlord’s bluff - for example, threatening to instruct a surveyor, or referral to ‘arbitration’ - will only work when the landlord is fearful of the prospect. A landlord will wait to see whom the tenant has instructed, before deciding whether to enter into combat.
Although lowest rent is important, it may be all the more where the lease contains a tenant’s option to buy the freehold for the price valuation formula is based on the rent.
In my opinion, things go wrong in the landlord and tenant relationship when negotiations become subjective, and wider consequences for the actual landlord and tenant dominate. It is not simply a clash of personality or viewpoint. Costs can figure largely, the tenant baulks at the expense of referral, angles are not spotted or explored, so a new rent does not reflect the market at the valuation date, but is a product of the past, based almost solely on other rent review and lease renewal agreements. The cumulative effect can take its toll.
To quote from Wallshire Ltd v Aarons [1988] “second best are rent reviews which are negotiated between valuers, because although their aim is to achieve the same end-result of deciding what the market rent is, their decision is not tested by the market; their decision, their agreement, is based on their conclusions about what the market would decide. Negotiated settlements therefore can be unreliable because of the possibility of error piled on error. They need … an occasional window of reality provided by open market decisions. ”
The difficulty for a solicitor, when acting for a tenant, is their advisory role differs from that of a surveyor. Solicitors act only on client instructions, whereas surveyors can act off their own bat. When the tenant tells you the landlord’s proposal is excessive, or such like, and wants to reply with a counter-offer of what he could afford, how the response is received by the landlord is likely to be construed as an outburst, merely letting off steam. While some landlords do overstate, the proposal may in fact be close to market rent. Generally, particularly when substantial increase is proposed, the tenant’s reaction is anticipated. A emotional plea is unlikely to cut any ice. Since a review is a function of tenancy management, the tenant may forget, or not realise, the process is nothing personal.
It is also important to realise the review process is not only about rent, but also whether the review can be implemented and/or the proposal negotiated. Implementation often requires some notice to be given, the notice must be valid, and time-limits adhered to. Similarly, it may be necessary to serve a counter-notice. It is vital to respect the guidelines. Bellinger v South London Stationers Ltd [1979] is an example of what can go wrong: “we would hardly need to add that we do not accept your revised figure” was not considered sufficiently specific to be a counter-notice.
Where many tenants go wrong is not consulting a surveyor. It’s all very well wanting to save on fees by tackling the landlord themselves, or getting their solicitor or accountant to write, but, at rent review, as with anything involving a business tenancy, it’s not simply a matter of the tenant agreeing what it can afford, but what others would agree for the same situation. Anything the tenant agrees by themselves could end up backfiring on them at a later date. Whether through a solicitor or an accountant, a tenant trying to negotiate a rent review without involving a surveyor can leave the tenant with the feeling the cards are stacked in favour of the landlord but, in my experience, how negotiations are handled from the start can make a difference to the outcome.
Presumption of Reality
01/01/2014
It has long been recognised that too literal an approach is to be avoided in the interpretation of contracts.
The reason for that was explained thus by Lord Reid in Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235: "No doubt some words used by lawyers do have a rigid inflexible meaning. But we must remember that we are seeking to discover intention as disclosed by the contract as a whole … The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result, the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear."
On the same theme, in Antaios Compania Naviera SA v Salen Rederierna AB (“The Antaios”) [1985] AC 191, Lord Diplock famously stated that:"… if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense."
The ways in which the process of interpretation can be made to accommodate such common sense have varied, with the battle lines being drawn between (a) those judges who are reluctant to allow the business common-sense of the contract to cause them to depart from the natural meaning of the words used; (b) those who strain the meaning of words in order to arrive at what they consider to be a commercial outcome that best expresses the perceived intention of the parties while avoiding absurdity; and (c) those who feel able to disregard or even rewrite the parties’ words to achieve the same effect.
In Westpac Banking Corporation v Tanzone Pty (2000) , the New South Wales Court of Appeal held that, literally construed, an indexation provision in a rent review clause produced such dramatic cumulative increases as to amount to an absurd result, and was able to construe the clause by reading in words that must have been accidentally omitted. In other cases, although it may be possible to detect absurdity, it may be less easy to divine what the parties must have intended their bargain to be instead.
The reason for that was explained thus by Lord Reid in Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235: "No doubt some words used by lawyers do have a rigid inflexible meaning. But we must remember that we are seeking to discover intention as disclosed by the contract as a whole … The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result, the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear."
On the same theme, in Antaios Compania Naviera SA v Salen Rederierna AB (“The Antaios”) [1985] AC 191, Lord Diplock famously stated that:"… if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense."
The ways in which the process of interpretation can be made to accommodate such common sense have varied, with the battle lines being drawn between (a) those judges who are reluctant to allow the business common-sense of the contract to cause them to depart from the natural meaning of the words used; (b) those who strain the meaning of words in order to arrive at what they consider to be a commercial outcome that best expresses the perceived intention of the parties while avoiding absurdity; and (c) those who feel able to disregard or even rewrite the parties’ words to achieve the same effect.
In Westpac Banking Corporation v Tanzone Pty (2000) , the New South Wales Court of Appeal held that, literally construed, an indexation provision in a rent review clause produced such dramatic cumulative increases as to amount to an absurd result, and was able to construe the clause by reading in words that must have been accidentally omitted. In other cases, although it may be possible to detect absurdity, it may be less easy to divine what the parties must have intended their bargain to be instead.
Pension Plan
01/01/2014
A pension is a long-term commitment and tax relief is attractive, but setting-up fees and on-going charges for pension plans can be disproportionately high. I suggest thinking inside the box. The question to ask is: would the proposition be worth buying if there were no tax advantages? Many property investment schemes and plans are sold on tax advantages but unless the property itself makes sense as a long-term investment then I suggest the only likely advantage would be for the scheme promoter and manager of the plan.
Generally, commercial property is a depreciating asset. Since costs of buying (including Stamp Duty) and selling, and non-recoverable expenses during ownership, can be substantial, to get your money back, the value of the property must increase by enough to cover all those costs, plus loss of interest on your equity, plus adjustment for inflation, and allowing for tax on the gain. If, when you want to sell, the value has not increased by at least enough to cover all those costs and adjustments then you would either break-even, or be worse off.
There is a school of thought that treats property investment as an annuity. Provided the tenant is financially stable and likely to remain sound for the duration of the term of the tenancy, buying an investment for yield, regardless of the value of the asset may be lucrative. Even so, it is all too easy to overpay for income. Furthermore, unless the landlord’s interest is leasehold, (in which case the interest would probably revert to the freeholder on expiry (subject to any rights to renew or enfranchise), the property would revert to the landlord on expiry of the tenancy (subject to any rights of the tenant to renew) and any difficulties in reletting or otherwise disposing of the property could cause problems for the landlords.
For a SIPP (self-investment personal pension), generally buying a shop property investment for a pension based on tax advantages is not the best way to go about creating a pension. Unless the purchase is wholly a business-expense, in which case what I am about to say does not apply, the snag with buying property for investment because of the tax advantages can lead to the prospect of getting tax relief ignoring the prospects for the property as an investment itself.
I am sure there are many landlords that over the years since SIPPS were introduced in 2000 nowadays own properties that have fallen in value with no obvious likelihood of going back up to the price paid. Of course, when you are buying long-term, the occasional drop in value is only to be expected, but the question is whether any fall in value can be reasonably expected to be offset by any rise, or whether the ups-and-downs over the period of time simply cancel out each other.
Since most propositions are going to decline over the years, because of the principles of marketing, it is very much a matter of timing: the challenge is to sell and let someone else buy the slack before it becomes obvious that the investment is not going to perform. To some people, the idea of dumping on the unsuspecting might be thought anti-social, but when it’s your money you’re investing why stick around just in case?
The question is: long-term buy and hold, or long-term buy and lose?
Generally, commercial property is a depreciating asset. Since costs of buying (including Stamp Duty) and selling, and non-recoverable expenses during ownership, can be substantial, to get your money back, the value of the property must increase by enough to cover all those costs, plus loss of interest on your equity, plus adjustment for inflation, and allowing for tax on the gain. If, when you want to sell, the value has not increased by at least enough to cover all those costs and adjustments then you would either break-even, or be worse off.
There is a school of thought that treats property investment as an annuity. Provided the tenant is financially stable and likely to remain sound for the duration of the term of the tenancy, buying an investment for yield, regardless of the value of the asset may be lucrative. Even so, it is all too easy to overpay for income. Furthermore, unless the landlord’s interest is leasehold, (in which case the interest would probably revert to the freeholder on expiry (subject to any rights to renew or enfranchise), the property would revert to the landlord on expiry of the tenancy (subject to any rights of the tenant to renew) and any difficulties in reletting or otherwise disposing of the property could cause problems for the landlords.
For a SIPP (self-investment personal pension), generally buying a shop property investment for a pension based on tax advantages is not the best way to go about creating a pension. Unless the purchase is wholly a business-expense, in which case what I am about to say does not apply, the snag with buying property for investment because of the tax advantages can lead to the prospect of getting tax relief ignoring the prospects for the property as an investment itself.
I am sure there are many landlords that over the years since SIPPS were introduced in 2000 nowadays own properties that have fallen in value with no obvious likelihood of going back up to the price paid. Of course, when you are buying long-term, the occasional drop in value is only to be expected, but the question is whether any fall in value can be reasonably expected to be offset by any rise, or whether the ups-and-downs over the period of time simply cancel out each other.
Since most propositions are going to decline over the years, because of the principles of marketing, it is very much a matter of timing: the challenge is to sell and let someone else buy the slack before it becomes obvious that the investment is not going to perform. To some people, the idea of dumping on the unsuspecting might be thought anti-social, but when it’s your money you’re investing why stick around just in case?
The question is: long-term buy and hold, or long-term buy and lose?
Open Market
01/01/2014
The open market is made up of different ‘afford-abilities’, so, in linking the review to “open market rent” (OMR) ‘open’ means everyone and anyone (A).
As indicative or comparable evidence, a new letting to an inexperienced first-time tenant at a rent that might amaze is as valid as any hard-driven bargain by a multiple retailer with hundreds of branches. So, since rents in the open market are unregulated, any tenant committing to a review to OMR is exposing its business to all manner of risks beyond its control (a situation that can strain compliance with the Turnbull report on internal control and risk management, to safeguard shareholders' investment and the company's assets). That is the nature of the system; and when tenants choose to agree to a rent review to the open market rent it is implicit the tenant is agreeing to the underlying purpose and overriding objective: namely to enable the landlord to obtain the open market rent at the valuation date per terms of the tenancy, not for the tenant to expect to pay any less.
Similarly, since, in the open market, different landlords are likely to have different investment performance strategies, risks also apply to the landlord’s investment. Hence, the only way the actual landlord and actual tenant can have any control over the direction of the rental relationship is by recording their requirements in the lease, per the rent review guidelines.
Hoffmann LJ commented on the concept of the open market in a capital transfer tax case, IRC v Gray [1994] STC 360:
"It cannot be too strongly emphasised that although the sale is hypothetical, there is nothing hypothetical about the open market in which it is supposed to have taken place. The concept of the open market involves assuming that the whole world was free to bid, and then forming a view about what in those circumstances would in real life have been the best price reasonably obtainable …"
As indicative or comparable evidence, a new letting to an inexperienced first-time tenant at a rent that might amaze is as valid as any hard-driven bargain by a multiple retailer with hundreds of branches. So, since rents in the open market are unregulated, any tenant committing to a review to OMR is exposing its business to all manner of risks beyond its control (a situation that can strain compliance with the Turnbull report on internal control and risk management, to safeguard shareholders' investment and the company's assets). That is the nature of the system; and when tenants choose to agree to a rent review to the open market rent it is implicit the tenant is agreeing to the underlying purpose and overriding objective: namely to enable the landlord to obtain the open market rent at the valuation date per terms of the tenancy, not for the tenant to expect to pay any less.
Similarly, since, in the open market, different landlords are likely to have different investment performance strategies, risks also apply to the landlord’s investment. Hence, the only way the actual landlord and actual tenant can have any control over the direction of the rental relationship is by recording their requirements in the lease, per the rent review guidelines.
Hoffmann LJ commented on the concept of the open market in a capital transfer tax case, IRC v Gray [1994] STC 360:
"It cannot be too strongly emphasised that although the sale is hypothetical, there is nothing hypothetical about the open market in which it is supposed to have taken place. The concept of the open market involves assuming that the whole world was free to bid, and then forming a view about what in those circumstances would in real life have been the best price reasonably obtainable …"
Negotiation
01/01/2014
Contrary to popular belief, there is, assuming the review to market rent, no right or wrong way to negotiate a rent review. The tenant may like to assert that the landlord should produce evidence to justify a proposed increase and if none were forthcoming then the rent should not go up, but that stance has no basis in law. On the contrary, a principle of business tenancy law is that a rent review is for the benefit of both parties, so co-operation is called for.
In United Scientific Holdings v Burnley Borough Council (1978), Lord Salmon said: “To my mind, it is totally unrealistic to regard such clauses (rent review) as conferring a privilege upon the landlord or as imposing a burden upon the tenant. Both the landlord and the tenant recognise the obvious, viz., that such clauses are fair and reasonable for each of them. I do not agree with what has been said in some of the authorities, namely, that a rent revision clause is for the benefit of the landlord alone and not at all for the benefit of the tenant. It is plainly for the benefit of them both. It is for the benefit of the tenant because without such a clause he would never get the long lease which he required; and under modern conditions it would be grossly unfair that he should. It is for the benefit of the landlord because it ensures that for the duration of the lease he will receive a fair rent instead of a rent far below the market value of the property which he demises. ”
A review ensures the tenant is not subsidised. Even so, tenants rarely see it like that; and, for many, the only way the business can remain profitable is when costs are below the going rate. A business plan is rarely straightforward, and with the gap widening between retailers that have what customers want, and those that do not, retailers not on the receiving end of profitable demand are often fighting to preserve an outmoded business model. When the survival of the tenant’s business depends to a large extent upon the landlord not wanting any (hefty) increase, the tenant’s reaction to a proposed increase is much more likely to be emotional, than dispassionate. What might be described as 'woolly-headed liberal thinking' has entered the popular fray but retailing is not an extension of social services. A tenant’s failure to adapt its business style to changing circumstances cannot possibly be something for which the landlord should be expected to share responsibility. It is not a fault of landlords that rents have become uneconomical for some retailers, but a function of the market, which includes competition from other retailers, consumer spending-priorities, rental valuation methodology, and tenants straying from review guidelines.
In United Scientific Holdings v Burnley Borough Council (1978), Lord Salmon said: “To my mind, it is totally unrealistic to regard such clauses (rent review) as conferring a privilege upon the landlord or as imposing a burden upon the tenant. Both the landlord and the tenant recognise the obvious, viz., that such clauses are fair and reasonable for each of them. I do not agree with what has been said in some of the authorities, namely, that a rent revision clause is for the benefit of the landlord alone and not at all for the benefit of the tenant. It is plainly for the benefit of them both. It is for the benefit of the tenant because without such a clause he would never get the long lease which he required; and under modern conditions it would be grossly unfair that he should. It is for the benefit of the landlord because it ensures that for the duration of the lease he will receive a fair rent instead of a rent far below the market value of the property which he demises. ”
A review ensures the tenant is not subsidised. Even so, tenants rarely see it like that; and, for many, the only way the business can remain profitable is when costs are below the going rate. A business plan is rarely straightforward, and with the gap widening between retailers that have what customers want, and those that do not, retailers not on the receiving end of profitable demand are often fighting to preserve an outmoded business model. When the survival of the tenant’s business depends to a large extent upon the landlord not wanting any (hefty) increase, the tenant’s reaction to a proposed increase is much more likely to be emotional, than dispassionate. What might be described as 'woolly-headed liberal thinking' has entered the popular fray but retailing is not an extension of social services. A tenant’s failure to adapt its business style to changing circumstances cannot possibly be something for which the landlord should be expected to share responsibility. It is not a fault of landlords that rents have become uneconomical for some retailers, but a function of the market, which includes competition from other retailers, consumer spending-priorities, rental valuation methodology, and tenants straying from review guidelines.
Mortgage and Loan
01/01/2014
Even if they start by using cash, many purchasers are concerned with the cost of financing property. In my experience, they can often be more concerned with finance than the value of the proposition. This situation typically arises when property is offered at a high yield, compared with interest rates, but not high enough when measured on (traditional) investment criteria.
Depending on lending criteria, that may range from stringent to lax depending the lender's policy at the time, commercial mortgages can usually be obtained for between 40-70% of capital value, provided the cost of repaying the mortgage is covered by the rental income.
When a mortgage based on the value of the investment, as distinct from the property, and if the investment value has gone up, it may be possible to remortgage.
Where a rent is subject to early review or the tenancy to expiry (reversion), mortgagees will normally lend only by reference to the rent passing, but subject to the borrower's other resources and the relationship with the lender, it may be possible to extract extra funds in anticipation of the level of increase and its immediate effect on capital value. Once the new rent is established, it may then be possible to re-mortgage so as to release further equity.
The source of finance is important. Since the price of shop property can be substantial and may be beyond the reach of cash buyers, where would the money come from to fuel demand for shop property investments?
The answer is there is plenty of money about. You only have to look at the turnover figures for retailers and other businesses to realise how many GBP billions are in circulation. The criteria for bank lending is judicious choice of borrower. By lending (more) to fewer borrowers, the banks are doing what all forward-thinking businesses have been doing for years: moving away from the mass-market catering for everyone and concentrating on the more profitable customers/borrowers.
The amount of funds and facilities for borrowing determines flexibility. Income can be used to finance mortgage, capital can be released for buying a second investment and so on. If you do not want to borrow, then your purchase would be limited to your own resources, the price range and/or required initial yield, in which case decisions can be harder for fear that something better might turn up. The more you have to invest, the more flexible you can be. Even so, successful investment in shop property is not about spreading the risk, but buying wisely.
A wise investment is one that performs through thick and thin. Property performance is a measure of confidence. At any time the value of a shop investment is what other investors in the market at that time would pay, but how the value is calculated depends upon the terms and provisions of the tenancy and that depends upon the tenant’s agreement or if a dispute has to be resolved then the tenant’s conduct in the aftermath.
Depending on lending criteria, that may range from stringent to lax depending the lender's policy at the time, commercial mortgages can usually be obtained for between 40-70% of capital value, provided the cost of repaying the mortgage is covered by the rental income.
When a mortgage based on the value of the investment, as distinct from the property, and if the investment value has gone up, it may be possible to remortgage.
Where a rent is subject to early review or the tenancy to expiry (reversion), mortgagees will normally lend only by reference to the rent passing, but subject to the borrower's other resources and the relationship with the lender, it may be possible to extract extra funds in anticipation of the level of increase and its immediate effect on capital value. Once the new rent is established, it may then be possible to re-mortgage so as to release further equity.
The source of finance is important. Since the price of shop property can be substantial and may be beyond the reach of cash buyers, where would the money come from to fuel demand for shop property investments?
The answer is there is plenty of money about. You only have to look at the turnover figures for retailers and other businesses to realise how many GBP billions are in circulation. The criteria for bank lending is judicious choice of borrower. By lending (more) to fewer borrowers, the banks are doing what all forward-thinking businesses have been doing for years: moving away from the mass-market catering for everyone and concentrating on the more profitable customers/borrowers.
The amount of funds and facilities for borrowing determines flexibility. Income can be used to finance mortgage, capital can be released for buying a second investment and so on. If you do not want to borrow, then your purchase would be limited to your own resources, the price range and/or required initial yield, in which case decisions can be harder for fear that something better might turn up. The more you have to invest, the more flexible you can be. Even so, successful investment in shop property is not about spreading the risk, but buying wisely.
A wise investment is one that performs through thick and thin. Property performance is a measure of confidence. At any time the value of a shop investment is what other investors in the market at that time would pay, but how the value is calculated depends upon the terms and provisions of the tenancy and that depends upon the tenant’s agreement or if a dispute has to be resolved then the tenant’s conduct in the aftermath.
Growth
01/01/2014
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
Economical Rent
01/01/2014
In business tenancy law, the actual tenant’s ability to afford the rent at review is generally considered irrelevant. So, the actual tenant faces a dilemma, because - unless the review goes to ‘arbitration’ - the tenant must decide what rent to agree and no tenant will willingly agree more than they can afford. Since affordability is a big issue, solicitors acting for tenant-retailers can encounter difficulties in obtaining instructions when the client is at a loss to know what to do.
It is vital the tenant understands the review process. When premises are offered to let in the open market, as well as negotiating the best deal it can, a tenant will do one or both of two things. All tenants decide whether, on their projected figures, the rent would be affordable. The second thing, which is not something all tenants do, is to check whether the proposed rent is realistic, compared with what other tenants nearby pay for their premises. Ascertaining what others pay for their premises helps avoid a hike in the rental benchmark, which can happen if the transaction were cited as evidence for nearby reviews. With shop property, for example, the Zone A value could destabilise the cost of the trading position for those retailers whose established presence is one attraction of the position in the first place. Few tenants care about the wider long-term consequences of their business expansion plans and most are single-minded. Some deliberately pay top rents to ingratiate themselves with landlords, whilst others agree what they can afford at the time, expecting future rent reviews also to be based on affordability.
As soon as the lease is completed, affordability and business tenancy law part company. At rent review, it is assumed the actual tenant can afford, pro-rata, the same as everyone else, because the purpose of a review is to enable the landlord to receive the market rent. However, although each new letting reflects that particular tenant’s affordability, the profit margin and rate of stock-turn mean not all tenants can afford the same as everyone else. Furthermore - and this point is frequently overlooked - because rent is payable regardless of the profitability of the business, it is assumed the tenant is of independent means, even though most tenants rely entirely on business cash-flow.
Although retailers in trouble are managing to persuade landlords to accept rents paid monthly, a growing number of retailers that are not in any difficulty are expecting the same treatment.
Some landlords can afford to be accommodating, but many cannot. Landlords that themselves are borrowing money are likely to be paying their interest quarterly, so accepting rents monthly from the tenant will mean the landlord subsidising the tenant.
In any event, such an arrangement, where it is a departure from the terms and conditions of the lease, should only be temporary, and subject to notice to end the arrangement if the landlord should so desire. Landlords should also put the agreement in writing, in a side-letter with the lease, setting out clearly the terms and conditions of the arrangement.
To avoid problems should the landlord want to sell the investment, the arrangement should be personal to the tenant and landlord and non-transferable.
In my opinion, the investment value of a property where the tenant is being allowed to pay monthly could well be lower than where payments are quarterly.
It is vital the tenant understands the review process. When premises are offered to let in the open market, as well as negotiating the best deal it can, a tenant will do one or both of two things. All tenants decide whether, on their projected figures, the rent would be affordable. The second thing, which is not something all tenants do, is to check whether the proposed rent is realistic, compared with what other tenants nearby pay for their premises. Ascertaining what others pay for their premises helps avoid a hike in the rental benchmark, which can happen if the transaction were cited as evidence for nearby reviews. With shop property, for example, the Zone A value could destabilise the cost of the trading position for those retailers whose established presence is one attraction of the position in the first place. Few tenants care about the wider long-term consequences of their business expansion plans and most are single-minded. Some deliberately pay top rents to ingratiate themselves with landlords, whilst others agree what they can afford at the time, expecting future rent reviews also to be based on affordability.
As soon as the lease is completed, affordability and business tenancy law part company. At rent review, it is assumed the actual tenant can afford, pro-rata, the same as everyone else, because the purpose of a review is to enable the landlord to receive the market rent. However, although each new letting reflects that particular tenant’s affordability, the profit margin and rate of stock-turn mean not all tenants can afford the same as everyone else. Furthermore - and this point is frequently overlooked - because rent is payable regardless of the profitability of the business, it is assumed the tenant is of independent means, even though most tenants rely entirely on business cash-flow.
Although retailers in trouble are managing to persuade landlords to accept rents paid monthly, a growing number of retailers that are not in any difficulty are expecting the same treatment.
Some landlords can afford to be accommodating, but many cannot. Landlords that themselves are borrowing money are likely to be paying their interest quarterly, so accepting rents monthly from the tenant will mean the landlord subsidising the tenant.
In any event, such an arrangement, where it is a departure from the terms and conditions of the lease, should only be temporary, and subject to notice to end the arrangement if the landlord should so desire. Landlords should also put the agreement in writing, in a side-letter with the lease, setting out clearly the terms and conditions of the arrangement.
To avoid problems should the landlord want to sell the investment, the arrangement should be personal to the tenant and landlord and non-transferable.
In my opinion, the investment value of a property where the tenant is being allowed to pay monthly could well be lower than where payments are quarterly.
Demise
01/01/2014
A “demise” or “lease” is the grant of a right to the exclusive possession of land for a determinate term less than that which the grantor has himself in the land. A lease is therefore a species of conveyance, and it is provided by s (2)05(1)(ii) of the Law of Property Act 1925 that the word “conveyance” in that Act includes “lease” unless the context otherwise requires. The word “lease” may be used, however, to refer either to the grant of the right or to the right itself, namely, the term vested in the grantee. A leasehold interest, or a term of years absolute is one of the two categories of legal estate capable of being created or of subsisting in English law (1) Although a lease is created by contract, it results in the creation of an estate (or status) which can exist independently of contract, at least in so far as the obligations created by the lease touch and concern the land. Thus a leasehold estate may subsist even though the original tenant has ceased to be contractually liable to perform any of the obligations contained in the lease. “The contractual obligations which touch and concern the land having become imprinted on the estate, the tenancy is capable of existence as a species of property independently of the contract.”2
In the relationship between landlord and tenant, the landlord owns the building and the premises demised to the tenant is the whole or part of the building. The tenant leases the demised premises (or premises) and the legal relationship between landlord and tenant is based upon the terms and conditions of the lease. The terms and conditions are often described as provisions.
The terms and conditions of a tenancy are embodied in a document, known as a 'lease'. Although the word ‘lease’ is commonly used, actually the lease is the document, the type of occupancy either a tenancy or licence. I use the terminology ‘lease’ loosely, because the terms and conditions of a licence are also in a document, but calling a document a ‘licence’ does not make it one.
In the relationship between landlord and tenant, the landlord owns the building and the premises demised to the tenant is the whole or part of the building. The tenant leases the demised premises (or premises) and the legal relationship between landlord and tenant is based upon the terms and conditions of the lease. The terms and conditions are often described as provisions.
The terms and conditions of a tenancy are embodied in a document, known as a 'lease'. Although the word ‘lease’ is commonly used, actually the lease is the document, the type of occupancy either a tenancy or licence. I use the terminology ‘lease’ loosely, because the terms and conditions of a licence are also in a document, but calling a document a ‘licence’ does not make it one.