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Introduction
31/December/2014
In 1984, I launched a newsletter, Quarterly Commentary, subsequently renamed Current Review, and now Rent Review Matters. An outlet for my opinions, technical comment and insight, the newsletter Rent Review Matters, and writings elsewhere, provide a mine of useful information, designed to stimulate and inspire.
You will find an Index of keywords and archive years on the left-hand-side of this page and if you'd like to keep in touch via email updates then please click the RSS Feed at the foot of the Index.
I hope you enjoy reading and look forward to helping you in some way.
Michael Lever
PS - Since 2012, I've contributed to LandlordZONE's monthly newsletter and from 2014 I'm a Guest Writer for its twice-a-month blog. LandlordZONE® ("LZ") is a website community and forum for landlords, tenants and others involved in letting property. You may visit LZ by clicking the links or you can read the articles by clicking on Landlordzone in the Index here.
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You will find an Index of keywords and archive years on the left-hand-side of this page and if you'd like to keep in touch via email updates then please click the RSS Feed at the foot of the Index.
I hope you enjoy reading and look forward to helping you in some way.
Michael Lever
PS - Since 2012, I've contributed to LandlordZONE's monthly newsletter and from 2014 I'm a Guest Writer for its twice-a-month blog. LandlordZONE® ("LZ") is a website community and forum for landlords, tenants and others involved in letting property. You may visit LZ by clicking the links or you can read the articles by clicking on Landlordzone in the Index here.
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How to Appraise a Shop Investment
02/June/2014 - Shop Investment - Appraisal - Zone A - ITZA - Trading Position - Reversionary - Rental Growth
The short answer to the question how to appraise a shop investment is that everything about the proposition is reflected in the level of Zone A rent. But, because people generally like to have things spelled out, if only to ensure nothing much has been overlooked, here is the long version.
Shop investments are valued by reference to specifics, rather than generalities: namely, the nature of the particular town and importance of the particular trading position in that town. Towns and cities are ranked in terms of national and regional importance, according to multiple retailer representation and associated criteria, such as customer spending-power. The era of local and catchment population only shopping in the town where they live and/or work is long gone. Nowadays, spending-power, drive-time, parking facilities and the customer experience overall are determining factors. While each town will have its own trading positions, more important for investment potential is the relationship between one particular town and another, together with any wider influences that could affect that importance, such as new developments in the offing.
Towns vary in character, heritage, population (resident and catchment) and other socio-economic demographics. Each town has its own trading positions: in-town, the best position is the prime position, which might include a purpose-built shopping centre or mall at the heart of the town centre; everything else is classified as secondary. Secondary comprises secondary, tertiary, local, and neighbourhood. Out-of-town (including edge-of-town) shopping centres, malls, precincts, outlet centres and supermarkets are in a league of their own and depending upon the overall shopping experience may be the dominant shopping location for the whole town.
Over time, sometimes almost overnight in the case of a new shopping development, in-town trading positions can change. What used to be the prime position may become secondary, and vice versa. The presence of multiple retailers does not itself define a prime position: many multiple retailers prefer secondary positions.
Unlike town centre 'high streets' including secondary positions where the ownership of shop property comprises different landlords and owner-occupiers, purpose-built shopping centres, whether in- or out-of-town, are usually owned by a single landlord able to control tenant-mix. Shopping centre management is directed toward maximising the trading potential for both the centre's owner and the centre's tenants, whereas with fragmented ownerships, different landlords and so on, each individual landlord is likely to have their own investment policy, tenants having to fend for themselves.
Purpose-built shopping centres, being privately-owned, can be managed to a marketing plan, but investing in individual properties in the 'high street' is riskier. In the firing line of day-to-day trading reality, retailers fall into two categories: those that actively support and contribute to community initiatives to generate custom, and those that don't. Those that don't are sometimes criticised by those that do but only because those that do resent the freely cashing-in on community initiatives. It's not that those that don't are anti-social, so much as a difference in approach to attracting custom.
Some retailers are destinations in their own right, others rely far more on passing trade. Ideologically, a town centre might be presented as a community but, in practice, it is not a level playing field: business is not an extension of social services. Ultimately, some retailers are better at attracting profitable trade than others. Generally, the least capable are prone to bleating, the more successful adjust and adapt.
Amongst the factors affecting asset management and investment potential is not just the relationship between each particular building and its trading position, but also the relationship between that trading position and other trading positions in the town and other towns elsewhere. In the absence of a united front involving all interested parties, competing interests between (1) owners and their tenants in single ownership shopping centres and (2) the relatively dysfunctional policies of different landlords and tenants in 'high streets' can result in the 'high street' interests losing out.
Unlike single-ownership shopping centres where rent levels are geared to positioning of the tenant mix, with all leases generally containing more or less the same terms and conditions, other than rent, there is no obligation on a landlord of an individual shop property in 'high street' trading position to want the highest rent and/or to pursue rent review so, for example, rent reviews might remain outstanding. Consequently, rental levels even in the same street do not have to be consistent. Furthermore, since transactions are particular landlord-tenant specific, a tenant is not obliged to agree the lowest rent and many retailers are rumoured to ingratiate themselves with landlords in exchange for preferential treatment elsewhere. Establishing a surveyor-acceptable common denominator for the level of rents is a matter for informed opinion. The adage 'one swallow does not make a summer' is cited whenever a transaction is thought to be out of line.
For decades, it's been said there are too many shops. The polarisation of the retail market over the past twenty years or so suggests there may now be too many towns. To evaluate prospects for a town, thinking that it's nice place to live in may not be the correct criterion. It also has to be a nice place for most people to shop compared to whatever else is nearby. To avoid being subjective the definition of "a nice place to shop" must allow for different tastes and spending-power. A busy-looking town centre might suggest popularity but is not necessarily indicative of a growth area for investment.
Having decided whether the town itself would be worthwhile investing in, the next decision is to select the trading position in that town. As well as monitoring footfall, (passers-by, where do they come from, where are they going), the question is what influences if any could affect the potential for that trading position. Depending upon the location, influences are numerous, ranging from tourist attractions and public transport facilities to proposed redevelopments. Successful retailers have it within their power to make or break the popularity of a trading position. Unless one is privy to the facts, it is difficult if not impossible to assess whether a particular tenant or other retailers nearby are doing well. A shop that looks busy isn't necessarily a profitable business. The stability of a trading position and its attraction for new tenants will depend upon whether the established tenants are trading profitably as defined by the established retailers' particular requirements. It is possible to buy a service that assesses tenant-covenant, financial standing and so on - in my opinion the sort of information for gauging rental security that is readily available on-line if you know where to look - but rarely will an investor get the sort of information that is vital. It's all very well paying to be told that 'x plc' has for example 300 branches, a turnover of £xM, net profit £yM and net assets of £zM but what's equally if not more important is whether that particular retailer intends to remain in occupation in a particular trading position and for how long. In the absence of procuring confidential commercially-sensitive information, including whether the shop lease is on the market, the experienced-eye becomes the reliant factor.
The best properties rarely come on to the market so generally investors will have to be content with second-best and within their affordable price range. Property dealers trade on opportunity, but private investors like to buy for long term hold, often the life of a mortgage of say 20 years. The prospects for the investment should be assessed by reference to the envisaged period of ownership. Using the 20 years example, how likely is is that the proposition will perform as investment over 20 years? I reckon towns that provide a ready supply of propositions available on the market tend to be unstable and lacking investment prospects. Many properties do the rounds, cropping up for sale over the years, sometimes via the same auctioneers or agencies. At present, I'm advising on a shop property that's been sold in 5 different auctions since 1999, on each occasion at a different price.
The proposition is a particular property so the nature of the property itself is important. Generally, investors prefer to own complete buildings (shop and upper part) rather buy piecemeal (shop only, upper part sold off). For residential investors looking for bargains, there is a lot to be said for a shop and upper part. It may be possible to convert the upper part into one or more flats, and/or to sell any existing flat separately should the opportunity arise. Where the shop premises includes a flat above, all let on a business tenancy, and where the shop tenant is not in occupation of the flat, there is potential within the Landlord & Tenant Act 1954 for opposing renewal of the whole on expiry or denying the shop tenant the right to renew of the flat as well and getting the flat back for a relatively low amount of compensation.
Having selected the property, the next point to consider is the rental value. The benchmark is the open market rent for the premises. The open market rent differs from the closed market. The closed market is where the tenant has negotiating rights and a dispute resolution procedure. The practical distinction is whether the landlord is in control and the tenant’s only choice to take or leave it.
When the shop property is let already, the starting point for comparison with the benchmark is the rent currently payable (the 'passing' rent). When the shop is vacant and to let, the starting point is the estimated rental that would be obtainable on the grant of a new lease. The passing rent is certain. The estimated rental is uncertain.
The first question is whether the passing rent is correct, or too high or too low. To answer, first establish the type of occupancy: is it a tenancy (popularly a lease), a periodic tenancy, a tenancy-at-will, or a bare licence? The passing rent would have been agreed on some basis: the question upon what basis includes what rights, if any, does the tenant have. It is also necessary to read the existing documentation.
The basis for the rent is important. Rent does not exist in isolation: rent is the product of the terms and conditions of the lease upon which the premises are let and would be let. One cannot state categorically “this is the rent for the premises” without also defining the terms and conditions in the lease. That surveyors generally do say 'this is the rent for the premises' includes, by implication, assumptions regarding the terms and conditions of the lease granted or to be granted. Anyone that answers the question 'what is the estimated rent?' for premises that are let already without taking into account the terms and conditions of the lease or the nature of the occupancy that is in force is likely to come up with the wrong answer. For example, if the existing lease contained a restricted user clause then the passing rent might be lower than if there were no restriction. Similarly, if tenant has carried out structural alterations to the property then the effect on rent of those improvements might have been disregarded at the last rent review; the question then is whether and when the rental value of those improvements would revert to the landlord.
(On renewal of an existing tenancy where Landlord and Tenant Act 1954 case-management procedure is underway, a draft lease for the uncontentious terms and conditions will be agreed between the respective parties’ lawyers before the respective parties' expert witness surveyor reports on rental value are prepared and exchanged. To value a rent, the surveyors must have something tangible and agreed in principle to go on. With a brand new letting, it is rare for the draft lease to be submitted before the tenant makes an acceptable offer of rent. Usually, the draft lease is submitted after outline terms and conditions are agreed in principle (heads of terms, subject to contract, etc). Since rent is a product of the terms and conditions of the actual lease, the test of integrity when drafting the lease is whether if there were a rent review on the same day as completion of the lease the rent would then be the same as the initial rent.)
To compare the passing rent with the estimated open market rent, the passing rent is devalued. Depending upon the type and size of the premises, shop rents are normally devalued to the Zone A rate. Zoning is a measuring methodology for comparing shops of different sizes and layouts to arrive at a common denominator. Having calculated the area in terms of Zone A (known as “ITZA”) and deducted values for non-zoned parts of the premises including, for example, any residential accommodation, the net rent for the shop is divided by ITZA and the result is the Zone A rent. You can find out more about zoning here.
To make a comparison with the estimated open market rent, it is necessary to devalue the evidence, preferably of open market lettings but if not available then the next best thing, according to the hierarchy of evidence. Evidence generally is what other landlords and tenants have agreed or had ascertained for similar types of premises. However, evidence is not only of other rents agreed but also the terms and conditions of the leases and other types of occupancy. For that you would need to know precisely or as near as possible exactly what has been agreed by others.
For the do-it-yourself investor/landlord, sourcing comparable evidence is not straightforward. Rents and agreements are confidential to the parties concerned. There is no public register. The nearest to a national resource is to buy copy leases that are registered with the Land Registry. However, having a copy of someone else’s lease isn’t going to get you very far if you don’t have the rental devaluation. Rateable value could be a clue: rating areas on-line are freely accessible but rating areas, as well as being notoriously unreliable (arithmetical inaccuracies, also it depends when the premises were last referenced (measured) for rating), often differ from valuation areas for actual rent so can only provide a rough guide and should not be relied upon. Other quasi-public domain sources include shop agents' websites, auction catalogues, and stock exchange public property company results and announcements. For surveyors, our sources include subscriber-databases (generally a mishmash of agents particulars, auction catalogues, and industry press-releases), information that we obtain direct from landlords, tenants, and other surveyors, our experience from work undertaken and in-hand, and our own record systems. Created in 1975 for my own use, I own possibly one of the largest computerised databases of shop rents; at the touch of a button, I can access information in seconds and whilst I don’t profess to know about everything happening in the places I monitor, it doesn’t take me long to familiarise and gather evidence.
An important point to remember about comparable evidence is that transactions are confidential and the information, often of considerable value, is guarded jealously. The commercial property market thrives on the free circulation of comparable evidence but it’s not ‘free’ in the true sense: it comes with the implied understanding to not misuse it. Arguably, Data Protection Act limitations apply; it is suggested that either or both parties' permission should be obtained before facts are released. In any event, it is not compulsory for either landlord or tenant and/or their respective surveyors to cooperate with requests for evidence. Since shop tenants tend to close ranks over disclosure of rental agreements, unless it suits them to co-operate, it can be difficult if not impossible for a landlord wanting to establish the facts if you don't have the contacts.
The reason surveyors are more likely to be able to procure evidence is that landlords and tenants come and go, whereas surveyors endure, so are likely to come into contact with one another sufficiently regularly to want to reciprocate. The shop property market comprises thousands of different landlords and tenants, (approximately 400,000 trading fascias have been identified) but there are only about 4,000 multiple retailers (including banks) which narrows things down a bit, and since fewer surveyors deal with shop property rents on a regular basis and reliably so, knowing whom to ask comes from experience.
Having devalued the evidence and compared the Zone A level with the passing rent Zone A, any other differences must be considered carefully. Apart from any technical adjustments and allowances, the effective date of the evidence is important. Evidence can be historic and the definition of historic varies. Generally, evidence within the same year or so, unless 2008 when before August that year predated the downturn, is preferred but where there is no recent evidence it becomes a matter of informed opinion which is where surveyors come into their own: informed opinion may also be used as evidence.
Particulars for the sale or auction catalogues of shop investments often mention Zone A rents nearby. Such mentions should be treated with caution. As I’ve said, it’s not just extrapolating the Zone A rent from one transaction and applying it to the shop premises under scrutiny: the terms and conditions of the respective leases are also vital.
After ascertaining the Zone A relationship between the passing rent and open market rent, the next question is how to value the investment. Where the passing and open market Zone A rents are about the same, the question is why or whether the rent should increase at the next opportunity, normally a review or lease expiry/renewal. In my last missive, I've already said that 'upward-only' rent review doesn't mean the rent necessarily has to increase. Why is about the future direction of the market for the premises, also known as supply and demand. A change in ownership of an existing property does not increase the supply so the question is whether there is any demand for the premises. If there’s no likelihood of any increase then the investment is not going to perform, except in the context of the buyer’s subjective reasons for wanting the proposition.
Historically, a rule-of-thumb yield for non-growth propositions was at least 10% but since the early 1970s - when for reasons, if you’re interested, you can read more about here Valuation and Overpaying - the traditional demarcation of the market into non-growth and growth is virtually non-existent. Based upon the cost of borrowing, the same nationwide, yield rather than ‘location, location, location’ has become the determining factor for most buyers.
Assessing risk by reference to yield depends upon the tenant's covenant. National companies, multiple retailers and banks, all considered more secure propositions tend to fetch higher prices than shops let to independent retailers and local shopkeepers. The fact that larger companies can up-sticks or go broke without warning doesn’t seem to have altered a view amongst some investors that a shop let to a multiple retailer is likely to relet to another multiple retailer. That view is based on no evidence whatsoever: one reason many trading positions (including numerous ‘high streets’) are not as primary as they were is that multiple retailers have relocated to better locations.
When the passing Zone A rent exceeds the open market Zone A rent, the question is for how long is the passing rent secure. Assuming the tenant does not go bust in the meantime, the over-renting will expire on renewal of the lease when the market rent will apply.
When the passing Zone A rent is below the open market rent, the investment is reversionary. Reversionary implies growth because the reversionary rent is the rental value of the property if it were let now at the estimated open market rental. Since the estimated rental would not be known for certain, either agreed or ascertained, until sometime in the future, the reversionary value is deferred by the number of years to the reversion. (I've emphasised 'implies' because growth is not certain merely because of differences in the respective Zone A levels. The next rent review date may be years off by which time what is now the latest open market letting could be historic; in the meantime, the market might have changed.)
The starting point for the valuation of a shop investment ought to be the valuation of the property if vacant, but invariably it is not. Vacant possession value could be more than or less than or the same as the investment value, depending upon the location and trading position.
Shop property let already is generally valued subject to the benefit of the existing lease (occupancy) so the two elements get muddled and the proposition (property plus investment) treated as one. Since the tenant's covenant (identity of the tenant) often makes a difference to the value of the investment, it can be difficult to distinguish the separate elements.
The muddling of values (where the shop premises are let already) tends to be linked to sentiment. Generally, sentiment is a better driver of market momentum than technical valuation. Hence, depending upon the degree of sentiment in the market, the same shop property investment could, for example, be valued at anything between about 1% and 15%+ which means that the timing of the purchase becomes critical if you want to avoid overpaying, and the timing of selling if you want to avoid becoming lumbered.
The property industry has debated at length the difference between price, worth and value. In outline, price is what the seller asks and buyer agrees and the amount that the proposition fetches is what the proposition is worth to the actual buyer. In other words, worth is subjective. Value is objective: what the property would fetch generally, regardless of whether anyone would pay more. Anyone who has agreed a price with a buyer only to have the property down-valued by a surveyor for the bank will have their own views, but thinking that value must surely be what the particular buyer pays is wrong because that view makes no allowance for the actual circumstances.
There is a school of thought that will only buy where a profit can be had from the difference between the cost of borrowing and the starting yield from the property. There is nothing wrong with that, provided it is not confused with property investment. The cost of borrowing, interest rates generally, is nothing to do with the value of property, but that doesn’t stop countless investors believing there is. Consequently, prices vary according to prevailing interest rates and market sentiment. Strong demand, combined with easy borrowing, generally results in lower yields.
When price is sentiment-oriented, the technical value can be difficult to gauge. Arguably, the best indication is the forced-sale valuation that banks and lenders require. The challenge of sentiment is that it is subjective to the buyer and geared to market-momentum. It may sound bizarre for a proposition to be priced at 3%, 7%, 10% or whatever depending upon the instability of market momentum, but that's sentiment for you. Sentiment distorts underlying value. When you buy priced on sentiment, you are taking a risk that the market would be at least equally sentimental when you want to sell the investment. One reason guide prices for auction lots often bear no relationship to the result is not a consequence of the auctioneer or seller underpricing, but of underestimating the degree of sentiment. Auction reserves are normally based on technical valuation considerations.
When you buy on valuation, as distinct from sentiment, you are also taking a risk that the valuation is correct. Since valuation is only an opinion, albeit an informed opinion, the question is whether the opinion would prove correct when tested in the market. The beauty of opinion, at least from the surveyor's perspective, is that the valuation is at a certain date. It is not possible to value in advance - that's prediction - so it's anyone guess whether the opinion would stand the test of time. There are valuation criteria that surveyors have to respect, also a duty of care, but a margin for error is permissible. Study case-law on negligence claims and you’ll find they tend to be circumstances-specific.
Capital value is expressed as percentage or years' purchase ('YP'). Whether % or YP, each is another way of saying the same. Yield is the income return on capital and is calculated by multiplying the required return by the passing rent plus the estimated rental value deferred. (Some landlords and surveyors prefer discounted cash flow ('DCF') analysis, which is a method of valuing using the concepts of the time value of money. All future cash flows are estimated and discounted to give their present values —the sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question.)
YP is a similar calculation but instead of percentage yield is expressed as a number of years. For example, a property let at £100,000 a year yielding 10% would be priced at £1M. 10% = 10 YP. (100/10=10). One advantage of thinking years' purchase is not just to have an instant calculation of the number of years to get your money back, as much as to increase awareness of the potential. For example, at present 7% yield sounds better than 1 or 2% interest from cash on deposit but it'll take 14.28 years (ignoring tax, etc) to get your money back by which time anything could happen to the particular property and/or the tenant and/or the location you're buying into.
In conclusion, to appraise a shop investment properly requires a technical approach and a thorough understanding of business tenancy law and and valuation, which is why it's advisable to consult an experienced retail property surveyor. If you don't want to pay for what might be perceived common sense, instead perhaps taking comfort from what others are paying for similar propositions, then at the very least, in my opinion, you really ought, with respect, be giving more credence to whether (1) the town and (2) the trading position will endure, (3) the passing rent would reasonably be expected to increase during the remainder of the term and on renewal, and (4) for how long the tenant's covenant (for which you may be paying a premium) at the property will last. If you skip all that and simply focus on the yield and tenant covenant then more than likely you'll come unstuck.
Shop investments are valued by reference to specifics, rather than generalities: namely, the nature of the particular town and importance of the particular trading position in that town. Towns and cities are ranked in terms of national and regional importance, according to multiple retailer representation and associated criteria, such as customer spending-power. The era of local and catchment population only shopping in the town where they live and/or work is long gone. Nowadays, spending-power, drive-time, parking facilities and the customer experience overall are determining factors. While each town will have its own trading positions, more important for investment potential is the relationship between one particular town and another, together with any wider influences that could affect that importance, such as new developments in the offing.
Towns vary in character, heritage, population (resident and catchment) and other socio-economic demographics. Each town has its own trading positions: in-town, the best position is the prime position, which might include a purpose-built shopping centre or mall at the heart of the town centre; everything else is classified as secondary. Secondary comprises secondary, tertiary, local, and neighbourhood. Out-of-town (including edge-of-town) shopping centres, malls, precincts, outlet centres and supermarkets are in a league of their own and depending upon the overall shopping experience may be the dominant shopping location for the whole town.
Over time, sometimes almost overnight in the case of a new shopping development, in-town trading positions can change. What used to be the prime position may become secondary, and vice versa. The presence of multiple retailers does not itself define a prime position: many multiple retailers prefer secondary positions.
Unlike town centre 'high streets' including secondary positions where the ownership of shop property comprises different landlords and owner-occupiers, purpose-built shopping centres, whether in- or out-of-town, are usually owned by a single landlord able to control tenant-mix. Shopping centre management is directed toward maximising the trading potential for both the centre's owner and the centre's tenants, whereas with fragmented ownerships, different landlords and so on, each individual landlord is likely to have their own investment policy, tenants having to fend for themselves.
Purpose-built shopping centres, being privately-owned, can be managed to a marketing plan, but investing in individual properties in the 'high street' is riskier. In the firing line of day-to-day trading reality, retailers fall into two categories: those that actively support and contribute to community initiatives to generate custom, and those that don't. Those that don't are sometimes criticised by those that do but only because those that do resent the freely cashing-in on community initiatives. It's not that those that don't are anti-social, so much as a difference in approach to attracting custom.
Some retailers are destinations in their own right, others rely far more on passing trade. Ideologically, a town centre might be presented as a community but, in practice, it is not a level playing field: business is not an extension of social services. Ultimately, some retailers are better at attracting profitable trade than others. Generally, the least capable are prone to bleating, the more successful adjust and adapt.
Amongst the factors affecting asset management and investment potential is not just the relationship between each particular building and its trading position, but also the relationship between that trading position and other trading positions in the town and other towns elsewhere. In the absence of a united front involving all interested parties, competing interests between (1) owners and their tenants in single ownership shopping centres and (2) the relatively dysfunctional policies of different landlords and tenants in 'high streets' can result in the 'high street' interests losing out.
Unlike single-ownership shopping centres where rent levels are geared to positioning of the tenant mix, with all leases generally containing more or less the same terms and conditions, other than rent, there is no obligation on a landlord of an individual shop property in 'high street' trading position to want the highest rent and/or to pursue rent review so, for example, rent reviews might remain outstanding. Consequently, rental levels even in the same street do not have to be consistent. Furthermore, since transactions are particular landlord-tenant specific, a tenant is not obliged to agree the lowest rent and many retailers are rumoured to ingratiate themselves with landlords in exchange for preferential treatment elsewhere. Establishing a surveyor-acceptable common denominator for the level of rents is a matter for informed opinion. The adage 'one swallow does not make a summer' is cited whenever a transaction is thought to be out of line.
For decades, it's been said there are too many shops. The polarisation of the retail market over the past twenty years or so suggests there may now be too many towns. To evaluate prospects for a town, thinking that it's nice place to live in may not be the correct criterion. It also has to be a nice place for most people to shop compared to whatever else is nearby. To avoid being subjective the definition of "a nice place to shop" must allow for different tastes and spending-power. A busy-looking town centre might suggest popularity but is not necessarily indicative of a growth area for investment.
Having decided whether the town itself would be worthwhile investing in, the next decision is to select the trading position in that town. As well as monitoring footfall, (passers-by, where do they come from, where are they going), the question is what influences if any could affect the potential for that trading position. Depending upon the location, influences are numerous, ranging from tourist attractions and public transport facilities to proposed redevelopments. Successful retailers have it within their power to make or break the popularity of a trading position. Unless one is privy to the facts, it is difficult if not impossible to assess whether a particular tenant or other retailers nearby are doing well. A shop that looks busy isn't necessarily a profitable business. The stability of a trading position and its attraction for new tenants will depend upon whether the established tenants are trading profitably as defined by the established retailers' particular requirements. It is possible to buy a service that assesses tenant-covenant, financial standing and so on - in my opinion the sort of information for gauging rental security that is readily available on-line if you know where to look - but rarely will an investor get the sort of information that is vital. It's all very well paying to be told that 'x plc' has for example 300 branches, a turnover of £xM, net profit £yM and net assets of £zM but what's equally if not more important is whether that particular retailer intends to remain in occupation in a particular trading position and for how long. In the absence of procuring confidential commercially-sensitive information, including whether the shop lease is on the market, the experienced-eye becomes the reliant factor.
The best properties rarely come on to the market so generally investors will have to be content with second-best and within their affordable price range. Property dealers trade on opportunity, but private investors like to buy for long term hold, often the life of a mortgage of say 20 years. The prospects for the investment should be assessed by reference to the envisaged period of ownership. Using the 20 years example, how likely is is that the proposition will perform as investment over 20 years? I reckon towns that provide a ready supply of propositions available on the market tend to be unstable and lacking investment prospects. Many properties do the rounds, cropping up for sale over the years, sometimes via the same auctioneers or agencies. At present, I'm advising on a shop property that's been sold in 5 different auctions since 1999, on each occasion at a different price.
The proposition is a particular property so the nature of the property itself is important. Generally, investors prefer to own complete buildings (shop and upper part) rather buy piecemeal (shop only, upper part sold off). For residential investors looking for bargains, there is a lot to be said for a shop and upper part. It may be possible to convert the upper part into one or more flats, and/or to sell any existing flat separately should the opportunity arise. Where the shop premises includes a flat above, all let on a business tenancy, and where the shop tenant is not in occupation of the flat, there is potential within the Landlord & Tenant Act 1954 for opposing renewal of the whole on expiry or denying the shop tenant the right to renew of the flat as well and getting the flat back for a relatively low amount of compensation.
Having selected the property, the next point to consider is the rental value. The benchmark is the open market rent for the premises. The open market rent differs from the closed market. The closed market is where the tenant has negotiating rights and a dispute resolution procedure. The practical distinction is whether the landlord is in control and the tenant’s only choice to take or leave it.
When the shop property is let already, the starting point for comparison with the benchmark is the rent currently payable (the 'passing' rent). When the shop is vacant and to let, the starting point is the estimated rental that would be obtainable on the grant of a new lease. The passing rent is certain. The estimated rental is uncertain.
The first question is whether the passing rent is correct, or too high or too low. To answer, first establish the type of occupancy: is it a tenancy (popularly a lease), a periodic tenancy, a tenancy-at-will, or a bare licence? The passing rent would have been agreed on some basis: the question upon what basis includes what rights, if any, does the tenant have. It is also necessary to read the existing documentation.
The basis for the rent is important. Rent does not exist in isolation: rent is the product of the terms and conditions of the lease upon which the premises are let and would be let. One cannot state categorically “this is the rent for the premises” without also defining the terms and conditions in the lease. That surveyors generally do say 'this is the rent for the premises' includes, by implication, assumptions regarding the terms and conditions of the lease granted or to be granted. Anyone that answers the question 'what is the estimated rent?' for premises that are let already without taking into account the terms and conditions of the lease or the nature of the occupancy that is in force is likely to come up with the wrong answer. For example, if the existing lease contained a restricted user clause then the passing rent might be lower than if there were no restriction. Similarly, if tenant has carried out structural alterations to the property then the effect on rent of those improvements might have been disregarded at the last rent review; the question then is whether and when the rental value of those improvements would revert to the landlord.
(On renewal of an existing tenancy where Landlord and Tenant Act 1954 case-management procedure is underway, a draft lease for the uncontentious terms and conditions will be agreed between the respective parties’ lawyers before the respective parties' expert witness surveyor reports on rental value are prepared and exchanged. To value a rent, the surveyors must have something tangible and agreed in principle to go on. With a brand new letting, it is rare for the draft lease to be submitted before the tenant makes an acceptable offer of rent. Usually, the draft lease is submitted after outline terms and conditions are agreed in principle (heads of terms, subject to contract, etc). Since rent is a product of the terms and conditions of the actual lease, the test of integrity when drafting the lease is whether if there were a rent review on the same day as completion of the lease the rent would then be the same as the initial rent.)
To compare the passing rent with the estimated open market rent, the passing rent is devalued. Depending upon the type and size of the premises, shop rents are normally devalued to the Zone A rate. Zoning is a measuring methodology for comparing shops of different sizes and layouts to arrive at a common denominator. Having calculated the area in terms of Zone A (known as “ITZA”) and deducted values for non-zoned parts of the premises including, for example, any residential accommodation, the net rent for the shop is divided by ITZA and the result is the Zone A rent. You can find out more about zoning here.
To make a comparison with the estimated open market rent, it is necessary to devalue the evidence, preferably of open market lettings but if not available then the next best thing, according to the hierarchy of evidence. Evidence generally is what other landlords and tenants have agreed or had ascertained for similar types of premises. However, evidence is not only of other rents agreed but also the terms and conditions of the leases and other types of occupancy. For that you would need to know precisely or as near as possible exactly what has been agreed by others.
For the do-it-yourself investor/landlord, sourcing comparable evidence is not straightforward. Rents and agreements are confidential to the parties concerned. There is no public register. The nearest to a national resource is to buy copy leases that are registered with the Land Registry. However, having a copy of someone else’s lease isn’t going to get you very far if you don’t have the rental devaluation. Rateable value could be a clue: rating areas on-line are freely accessible but rating areas, as well as being notoriously unreliable (arithmetical inaccuracies, also it depends when the premises were last referenced (measured) for rating), often differ from valuation areas for actual rent so can only provide a rough guide and should not be relied upon. Other quasi-public domain sources include shop agents' websites, auction catalogues, and stock exchange public property company results and announcements. For surveyors, our sources include subscriber-databases (generally a mishmash of agents particulars, auction catalogues, and industry press-releases), information that we obtain direct from landlords, tenants, and other surveyors, our experience from work undertaken and in-hand, and our own record systems. Created in 1975 for my own use, I own possibly one of the largest computerised databases of shop rents; at the touch of a button, I can access information in seconds and whilst I don’t profess to know about everything happening in the places I monitor, it doesn’t take me long to familiarise and gather evidence.
An important point to remember about comparable evidence is that transactions are confidential and the information, often of considerable value, is guarded jealously. The commercial property market thrives on the free circulation of comparable evidence but it’s not ‘free’ in the true sense: it comes with the implied understanding to not misuse it. Arguably, Data Protection Act limitations apply; it is suggested that either or both parties' permission should be obtained before facts are released. In any event, it is not compulsory for either landlord or tenant and/or their respective surveyors to cooperate with requests for evidence. Since shop tenants tend to close ranks over disclosure of rental agreements, unless it suits them to co-operate, it can be difficult if not impossible for a landlord wanting to establish the facts if you don't have the contacts.
The reason surveyors are more likely to be able to procure evidence is that landlords and tenants come and go, whereas surveyors endure, so are likely to come into contact with one another sufficiently regularly to want to reciprocate. The shop property market comprises thousands of different landlords and tenants, (approximately 400,000 trading fascias have been identified) but there are only about 4,000 multiple retailers (including banks) which narrows things down a bit, and since fewer surveyors deal with shop property rents on a regular basis and reliably so, knowing whom to ask comes from experience.
Having devalued the evidence and compared the Zone A level with the passing rent Zone A, any other differences must be considered carefully. Apart from any technical adjustments and allowances, the effective date of the evidence is important. Evidence can be historic and the definition of historic varies. Generally, evidence within the same year or so, unless 2008 when before August that year predated the downturn, is preferred but where there is no recent evidence it becomes a matter of informed opinion which is where surveyors come into their own: informed opinion may also be used as evidence.
Particulars for the sale or auction catalogues of shop investments often mention Zone A rents nearby. Such mentions should be treated with caution. As I’ve said, it’s not just extrapolating the Zone A rent from one transaction and applying it to the shop premises under scrutiny: the terms and conditions of the respective leases are also vital.
After ascertaining the Zone A relationship between the passing rent and open market rent, the next question is how to value the investment. Where the passing and open market Zone A rents are about the same, the question is why or whether the rent should increase at the next opportunity, normally a review or lease expiry/renewal. In my last missive, I've already said that 'upward-only' rent review doesn't mean the rent necessarily has to increase. Why is about the future direction of the market for the premises, also known as supply and demand. A change in ownership of an existing property does not increase the supply so the question is whether there is any demand for the premises. If there’s no likelihood of any increase then the investment is not going to perform, except in the context of the buyer’s subjective reasons for wanting the proposition.
Historically, a rule-of-thumb yield for non-growth propositions was at least 10% but since the early 1970s - when for reasons, if you’re interested, you can read more about here Valuation and Overpaying - the traditional demarcation of the market into non-growth and growth is virtually non-existent. Based upon the cost of borrowing, the same nationwide, yield rather than ‘location, location, location’ has become the determining factor for most buyers.
Assessing risk by reference to yield depends upon the tenant's covenant. National companies, multiple retailers and banks, all considered more secure propositions tend to fetch higher prices than shops let to independent retailers and local shopkeepers. The fact that larger companies can up-sticks or go broke without warning doesn’t seem to have altered a view amongst some investors that a shop let to a multiple retailer is likely to relet to another multiple retailer. That view is based on no evidence whatsoever: one reason many trading positions (including numerous ‘high streets’) are not as primary as they were is that multiple retailers have relocated to better locations.
When the passing Zone A rent exceeds the open market Zone A rent, the question is for how long is the passing rent secure. Assuming the tenant does not go bust in the meantime, the over-renting will expire on renewal of the lease when the market rent will apply.
When the passing Zone A rent is below the open market rent, the investment is reversionary. Reversionary implies growth because the reversionary rent is the rental value of the property if it were let now at the estimated open market rental. Since the estimated rental would not be known for certain, either agreed or ascertained, until sometime in the future, the reversionary value is deferred by the number of years to the reversion. (I've emphasised 'implies' because growth is not certain merely because of differences in the respective Zone A levels. The next rent review date may be years off by which time what is now the latest open market letting could be historic; in the meantime, the market might have changed.)
The starting point for the valuation of a shop investment ought to be the valuation of the property if vacant, but invariably it is not. Vacant possession value could be more than or less than or the same as the investment value, depending upon the location and trading position.
Shop property let already is generally valued subject to the benefit of the existing lease (occupancy) so the two elements get muddled and the proposition (property plus investment) treated as one. Since the tenant's covenant (identity of the tenant) often makes a difference to the value of the investment, it can be difficult to distinguish the separate elements.
The muddling of values (where the shop premises are let already) tends to be linked to sentiment. Generally, sentiment is a better driver of market momentum than technical valuation. Hence, depending upon the degree of sentiment in the market, the same shop property investment could, for example, be valued at anything between about 1% and 15%+ which means that the timing of the purchase becomes critical if you want to avoid overpaying, and the timing of selling if you want to avoid becoming lumbered.
The property industry has debated at length the difference between price, worth and value. In outline, price is what the seller asks and buyer agrees and the amount that the proposition fetches is what the proposition is worth to the actual buyer. In other words, worth is subjective. Value is objective: what the property would fetch generally, regardless of whether anyone would pay more. Anyone who has agreed a price with a buyer only to have the property down-valued by a surveyor for the bank will have their own views, but thinking that value must surely be what the particular buyer pays is wrong because that view makes no allowance for the actual circumstances.
There is a school of thought that will only buy where a profit can be had from the difference between the cost of borrowing and the starting yield from the property. There is nothing wrong with that, provided it is not confused with property investment. The cost of borrowing, interest rates generally, is nothing to do with the value of property, but that doesn’t stop countless investors believing there is. Consequently, prices vary according to prevailing interest rates and market sentiment. Strong demand, combined with easy borrowing, generally results in lower yields.
When price is sentiment-oriented, the technical value can be difficult to gauge. Arguably, the best indication is the forced-sale valuation that banks and lenders require. The challenge of sentiment is that it is subjective to the buyer and geared to market-momentum. It may sound bizarre for a proposition to be priced at 3%, 7%, 10% or whatever depending upon the instability of market momentum, but that's sentiment for you. Sentiment distorts underlying value. When you buy priced on sentiment, you are taking a risk that the market would be at least equally sentimental when you want to sell the investment. One reason guide prices for auction lots often bear no relationship to the result is not a consequence of the auctioneer or seller underpricing, but of underestimating the degree of sentiment. Auction reserves are normally based on technical valuation considerations.
When you buy on valuation, as distinct from sentiment, you are also taking a risk that the valuation is correct. Since valuation is only an opinion, albeit an informed opinion, the question is whether the opinion would prove correct when tested in the market. The beauty of opinion, at least from the surveyor's perspective, is that the valuation is at a certain date. It is not possible to value in advance - that's prediction - so it's anyone guess whether the opinion would stand the test of time. There are valuation criteria that surveyors have to respect, also a duty of care, but a margin for error is permissible. Study case-law on negligence claims and you’ll find they tend to be circumstances-specific.
Capital value is expressed as percentage or years' purchase ('YP'). Whether % or YP, each is another way of saying the same. Yield is the income return on capital and is calculated by multiplying the required return by the passing rent plus the estimated rental value deferred. (Some landlords and surveyors prefer discounted cash flow ('DCF') analysis, which is a method of valuing using the concepts of the time value of money. All future cash flows are estimated and discounted to give their present values —the sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question.)
YP is a similar calculation but instead of percentage yield is expressed as a number of years. For example, a property let at £100,000 a year yielding 10% would be priced at £1M. 10% = 10 YP. (100/10=10). One advantage of thinking years' purchase is not just to have an instant calculation of the number of years to get your money back, as much as to increase awareness of the potential. For example, at present 7% yield sounds better than 1 or 2% interest from cash on deposit but it'll take 14.28 years (ignoring tax, etc) to get your money back by which time anything could happen to the particular property and/or the tenant and/or the location you're buying into.
In conclusion, to appraise a shop investment properly requires a technical approach and a thorough understanding of business tenancy law and and valuation, which is why it's advisable to consult an experienced retail property surveyor. If you don't want to pay for what might be perceived common sense, instead perhaps taking comfort from what others are paying for similar propositions, then at the very least, in my opinion, you really ought, with respect, be giving more credence to whether (1) the town and (2) the trading position will endure, (3) the passing rent would reasonably be expected to increase during the remainder of the term and on renewal, and (4) for how long the tenant's covenant (for which you may be paying a premium) at the property will last. If you skip all that and simply focus on the yield and tenant covenant then more than likely you'll come unstuck.
Business Tenancy Law
A business tenancy is a commercial contract, which means the parties are deemed to know what they are doing. The terms and conditions that the parties agree before the lease is signed and completed are subject to a combination of legislation which may or may not be overriding, and the body of case law for the interpretation of actual wording and phrasing.
Business tenancy law comprises legislation (Acts of Parliament, including Orders and Regulations) and case law derived from court rulings on particular issues which in many instances set a precedent and constitute evidence in support of an opinion.
Case law is the set of existing rulings that have made new interpretations of law and can be cited as precedent. Legal principles are often enunciated and embodied in judicial decisions.
For the most part, the interpretation of the construction of the wording and phrasing in leases, including lease analysis, is based upon an understanding and appreciation of case law. In my computerised law library, I have details of thousands of cases, with information and articles from reputable sources. I also subscribe to leading on-line law resources.
Whether case-law is reported or unreported, it could be binding.
To quote Lord Denning, writing in the foreword to the microfiche edition of The Court of Appeal Transcripts 1951-1980:
… every decision of the Court of Appeal on a point of law is binding on all courts of first instance and on the Court of Appeal itself. No matter whether the decision is reported in the regular series of Law Reports, or is unreported, it is binding. Once you have the transcript of an unreported decision, you can cite it as of equal authority to a reported decision, so it behoves every counsel or solicitor to find, if he can, a case – reported or unreported – which will help him advise or win his case.
Generally, I find Clients are not that interested in the details of a particular case (unless, of course, it's a matter they themselves took to court). Of greater interest and much more importance is how a particular case could and might affect their own situation. With business tenancies, use of and reliable on precedent is not necessarily sacrosanct, because much may depend upon the particular circumstances or facts surrounding the case, and often each new situation has to be assessed on its merits. The interpretation of the construction of leases is fashionable. Literal interpretation may have given way to a presumption in favour of reality, but not necessarily in all instances.
Typical matters where I am consulted on the legal aspects include whether time is of the essence for a rent review, the validity of notices, the wording of Calderbank offers, how best to defeat landlord opposition to renewal of a tenancy, whether better to take a long term lease with a break clause or a short lease with an option to renew, how to obtain more than the statutory compensation on non-renewal, reducing service charges, the effect of the Competition Act on the permitted user clause. Negotiation for rent review, include dispute resolution procedure and lease renewal including expert witness reports is also heavily dependent upon case law.
Business tenancy law comprises legislation (Acts of Parliament, including Orders and Regulations) and case law derived from court rulings on particular issues which in many instances set a precedent and constitute evidence in support of an opinion.
Case law is the set of existing rulings that have made new interpretations of law and can be cited as precedent. Legal principles are often enunciated and embodied in judicial decisions.
For the most part, the interpretation of the construction of the wording and phrasing in leases, including lease analysis, is based upon an understanding and appreciation of case law. In my computerised law library, I have details of thousands of cases, with information and articles from reputable sources. I also subscribe to leading on-line law resources.
Whether case-law is reported or unreported, it could be binding.
To quote Lord Denning, writing in the foreword to the microfiche edition of The Court of Appeal Transcripts 1951-1980:
… every decision of the Court of Appeal on a point of law is binding on all courts of first instance and on the Court of Appeal itself. No matter whether the decision is reported in the regular series of Law Reports, or is unreported, it is binding. Once you have the transcript of an unreported decision, you can cite it as of equal authority to a reported decision, so it behoves every counsel or solicitor to find, if he can, a case – reported or unreported – which will help him advise or win his case.
Generally, I find Clients are not that interested in the details of a particular case (unless, of course, it's a matter they themselves took to court). Of greater interest and much more importance is how a particular case could and might affect their own situation. With business tenancies, use of and reliable on precedent is not necessarily sacrosanct, because much may depend upon the particular circumstances or facts surrounding the case, and often each new situation has to be assessed on its merits. The interpretation of the construction of leases is fashionable. Literal interpretation may have given way to a presumption in favour of reality, but not necessarily in all instances.
Typical matters where I am consulted on the legal aspects include whether time is of the essence for a rent review, the validity of notices, the wording of Calderbank offers, how best to defeat landlord opposition to renewal of a tenancy, whether better to take a long term lease with a break clause or a short lease with an option to renew, how to obtain more than the statutory compensation on non-renewal, reducing service charges, the effect of the Competition Act on the permitted user clause. Negotiation for rent review, include dispute resolution procedure and lease renewal including expert witness reports is also heavily dependent upon case law.
A Refreshing Change
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 enlightening. A business plan is rarely straightforward; at a higher more focussed level of understanding, your way forward will be clearer. What next to do for the best is less likely to be an issue.
The taking of advice and help is still necessary, but not from anyone. What’s needed is advice and practical help from people who really do know what they are doing, what is happening at a deep level of understanding. New ways of thinking are emerging, advancement in technology sees to that, but the fundamental principles are unchanged. Professional advisers have a dual-role: to act for you and guide you through the complexity of the property system, the law and valuation and to extricate you from your mistakes. Good advice will point out the pitfalls and prevent falling into them; wise advice will help prevent making mistakes in the first place.
With commercial property, mistakes are readily available. They serve as a reminder a landlord is not infallible. Anyone can buy what they fancy, but beauty is not necessarily packaged to appear obvious. There may be hidden qualities in the discarded and neglected – as anyone that paid next-to-nothing for commercial property in run-down parts of East and North London can testify now that prices have shot through the roof. Anyone can read a lease but literally is not necessarily the correct conclusion. Legislation can override, so too can case-law.
Investment may be a passive, you can buy to hold, come what may, but what to buy is a challenge. All property is owned by someone somewhere but it doesn’t have to be you. Statistics are averages. For the long term, you have to get your choice of a particular property right from the start or over time you could find yourself out of pocket.
For successful investment it pays to be pro-active. With business tenancy asset management, problems can crop up all the time, often when least expected, frequently when least convenient. A difference between a passive and pro-active investor is the ability to transform problems into opportunities.
Tenants may be corporate entities but are run by people; and people have feelings. If already in your nature then it may not hurt to be accommodating of tenant requests, but nevertheless it will pain if your approach does not lead to you becoming better off. Business tenants are very good at getting what they want at the expense of the landlord. You will have to be firm in your dealings with them, possibly tougher than you normally are with others. To call a bluff, you may have to be willing to let go of the existing tenant, no matter how tempting to hang on. You may have to leap into the unknown and risk a void to improve your prospects. Wise advice from a professional sounding-board will prove a good investment.
Property does not perform, people do. Performance is a measure of achievement. “Wealth is the product of man’s capacity to think”. How wealthy you become depends upon thinking like a wealthy person. Property is not simply a commodity, land and buildings for occupation, it can also double as a store of money. Play the property game well and substantial amounts of money can come your way. You can jump on the bandwagon whenever excitement is in the air, but the big money comes from listening. Listening to wise advisers, listening to what you don’t want to hear, listening to yourself.
When you listen, you hear timing. Successful investment and all that entails is about the art of timing. When to say yes, when to say no. Indecision and choice become things of the past. The more adept, the more you trust your intuition at all times, not just in emergencies and in crisis as do most people. Most people lurch, thinking problems are normal. Essentially, a problem is about direction, a helpful signal in a tangible form. Letting go of wanting to be like other people will result in being yourself. Being yourself is the first step in knowing what to do, to whom to turn for help and guidance.
Anyone can become a property investor by putting their money and mind to it, but there’s a cut-off point, a limit after which things start to go downhill. The point of no return is to warn you. To change your approach to investment. When something comes naturally, you are made for each other, well-suited. All property belongs to someone somewhere but not all property comes onto the market. At any time, the selection of property for sale may not be the property for you. You may have to bide your time, to be patient, perhaps extremely, until the right moment arrives for you to strike while the iron is hot.
People generally are impatient. Most people are scared of going it alone because they are inhibited by a desire to be popular. Lacking emotional self-confidence, they follow the crowd. As Warren Buffett said of equities, “you pay a very high price in the stock market for a cheery consensus.”
To swim against the current of common opinion is contrarian, but to succeed in commercial property investment requires a different mindset. Serious research and a thorough understanding of the principles and forces at work to ensure the crowd is wrong or else the signs can be misinterpreted. The market is so distorted by sentiment and eagerness that long-gone are the days when low yield could be interpreted as certain growth or high yield meaning trouble ahead. Impatience will cause you to become involved regardless. Impatience is an addiction, it takes hold of you and habitually destroys your capacity to think.
Be yourself and you will have one strategy in common with successful investors – let the market bring the deals to you, rather than you chasing after them.
The taking of advice and help is still necessary, but not from anyone. What’s needed is advice and practical help from people who really do know what they are doing, what is happening at a deep level of understanding. New ways of thinking are emerging, advancement in technology sees to that, but the fundamental principles are unchanged. Professional advisers have a dual-role: to act for you and guide you through the complexity of the property system, the law and valuation and to extricate you from your mistakes. Good advice will point out the pitfalls and prevent falling into them; wise advice will help prevent making mistakes in the first place.
With commercial property, mistakes are readily available. They serve as a reminder a landlord is not infallible. Anyone can buy what they fancy, but beauty is not necessarily packaged to appear obvious. There may be hidden qualities in the discarded and neglected – as anyone that paid next-to-nothing for commercial property in run-down parts of East and North London can testify now that prices have shot through the roof. Anyone can read a lease but literally is not necessarily the correct conclusion. Legislation can override, so too can case-law.
Investment may be a passive, you can buy to hold, come what may, but what to buy is a challenge. All property is owned by someone somewhere but it doesn’t have to be you. Statistics are averages. For the long term, you have to get your choice of a particular property right from the start or over time you could find yourself out of pocket.
For successful investment it pays to be pro-active. With business tenancy asset management, problems can crop up all the time, often when least expected, frequently when least convenient. A difference between a passive and pro-active investor is the ability to transform problems into opportunities.
Tenants may be corporate entities but are run by people; and people have feelings. If already in your nature then it may not hurt to be accommodating of tenant requests, but nevertheless it will pain if your approach does not lead to you becoming better off. Business tenants are very good at getting what they want at the expense of the landlord. You will have to be firm in your dealings with them, possibly tougher than you normally are with others. To call a bluff, you may have to be willing to let go of the existing tenant, no matter how tempting to hang on. You may have to leap into the unknown and risk a void to improve your prospects. Wise advice from a professional sounding-board will prove a good investment.
Property does not perform, people do. Performance is a measure of achievement. “Wealth is the product of man’s capacity to think”. How wealthy you become depends upon thinking like a wealthy person. Property is not simply a commodity, land and buildings for occupation, it can also double as a store of money. Play the property game well and substantial amounts of money can come your way. You can jump on the bandwagon whenever excitement is in the air, but the big money comes from listening. Listening to wise advisers, listening to what you don’t want to hear, listening to yourself.
When you listen, you hear timing. Successful investment and all that entails is about the art of timing. When to say yes, when to say no. Indecision and choice become things of the past. The more adept, the more you trust your intuition at all times, not just in emergencies and in crisis as do most people. Most people lurch, thinking problems are normal. Essentially, a problem is about direction, a helpful signal in a tangible form. Letting go of wanting to be like other people will result in being yourself. Being yourself is the first step in knowing what to do, to whom to turn for help and guidance.
Anyone can become a property investor by putting their money and mind to it, but there’s a cut-off point, a limit after which things start to go downhill. The point of no return is to warn you. To change your approach to investment. When something comes naturally, you are made for each other, well-suited. All property belongs to someone somewhere but not all property comes onto the market. At any time, the selection of property for sale may not be the property for you. You may have to bide your time, to be patient, perhaps extremely, until the right moment arrives for you to strike while the iron is hot.
People generally are impatient. Most people are scared of going it alone because they are inhibited by a desire to be popular. Lacking emotional self-confidence, they follow the crowd. As Warren Buffett said of equities, “you pay a very high price in the stock market for a cheery consensus.”
To swim against the current of common opinion is contrarian, but to succeed in commercial property investment requires a different mindset. Serious research and a thorough understanding of the principles and forces at work to ensure the crowd is wrong or else the signs can be misinterpreted. The market is so distorted by sentiment and eagerness that long-gone are the days when low yield could be interpreted as certain growth or high yield meaning trouble ahead. Impatience will cause you to become involved regardless. Impatience is an addiction, it takes hold of you and habitually destroys your capacity to think.
Be yourself and you will have one strategy in common with successful investors – let the market bring the deals to you, rather than you chasing after them.
"Upward only" rent review
12/May/2014 - LandlordZONE - Rent Review - Market Rent - Negotiation - Index-linked - Open Market Rent
Contrary to popular belief, ‘upward-only’ rent review does not mean the rent must increase.
An ‘upward-only’ review means that the rent payable after the review to open market rental is agreed or ascertained would not be less than the rent payable before the rent review, even if the open market rent were lower.
I think the reason for the misunderstanding stems from not appreciating the difference between rent review and rent payable.
Where the review is to open market rent, as distinct from some formulaic change, such as inflation index-linked or percentage uplift, the rent will be the open market rental at the valuation date. The valuation date is normally the same as the review date unless otherwise stated in the lease.
The rent payable is the amount payable after the review is agreed or ascertained. Therefore, depending upon the market rent at the valuation date, it is possible for that rent to either be less or the same or more than the rent payable before the review.
When the market rent is lower than the rent previously payable, an “upward-only” review could in some circumstances still result in the rent payable after the review is agreed or ascertained being less than rent payable before that review. For example, if at the previous review in say 2009 it was agreed that the increased rent then would be phased over the ensuing period of 5 years, such as £25,000 pa for the first two years, rising to £26,000 at the third year, rising to £30,000 pa at the fourth and fifth years, the average rent over five years is £27,200 per annum. The passing rent immediately before the 2014 review would be £30,000 per annum, but whether the rent payable after the 2014 review is agreed or ascertained would be defined as £30,000 or £27,200 pa would depend upon what was agreed by the parties when the 2009 review was documented.
Rent review dates are normally at pre-set intervals calculated from and including the commencement of the contractual term. The dates do not have to be at logical intervals: it all depends upon what was agreed by the parties when the lease was granted or subsequently varied. Also, the term commencement doesn’t have to be the same date of the lease: the date of lease is simply the date of the document.
It is irrelevant the rent will be fixed for several years, the duration of the revised rent is built into the rent review system, with adjustments or allowances for variations from the norm, the norm itself depends upon the evidence.
Depending upon the state of the market at each review/valuation date, the timing of each subsequent review might coincide with upturns or downturns in the market and/or a different interpretation of the valuation guidelines in the lease; in the event of downturns or static periods resulting in nil increase. Hence, when the review is during a downturn or static period, the rent agreed or ascertained at an earlier review could be greater than the market rent at each subsequent review, with the result that the premises could become overrented. Also, particularly with sale-and-leasebacks and lease restructuring, the initial rent on grant of lease might have been set above the level of market rent at that time, the tenant’s intention that the rent should not increase throughout the term. In fact, in many locations, no evidential justification for any increase at all in rent throughout the term is precisely the fate that befalls many an inexperienced investor. (A lack of evidence may not mean nil increase; there are other ways of procuring an increase, including having a thorough grasp of the finer points of rental valuation and lease analysis.)
It might be thought that over-renting, as a result of an upturn in the market at some stage followed by a downturn, or a deliberate ploy only creates problems for tenants that cannot afford continuing to pay more or want to assign or sub-let, but it can also affect the capital value of the landlord’s investment because the excess rent would only endure for the remainder of the term and during any holding-over period, if any (before statutory procedures are underway). On reversion (expiry of the lease), and assuming the tenant wants to renew, and assuming the Landlord and Tenant 1954 procedures are observed, the rent at the commencement of the renewal term will be the market rent regardless of any previous ‘upward-only’ cushion. Therefore, if the rent payable before expiry of the lease were greater than the market rent on expiry, that lower market rent would be the initial rent on renewal.
It is not just over-renting as a result of higher rent at an earlier rent review date that can lead to a lower rent on expiry/renewal of the lease. Where the rent review basis in the expired lease is index-linked or a percentage uplift, the initial rent on renewal, assuming Landlord and Tenant Act 1954 principles, will be the market rent, regardless. Since index-linked rent review and minimum uplifts can result in the rent payable becoming higher than the market rent, the landlord would be worse off on renewal of the lease and depending on the market rent at the start of the renewal might not recover for years. For example, assuming the initial rent was £50,000 per annum, for a term of 20 years and at each 5-yearly review the rent increased by 5% then after three reviews the rent payable would be £57,881.25. On expiry, the lease is renewed for another 20 years but even though the same percentage arrangement might continue as the basis for reviews in the renewal lease, the initial rent at start of the renewal lease would be the market rent which might be lower, say £45,000 per annum; if so then at the third review of the renewal term the rent would be £52,093.13 per annum.
Erroneously thinking that ‘upward-only’ rent review is a panacea for successful investment is something that commonly befalls inexperienced landlords and can play havoc with expectations.
Generally, minimum percentage uplifts and index-linked reviews are artificial devices ostensibly to enable the tenant to budget for future increases, but primarily designed to trick inexperienced investors into paying more for the investment proposition than the property would otherwise fetch if the rent review(s) were to open market only. Consequently, investments whose rent reviews are index-linked or fixed percentage increase make sense for easy management and rental income cash-flow but don’t be fooled into thinking they are also blue-chip for growth and investment performance. At rent review, the likelihood of encountering tenant resolute resistance to any increase over and above the contractual obligation is almost guaranteed.
An ‘upward-only’ review means that the rent payable after the review to open market rental is agreed or ascertained would not be less than the rent payable before the rent review, even if the open market rent were lower.
I think the reason for the misunderstanding stems from not appreciating the difference between rent review and rent payable.
Where the review is to open market rent, as distinct from some formulaic change, such as inflation index-linked or percentage uplift, the rent will be the open market rental at the valuation date. The valuation date is normally the same as the review date unless otherwise stated in the lease.
The rent payable is the amount payable after the review is agreed or ascertained. Therefore, depending upon the market rent at the valuation date, it is possible for that rent to either be less or the same or more than the rent payable before the review.
When the market rent is lower than the rent previously payable, an “upward-only” review could in some circumstances still result in the rent payable after the review is agreed or ascertained being less than rent payable before that review. For example, if at the previous review in say 2009 it was agreed that the increased rent then would be phased over the ensuing period of 5 years, such as £25,000 pa for the first two years, rising to £26,000 at the third year, rising to £30,000 pa at the fourth and fifth years, the average rent over five years is £27,200 per annum. The passing rent immediately before the 2014 review would be £30,000 per annum, but whether the rent payable after the 2014 review is agreed or ascertained would be defined as £30,000 or £27,200 pa would depend upon what was agreed by the parties when the 2009 review was documented.
Rent review dates are normally at pre-set intervals calculated from and including the commencement of the contractual term. The dates do not have to be at logical intervals: it all depends upon what was agreed by the parties when the lease was granted or subsequently varied. Also, the term commencement doesn’t have to be the same date of the lease: the date of lease is simply the date of the document.
It is irrelevant the rent will be fixed for several years, the duration of the revised rent is built into the rent review system, with adjustments or allowances for variations from the norm, the norm itself depends upon the evidence.
Depending upon the state of the market at each review/valuation date, the timing of each subsequent review might coincide with upturns or downturns in the market and/or a different interpretation of the valuation guidelines in the lease; in the event of downturns or static periods resulting in nil increase. Hence, when the review is during a downturn or static period, the rent agreed or ascertained at an earlier review could be greater than the market rent at each subsequent review, with the result that the premises could become overrented. Also, particularly with sale-and-leasebacks and lease restructuring, the initial rent on grant of lease might have been set above the level of market rent at that time, the tenant’s intention that the rent should not increase throughout the term. In fact, in many locations, no evidential justification for any increase at all in rent throughout the term is precisely the fate that befalls many an inexperienced investor. (A lack of evidence may not mean nil increase; there are other ways of procuring an increase, including having a thorough grasp of the finer points of rental valuation and lease analysis.)
It might be thought that over-renting, as a result of an upturn in the market at some stage followed by a downturn, or a deliberate ploy only creates problems for tenants that cannot afford continuing to pay more or want to assign or sub-let, but it can also affect the capital value of the landlord’s investment because the excess rent would only endure for the remainder of the term and during any holding-over period, if any (before statutory procedures are underway). On reversion (expiry of the lease), and assuming the tenant wants to renew, and assuming the Landlord and Tenant 1954 procedures are observed, the rent at the commencement of the renewal term will be the market rent regardless of any previous ‘upward-only’ cushion. Therefore, if the rent payable before expiry of the lease were greater than the market rent on expiry, that lower market rent would be the initial rent on renewal.
It is not just over-renting as a result of higher rent at an earlier rent review date that can lead to a lower rent on expiry/renewal of the lease. Where the rent review basis in the expired lease is index-linked or a percentage uplift, the initial rent on renewal, assuming Landlord and Tenant Act 1954 principles, will be the market rent, regardless. Since index-linked rent review and minimum uplifts can result in the rent payable becoming higher than the market rent, the landlord would be worse off on renewal of the lease and depending on the market rent at the start of the renewal might not recover for years. For example, assuming the initial rent was £50,000 per annum, for a term of 20 years and at each 5-yearly review the rent increased by 5% then after three reviews the rent payable would be £57,881.25. On expiry, the lease is renewed for another 20 years but even though the same percentage arrangement might continue as the basis for reviews in the renewal lease, the initial rent at start of the renewal lease would be the market rent which might be lower, say £45,000 per annum; if so then at the third review of the renewal term the rent would be £52,093.13 per annum.
Erroneously thinking that ‘upward-only’ rent review is a panacea for successful investment is something that commonly befalls inexperienced landlords and can play havoc with expectations.
Generally, minimum percentage uplifts and index-linked reviews are artificial devices ostensibly to enable the tenant to budget for future increases, but primarily designed to trick inexperienced investors into paying more for the investment proposition than the property would otherwise fetch if the rent review(s) were to open market only. Consequently, investments whose rent reviews are index-linked or fixed percentage increase make sense for easy management and rental income cash-flow but don’t be fooled into thinking they are also blue-chip for growth and investment performance. At rent review, the likelihood of encountering tenant resolute resistance to any increase over and above the contractual obligation is almost guaranteed.
Safety in Numbers
Physically outwardly people are different and different nationalities each have their own cultures but, other than gender, human beings are basically inwardly the same. When for whatever reason we are emotionally upset at some level, whether consciously or subconsciously, we become psychologically off-balance so will have a propensity that steers us in one direction more than another. It is inclination, a ‘position of comfort’, that is, for example, why people generally only listen to what they want to hear, or don’t take any notice of anything that doesn’t make sense to them. In such a state, warning signals, often subtle, can go unheeded. Often it is only after a tangible symptom is experienced that we take action to remedy the situation in the hope it is not too late to do anything about the underlying problem.
Many people think problems of any sort are normal, but I do not. In my philosophy, a problem is a fault in direction so, essentially, it is not possible to have more than one problem at a time. In reality, having more than one problem at any time is simply fragments of the same underlying problem. Delve and you’ll find a common thread. A problem will not go away of its own accord: it may be swept under the metaphorical carpet, put to the back of your mind, but inevitably it will find a way to attract your attention. You will have to do something about it. The longer the delay, the harder it can get, the more expensive it can become to remedy. The reason problems are direction-related is to enable us and the reality we can create for ourselves to remain in sync with the ups-and-downs of life generally. About how you respond and react to whatever is happening right now, including what you are reading now and thinking about as you go. A problem must be transformed into an opportunity and the more adept you are at doing that as you go the less likely you’ll come unstuck in times of change. As I say, everything in life hinges upon the consequences of two words ‘yes’ and ‘no’. Which means problems can be avoided by taking preventative action. (Word of warning: trying to think of every possibility in advance is likely to leads to nervous breakdown.)
Applied self-development is integral to investment success. When you know yourself inside out, you’ll naturally know whatever you need to say and do and if you want to help make a difference to the lives of others what needs saying and doing. (Caution: don’t try this at home unless you feel confident enough)
In a balanced frame of mind and in the context of property investment, essentially, there is no difference between residential and commercial, or any other type of property for that matter. Both have the potential for investment, of enabling you to become better off than you are now. The only differences that can affect your prospects of success are in how the property is bought, managed, and sold. Any other differences are by-products of bias and prejudice. Both have their share of success stories, of the property that spectacularly outperforms, or the tenant whose improved covenant and financial standing enhances capital value. And both have their share of horror stories, of the tenant that goes broke or trashes the place before leaving.
Demand and supply provide the fuel for short-term action and whether change is seen as for the better or worse depends upon your ability to capitalise on opportunity. The long-term driving force is the socio-political economy and how the property market relates to what will happen in future.
At macro-level, residential property is subject to political ideology, a continual cry to build more new homes suggests shortage to the opportunist but can put a damper on prices for existing properties in the locality. Rents for residential property can increase as mortgage criteria for would-be buyers tightens, but lending relaxation can remove the froth. Commercial property can be affected by new development, changes in the law, and tenants rethinking their business priorities. Ultimately investment value of all property depends upon someone else paying more than you; and the profitability of the particular property to you depends upon how much you pay when you buy, what return you get during the period of ownership, and what you get when you sell.
For peak performance, the goal for human beings is perfect balance and harmony. Extremely challenging self-discipline to always be spot-on, second-best is to have emotional flexibility and financial agility, to be able to adjust your attitude and consequently your thinking at a moment’s notice. But most people are not as fit as that: instead they are set in their ways, do not have what it takes, and most investments prove second-rate. Hence, the property is held beyond its shelf -life as an investment and gradually becomes a problem, where the tenant’s conduct and requests are accommodated regardless.
A common reason for not wanting to sell is tax. Private investors particularly dislike paying tax even though the net proceeds from selling at peak will often be more than after management problems have set in. Another reason is what to do with the money which considering many private investors do depend upon the income from their property might in principle make one think they would be more canny at maximising were it not for a laziness that comes from being an armchair investor. The question is not what to do with the money but whether it would pay to re-invest in a prevailing market when prices are out of sync with property fundamentals. But that is also symptomatic of impatience. It doesn’t follow that one should immediately reinvest the proceeds for the sake of it: what should follow is to hold the cash until the right investment opportunity comes along whereupon it can be bought at a moment’s notice: an investment approach which held in good stead many investors during the immediate aftermath of the 2008 financial crisis. The best time to buy is when the world and his wife cannot. A contrarian approach that calls for deep thinking of a special kind.
Investment is about liquidity, about being able to at least get your money back at short notice. Inflation is present by default so can be ignored in the calculation. In the pecking order, cash on deposit is the purist form of investment, closely followed by equities (stocks and shares) which provide the most opportunity to pit your wits and skills, the sheer volume of transactions assists market liquidity and keeps costs to a minimum. Then there are alternative forms of investment of which property is especially attractive for its unique attribute: the legally-binding payment of rent and in the case of commercial property the ‘upward-only’ rent review whereby at the least the same rent as passing will endure for the contractual term.
Measuring return on investment can be benchmark-related, such as an index, or absolute. In my opinion, absolute, cash performance net of tax, is the better approach. Generally, the financial services industry thinks in headlines. Being told an investment has grown by 10% is more impressive than the true figure after adjusting for inflation and the costs of realising that gain.
Unlike shares in a property company that is quoted on the stock market, where share-price performance is subject to stock market psychology as well as the skill of the company’s managers, direct ownership of property is an illiquid investment, whose costs are hefty which means the risk of loss is greater so the need for rewarding performance to counteract has to be certain. There are however no guarantees, no reason other than emotional and intellectual know-how for your choice of particular property to succeed as an investment. Therefore, because know- how is the test that most investors fail to pass, to overcome the uncertainty and to prevent demand from becoming static, property has developed a reputation as a hedge against inflation. Consequently, people generally buy into the idea that the property market must be viewed as a long-term investment.
Long-term investment in the property market is a source of rich pickings for banks and advisers. Regardless of whether or not your choice of property performs, whether or not you do in fact become better off, a substantial percentage of financial resources is extracted from you, being one of the multitude, into lining the pockets of the few. That is why, all other factors remaining equal, the ease of management in the choice of property medium is critical. And that is why the cost of borrowing and the cost of advice in themselves will make a difference to your return on capital.
Psychological imbalance is caused by adverse influence in early upbringing, social conditioning, and peer pressure. Instead of equal measures of yes and no, a combination of positive support and constructive criticism, the cumulative affect of an overly negatively or underly-enthusiastic here and there can as the years pass make all the difference. I believe that in our heart of hearts, we are all purists. It is at the more mundane superficial levels where the impurities have crept in and toxins allowed to fester and run riot that psychological damage occurs. Naturally geared to balance and harmony, we can counter-act any deficiencies but what sort of adjustments and how much fine-tuning depends upon each individual. Only you know what you need.
It is natural to want to be better off, so choice of investment ought not be a hit and miss affair, but frequently it is. Indeed, choice, a psychological device for ensuring we are on track for our own individual aspirations rather than those of others, ought not to enter our thinking at all, but it does. Decisions, decisions. Bombarded by attention-seekers and half-baked ideas, we can, unless we learn to be ruthless become confused, thought and feeling in a state of uncertainty. (If the idea of becoming ‘ruthless’ bothers then define it as being friendly to everyone but saying no to most of them.) Living in fear, to protect ourselves from repeating mistakes, evidence is preferred to instinct. Rather than unreservedly trust intuition, gut-feeling is analysed and doubted. Instead of formulating a strategy, we disconnect from our metaphorical true path and end up buying whatever takes the fancy, the mood of the moment. The property investment portfolio is a hotchpotch which we might justify as diversification for spreading the risk but really it’s just safety in numbers.
Many people think problems of any sort are normal, but I do not. In my philosophy, a problem is a fault in direction so, essentially, it is not possible to have more than one problem at a time. In reality, having more than one problem at any time is simply fragments of the same underlying problem. Delve and you’ll find a common thread. A problem will not go away of its own accord: it may be swept under the metaphorical carpet, put to the back of your mind, but inevitably it will find a way to attract your attention. You will have to do something about it. The longer the delay, the harder it can get, the more expensive it can become to remedy. The reason problems are direction-related is to enable us and the reality we can create for ourselves to remain in sync with the ups-and-downs of life generally. About how you respond and react to whatever is happening right now, including what you are reading now and thinking about as you go. A problem must be transformed into an opportunity and the more adept you are at doing that as you go the less likely you’ll come unstuck in times of change. As I say, everything in life hinges upon the consequences of two words ‘yes’ and ‘no’. Which means problems can be avoided by taking preventative action. (Word of warning: trying to think of every possibility in advance is likely to leads to nervous breakdown.)
Applied self-development is integral to investment success. When you know yourself inside out, you’ll naturally know whatever you need to say and do and if you want to help make a difference to the lives of others what needs saying and doing. (Caution: don’t try this at home unless you feel confident enough)
In a balanced frame of mind and in the context of property investment, essentially, there is no difference between residential and commercial, or any other type of property for that matter. Both have the potential for investment, of enabling you to become better off than you are now. The only differences that can affect your prospects of success are in how the property is bought, managed, and sold. Any other differences are by-products of bias and prejudice. Both have their share of success stories, of the property that spectacularly outperforms, or the tenant whose improved covenant and financial standing enhances capital value. And both have their share of horror stories, of the tenant that goes broke or trashes the place before leaving.
Demand and supply provide the fuel for short-term action and whether change is seen as for the better or worse depends upon your ability to capitalise on opportunity. The long-term driving force is the socio-political economy and how the property market relates to what will happen in future.
At macro-level, residential property is subject to political ideology, a continual cry to build more new homes suggests shortage to the opportunist but can put a damper on prices for existing properties in the locality. Rents for residential property can increase as mortgage criteria for would-be buyers tightens, but lending relaxation can remove the froth. Commercial property can be affected by new development, changes in the law, and tenants rethinking their business priorities. Ultimately investment value of all property depends upon someone else paying more than you; and the profitability of the particular property to you depends upon how much you pay when you buy, what return you get during the period of ownership, and what you get when you sell.
For peak performance, the goal for human beings is perfect balance and harmony. Extremely challenging self-discipline to always be spot-on, second-best is to have emotional flexibility and financial agility, to be able to adjust your attitude and consequently your thinking at a moment’s notice. But most people are not as fit as that: instead they are set in their ways, do not have what it takes, and most investments prove second-rate. Hence, the property is held beyond its shelf -life as an investment and gradually becomes a problem, where the tenant’s conduct and requests are accommodated regardless.
A common reason for not wanting to sell is tax. Private investors particularly dislike paying tax even though the net proceeds from selling at peak will often be more than after management problems have set in. Another reason is what to do with the money which considering many private investors do depend upon the income from their property might in principle make one think they would be more canny at maximising were it not for a laziness that comes from being an armchair investor. The question is not what to do with the money but whether it would pay to re-invest in a prevailing market when prices are out of sync with property fundamentals. But that is also symptomatic of impatience. It doesn’t follow that one should immediately reinvest the proceeds for the sake of it: what should follow is to hold the cash until the right investment opportunity comes along whereupon it can be bought at a moment’s notice: an investment approach which held in good stead many investors during the immediate aftermath of the 2008 financial crisis. The best time to buy is when the world and his wife cannot. A contrarian approach that calls for deep thinking of a special kind.
Investment is about liquidity, about being able to at least get your money back at short notice. Inflation is present by default so can be ignored in the calculation. In the pecking order, cash on deposit is the purist form of investment, closely followed by equities (stocks and shares) which provide the most opportunity to pit your wits and skills, the sheer volume of transactions assists market liquidity and keeps costs to a minimum. Then there are alternative forms of investment of which property is especially attractive for its unique attribute: the legally-binding payment of rent and in the case of commercial property the ‘upward-only’ rent review whereby at the least the same rent as passing will endure for the contractual term.
Measuring return on investment can be benchmark-related, such as an index, or absolute. In my opinion, absolute, cash performance net of tax, is the better approach. Generally, the financial services industry thinks in headlines. Being told an investment has grown by 10% is more impressive than the true figure after adjusting for inflation and the costs of realising that gain.
Unlike shares in a property company that is quoted on the stock market, where share-price performance is subject to stock market psychology as well as the skill of the company’s managers, direct ownership of property is an illiquid investment, whose costs are hefty which means the risk of loss is greater so the need for rewarding performance to counteract has to be certain. There are however no guarantees, no reason other than emotional and intellectual know-how for your choice of particular property to succeed as an investment. Therefore, because know- how is the test that most investors fail to pass, to overcome the uncertainty and to prevent demand from becoming static, property has developed a reputation as a hedge against inflation. Consequently, people generally buy into the idea that the property market must be viewed as a long-term investment.
Long-term investment in the property market is a source of rich pickings for banks and advisers. Regardless of whether or not your choice of property performs, whether or not you do in fact become better off, a substantial percentage of financial resources is extracted from you, being one of the multitude, into lining the pockets of the few. That is why, all other factors remaining equal, the ease of management in the choice of property medium is critical. And that is why the cost of borrowing and the cost of advice in themselves will make a difference to your return on capital.
Psychological imbalance is caused by adverse influence in early upbringing, social conditioning, and peer pressure. Instead of equal measures of yes and no, a combination of positive support and constructive criticism, the cumulative affect of an overly negatively or underly-enthusiastic here and there can as the years pass make all the difference. I believe that in our heart of hearts, we are all purists. It is at the more mundane superficial levels where the impurities have crept in and toxins allowed to fester and run riot that psychological damage occurs. Naturally geared to balance and harmony, we can counter-act any deficiencies but what sort of adjustments and how much fine-tuning depends upon each individual. Only you know what you need.
It is natural to want to be better off, so choice of investment ought not be a hit and miss affair, but frequently it is. Indeed, choice, a psychological device for ensuring we are on track for our own individual aspirations rather than those of others, ought not to enter our thinking at all, but it does. Decisions, decisions. Bombarded by attention-seekers and half-baked ideas, we can, unless we learn to be ruthless become confused, thought and feeling in a state of uncertainty. (If the idea of becoming ‘ruthless’ bothers then define it as being friendly to everyone but saying no to most of them.) Living in fear, to protect ourselves from repeating mistakes, evidence is preferred to instinct. Rather than unreservedly trust intuition, gut-feeling is analysed and doubted. Instead of formulating a strategy, we disconnect from our metaphorical true path and end up buying whatever takes the fancy, the mood of the moment. The property investment portfolio is a hotchpotch which we might justify as diversification for spreading the risk but really it’s just safety in numbers.
Sentiment v Technicalities
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: those that are only interested in the end-result, and those that want to have the process explained at every step of the way.
I used to think the types were age-related, but I have come to realise it is more about the degree of faith and level of trust that the client has in the surveyor’s overall ability. A youngster surveyor with only a few years’ experience under their belt may have the technical competence that comes from text-book thinking, but is less likely to have anything like the amount of wisdom that stems from dealing with situations over many economic cycles. Any lack of experience is normally reflected in demeanour and conversational style.
To be required to provide explanation at every step of the way can be very tiring and frustrating for the surveyor. It is one thing keeping an experienced knowledgeable client informed because the terminology and subtleties won’t need spelling out, but you try telling someone whose knowledge of the subject is obviously lacking, even if they don’t think it is, and immediately you’re into having to manage the client’s expectations.
When you trust a surveyor that knows what they are doing, amongst the benefits you get is the one thing that micro-managing a surveyor will stifle: creativity. A surveyor left to their own devices without being influenced by the client does not necessarily mean that the surveyor will automatically think of everything, but it should at least avoid the pressure that can be imposed by limitation. In my opinion, there is no point in wanting a surveyor to provide practical help only to insist upon how that help is performed.
Surveyors do not make the market, we merely interpret it for the benefit of our clients. The market is indifferent, it does not care about what happens to participants, but surveyors are concerned (a cynic might say for their own livelihoods if nothing else) so have developed a methodology that may be summed up as a combination of opinion and evidence.
Even though valuation is an art just as much as a science, the evidential approach tends to be preferred because that enables surveyors to be able to justify opinions. To be able to satisfy the assertion to prove it. Our ways of interpretation presuppose sufficient experience to cover every eventuality, but whether there is no difference between theory and practice depends upon remembering that people have feelings, as I keep being reminded, when I venture into sensitive territory, because our ways of interpreting can be stuck in the past or subject to ideology.
Interpretation of the market as a whole comes from a combination of practical experience, industry comment and informed anecdotes. The market as a whole is diverse with a myriad of interests and whether surveyors get a look in to the entire gamut depends upon how much of the market a surveyor is exposed to. Anything unusual or out of line with orthodox ways of interpreting can tend to be dismissed as an aberration.
It is not compulsory for a tenant to take advice from a surveyor, but that doesn’t prevent surveyors from rejecting evidence involving an unrepresented tenant as unrepresentative of the market. In my opinion, it is surveyor-snobbery to think that unrepresented tenants cannot possibly know what they are doing even though it is the tenant that commits to the lease, not the surveyor. A lease of commercial property is a commercial contract which means the parties are deemed to know what they are doing. For a surveyor to override that built-in assumption is tantamount to asserting that only surveyors have the right to decide what is and what is not evidence.
Even so, there is some truth in that, to be precise in deciding the weight that should be attached to the evidence. Evidence is proof but the evidence should also be able to show on the balance of probabilities that the source is au fait with the technicalities. Weight is not the same as admissible: weight is how much notice ought be taken of the evidence for purpose of being influenced by that evidence.
Nor is it compulsory for a landlord to take advice from a surveyor and many landlords do not. Many landlords see no point in incurring the extra expense when as the decision-makers themselves they are perfectly capable of making up their own mind whether to accept the tenant’s offer. Hence, the evidence unrepresented landlords create is as far as such landlords are concerned beyond reproach. It can come as a surprise therefore to be told by a surveyor that evidence provided by an unrepresented landlord is just as likely to be questionable as that of an unrepresented tenant.
The sector of the market involving surveyors tends to be more sophisticated and in the upper reaches where rent level are at least £15,000 pa, but there are pockets amongst the lower echelons where surveyors are involved because what starts as an unrepresented scenario can becomes so frustrating for the parties concerned that surveyors are brought in to sort things out.
A sizeable sector of the market is unrepresented and in a world of its own. In this sector, it is common for rents either to be significantly less or substantially more than if surveyors were involved. Less is when the landlord’s investment policy is to want full occupancy regardless. More is when the business philosophy of the landlord and tenant is contrary to the surveyor-system.
Client-expectations are sentiment-oriented, never mind the small print of business tenancy law and valuation; instead, the landlord believes a right to expect a proper return on the investment, the tenant is doing well so should pay more; while the tenant may not be able to afford so much but doesn’t want to upset the landlord. Surveyor-thinking is technicalities regardless of affordability. Different sectors of the market have their own ways of reaching agreement. It is only when the lines of communication cross between the unrepresented and surveyor-methodology that the attitudinal fireworks begin.
I used to think the types were age-related, but I have come to realise it is more about the degree of faith and level of trust that the client has in the surveyor’s overall ability. A youngster surveyor with only a few years’ experience under their belt may have the technical competence that comes from text-book thinking, but is less likely to have anything like the amount of wisdom that stems from dealing with situations over many economic cycles. Any lack of experience is normally reflected in demeanour and conversational style.
To be required to provide explanation at every step of the way can be very tiring and frustrating for the surveyor. It is one thing keeping an experienced knowledgeable client informed because the terminology and subtleties won’t need spelling out, but you try telling someone whose knowledge of the subject is obviously lacking, even if they don’t think it is, and immediately you’re into having to manage the client’s expectations.
When you trust a surveyor that knows what they are doing, amongst the benefits you get is the one thing that micro-managing a surveyor will stifle: creativity. A surveyor left to their own devices without being influenced by the client does not necessarily mean that the surveyor will automatically think of everything, but it should at least avoid the pressure that can be imposed by limitation. In my opinion, there is no point in wanting a surveyor to provide practical help only to insist upon how that help is performed.
Surveyors do not make the market, we merely interpret it for the benefit of our clients. The market is indifferent, it does not care about what happens to participants, but surveyors are concerned (a cynic might say for their own livelihoods if nothing else) so have developed a methodology that may be summed up as a combination of opinion and evidence.
Even though valuation is an art just as much as a science, the evidential approach tends to be preferred because that enables surveyors to be able to justify opinions. To be able to satisfy the assertion to prove it. Our ways of interpretation presuppose sufficient experience to cover every eventuality, but whether there is no difference between theory and practice depends upon remembering that people have feelings, as I keep being reminded, when I venture into sensitive territory, because our ways of interpreting can be stuck in the past or subject to ideology.
Interpretation of the market as a whole comes from a combination of practical experience, industry comment and informed anecdotes. The market as a whole is diverse with a myriad of interests and whether surveyors get a look in to the entire gamut depends upon how much of the market a surveyor is exposed to. Anything unusual or out of line with orthodox ways of interpreting can tend to be dismissed as an aberration.
It is not compulsory for a tenant to take advice from a surveyor, but that doesn’t prevent surveyors from rejecting evidence involving an unrepresented tenant as unrepresentative of the market. In my opinion, it is surveyor-snobbery to think that unrepresented tenants cannot possibly know what they are doing even though it is the tenant that commits to the lease, not the surveyor. A lease of commercial property is a commercial contract which means the parties are deemed to know what they are doing. For a surveyor to override that built-in assumption is tantamount to asserting that only surveyors have the right to decide what is and what is not evidence.
Even so, there is some truth in that, to be precise in deciding the weight that should be attached to the evidence. Evidence is proof but the evidence should also be able to show on the balance of probabilities that the source is au fait with the technicalities. Weight is not the same as admissible: weight is how much notice ought be taken of the evidence for purpose of being influenced by that evidence.
Nor is it compulsory for a landlord to take advice from a surveyor and many landlords do not. Many landlords see no point in incurring the extra expense when as the decision-makers themselves they are perfectly capable of making up their own mind whether to accept the tenant’s offer. Hence, the evidence unrepresented landlords create is as far as such landlords are concerned beyond reproach. It can come as a surprise therefore to be told by a surveyor that evidence provided by an unrepresented landlord is just as likely to be questionable as that of an unrepresented tenant.
The sector of the market involving surveyors tends to be more sophisticated and in the upper reaches where rent level are at least £15,000 pa, but there are pockets amongst the lower echelons where surveyors are involved because what starts as an unrepresented scenario can becomes so frustrating for the parties concerned that surveyors are brought in to sort things out.
A sizeable sector of the market is unrepresented and in a world of its own. In this sector, it is common for rents either to be significantly less or substantially more than if surveyors were involved. Less is when the landlord’s investment policy is to want full occupancy regardless. More is when the business philosophy of the landlord and tenant is contrary to the surveyor-system.
Client-expectations are sentiment-oriented, never mind the small print of business tenancy law and valuation; instead, the landlord believes a right to expect a proper return on the investment, the tenant is doing well so should pay more; while the tenant may not be able to afford so much but doesn’t want to upset the landlord. Surveyor-thinking is technicalities regardless of affordability. Different sectors of the market have their own ways of reaching agreement. It is only when the lines of communication cross between the unrepresented and surveyor-methodology that the attitudinal fireworks begin.
Location, location, location
In the last blog (April Fool or Successful Investor, 01 April 2014), I said “successful investment in commercial property includes the ability to be discerning, the more adept you become, the more you can gauge at a glance whether the proposition is likely to perform. Performance despite any resistance by the tenant. Why would the tenant resist?”
Apart from vacant property that might go up in value of its own accord, an occurrence that can reflect change of use for planning permission, development potential, and demand from owner-occupiers, the investment potential in commercial property depends upon tenants.
Tenants are the customers for investors in commercial property.
The property-relationship between landlord and tenant hinges on the terms and conditions of the tenancy; in popular parlance, the lease. Generally, investors prefer what is known as a ‘clean’ lease: an institutional standard whereby most if not all the responsibilities for the use of the premises fall on the tenant, and with no ambiguity in the interpretation of the contract.
Leases in the commercial property market are a challenge for investors, because there is no standard form of lease in common usage. Many landlords and tenants and lawyers have their own standard leases that incorporate specific requirements, but all are subjective. To assume the terms and conditions in each lease would be the same in every other is a mistake.
Drafting a lease is about recording the agreement in writing, the choice of words and phrases that spell out the responsibilities between landlord and tenant. On grant of a new lease, the onus is on the landlord’s side to draft and on the tenant’s side to approve. Sometimes, where the tenant has specific requirements, the tenant’s lawyer will offer to draft the lease but that is usually only to save time. Better for the tenant to provide the wording required rather than the landlord have to guess. Unfortunately, whether through drafting inexperience or error, and because many landlords and tenants can’t be bothered to read the ‘small print’ before signing the document, the wording of a lease will often differ from what the parties intended, so ambiguities in interpretation can arise.
Disputes involving differences in interpretation that are taken to court constitute the body of case-law. The drafting of leases is also fashionable. The widespread use of precedents, often followed slavishly, can result in little or no thought being given to ensuring the performance of the investment.
The duration of a lease, the term of the tenancy, is often for years. Leases may be shorter now, 10 years perhaps with a break clause at the 5th year, but 15-25 years remain popular, not least because bank criteria for lending to tenants requires a secure term of at least 8 years.
Leases are fixed documents whose terms and conditions can only be varied by mutual agreement, or rectification usually only by the original parties. The market, however, is not fixed: it is continually changing. What is a market? A market is anywhere business is done. Transactions are usually for money, but may involve bartering goods and are conducted between sellers and buyers, or through agents, wholesalers, manufacturers, brokers, etc. Marketing happens when we want to satisfy a need and are willing to exchange something with someone able to help us satisfy that need. The process exists to bring buyers and sellers into a market. In business, the transaction is reciprocal. Business is about helping people in exchange for money.
Markets exist to serve the needs of participants and for identification have classifications and categories: for example, the property market, whose categories include residential property, commercial property, and so on. Naturally inactive, markets become active when fuelled and driven by a range of different influences, all of which originate in how the participants in the particular market respond to whatever is or perceived to be happening in the reality that the market exists to serve.
With commercial property, the ups-and-downs of the market are not necessarily dependent upon whatever is happening in the economy at large so the line of reasoning may be hard to follow, but that doesn’t mean we cannot remain in sync with any changes: all that’s needed is flexibility. Leases, however, are inflexible: what was agreed years ago may not be relevant now.
Where the landlord and tenant are the same parties throughout the term, it is probably less likely for either or both to want to interpret the terms and conditions of the lease in a way that differed from their original intention, unless to material advantage and being unconcerned about the risk of falling out over a dispute. Where one or both of the original parties have changed, and since leases are themselves assets that can be bought and sold (subject to any restrictions), a successor-landlord or successor-tenant might have a different view of the intention of the original parties.
Buying an existing investment means taking over a lease that may be outmoded or badly drafted, whose terms and conditions may work against the investment objective. Conversely, leases may contain words and phrases that serve the landlord more than the tenant. It is a question of finding. As I say, anyone can read a lease, it’s knowing what to look for that really counts.
Once upon a time, it would have been unusual for tenants to take professional advice from surveyors. Surveyors acted for landlords and tenants generally did as they were told. Tenants were subservient. For many years, on the RICS application form for dispute resolution procedure, under the heading ‘tenant representative’ were the words, in parentheses, “if any”.
Life was never the same again for landlords following the House of Lords ruling in United Scientific Holdings v Burnley Borough Council [1978]. Briefly, the landlord had missed the date for the rent review notice, so the tenant argued the landlord had lost the right to review the rent.
As I said, (01 April 2014) “We (surveyors) know that landlords become successful when their investments perform. We also know that tenants become successful not just when their businesses are performing well but also when the total property cost commitment is kept to a minimum.” Reducing property costs and minimising tenancy liabilities makes sense for tenants but is unlikely to make any sense for landlords. The idea that provided the premises are economical, tenants more likely to stay the course, is defeated because tenants want to have it both ways. They want the lowest rents and the least liabilities together with the most flexibility. Scrutinising the wording and phrasing of the terms and conditions of leases in the hope of scoring points either for landlord or tenant is big business for surveyors and lawyers. It works both ways: landlords can benefit enormously from a different interpretation; for tenants, a single word, a turn of phrase, can often result in a substantial reduction in rent or relief from liability.
Apart from whether the landlord is legally entitled to more (as distinct from having the right to expect more) and whether the tenant is legally entitled to less (as distinct from thinking the world owes it a living), landlord and tenant each in their own ways want to maintain a profitable relationship with the location of the property. The adage “location, location, location” is a fundamental ingredient for successful investment which might be thought ‘old school’ compared with the relatively recent popular demand for tenant-covenant, but the adage remains nevertheless the more important. Unlike covenant which depends upon the tenant wanting to remain in occupation, the property is fixed and immoveable. In other words, if you buy a property let, for example, to a bank which, as a blue-chip covenant, would normally fetch a higher price in the investment market, but the bank does not renew its lease or exercises a break clause then you’d no longer have the bank as a tenant but you still have the property.
Subject to compliance with the lease, how the tenant chooses to run its business is nothing to do with the landlord, but it is to do with the customers whom the tenant’s business serves. Why those customers and/or type of customers choose to have their needs satisfied by one particular business over another is a function of marketing, and of location. Therefore, the challenge for any tenant that is doing well is whether the success of the business venture is more a reflection of the tenant’s modus operandi or mostly a spin-off from the popularity of the location. For example, acting for a landlord, I let a shop to a business specialising in sale and hire of videos (DVDs, etc) of old movies. The tenant needed to relocate from nearby because its premises there were going to be redeveloped. The tenant was convinced he was doing well because of the specialised nature of his business but as he soon discovered it was more to do with where he was based before. My Client’s shop was not in such a good position and the passing trade was not enough to support the tenant’s business at rent the tenant had agreed. That didn’t make the rent wrong in itself; but just for that type of business.
Appraising the merits of location has become more difficult now that on-line commerce is accepted generally amongst customers. There are many tenants that have downsized to improve efficiency and consolidated premises in order to reduce costs. Many retailers have closed their bricks-and-mortar presence on the high street because the cost of providing a physical place for doing business is considerably more expensive than trading on-line. A virtual presence on-line is akin to mail order but with trimmings.
For multiple retailers, it used to be that to have branches in 200 towns (and cities) would provide almost 100% geographical catchment. Now it’s 50 or so and in future a few stores in top centres might be all that is needed. Whenever locations become centres of attention, the benchmark changes for everyone else. Hence, the ongoing and potentially improving popularity of the location, attractiveness and so on, is important for a landlord. A location that doesn’t have what it takes to attract the calibre of tenant that would contribute to the appeal of the location is unlikely to be able to compete successfully with those locations that do. Since the location is where the property is, the potential for the property should be considered by reference to the factors that obviously contribute now and those in the offing.
Factors in the offing may not be apparent, or rather not so acceptable to the majority: what is clear to some or a few may be laughable to others, but location is not about personal resistance to change, but swirling undercurrents gathering steam, the groundswell of powerful feelings. For example, in the June 1989 issue of my newsletter for clients and contacts, I said that the emergence of the ‘Green’ consumer marked the onset of a major shift in attitude that would have repercussions for all aspects of future retailing. Nowadays, ‘Green’ issues and all that they have spawned such as sustainability, Energy Performance Certificates, and such like, are taken for granted but in the same way the world-wide-web has only been with us for 25 years yet seems like forever so ‘Green’ is a relatively new entrant to mainstream thinking.
Essentially, the direction of a market is geared to progress, which, in the context of personal and business development, may be inwards or outwards depending upon priorities and aspirations. The challenge for all business tenants is to synchronise with customers, and for all landlords to synchronise with tenants, but that does not have to mean the actual tenant. Whether a landlord wants to hang on the actual tenant, rather than take its chances in the market, is a matter of investment policy. And whether a tenant wants to become a tenant of a particular landlord depends upon what that landlord has to offer in the way of property. Similarly, whether a tenant wants to continue catering for a particular type of customer is a matter for that particular tenant. Not so much an instability as the desire to remain in sync, the constant re-aligning, rejigging, pruning and fine-tuning of freehold and leasehold interests by thousands of landlords and tenants is the reason for the number of commercial properties in the market at any time.
For retailers, for example, trading positions change according to the influences on (potential) trade. A prime position today could be become secondary in future, and vice versa. The identity of multiple retailers is not in itself a reliable indicator of a good location: the question is whether most if not all of those particular multiple retailers would jump at the chance of getting a shop in that location if they were not already there. Or would they leap at the first opportunity to get out? When you buy a property, you are not buying the whole of the market, you are buying a particular property. Assessing tenant-covenant is not just about appraising the financial standing of the tenant as a whole, but also identifying the tenant’s intention for that particular property. What you have to ask is if the tenant vacates on break clause or end of the lease, whether the property would relet to a tenant whose covenant would at least be on a par with the outgoing tenant and the rent, the terms and conditions of the new lease at least maintain the investment value.
Since properties worth keeping through thick and thin are rarely offered for sale, which means 99% of propositions in any auction catalogue are probably not worth buying, anyone following my advice might think they’d never buy anything! But why buy for the sake of it? Why invest in buying and owning a commercial property if there’s little or no likelihood of it performing? Of you being better off than you were? One answer, of course, is that I could be wrong. In a market whose prices are mostly driven by sentiment, rather than technicalities, surely any property acquired at the right price will perform over the long term at least? Therefore, it may be not that you shouldn’t buy anything that takes your fancy, but just a question of price. The answer to whether the price is right can only be subjective. The intrinsic value of an asset, over and above its scrap value is largely based on sentiment. [Talking of scrap value, just because the property could cost more to build than the asking price for the end-product does not make the property worth buying. All property has a shelf-life in the demand-market, regardless of any potential for change of planning use.]
Sentiment can get in the way of appraisal by scoffing at technicalities as surmountable. In other words, if all else fails then buy yourself out of trouble. If I were an investor in property then frankly I’d rather not waste time on what is likely to prove a non-performing investment based on technicalities, but since I don’t invest in property (other than a home) the only way I can emphasise with sentiment-investment is in the context of trading: buy to resell on the momentum. Otherwise all I can do is point out the pitfalls and what can go wrong by ignoring the technicalities. What can wrong because the tenant resists resolutely. Hence, my contribution to the success of the landlord’s choice of commercial property is to use my know-how to either at least maintain or better still improve the investment performance. And for that one needs an in-depth knowledge of the technicalities and negotiating psychology, because it is through the use of the technicalities and ploys that tenants can make or break the landlord’s investment.
Although the pace of change is tenant-demand geared to customers, the driving force that has transformed the commercial property landscape from a relatively level-playing field into a polarised market is the successful use of the technicalities and negotiating ploys by tenants and their advisers. Consequently, at a macro-level, some locations have what is takes and have gone for it, others are fighting for survival and in many cases dying on their feet. In the quest for solutions to the havoc wreaked on local economies and communities, one can pinpoint the more obvious macro- reasons for decline, business rates, high rents, local authority parking charges, out-of-town supermarkets, retail parks, etc, but since those factors are nationwide, it still doesn’t explain why some locations are more successful than others.
In my opinion, the underlying reason is organic: a feeling that is equivalent to the institutional property investor’s idea of a ‘clean’ lease. In its tangible form, it is a desire by profitable customers and successful and aspirational tenants to avoid mixing with all and sundry. Why lease tatty premises from a greedy amateur investor in a declining area when one can rent a gleaming building from a professional landlord in a good location, and often for not that much more, all told. The desire for organic in the sense of authenticity, open communication and transparency remains as strong as ever. In my opinion, one that seems to be shared by a good many others, most provincial towns have gone ex-growth. The core organic positions have been redeveloped, thereby acting as a magnet for the tenant-spending power, leaving the peripheral positions to fend for themselves.
The art of selling investments that in future will under-perform has succeeded in wooing hundreds of private investors into dud locations. The dumping of non-performing investments by shrewd sellers on the inexperienced is nothing new but, nowadays, with the bulk of investments offered at auction the fever has spread. There is, of course, nothing wrong with wanting to buy a property currently let to a good tenant in a nice place. But that’s not the point: it’s not whether you as the landlord would like the location, but whether the tenant would renew the lease on at least the same overall basis as now, and the premises would if vacant be lettable to a tenant whose corporate image would help enhance the location and stimulate demand from other like-minded tenants as well. If there is any doubt whatsoever about either one or both of those factors then until a change arises you are stuck with the technicalities, so you may as well use them to your advantage.
to be continued……
Apart from vacant property that might go up in value of its own accord, an occurrence that can reflect change of use for planning permission, development potential, and demand from owner-occupiers, the investment potential in commercial property depends upon tenants.
Tenants are the customers for investors in commercial property.
The property-relationship between landlord and tenant hinges on the terms and conditions of the tenancy; in popular parlance, the lease. Generally, investors prefer what is known as a ‘clean’ lease: an institutional standard whereby most if not all the responsibilities for the use of the premises fall on the tenant, and with no ambiguity in the interpretation of the contract.
Leases in the commercial property market are a challenge for investors, because there is no standard form of lease in common usage. Many landlords and tenants and lawyers have their own standard leases that incorporate specific requirements, but all are subjective. To assume the terms and conditions in each lease would be the same in every other is a mistake.
Drafting a lease is about recording the agreement in writing, the choice of words and phrases that spell out the responsibilities between landlord and tenant. On grant of a new lease, the onus is on the landlord’s side to draft and on the tenant’s side to approve. Sometimes, where the tenant has specific requirements, the tenant’s lawyer will offer to draft the lease but that is usually only to save time. Better for the tenant to provide the wording required rather than the landlord have to guess. Unfortunately, whether through drafting inexperience or error, and because many landlords and tenants can’t be bothered to read the ‘small print’ before signing the document, the wording of a lease will often differ from what the parties intended, so ambiguities in interpretation can arise.
Disputes involving differences in interpretation that are taken to court constitute the body of case-law. The drafting of leases is also fashionable. The widespread use of precedents, often followed slavishly, can result in little or no thought being given to ensuring the performance of the investment.
The duration of a lease, the term of the tenancy, is often for years. Leases may be shorter now, 10 years perhaps with a break clause at the 5th year, but 15-25 years remain popular, not least because bank criteria for lending to tenants requires a secure term of at least 8 years.
Leases are fixed documents whose terms and conditions can only be varied by mutual agreement, or rectification usually only by the original parties. The market, however, is not fixed: it is continually changing. What is a market? A market is anywhere business is done. Transactions are usually for money, but may involve bartering goods and are conducted between sellers and buyers, or through agents, wholesalers, manufacturers, brokers, etc. Marketing happens when we want to satisfy a need and are willing to exchange something with someone able to help us satisfy that need. The process exists to bring buyers and sellers into a market. In business, the transaction is reciprocal. Business is about helping people in exchange for money.
Markets exist to serve the needs of participants and for identification have classifications and categories: for example, the property market, whose categories include residential property, commercial property, and so on. Naturally inactive, markets become active when fuelled and driven by a range of different influences, all of which originate in how the participants in the particular market respond to whatever is or perceived to be happening in the reality that the market exists to serve.
With commercial property, the ups-and-downs of the market are not necessarily dependent upon whatever is happening in the economy at large so the line of reasoning may be hard to follow, but that doesn’t mean we cannot remain in sync with any changes: all that’s needed is flexibility. Leases, however, are inflexible: what was agreed years ago may not be relevant now.
Where the landlord and tenant are the same parties throughout the term, it is probably less likely for either or both to want to interpret the terms and conditions of the lease in a way that differed from their original intention, unless to material advantage and being unconcerned about the risk of falling out over a dispute. Where one or both of the original parties have changed, and since leases are themselves assets that can be bought and sold (subject to any restrictions), a successor-landlord or successor-tenant might have a different view of the intention of the original parties.
Buying an existing investment means taking over a lease that may be outmoded or badly drafted, whose terms and conditions may work against the investment objective. Conversely, leases may contain words and phrases that serve the landlord more than the tenant. It is a question of finding. As I say, anyone can read a lease, it’s knowing what to look for that really counts.
Once upon a time, it would have been unusual for tenants to take professional advice from surveyors. Surveyors acted for landlords and tenants generally did as they were told. Tenants were subservient. For many years, on the RICS application form for dispute resolution procedure, under the heading ‘tenant representative’ were the words, in parentheses, “if any”.
Life was never the same again for landlords following the House of Lords ruling in United Scientific Holdings v Burnley Borough Council [1978]. Briefly, the landlord had missed the date for the rent review notice, so the tenant argued the landlord had lost the right to review the rent.
As I said, (01 April 2014) “We (surveyors) know that landlords become successful when their investments perform. We also know that tenants become successful not just when their businesses are performing well but also when the total property cost commitment is kept to a minimum.” Reducing property costs and minimising tenancy liabilities makes sense for tenants but is unlikely to make any sense for landlords. The idea that provided the premises are economical, tenants more likely to stay the course, is defeated because tenants want to have it both ways. They want the lowest rents and the least liabilities together with the most flexibility. Scrutinising the wording and phrasing of the terms and conditions of leases in the hope of scoring points either for landlord or tenant is big business for surveyors and lawyers. It works both ways: landlords can benefit enormously from a different interpretation; for tenants, a single word, a turn of phrase, can often result in a substantial reduction in rent or relief from liability.
Apart from whether the landlord is legally entitled to more (as distinct from having the right to expect more) and whether the tenant is legally entitled to less (as distinct from thinking the world owes it a living), landlord and tenant each in their own ways want to maintain a profitable relationship with the location of the property. The adage “location, location, location” is a fundamental ingredient for successful investment which might be thought ‘old school’ compared with the relatively recent popular demand for tenant-covenant, but the adage remains nevertheless the more important. Unlike covenant which depends upon the tenant wanting to remain in occupation, the property is fixed and immoveable. In other words, if you buy a property let, for example, to a bank which, as a blue-chip covenant, would normally fetch a higher price in the investment market, but the bank does not renew its lease or exercises a break clause then you’d no longer have the bank as a tenant but you still have the property.
Subject to compliance with the lease, how the tenant chooses to run its business is nothing to do with the landlord, but it is to do with the customers whom the tenant’s business serves. Why those customers and/or type of customers choose to have their needs satisfied by one particular business over another is a function of marketing, and of location. Therefore, the challenge for any tenant that is doing well is whether the success of the business venture is more a reflection of the tenant’s modus operandi or mostly a spin-off from the popularity of the location. For example, acting for a landlord, I let a shop to a business specialising in sale and hire of videos (DVDs, etc) of old movies. The tenant needed to relocate from nearby because its premises there were going to be redeveloped. The tenant was convinced he was doing well because of the specialised nature of his business but as he soon discovered it was more to do with where he was based before. My Client’s shop was not in such a good position and the passing trade was not enough to support the tenant’s business at rent the tenant had agreed. That didn’t make the rent wrong in itself; but just for that type of business.
Appraising the merits of location has become more difficult now that on-line commerce is accepted generally amongst customers. There are many tenants that have downsized to improve efficiency and consolidated premises in order to reduce costs. Many retailers have closed their bricks-and-mortar presence on the high street because the cost of providing a physical place for doing business is considerably more expensive than trading on-line. A virtual presence on-line is akin to mail order but with trimmings.
For multiple retailers, it used to be that to have branches in 200 towns (and cities) would provide almost 100% geographical catchment. Now it’s 50 or so and in future a few stores in top centres might be all that is needed. Whenever locations become centres of attention, the benchmark changes for everyone else. Hence, the ongoing and potentially improving popularity of the location, attractiveness and so on, is important for a landlord. A location that doesn’t have what it takes to attract the calibre of tenant that would contribute to the appeal of the location is unlikely to be able to compete successfully with those locations that do. Since the location is where the property is, the potential for the property should be considered by reference to the factors that obviously contribute now and those in the offing.
Factors in the offing may not be apparent, or rather not so acceptable to the majority: what is clear to some or a few may be laughable to others, but location is not about personal resistance to change, but swirling undercurrents gathering steam, the groundswell of powerful feelings. For example, in the June 1989 issue of my newsletter for clients and contacts, I said that the emergence of the ‘Green’ consumer marked the onset of a major shift in attitude that would have repercussions for all aspects of future retailing. Nowadays, ‘Green’ issues and all that they have spawned such as sustainability, Energy Performance Certificates, and such like, are taken for granted but in the same way the world-wide-web has only been with us for 25 years yet seems like forever so ‘Green’ is a relatively new entrant to mainstream thinking.
Essentially, the direction of a market is geared to progress, which, in the context of personal and business development, may be inwards or outwards depending upon priorities and aspirations. The challenge for all business tenants is to synchronise with customers, and for all landlords to synchronise with tenants, but that does not have to mean the actual tenant. Whether a landlord wants to hang on the actual tenant, rather than take its chances in the market, is a matter of investment policy. And whether a tenant wants to become a tenant of a particular landlord depends upon what that landlord has to offer in the way of property. Similarly, whether a tenant wants to continue catering for a particular type of customer is a matter for that particular tenant. Not so much an instability as the desire to remain in sync, the constant re-aligning, rejigging, pruning and fine-tuning of freehold and leasehold interests by thousands of landlords and tenants is the reason for the number of commercial properties in the market at any time.
For retailers, for example, trading positions change according to the influences on (potential) trade. A prime position today could be become secondary in future, and vice versa. The identity of multiple retailers is not in itself a reliable indicator of a good location: the question is whether most if not all of those particular multiple retailers would jump at the chance of getting a shop in that location if they were not already there. Or would they leap at the first opportunity to get out? When you buy a property, you are not buying the whole of the market, you are buying a particular property. Assessing tenant-covenant is not just about appraising the financial standing of the tenant as a whole, but also identifying the tenant’s intention for that particular property. What you have to ask is if the tenant vacates on break clause or end of the lease, whether the property would relet to a tenant whose covenant would at least be on a par with the outgoing tenant and the rent, the terms and conditions of the new lease at least maintain the investment value.
Since properties worth keeping through thick and thin are rarely offered for sale, which means 99% of propositions in any auction catalogue are probably not worth buying, anyone following my advice might think they’d never buy anything! But why buy for the sake of it? Why invest in buying and owning a commercial property if there’s little or no likelihood of it performing? Of you being better off than you were? One answer, of course, is that I could be wrong. In a market whose prices are mostly driven by sentiment, rather than technicalities, surely any property acquired at the right price will perform over the long term at least? Therefore, it may be not that you shouldn’t buy anything that takes your fancy, but just a question of price. The answer to whether the price is right can only be subjective. The intrinsic value of an asset, over and above its scrap value is largely based on sentiment. [Talking of scrap value, just because the property could cost more to build than the asking price for the end-product does not make the property worth buying. All property has a shelf-life in the demand-market, regardless of any potential for change of planning use.]
Sentiment can get in the way of appraisal by scoffing at technicalities as surmountable. In other words, if all else fails then buy yourself out of trouble. If I were an investor in property then frankly I’d rather not waste time on what is likely to prove a non-performing investment based on technicalities, but since I don’t invest in property (other than a home) the only way I can emphasise with sentiment-investment is in the context of trading: buy to resell on the momentum. Otherwise all I can do is point out the pitfalls and what can go wrong by ignoring the technicalities. What can wrong because the tenant resists resolutely. Hence, my contribution to the success of the landlord’s choice of commercial property is to use my know-how to either at least maintain or better still improve the investment performance. And for that one needs an in-depth knowledge of the technicalities and negotiating psychology, because it is through the use of the technicalities and ploys that tenants can make or break the landlord’s investment.
Although the pace of change is tenant-demand geared to customers, the driving force that has transformed the commercial property landscape from a relatively level-playing field into a polarised market is the successful use of the technicalities and negotiating ploys by tenants and their advisers. Consequently, at a macro-level, some locations have what is takes and have gone for it, others are fighting for survival and in many cases dying on their feet. In the quest for solutions to the havoc wreaked on local economies and communities, one can pinpoint the more obvious macro- reasons for decline, business rates, high rents, local authority parking charges, out-of-town supermarkets, retail parks, etc, but since those factors are nationwide, it still doesn’t explain why some locations are more successful than others.
In my opinion, the underlying reason is organic: a feeling that is equivalent to the institutional property investor’s idea of a ‘clean’ lease. In its tangible form, it is a desire by profitable customers and successful and aspirational tenants to avoid mixing with all and sundry. Why lease tatty premises from a greedy amateur investor in a declining area when one can rent a gleaming building from a professional landlord in a good location, and often for not that much more, all told. The desire for organic in the sense of authenticity, open communication and transparency remains as strong as ever. In my opinion, one that seems to be shared by a good many others, most provincial towns have gone ex-growth. The core organic positions have been redeveloped, thereby acting as a magnet for the tenant-spending power, leaving the peripheral positions to fend for themselves.
The art of selling investments that in future will under-perform has succeeded in wooing hundreds of private investors into dud locations. The dumping of non-performing investments by shrewd sellers on the inexperienced is nothing new but, nowadays, with the bulk of investments offered at auction the fever has spread. There is, of course, nothing wrong with wanting to buy a property currently let to a good tenant in a nice place. But that’s not the point: it’s not whether you as the landlord would like the location, but whether the tenant would renew the lease on at least the same overall basis as now, and the premises would if vacant be lettable to a tenant whose corporate image would help enhance the location and stimulate demand from other like-minded tenants as well. If there is any doubt whatsoever about either one or both of those factors then until a change arises you are stuck with the technicalities, so you may as well use them to your advantage.
to be continued……
April Fool or Successful Investor
Successful investment is about judicious choice and timing: what to buy, how much to pay, how to manage, when and how to sell.
Most or all of which may be easier said than done, because investors generally are far more influenced towards poor judgement than they might realise. In this scientific world we have created for ourselves, opinions that are not evidence-based don’t seem to count for much. Yet successful investment is not only about considering the evidence, but also the art of knowing.
Knowing is awareness, about being informed. Knowing is different from knowledge. Facts, information and skills can all be learned and from experience relied upon. But experience may be out-of-date, limited, or not suited to different ways of thinking. Knowledge provides a basis for logic. People are comfortable with logic: it is reasoned so it follows. But, logical thinking is based on past experience, whereas the future is uncertain. Life changes, attitudes shift, people change. That’s why past performance is no guide to the future. No one knows for sure, but that doesn’t mean we can’t predict with a fair degree of accuracy, especially when you know what you’re about. Which brings me to asking you to ask yourself: what are you about? What is it about you that would enable you to appraise an investment with sufficient confidence to be certain of your conclusion. How come you can pick winners?
Successful investment in commercial property includes the ability to be discerning, the more adept you become, the more you can gauge at a glance whether the proposition is likely to perform. Performance despite any resistance by the tenant. Why would the tenant resist?
The answer is that you understand the market in which you’re investing. You understand what makes it tick and where it’s heading.
It’s when you don’t understand the fundamental principles that you are likely to come unstuck somewhere along the way. With commercial property, coming unstuck is what plenty of investors do do through fault of their own.
It doesn’t have to be like that.
If through my explaining the principles, you say to yourself, ‘yes, I know all that’ then fair enough. At least we’ve started with the basics rather than charged straight into the deep-end. Jumping to conclusions is what investors in commercial property generally do, only to discover that finding out the hard way can prove an expensive mistake.
Once upon a time, commercial property could be relied upon to adjust to its owner’s mistakes. Never mind if you got it wrong, somehow the market would find a way to bail you out. It’s different now. here have you heard that before? But it is. The commercial property market is polarising, it has been for years. Every so often another gap appears in the level of understanding whereupon another load of investors falls by the wayside. The credit-crunch, the recession, merely brought it to the surface. Take away the money-supply and the commercial property market is exposed for what it is. Overnight, yields soared, prices fell, loan covenants breached, the banks repossessed. An aberration in an otherwise long-term hedge that is generally interpreted a consequence of the state of the economy, but it wasn’t; at least not in my opinion, it wasn’t. I should know, I act for and against more than enough different landlords to know whose investments have powered ahead despite the downturn, and whose haven’t.
The experts tell us the property market is cyclical, but is it? Perhaps it’s steady all the way. Naturally, life has ups-and-downs, but attitudes are flexible, we can remain in sync. We’re not supposed to come unstuck in times of change. Thinking problems are normal is where people go wrong.
In my philosophy, a problem is symptomatic of a fault in direction: either you are thinking the wrong way for you, or the wrong way for the property, or a combination of both. The wrong way for you could be that you’re not cut out for commercial property, you don’t have what it takes to manage the investment as it should be done. The wrong way for the property is that it is no longer fit for purpose, it has outlived its usefulness.
A cyclical market can become a roller-coaster, bliss “if you like that sort of thing” (to quote the comic actor Tim Brooke-Taylor), but perhaps the norm is when yield is high, commensurate with the risk? After all, when you assess a commercial property investment based upon property fundamentals, as distinct from comparing returns with what you get from cash on deposit, it is unlikely there’ll be that many places where growth would be expected.
Performance is the measure of growth. Whether after allowing for all the costs, and adjusting for inflation, and net of tax you are actually that much better off – and not just in the long-run, but from day one.
The ‘day one’ test is that if you were to sell the property on the day immediately following exchange of contracts or completion then you’d get your money back and more. Even if ‘day one’ is too much like wishful thinking for your taste, whatever longer period of time you’d prefer, the test is whether at any point in time your investment would pass the test of getting your money back and more, regardless of the state of the market.
———————————–
The property market is composed of owner-occupiers, developers, landlords (also known as investors) and tenants (also known as occupiers).
There are two ways to participate in the commercial property investment market: each has its advantages and disadvantages.
You can invest in commercial property indirectly, buying shares in a quoted property company on the stock-market, or a property investment trust, or real estate investment trust (REIT), or property unit trust (PUT), or property fund or a property bond. With indirect investment, you are entrusting the success of your investment to the skills and judgement of the directors and managers of the company, and your interpretation of the company’s accounts. A key indicator is the net asset value, so why pay more for a share than the NAV. Share prices at a premium to NAV are an expectancy that the NAV will continue to rise, but it may not. The stock may be in short-supply so you may be competing with demand or market-makers flexing their muscles. In any event, NAV is not enough by itself: it’s also a question of who provided the valuation: surveyors vary in their opinions and estimates from the cautious to the optimistic. It’s also a question of the quality of the company’s existing properties and whether if in the market to sell they’d then fetch at least the same as the value in the company’s books. Where’s the money coming from to pay dividends and how come the directors and staff get pay rises and issue themselves with stock options, but the shareholders can’t count on getting higher dividends. Then there’s the ultimate challenge for anyone investing in equities: timing the volatility of the stock market.
You can invest directly in commercial property, either buying an empty property and letting it from scratch and/or developing the property into something more valuable or buying an existing investment; in doing so you are exposed to an unregulated market. To give the impression that the risk of loss would be minimised, the market is dominated by professional advisers: surveyors, lawyers, and accountants, many of whom also advise the banks and other lenders on the value of property.
(Another way, which is nearly the same as buying directly, is to be a tenant, buy the freehold (assuming the owner would sell) and then when you sell your business as a going-concern, keep the property and grant a new lease to the buyer of your business. )
The volume of information on-line and in the media has exacerbated the mass-market influences for how to appraise commercial property for investment but rarely are the reasons for under-and non-performance of commercial property investments highlighted. The reason I suspect is that the emphasis is on getting you to invest and thereafter using the advisers’ services to maximise performance.
Advisers have a duty of care but the duty doesn’t always extend beyond the adviser’s client. For the most part, it’s caveat emptor (“let the buyer beware”). Therefore, if you choose to be on your own, left to your own devices, and take the view that the people who run the market presumably know what they’re doing, then don’t complain when the experts tell you that the state of the market is the reason your investment isn’t performing as well as you expected when you bought it.
For successful investment in commercial property, there are three levels of understanding, all inter-dependent, and none of which should be considered in isolation:
Generally, property fundamentals are easily identifiable. Technical analysis is experience of business tenancy law and valuation. Sentiment is when investors get carried away.
Market activity and momentum conveys feelings of comfort and reassurance but, when you go along with what you think others know, all you’re doing is following: buying into investor confidence, what is known as market sentiment. Fair enough if you’re going to cash in and sell as prices rise further, but not if you’re planning to hold long-term for a pension plan. Property dealers trade but, generally, investors buy to hold for at the least the duration of the mortgage.
Wealth warning: sentiment is mostly hot air which makes the market hot and inflates bubbles.
A bubble is a situation where market prices are unsustainable. The life-cycle of a bubble starts with the stealth phase, the smart money. As the market takes off, and institutional investors become interested, the first sell off occurs. With the media attention, that grabs the enthusiasm of public, the mania phase fuels greed and delusion. At the peak is the new paradigm, the shift in thinking. Demand wobbles. A sell off occurs. Rebound. Fear and collapse set in. Despair arrives. As the dust settles, demand slowly picks up and return to the mean average.
At present, the market is booming, apparently it’s a no-brainer not to get involved. Low interest rates, awash with cash from overseas investors, émigrés fleeing equities and bonds, and anticipation of a wall of money from cashed-in pension pots. A leading auctioneer tells me demand for commercial property investment is outstripping supply, especially in London and the South-East. The state of the market is bound to be different this time. It always is, that’s the nature of sentiment, very persuasive.
Having set your sights on what you want to buy, a great deal of time, effort and cost can be expended on the preliminaries, so wondering about changing your mind at the last minute can be put down to pre-marital nerves. If you buy by private treaty then you can’t back out because word would soon get around the investment community that you’re unreliable, your word is not your bond, so you’ll have to exchange regardless, or come up with a plausible excuse.
It’s at times like these when stopping to think is crucial. Never mind the cost of borrowing and the yield that can be bought, the question is where is the demand going to come from to provide capital and rental growth. Why should the tenant want to pay more, when most tenants are struggling as it is or bargain-hunting? And if you think tenants have no choice because the rent review is upward-only then you really don’t understand.
There’s another thing: a difference exists between price and market value. Price is subjective, whatever the seller wants and how much the buyer is willing to pay. Market value is objective, what someone else would pay. If you don’t understand the difference or don’t think there is a difference then that’s where you’ll be going wrong.
Caveat emptor. The first point to remember about price is that when you buy, the seller is wanting to sell you something which, until you’ve bought, you might not discover what it is. With private treaty, ‘subject to contract’. you can take as long as you like for due-diligence, subject to the seller’s patience, but the answers to pre-contract enquiries are only as good as the questions you’ve asked. When you buy at auction, you only have about 6-8 weeks to make enquiries and carry out research, so you’ll have to have your wits about you, which should include someone on your side to point out the pitfalls and ensure any assumptions you may be making are in fact correct.
Commercial property investment involves commercial contracts, which means the parties are deemed to know what they’re doing. It’s one thing to know what you are doing when you do what you know, quite another to know what to do when something goes wrong or more usefully to know how to avoid going wrong in the first place.
The role of professional advisers is to help landlords and tenants to be successful. Professional advisers are know-alls, or at least they should be. We know that landlords become successful when their investments perform. We also know that tenants become successful not just when their businesses are performing well but also when the total property cost commitment is kept to a minimum. In our professional capacity, we’re on the client’s side. But deep down it’s a matter of whose side your adviser is really on, and that would depend upon a host of factors. In private, in our personal political views and ideology, we might be outright capitalist, woolly-headed liberal, or hardened socialist. Caring about the wider-consequences? How far we allow our personal beliefs to influence our professional advice depends upon our attitude, our experience, whether we mix business with pleasure, and our principal source of earnings.
Principal-to-principal, in theory, the relationship between landlord and tenant should be a partnership. In practice, it is not. In practice, there is wariness on both sides and in many cases a deep resentment that, through operation of law, rental valuation, and cunning, often involving skillful advisers, the landlord or the tenant is better off at the expense of the other.
The reason for the difference in achievement is that the commercial property market is not a perfect market which, from an investment perspective, is just as well, because the purpose of a perfect market is not to make profits, but to efficiently allocate resources. In a perfect market, profit is a sign of inefficiency, whereas in an imperfect market, profit arises in direct proportion to the imperfections. In a perfect market, there is a large number of buyers, a large number of sellers, the quantity bought by any individual so small relative to the total quantity traded that individual trades leave the market unaffected; the product is homogeneous (the same property for all buyers and sellers), all buyers and sellers have complete information on the prices being asked and offered in other parts of the market; and there is perfect freedom of entry to and exit from the market. In an imperfect market, there is no level playing field. Different people, different levels of experience, different approaches to asset management, some passive, others pro-active. As a tenant-client told me “for lessons in how to be stitched up, the shop property market has no equal”. Not just how to capitalise on opportunities but how to create opportunities. It all adds up to know-how.
As a specialist in rent review and business tenancy advice for landlords and retailers, I work at the sharp end of commercial property market, to be precise, shop property. I’m not an agent in the general-public perception of estate agency. My work is almost entirely behind-the scenes. Sometimes investors consult me on whether a proposition would be a good buy, but mostly I get involved after the property has been bought and at the stage when the landlord wants to take a back-seat in dealings with the tenant, for example on requests for assignment of the lease and such like, or at rent review and tenancy expiry/renewal when the relationship between landlord and tenant is more likely to be fraught.
Whether you are a landlord or a tenant, an advantage of your instructing a surveyor is to have a ‘shield’ between you and the other party. When you deal with the matter yourself, personality issues can get in the way and you could end being accommodating and agreeing to things that you wouldn’t otherwise or a surveyor would question. I tailor my approach to suit the client’s objective, the circumstances, the nature of the parties, so on.
The work is demanding and over the years has become more tiring. That is not a feature of advancing years, young surveyors tell me how exhausting the work can be. It would be so much easier if the other side would give in to reason without a fight, without resorting to ploys that can inject fear into cautious landlords and tenants. Socially, I’ll tell people what I do if they ask and if they probe then I say I argue for a living. It’s not ‘New Age’ negotiation “you win, I win, everyone’s happy”, but ruthless ‘I win, you lose’. I use my skills to increase rent for landlords, unless acting for the tenants in which case I’ll do the reverse. It may not be politically-correct to ignore the wider consequences and disregard the layer of socialism that pervades most walks of life, as summed up in the phrase “we’re all in this together” but when I’m being paid for my services, I’m a technician, not a philosopher. I can discuss whether something is a good idea, I can advise on the consequences, I can recommend, but ultimately it’s up to the client to decide.
Frankly, I think many landlords get a raw deal from tenants, especially from some multiple retailers whose surveyors seem to delight in putting the wind-up landlords. Something tenants are good at is selling: selling the idea they can’t afford any more, selling the idea they’d trigger the break clause if the landlord won’t agree. Whatever the ploy, it’s all grist to the mill of reducing property costs and keeping up appearances.
Is it possible for a surveyor to sit on the metaphorical fence, one moment acting for a landlord, the next for a tenant? In my philosophy, there is no need for emotional involvement or attachment. As a vegetarian, I wouldn’t be able to do my job properly if I were squeamish about going into a butcher’s shop. The more cosmopolitan the commercial property market becomes, the greater the diversity in attitude, the more flexible in views, opinions and application of skill one must be to stay on the ball. For me, landlords and tenants fall into two categories: those whose business methods and attitude generally I admire and respect, and everyone else. Over the years, I’ve honed my early warning system. Generally, people self-select. Even so, it’s not that easy to sift the wheat from the chaff: often the truth doesn’t emerge until after the work is underway. Ultimately, it’s about discernment: about helping the sort of people I like, people on the same wavelength.
Shortly after I established my practice, a public property company instructed me to manage a parade of shops and offices. Although I do manage property for a few clients, full management is not a service I offer as a matter of course – mostly I provide assisted-management, for example, the landlord deals with the rent collection, I do everything else. Curious why a plc should want me of all people to undertake full management, I was told that was the only way the company could instruct me to do any work for them and which it wanted to do because it was scared I should act against them!
I am unsure what I did to deserve being described as the ‘most obstinate surveyor in Harrow’ by a surveyor whom I crossed swords with on occasions, but as my reputation began to precede me, it got to the point that an auctioneer said that if it were known I were acting for the tenant then prospective investors could forget any idea of getting a rent increase. Over 20 years ago, having relocated my office to Herefordshire, where away from the noise and stress of London, it’s possible to think clearly, I had a go at mixing business with pleasure (until the novelty wore off and I reverted to my own method of marketing my services). The experience paid off: a tenant instructed me to deal with a rent review. The landlord had had a go himself but the tenant didn’t want to pay so much, so the landlord instructed a local surveyor who turned up the heat. I inspected the premises, read the lease, and told the surveyor no increase. The surveyor’s response that I might be right but if I wanted to get on in this part of the world then I should learn to play the game. I said I was happy to learn provided it wouldn’t cost my client any more. My client agreed with me, the landlord conceded.
Often employed as a troubleshooter, I crop up all over England and Wales but the bulk of my work is in London and the South-East. Dealing with different landlords, different tenants, different types of property, different locations, I have extensive experience of diversity.
Whether landlord or tenant, principals in commercial property market comprise professionals and amateurs. Professionals wouldn’t dream of agreeing to anything without taking advice and tend to stick with their trusted advisers, through thick and thin. Amateurs seem more concerned about the cost of advice than the quality, so shop around. The commercial property market attracts parasites: people that have latched on to property’s popularity and produce glowing reports and blind you with statistics. They take your money for transactions and all the glossy-stuff but frankly they haven’t a clue about life at the sharp end of tenancy management. Blaming the state of the market is an excuse which sounds plausible because investors are conditioned to think like that. Hence, if you invest without taking advice from people who really know their stuff, but instead doing your own research, gathering informations from all manner of sources and from that conclude that it can’t possibly be as complicated as the experts make out then you’d be correct in theory were it not for the difference between what it says in the classroom textbook and what happens in practice.
Most or all of which may be easier said than done, because investors generally are far more influenced towards poor judgement than they might realise. In this scientific world we have created for ourselves, opinions that are not evidence-based don’t seem to count for much. Yet successful investment is not only about considering the evidence, but also the art of knowing.
Knowing is awareness, about being informed. Knowing is different from knowledge. Facts, information and skills can all be learned and from experience relied upon. But experience may be out-of-date, limited, or not suited to different ways of thinking. Knowledge provides a basis for logic. People are comfortable with logic: it is reasoned so it follows. But, logical thinking is based on past experience, whereas the future is uncertain. Life changes, attitudes shift, people change. That’s why past performance is no guide to the future. No one knows for sure, but that doesn’t mean we can’t predict with a fair degree of accuracy, especially when you know what you’re about. Which brings me to asking you to ask yourself: what are you about? What is it about you that would enable you to appraise an investment with sufficient confidence to be certain of your conclusion. How come you can pick winners?
Successful investment in commercial property includes the ability to be discerning, the more adept you become, the more you can gauge at a glance whether the proposition is likely to perform. Performance despite any resistance by the tenant. Why would the tenant resist?
The answer is that you understand the market in which you’re investing. You understand what makes it tick and where it’s heading.
It’s when you don’t understand the fundamental principles that you are likely to come unstuck somewhere along the way. With commercial property, coming unstuck is what plenty of investors do do through fault of their own.
It doesn’t have to be like that.
If through my explaining the principles, you say to yourself, ‘yes, I know all that’ then fair enough. At least we’ve started with the basics rather than charged straight into the deep-end. Jumping to conclusions is what investors in commercial property generally do, only to discover that finding out the hard way can prove an expensive mistake.
Once upon a time, commercial property could be relied upon to adjust to its owner’s mistakes. Never mind if you got it wrong, somehow the market would find a way to bail you out. It’s different now. here have you heard that before? But it is. The commercial property market is polarising, it has been for years. Every so often another gap appears in the level of understanding whereupon another load of investors falls by the wayside. The credit-crunch, the recession, merely brought it to the surface. Take away the money-supply and the commercial property market is exposed for what it is. Overnight, yields soared, prices fell, loan covenants breached, the banks repossessed. An aberration in an otherwise long-term hedge that is generally interpreted a consequence of the state of the economy, but it wasn’t; at least not in my opinion, it wasn’t. I should know, I act for and against more than enough different landlords to know whose investments have powered ahead despite the downturn, and whose haven’t.
The experts tell us the property market is cyclical, but is it? Perhaps it’s steady all the way. Naturally, life has ups-and-downs, but attitudes are flexible, we can remain in sync. We’re not supposed to come unstuck in times of change. Thinking problems are normal is where people go wrong.
In my philosophy, a problem is symptomatic of a fault in direction: either you are thinking the wrong way for you, or the wrong way for the property, or a combination of both. The wrong way for you could be that you’re not cut out for commercial property, you don’t have what it takes to manage the investment as it should be done. The wrong way for the property is that it is no longer fit for purpose, it has outlived its usefulness.
A cyclical market can become a roller-coaster, bliss “if you like that sort of thing” (to quote the comic actor Tim Brooke-Taylor), but perhaps the norm is when yield is high, commensurate with the risk? After all, when you assess a commercial property investment based upon property fundamentals, as distinct from comparing returns with what you get from cash on deposit, it is unlikely there’ll be that many places where growth would be expected.
Performance is the measure of growth. Whether after allowing for all the costs, and adjusting for inflation, and net of tax you are actually that much better off – and not just in the long-run, but from day one.
The ‘day one’ test is that if you were to sell the property on the day immediately following exchange of contracts or completion then you’d get your money back and more. Even if ‘day one’ is too much like wishful thinking for your taste, whatever longer period of time you’d prefer, the test is whether at any point in time your investment would pass the test of getting your money back and more, regardless of the state of the market.
———————————–
The property market is composed of owner-occupiers, developers, landlords (also known as investors) and tenants (also known as occupiers).
There are two ways to participate in the commercial property investment market: each has its advantages and disadvantages.
You can invest in commercial property indirectly, buying shares in a quoted property company on the stock-market, or a property investment trust, or real estate investment trust (REIT), or property unit trust (PUT), or property fund or a property bond. With indirect investment, you are entrusting the success of your investment to the skills and judgement of the directors and managers of the company, and your interpretation of the company’s accounts. A key indicator is the net asset value, so why pay more for a share than the NAV. Share prices at a premium to NAV are an expectancy that the NAV will continue to rise, but it may not. The stock may be in short-supply so you may be competing with demand or market-makers flexing their muscles. In any event, NAV is not enough by itself: it’s also a question of who provided the valuation: surveyors vary in their opinions and estimates from the cautious to the optimistic. It’s also a question of the quality of the company’s existing properties and whether if in the market to sell they’d then fetch at least the same as the value in the company’s books. Where’s the money coming from to pay dividends and how come the directors and staff get pay rises and issue themselves with stock options, but the shareholders can’t count on getting higher dividends. Then there’s the ultimate challenge for anyone investing in equities: timing the volatility of the stock market.
You can invest directly in commercial property, either buying an empty property and letting it from scratch and/or developing the property into something more valuable or buying an existing investment; in doing so you are exposed to an unregulated market. To give the impression that the risk of loss would be minimised, the market is dominated by professional advisers: surveyors, lawyers, and accountants, many of whom also advise the banks and other lenders on the value of property.
(Another way, which is nearly the same as buying directly, is to be a tenant, buy the freehold (assuming the owner would sell) and then when you sell your business as a going-concern, keep the property and grant a new lease to the buyer of your business. )
The volume of information on-line and in the media has exacerbated the mass-market influences for how to appraise commercial property for investment but rarely are the reasons for under-and non-performance of commercial property investments highlighted. The reason I suspect is that the emphasis is on getting you to invest and thereafter using the advisers’ services to maximise performance.
Advisers have a duty of care but the duty doesn’t always extend beyond the adviser’s client. For the most part, it’s caveat emptor (“let the buyer beware”). Therefore, if you choose to be on your own, left to your own devices, and take the view that the people who run the market presumably know what they’re doing, then don’t complain when the experts tell you that the state of the market is the reason your investment isn’t performing as well as you expected when you bought it.
For successful investment in commercial property, there are three levels of understanding, all inter-dependent, and none of which should be considered in isolation:
- Property fundamentals
- Technical analysis
- Sentiment
Generally, property fundamentals are easily identifiable. Technical analysis is experience of business tenancy law and valuation. Sentiment is when investors get carried away.
Market activity and momentum conveys feelings of comfort and reassurance but, when you go along with what you think others know, all you’re doing is following: buying into investor confidence, what is known as market sentiment. Fair enough if you’re going to cash in and sell as prices rise further, but not if you’re planning to hold long-term for a pension plan. Property dealers trade but, generally, investors buy to hold for at the least the duration of the mortgage.
Wealth warning: sentiment is mostly hot air which makes the market hot and inflates bubbles.
A bubble is a situation where market prices are unsustainable. The life-cycle of a bubble starts with the stealth phase, the smart money. As the market takes off, and institutional investors become interested, the first sell off occurs. With the media attention, that grabs the enthusiasm of public, the mania phase fuels greed and delusion. At the peak is the new paradigm, the shift in thinking. Demand wobbles. A sell off occurs. Rebound. Fear and collapse set in. Despair arrives. As the dust settles, demand slowly picks up and return to the mean average.
At present, the market is booming, apparently it’s a no-brainer not to get involved. Low interest rates, awash with cash from overseas investors, émigrés fleeing equities and bonds, and anticipation of a wall of money from cashed-in pension pots. A leading auctioneer tells me demand for commercial property investment is outstripping supply, especially in London and the South-East. The state of the market is bound to be different this time. It always is, that’s the nature of sentiment, very persuasive.
Having set your sights on what you want to buy, a great deal of time, effort and cost can be expended on the preliminaries, so wondering about changing your mind at the last minute can be put down to pre-marital nerves. If you buy by private treaty then you can’t back out because word would soon get around the investment community that you’re unreliable, your word is not your bond, so you’ll have to exchange regardless, or come up with a plausible excuse.
It’s at times like these when stopping to think is crucial. Never mind the cost of borrowing and the yield that can be bought, the question is where is the demand going to come from to provide capital and rental growth. Why should the tenant want to pay more, when most tenants are struggling as it is or bargain-hunting? And if you think tenants have no choice because the rent review is upward-only then you really don’t understand.
There’s another thing: a difference exists between price and market value. Price is subjective, whatever the seller wants and how much the buyer is willing to pay. Market value is objective, what someone else would pay. If you don’t understand the difference or don’t think there is a difference then that’s where you’ll be going wrong.
Caveat emptor. The first point to remember about price is that when you buy, the seller is wanting to sell you something which, until you’ve bought, you might not discover what it is. With private treaty, ‘subject to contract’. you can take as long as you like for due-diligence, subject to the seller’s patience, but the answers to pre-contract enquiries are only as good as the questions you’ve asked. When you buy at auction, you only have about 6-8 weeks to make enquiries and carry out research, so you’ll have to have your wits about you, which should include someone on your side to point out the pitfalls and ensure any assumptions you may be making are in fact correct.
Commercial property investment involves commercial contracts, which means the parties are deemed to know what they’re doing. It’s one thing to know what you are doing when you do what you know, quite another to know what to do when something goes wrong or more usefully to know how to avoid going wrong in the first place.
The role of professional advisers is to help landlords and tenants to be successful. Professional advisers are know-alls, or at least they should be. We know that landlords become successful when their investments perform. We also know that tenants become successful not just when their businesses are performing well but also when the total property cost commitment is kept to a minimum. In our professional capacity, we’re on the client’s side. But deep down it’s a matter of whose side your adviser is really on, and that would depend upon a host of factors. In private, in our personal political views and ideology, we might be outright capitalist, woolly-headed liberal, or hardened socialist. Caring about the wider-consequences? How far we allow our personal beliefs to influence our professional advice depends upon our attitude, our experience, whether we mix business with pleasure, and our principal source of earnings.
Principal-to-principal, in theory, the relationship between landlord and tenant should be a partnership. In practice, it is not. In practice, there is wariness on both sides and in many cases a deep resentment that, through operation of law, rental valuation, and cunning, often involving skillful advisers, the landlord or the tenant is better off at the expense of the other.
The reason for the difference in achievement is that the commercial property market is not a perfect market which, from an investment perspective, is just as well, because the purpose of a perfect market is not to make profits, but to efficiently allocate resources. In a perfect market, profit is a sign of inefficiency, whereas in an imperfect market, profit arises in direct proportion to the imperfections. In a perfect market, there is a large number of buyers, a large number of sellers, the quantity bought by any individual so small relative to the total quantity traded that individual trades leave the market unaffected; the product is homogeneous (the same property for all buyers and sellers), all buyers and sellers have complete information on the prices being asked and offered in other parts of the market; and there is perfect freedom of entry to and exit from the market. In an imperfect market, there is no level playing field. Different people, different levels of experience, different approaches to asset management, some passive, others pro-active. As a tenant-client told me “for lessons in how to be stitched up, the shop property market has no equal”. Not just how to capitalise on opportunities but how to create opportunities. It all adds up to know-how.
As a specialist in rent review and business tenancy advice for landlords and retailers, I work at the sharp end of commercial property market, to be precise, shop property. I’m not an agent in the general-public perception of estate agency. My work is almost entirely behind-the scenes. Sometimes investors consult me on whether a proposition would be a good buy, but mostly I get involved after the property has been bought and at the stage when the landlord wants to take a back-seat in dealings with the tenant, for example on requests for assignment of the lease and such like, or at rent review and tenancy expiry/renewal when the relationship between landlord and tenant is more likely to be fraught.
Whether you are a landlord or a tenant, an advantage of your instructing a surveyor is to have a ‘shield’ between you and the other party. When you deal with the matter yourself, personality issues can get in the way and you could end being accommodating and agreeing to things that you wouldn’t otherwise or a surveyor would question. I tailor my approach to suit the client’s objective, the circumstances, the nature of the parties, so on.
The work is demanding and over the years has become more tiring. That is not a feature of advancing years, young surveyors tell me how exhausting the work can be. It would be so much easier if the other side would give in to reason without a fight, without resorting to ploys that can inject fear into cautious landlords and tenants. Socially, I’ll tell people what I do if they ask and if they probe then I say I argue for a living. It’s not ‘New Age’ negotiation “you win, I win, everyone’s happy”, but ruthless ‘I win, you lose’. I use my skills to increase rent for landlords, unless acting for the tenants in which case I’ll do the reverse. It may not be politically-correct to ignore the wider consequences and disregard the layer of socialism that pervades most walks of life, as summed up in the phrase “we’re all in this together” but when I’m being paid for my services, I’m a technician, not a philosopher. I can discuss whether something is a good idea, I can advise on the consequences, I can recommend, but ultimately it’s up to the client to decide.
Frankly, I think many landlords get a raw deal from tenants, especially from some multiple retailers whose surveyors seem to delight in putting the wind-up landlords. Something tenants are good at is selling: selling the idea they can’t afford any more, selling the idea they’d trigger the break clause if the landlord won’t agree. Whatever the ploy, it’s all grist to the mill of reducing property costs and keeping up appearances.
Is it possible for a surveyor to sit on the metaphorical fence, one moment acting for a landlord, the next for a tenant? In my philosophy, there is no need for emotional involvement or attachment. As a vegetarian, I wouldn’t be able to do my job properly if I were squeamish about going into a butcher’s shop. The more cosmopolitan the commercial property market becomes, the greater the diversity in attitude, the more flexible in views, opinions and application of skill one must be to stay on the ball. For me, landlords and tenants fall into two categories: those whose business methods and attitude generally I admire and respect, and everyone else. Over the years, I’ve honed my early warning system. Generally, people self-select. Even so, it’s not that easy to sift the wheat from the chaff: often the truth doesn’t emerge until after the work is underway. Ultimately, it’s about discernment: about helping the sort of people I like, people on the same wavelength.
Shortly after I established my practice, a public property company instructed me to manage a parade of shops and offices. Although I do manage property for a few clients, full management is not a service I offer as a matter of course – mostly I provide assisted-management, for example, the landlord deals with the rent collection, I do everything else. Curious why a plc should want me of all people to undertake full management, I was told that was the only way the company could instruct me to do any work for them and which it wanted to do because it was scared I should act against them!
I am unsure what I did to deserve being described as the ‘most obstinate surveyor in Harrow’ by a surveyor whom I crossed swords with on occasions, but as my reputation began to precede me, it got to the point that an auctioneer said that if it were known I were acting for the tenant then prospective investors could forget any idea of getting a rent increase. Over 20 years ago, having relocated my office to Herefordshire, where away from the noise and stress of London, it’s possible to think clearly, I had a go at mixing business with pleasure (until the novelty wore off and I reverted to my own method of marketing my services). The experience paid off: a tenant instructed me to deal with a rent review. The landlord had had a go himself but the tenant didn’t want to pay so much, so the landlord instructed a local surveyor who turned up the heat. I inspected the premises, read the lease, and told the surveyor no increase. The surveyor’s response that I might be right but if I wanted to get on in this part of the world then I should learn to play the game. I said I was happy to learn provided it wouldn’t cost my client any more. My client agreed with me, the landlord conceded.
Often employed as a troubleshooter, I crop up all over England and Wales but the bulk of my work is in London and the South-East. Dealing with different landlords, different tenants, different types of property, different locations, I have extensive experience of diversity.
Whether landlord or tenant, principals in commercial property market comprise professionals and amateurs. Professionals wouldn’t dream of agreeing to anything without taking advice and tend to stick with their trusted advisers, through thick and thin. Amateurs seem more concerned about the cost of advice than the quality, so shop around. The commercial property market attracts parasites: people that have latched on to property’s popularity and produce glowing reports and blind you with statistics. They take your money for transactions and all the glossy-stuff but frankly they haven’t a clue about life at the sharp end of tenancy management. Blaming the state of the market is an excuse which sounds plausible because investors are conditioned to think like that. Hence, if you invest without taking advice from people who really know their stuff, but instead doing your own research, gathering informations from all manner of sources and from that conclude that it can’t possibly be as complicated as the experts make out then you’d be correct in theory were it not for the difference between what it says in the classroom textbook and what happens in practice.
Investment Psychology
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.
The practical is the time that it takes to make a profit; the psychological the level of risk that the investor is willing to shoulder. How much profit depends upon your personal definition of whether the amount of profit is worthwhile. For example, if you want to make a profit to enable you to afford a property in a different league then the profit from each proposition could be likened to stepping stones.
A plan for creating a commercial property portfolio from scratch is to buy with a mortgage then re-mortgage the equity at intervals and use the released money to buy more property.
A difference ought not to exist between investment and successful investment but it does. Property is a depreciating asset whose value fluctuates depending on the state of the market. Allowing for costs of buying and selling, management costs, mortgage interest including loss of notional interest on personal equity, and adjusting for inflation and taxes, an investment might not perform as well as imagined.
If you ignore all those factors and simply calculate profit as the difference between how much you paid and what the property would fetch were you to sell it then growth is largely a delusion.
The rate of depreciation is not a constant so that in itself is challenging. To exceed or at least maintain parity with the rate of depreciation, the investment will have to perform. Property performance is the measure of growth.
Property has a reputation as a long-term hedge against inflation but, when you invest in property, you are not buying into the market in its entirety, but a particular property. Therefore, the criteria for whether the proposition is likely to perform needs to be assessed against that particular property, regardless of what might be happening in the market generally.
It may be suggested there is never a right time to buy property but there is. There are only two times: (1) when the seller has under-priced the value of the property, or (2) when mortgages are difficult to come by.
To assess whether a proposition is under-priced, you really have to know your stuff: the technicalities and the fundamentals. If you simply assess by reference to superficial criteria (for example, yield) then a proposition could appear cheap when actually it is not.
When credit is hard to get and market activity is driven by cash buyers, most investors will be left out in the cold. When bank lending criteria is relaxed, the number of investors increases and so do selling prices.
For successful investment, a rising market is a double-edged sword: on one side, an improvement in sentiment is comforting generally so can override caution. On the other, higher prices bring better quality propositions onto the market, thereby testing buyer experience of the nature of potential and the challenge of whether the propositions are really that much better.
Most investments fail to perform, sometimes miserably, but if your luck’s in then they end up ordinary, nothing special. Two reasons investments fail to succeed is to do with misunderstanding initial yield and buying covenant.
Yield is a measure of the rental return you’ll get from the property, all being well, but it is not the only measure. Indeed, it could be the least important even though the inexperienced invariably regard yield as paramount.
Over the years, covenant, the tenant’s financial standing, has worked its way up the appraisal–ladder, so much so that it has usurped technicalities and fundamentals and created a new layer of analysis: sentiment.
If you are borrowing to buy then the cost of borrowing may need to be covered by the rental. I emphasise ‘may’ because not all investors suffer the iniquity of having to justify each proposition to a lender. Many investors have facilities that do not require them to get the bank’s permission beforehand. When each proposition has to stack up so far as the bank is concerned, the buyer is less likely to apply for a loan on a proposition that the bank would reject. Hence, the popularity of readily-mortgageable investments.
For sellers, the measure of popularity amongst buyers is heaven-sent: attractively packaged, an investment dressed up to look good and ticking all the right boxes on the buyer checklist, such as long term lease and tenant covenant, is a guarantee that the price obtainable will most likely exceed the value of the proposition.
Value is not the same as price. Price is subjective. Price is the worth of the property to the buyer, the price that the buyer is willing to pay. Value is objective, how much the market would pay. Most buyers do not see it like that; most buyers think they are the market. Their concerns are for the attractiveness of the proposition.
The negative aspects are discounted in favour of the plus points. Criticism can sound illogical and be interpreted as out of touch. In this scientific world we have created for ourselves, the only test is evidence.
Opinions don’t count for much. Pitfalls can be explained away, doubts dispelled by overlooking the blemishes. Excited by market momentum, itching to spend, money burning a hole in the investor pocket, infected with auction fever, a show of hands, enthusiasm carries them away.
Investors that think themselves the market and take comfort from prices obtained in auction rooms are living in cloud cuckoo-land. If you do not strip away the superficiality and expose the proposition for what it is, if you do not listen to what you don’t want to hear, then more than likely you are going to experience the difference between investment and successful investment.
The practical is the time that it takes to make a profit; the psychological the level of risk that the investor is willing to shoulder. How much profit depends upon your personal definition of whether the amount of profit is worthwhile. For example, if you want to make a profit to enable you to afford a property in a different league then the profit from each proposition could be likened to stepping stones.
A plan for creating a commercial property portfolio from scratch is to buy with a mortgage then re-mortgage the equity at intervals and use the released money to buy more property.
A difference ought not to exist between investment and successful investment but it does. Property is a depreciating asset whose value fluctuates depending on the state of the market. Allowing for costs of buying and selling, management costs, mortgage interest including loss of notional interest on personal equity, and adjusting for inflation and taxes, an investment might not perform as well as imagined.
If you ignore all those factors and simply calculate profit as the difference between how much you paid and what the property would fetch were you to sell it then growth is largely a delusion.
The rate of depreciation is not a constant so that in itself is challenging. To exceed or at least maintain parity with the rate of depreciation, the investment will have to perform. Property performance is the measure of growth.
Property has a reputation as a long-term hedge against inflation but, when you invest in property, you are not buying into the market in its entirety, but a particular property. Therefore, the criteria for whether the proposition is likely to perform needs to be assessed against that particular property, regardless of what might be happening in the market generally.
It may be suggested there is never a right time to buy property but there is. There are only two times: (1) when the seller has under-priced the value of the property, or (2) when mortgages are difficult to come by.
To assess whether a proposition is under-priced, you really have to know your stuff: the technicalities and the fundamentals. If you simply assess by reference to superficial criteria (for example, yield) then a proposition could appear cheap when actually it is not.
When credit is hard to get and market activity is driven by cash buyers, most investors will be left out in the cold. When bank lending criteria is relaxed, the number of investors increases and so do selling prices.
For successful investment, a rising market is a double-edged sword: on one side, an improvement in sentiment is comforting generally so can override caution. On the other, higher prices bring better quality propositions onto the market, thereby testing buyer experience of the nature of potential and the challenge of whether the propositions are really that much better.
Most investments fail to perform, sometimes miserably, but if your luck’s in then they end up ordinary, nothing special. Two reasons investments fail to succeed is to do with misunderstanding initial yield and buying covenant.
Yield is a measure of the rental return you’ll get from the property, all being well, but it is not the only measure. Indeed, it could be the least important even though the inexperienced invariably regard yield as paramount.
Over the years, covenant, the tenant’s financial standing, has worked its way up the appraisal–ladder, so much so that it has usurped technicalities and fundamentals and created a new layer of analysis: sentiment.
If you are borrowing to buy then the cost of borrowing may need to be covered by the rental. I emphasise ‘may’ because not all investors suffer the iniquity of having to justify each proposition to a lender. Many investors have facilities that do not require them to get the bank’s permission beforehand. When each proposition has to stack up so far as the bank is concerned, the buyer is less likely to apply for a loan on a proposition that the bank would reject. Hence, the popularity of readily-mortgageable investments.
For sellers, the measure of popularity amongst buyers is heaven-sent: attractively packaged, an investment dressed up to look good and ticking all the right boxes on the buyer checklist, such as long term lease and tenant covenant, is a guarantee that the price obtainable will most likely exceed the value of the proposition.
Value is not the same as price. Price is subjective. Price is the worth of the property to the buyer, the price that the buyer is willing to pay. Value is objective, how much the market would pay. Most buyers do not see it like that; most buyers think they are the market. Their concerns are for the attractiveness of the proposition.
The negative aspects are discounted in favour of the plus points. Criticism can sound illogical and be interpreted as out of touch. In this scientific world we have created for ourselves, the only test is evidence.
Opinions don’t count for much. Pitfalls can be explained away, doubts dispelled by overlooking the blemishes. Excited by market momentum, itching to spend, money burning a hole in the investor pocket, infected with auction fever, a show of hands, enthusiasm carries them away.
Investors that think themselves the market and take comfort from prices obtained in auction rooms are living in cloud cuckoo-land. If you do not strip away the superficiality and expose the proposition for what it is, if you do not listen to what you don’t want to hear, then more than likely you are going to experience the difference between investment and successful investment.
Eureka
14/March/2014 - LandlordZONE - Autobiography - Experience - RICS - Blundell Memorial Lecture - Estates Gazette - Publications
After resigning from the partnership (? please read my first blog), for a while I rented a room from my ex-partners but, finding them nosy, I served notice, much their annoyance at loss of revenue, and relocated to renting a small self-contained office building in South Harrow which in keeping with delusions of grandeur I named “Lever House’.
On my own, with a part-time secretary, I started with the management of a parade of shops in Acton, London W3, the rent reviews of some industrial premises in Park Royal, and a few other instructions. I was trading as Fineman Lever & Co which led to special dispensation from the Registrar of Business Names because there were four different businesses all with that name: my father’s business in Acton, his original partner’s Central London office which by then was separate to my father’s and managed property for Dorrington Investments, the business of my ex-partners, and mine. Having the same name particularly in the Harrow area was causing confusion amongst clients and well-wishers so my assistant, whom I’d taken on to handle agency instructions, came up with the idea of Lever Commercial. I don’t think I was the first to add “Commercial’ to a trading name but the publicity I was generating as a consequence of my next decision certainly inspired dozens of agents and surveyors throughout the UK to tag ‘Commercial’ to their business names.
The decision that changed the course of my career history, and led to helping to create what has since become a vast industry for surveyors and lawyers, happened later on in 1975 after I’d been to an industry conference about rent review. One of the speakers, an eminent solicitor, said that the cause of problems at rent review was lack of communication between lawyers and surveyors in the drafting of leases. Spotting a gap in the market, I decided to specialise in rent review and lease renewal and promptly announced my services to the market.
For a while I had the field to myself. In those days, it was contrary to RICS rules for chartered surveyors to promote themselves as ‘specialists’ but soon after my publicity machine got going the RICS relaxed its rules whereupon chartered surveyors flooded the market themselves also claiming to be rent review specialists.
How to stand out from the crowd is all about marketing. Never one for mixing business with pleasure, I rely on different ways of attracting and retaining clients for my services. Unlike those people that find it easier to talk, I find it easier to write. Unlike those that prefer to copy, I find it easier to originate. Writing was the obvious route, but writing is only half the fun, the challenge is what to say.
My newsletter came about in consequence of writing so many letters to the Estates Gazette and other leading journals that hardly a week elapsed before another of my missives was published. Also, a surveyor-friend had asked me to suggest a topic he could write about so that if his letter were published in the EG then his bosses and colleagues would praise him. My suggestion of a topic that I was saving for my future use led to him getting an EG editorial on the same theme as well, he was delighted but of course I’d missed out. My having won an acknowledgement for initiating the longest-running correspondence in the Estate Gazette on a single subject, namely overage and non-standard rent-review intervals, and having been mentioned in a Blundell Memorial Lecture and as footnote in two law books, and what with publishing booklets of my own, including ‘Framework of Rent Review Clauses”, “How to do a Rent Review”, “How to Read an Auction Catalogue” and “Investment in Secondary Shops”, I concluded it might be better to publish my own newsletter in which I could say whatever I liked and to whom rather than risk censorship by the establishment or compete for editorial space.
In 1984, I launched a newsletter entitled Quarterly Commentary, which I subsequently renamed Current Review, and more recently Rent Review Matters. Rather than just a puff to be read and discarded, I wanted the content to be read and kept. In those days, I was in my spare time involved in the ‘mind-body-spirit’ New Age movement, having discovered I was a gifted healer and adept at relationship counselling. To be part of the ‘Green’ movement, I created Marketing Yourself, a business development philosophy for self-employed practitioners and therapists in the complementary and alternative health-care market; many of the people I helped have since become leading lights in their fields. Sensing the concepts of personal development as applied to business would become more mainstream if presented in a tangible pragmatic way, I incorporated a great deal of comment and advice in my newsletter for clients and contacts.
After a while, I dropped Lever Commercial in favour of Michael Lever. It’s easy for me to be myself. Fast-forward to the present, it is getting on for 40 years since I pioneered specialising in rent review and lease renewal. The market for my services has matured and evolved. Nowadays, it’s not only surveyors that deal with rent review, but also lawyers and accountants; and increasingly landlords and tenants are doing it themselves. It doesn’t help that the market is polarising between rent reviews that are worth doing so far as the landlord or tenant is concerned, and those reviews that are non-starters. A trend towards shorter leases is leading a reduction in rent review but an increase in tenancy expiry and renewal, even though to have a longer lease with break clause is often cheaper for the parties.
Anyone with money can buy a commercial property, but successful investment in commercial property requires a different mind-set. Activity in the investment market does not necessarily rub off on rental growth. Property is a depreciating asset. With costs and stamp duty, the moment you buy a property it goes down in value. Capital appreciation may come from blips in yield and/or confidence compression, but for greater certainty of performance, particularly for long-term pension planning, capital appreciation is best derived from rental growth. Rental growth is a product of judicious choice, shrewd management, a feel for tenant-dynamics, and a deep understanding of business tenancy law and rental valuation.
Successful investment is also about timing. The best time to buy is when there’s no money about, the worst time when credit is easy to come by. However, a paradox of market momentum is that the better properties are more likely to come up for sale when prices are high, which means the investor has to weigh up the likelihood of over-paying against the potential for further growth.
It is said that surveyors that deal with rent review have a greater understanding of business tenancy law and rental valuation than most. I also have an unusually good understanding of retailing as well as property. Over the course of this on-going blog, I shall explain how that understanding can be used to maintain and enhance the value of commercial property so that landlords can enjoy long-term consistent success, without coming unstuck in times of change.
As I say on my website, http://www.michaellever.co.uk, rent review is at the heart of commercial property.
I look forward to helping you in some way.
On my own, with a part-time secretary, I started with the management of a parade of shops in Acton, London W3, the rent reviews of some industrial premises in Park Royal, and a few other instructions. I was trading as Fineman Lever & Co which led to special dispensation from the Registrar of Business Names because there were four different businesses all with that name: my father’s business in Acton, his original partner’s Central London office which by then was separate to my father’s and managed property for Dorrington Investments, the business of my ex-partners, and mine. Having the same name particularly in the Harrow area was causing confusion amongst clients and well-wishers so my assistant, whom I’d taken on to handle agency instructions, came up with the idea of Lever Commercial. I don’t think I was the first to add “Commercial’ to a trading name but the publicity I was generating as a consequence of my next decision certainly inspired dozens of agents and surveyors throughout the UK to tag ‘Commercial’ to their business names.
The decision that changed the course of my career history, and led to helping to create what has since become a vast industry for surveyors and lawyers, happened later on in 1975 after I’d been to an industry conference about rent review. One of the speakers, an eminent solicitor, said that the cause of problems at rent review was lack of communication between lawyers and surveyors in the drafting of leases. Spotting a gap in the market, I decided to specialise in rent review and lease renewal and promptly announced my services to the market.
For a while I had the field to myself. In those days, it was contrary to RICS rules for chartered surveyors to promote themselves as ‘specialists’ but soon after my publicity machine got going the RICS relaxed its rules whereupon chartered surveyors flooded the market themselves also claiming to be rent review specialists.
How to stand out from the crowd is all about marketing. Never one for mixing business with pleasure, I rely on different ways of attracting and retaining clients for my services. Unlike those people that find it easier to talk, I find it easier to write. Unlike those that prefer to copy, I find it easier to originate. Writing was the obvious route, but writing is only half the fun, the challenge is what to say.
My newsletter came about in consequence of writing so many letters to the Estates Gazette and other leading journals that hardly a week elapsed before another of my missives was published. Also, a surveyor-friend had asked me to suggest a topic he could write about so that if his letter were published in the EG then his bosses and colleagues would praise him. My suggestion of a topic that I was saving for my future use led to him getting an EG editorial on the same theme as well, he was delighted but of course I’d missed out. My having won an acknowledgement for initiating the longest-running correspondence in the Estate Gazette on a single subject, namely overage and non-standard rent-review intervals, and having been mentioned in a Blundell Memorial Lecture and as footnote in two law books, and what with publishing booklets of my own, including ‘Framework of Rent Review Clauses”, “How to do a Rent Review”, “How to Read an Auction Catalogue” and “Investment in Secondary Shops”, I concluded it might be better to publish my own newsletter in which I could say whatever I liked and to whom rather than risk censorship by the establishment or compete for editorial space.
In 1984, I launched a newsletter entitled Quarterly Commentary, which I subsequently renamed Current Review, and more recently Rent Review Matters. Rather than just a puff to be read and discarded, I wanted the content to be read and kept. In those days, I was in my spare time involved in the ‘mind-body-spirit’ New Age movement, having discovered I was a gifted healer and adept at relationship counselling. To be part of the ‘Green’ movement, I created Marketing Yourself, a business development philosophy for self-employed practitioners and therapists in the complementary and alternative health-care market; many of the people I helped have since become leading lights in their fields. Sensing the concepts of personal development as applied to business would become more mainstream if presented in a tangible pragmatic way, I incorporated a great deal of comment and advice in my newsletter for clients and contacts.
After a while, I dropped Lever Commercial in favour of Michael Lever. It’s easy for me to be myself. Fast-forward to the present, it is getting on for 40 years since I pioneered specialising in rent review and lease renewal. The market for my services has matured and evolved. Nowadays, it’s not only surveyors that deal with rent review, but also lawyers and accountants; and increasingly landlords and tenants are doing it themselves. It doesn’t help that the market is polarising between rent reviews that are worth doing so far as the landlord or tenant is concerned, and those reviews that are non-starters. A trend towards shorter leases is leading a reduction in rent review but an increase in tenancy expiry and renewal, even though to have a longer lease with break clause is often cheaper for the parties.
Anyone with money can buy a commercial property, but successful investment in commercial property requires a different mind-set. Activity in the investment market does not necessarily rub off on rental growth. Property is a depreciating asset. With costs and stamp duty, the moment you buy a property it goes down in value. Capital appreciation may come from blips in yield and/or confidence compression, but for greater certainty of performance, particularly for long-term pension planning, capital appreciation is best derived from rental growth. Rental growth is a product of judicious choice, shrewd management, a feel for tenant-dynamics, and a deep understanding of business tenancy law and rental valuation.
Successful investment is also about timing. The best time to buy is when there’s no money about, the worst time when credit is easy to come by. However, a paradox of market momentum is that the better properties are more likely to come up for sale when prices are high, which means the investor has to weigh up the likelihood of over-paying against the potential for further growth.
It is said that surveyors that deal with rent review have a greater understanding of business tenancy law and rental valuation than most. I also have an unusually good understanding of retailing as well as property. Over the course of this on-going blog, I shall explain how that understanding can be used to maintain and enhance the value of commercial property so that landlords can enjoy long-term consistent success, without coming unstuck in times of change.
As I say on my website, http://www.michaellever.co.uk, rent review is at the heart of commercial property.
I look forward to helping you in some way.
Once upon a time…
It was in 1967, about a week after I left school just before my 18th birthday, that I got my first job as an employee at Montagu Evans & Son as it then was in Central London. A junior in the town planning department, along with errands for the surveyors, the job included colour-washing plans for appeals. It took a while to get the hang of the standard expected but once I’d got the knack I found it relaxing to spend time at a drawing board with paintbrushes and water-colours.
ME acted for major developers and I was on the planning team for the development of Brent Cross shopping centre, town centre schemes in Stockport, Saffron Walden and Cardiff, the latter involved a land use survey of the city. One job involved preparing plans on parchment for a private Act of Parliament to build on a disused cemetery.
My mother, more ambitious for my future, remarked that I couldn’t spend the rest of my life colouring plans so despite the pecking order whereby longer-serving juniors were given first refusal when vacancies arose I applied for and was transferred to another department. Others were not amused by my jumping the queue and the longest-serving junior left soon after.
In the management department, I looked after some residential properties. A block of flats in Sutton, Surrey, some tenanted houses in Brixton and West Ealing, London and an estate in Homerton, East London. The properties in West Ealing and Brixton were owned by an elderly spinster. Every year it fell upon my boss to take her out for lunch. When he suggested I do the honours, I was told I could keep the visit short but I got on well with the client so I didn’t. In Homerton, the weekly rent collection was every Monday morning. I’d travel straight there from home arriving by about 10am then walk the streets, knocking on doors and collecting rents and by about midday I’d travel by bus to ME’s office in Holborn, my raincoat pockets weighed down with coins and notes.
It was one of those estates where everyone knew one another and whenever a property became vacant someone related to someone already living on the estate would take over. I used to dress up for the occasion and plodded the streets by the same route every week for over a year cash-in-hand, but my successor wore a suit and after just a few weeks he was mugged, the cash stolen. After that all tenants were required to pay the rent either by cheque, postal order or banker’s standing order.
Elderly client didn’t have the money for the urgent repairs so we avoided local council enforcement by selling her properties in Brixton. To be rid of the responsibility entirely, she instructed us to also sell the 6 houses in West Ealing. In those days, ‘tenanted’ meant Rent Act controlled and regulated tenancies and tenanted residential property was valued not as nowadays as a percentage of capital value with vacant possession but by deducting estimated management costs and repairs from the gross rent, then multiplying the net rent by the years-purchase (YP is another way of estimating yield). Each house with sitting tenant valued at £1200 was offered for sale individually in the market whereupon all 6 were immediately snapped up by property ‘dealers’ – it was to be my real taste of decision-makers.
Five evenings a week I was attending evening classes at the College of Estate Management, then in South Kensington to study for qualification for the Chartered Auctioneers Institute (the CAI later merged with the Royal Institution of Chartered Surveyors). Frankly if it hadn’t been for my father’s sniffiness about the Incorporated Society of Valuers and Auctioneers, I could have become an associate member of the ISVA on the strength of my ‘O’ levels and without examination subsequently a Chartered Surveyor when the ISVA also merged with the RICS.
I might have worked my way up the career ladder of Montagu Evans had it not been for my getting claustrophobia on the London underground tube-trains so with travelling to and from work becoming impossible I left their employ in 1971. At a loss for what to do, my father, a chartered surveyor (BSc (Est Man, FRICS) offered me a job at the Harrow, NW London, estate agency branch of his firm.
I took a drop in salary from £11 to £8 a week but was given a company car. A strange experience being the boss’s son being shown the ropes by the long-serving estate agency staff and working in a town that was alien to me, I didn’t last long selling houses and ever since I’ve admired anyone that deals with the general public on a regular basis.
Whether my training at ME in Central London had prepared me, or helped reinforce my propensity for long-term thinking, in Harrow, out in the sticks, I found myself in the deep end of local insularity and indecision-makers. My father was based at his office in Acton, London W3 where behind closed doors managed estates of tenanted property and blocks of flats for landlords and residents alike. I worked at a desk in full view of passers-by where anyone off the street could open the door and enter. The Harrow office was all that was left of 3 estate agency branches that my father and his former business partner had bought from the final days of Corry and Corry. In their heyday, Corry had dominated the residential property market in NW Middlesex/South Hertfordshire, with little or no competition. Amongst old particulars found whilst having a clear-out was a lesson in inflation: a 7 bedroom/4 reception room detached photogenic house, a prime address priced at £5000. The other branches were in Rickmansworth and Eastcote, Rickmansworth didn’t last long for some reason and was disposed of. During my teens when at school I had a Saturday job at the Eastcote office helping with a building society agency; people depositing and withdrawing savings.
The Eastcote office, on the wrong side of the road, only paid its way from building society commission for by then more dynamic agents had set up in the wake of Corry. Harrow office was the jewel in the crown: panel surveyors for banks and building societies, including the Halifax. It must’ve been something to do with our corporate image in the eyes of the public, because the quality of agency instructions tended to be better than run-of-mill properties our competitors got but it didn’t matter because unless a property was good enough to sell itself the local agents circulated instructions on a half-commission sharing. I’d got involved with a local association of estate agents whose code of conduct was constantly under attack from what we respectables called sharp practice. Unable to stop the tide, I suggested a change in the rules; the proposal was voted in and led to the disbanding of the association.
Having had my fill of an indecisive general public, I turned to residential investment and commercial property. A contact from my time at Montagu Evans led to the acquisition of a block of shops and offices in Brentford which my contact, himself ex-ME, viewed in fog and exchanged contracts a few days later.
During the early 1970s there was a rise in inflation caused by the oil crisis, base rate rose from under 8% to over 14% and property prices were on the up. Having become friendly with some property dealers, I was hearing about propositions that were not on the market and felt I was in the swing of things. In one example, a dealer while at a theatre one evening overheard a conversation about a buyer hesitating whether to buy a large portfolio for several million pounds. Next morning, the dealer contacted the seller and within hours had exchanged contracts. I suggested my father’s office to manage the properties that passed through this dealer’s hands: it proved a successful relationship while it lasted, despite my father being more accustomed to the definition of investment as meaning years rather than days and weeks.
Harrow office was autonomous, with an overdraft. After the manager left, I head-hunted someone locally respected from another agent and with the chartered surveyor for surveys, we were all made equity partners. I was 23 and single, my colleagues in their 30s and married with young children, my father in his 50s with my mother and my sister. My father was not a wealthy man in his own right: amongst his wider family were cousins whom I was told had had Rolls-Royces and chauffeurs pre-war, but his own circumstances were much more modest.
My father’s main assets were academic giftedness, never spending a penny of capital, and only living off income: I have never managed to emulate those achievements! My father wasn’t involved with the running of the Harrow office on a daily basis and we three were left to our own devices. It was decided, I don’t remember being consulted, we should each contribute equally to the total revenue. I think that was one of the factors contributing to the failure of the partnership.
My work was longer-term and wishful thinking, theirs short turnaround and certain. Ups-and-downs, interrogation and often stressful, in 1975, my relationship with the others having become untenable, I resigned to set up on my own. The split was backdated: required to reimburse expenses I’d incurred whilst under the same roof. I also bought my car from them for the princely sum of £1100 which is the only time in my life when thanks to the devaluation of the Deutsche Mark the value of a second-hand car increased when I sold it a year later.
Shortly before I set up on my own, I’d had a good year, all my long-term jobs having reached fruition so wanting a place of my own to live in I’d bought a house on Harrow-on-the Hill, a terraced 2-up-2-down in need of modernisation. I paid £9800 with £9000 mortgage from a building society. The property needed a lot spending on it to make it habitable and I got an improvement grant from the Council which I later had to repay in full because I forgot that I couldn’t sell the property for 5 years.
I didn’t have much in the way of savings, having to reimburse my ex-partners which I paid in instalments, and the cost of setting up on my own, it was a struggle. The first year on my own I earned £975 after tax; my accountant enquired whether it was worth it.
To be continued…
ME acted for major developers and I was on the planning team for the development of Brent Cross shopping centre, town centre schemes in Stockport, Saffron Walden and Cardiff, the latter involved a land use survey of the city. One job involved preparing plans on parchment for a private Act of Parliament to build on a disused cemetery.
My mother, more ambitious for my future, remarked that I couldn’t spend the rest of my life colouring plans so despite the pecking order whereby longer-serving juniors were given first refusal when vacancies arose I applied for and was transferred to another department. Others were not amused by my jumping the queue and the longest-serving junior left soon after.
In the management department, I looked after some residential properties. A block of flats in Sutton, Surrey, some tenanted houses in Brixton and West Ealing, London and an estate in Homerton, East London. The properties in West Ealing and Brixton were owned by an elderly spinster. Every year it fell upon my boss to take her out for lunch. When he suggested I do the honours, I was told I could keep the visit short but I got on well with the client so I didn’t. In Homerton, the weekly rent collection was every Monday morning. I’d travel straight there from home arriving by about 10am then walk the streets, knocking on doors and collecting rents and by about midday I’d travel by bus to ME’s office in Holborn, my raincoat pockets weighed down with coins and notes.
It was one of those estates where everyone knew one another and whenever a property became vacant someone related to someone already living on the estate would take over. I used to dress up for the occasion and plodded the streets by the same route every week for over a year cash-in-hand, but my successor wore a suit and after just a few weeks he was mugged, the cash stolen. After that all tenants were required to pay the rent either by cheque, postal order or banker’s standing order.
Elderly client didn’t have the money for the urgent repairs so we avoided local council enforcement by selling her properties in Brixton. To be rid of the responsibility entirely, she instructed us to also sell the 6 houses in West Ealing. In those days, ‘tenanted’ meant Rent Act controlled and regulated tenancies and tenanted residential property was valued not as nowadays as a percentage of capital value with vacant possession but by deducting estimated management costs and repairs from the gross rent, then multiplying the net rent by the years-purchase (YP is another way of estimating yield). Each house with sitting tenant valued at £1200 was offered for sale individually in the market whereupon all 6 were immediately snapped up by property ‘dealers’ – it was to be my real taste of decision-makers.
Five evenings a week I was attending evening classes at the College of Estate Management, then in South Kensington to study for qualification for the Chartered Auctioneers Institute (the CAI later merged with the Royal Institution of Chartered Surveyors). Frankly if it hadn’t been for my father’s sniffiness about the Incorporated Society of Valuers and Auctioneers, I could have become an associate member of the ISVA on the strength of my ‘O’ levels and without examination subsequently a Chartered Surveyor when the ISVA also merged with the RICS.
I might have worked my way up the career ladder of Montagu Evans had it not been for my getting claustrophobia on the London underground tube-trains so with travelling to and from work becoming impossible I left their employ in 1971. At a loss for what to do, my father, a chartered surveyor (BSc (Est Man, FRICS) offered me a job at the Harrow, NW London, estate agency branch of his firm.
I took a drop in salary from £11 to £8 a week but was given a company car. A strange experience being the boss’s son being shown the ropes by the long-serving estate agency staff and working in a town that was alien to me, I didn’t last long selling houses and ever since I’ve admired anyone that deals with the general public on a regular basis.
Whether my training at ME in Central London had prepared me, or helped reinforce my propensity for long-term thinking, in Harrow, out in the sticks, I found myself in the deep end of local insularity and indecision-makers. My father was based at his office in Acton, London W3 where behind closed doors managed estates of tenanted property and blocks of flats for landlords and residents alike. I worked at a desk in full view of passers-by where anyone off the street could open the door and enter. The Harrow office was all that was left of 3 estate agency branches that my father and his former business partner had bought from the final days of Corry and Corry. In their heyday, Corry had dominated the residential property market in NW Middlesex/South Hertfordshire, with little or no competition. Amongst old particulars found whilst having a clear-out was a lesson in inflation: a 7 bedroom/4 reception room detached photogenic house, a prime address priced at £5000. The other branches were in Rickmansworth and Eastcote, Rickmansworth didn’t last long for some reason and was disposed of. During my teens when at school I had a Saturday job at the Eastcote office helping with a building society agency; people depositing and withdrawing savings.
The Eastcote office, on the wrong side of the road, only paid its way from building society commission for by then more dynamic agents had set up in the wake of Corry. Harrow office was the jewel in the crown: panel surveyors for banks and building societies, including the Halifax. It must’ve been something to do with our corporate image in the eyes of the public, because the quality of agency instructions tended to be better than run-of-mill properties our competitors got but it didn’t matter because unless a property was good enough to sell itself the local agents circulated instructions on a half-commission sharing. I’d got involved with a local association of estate agents whose code of conduct was constantly under attack from what we respectables called sharp practice. Unable to stop the tide, I suggested a change in the rules; the proposal was voted in and led to the disbanding of the association.
Having had my fill of an indecisive general public, I turned to residential investment and commercial property. A contact from my time at Montagu Evans led to the acquisition of a block of shops and offices in Brentford which my contact, himself ex-ME, viewed in fog and exchanged contracts a few days later.
During the early 1970s there was a rise in inflation caused by the oil crisis, base rate rose from under 8% to over 14% and property prices were on the up. Having become friendly with some property dealers, I was hearing about propositions that were not on the market and felt I was in the swing of things. In one example, a dealer while at a theatre one evening overheard a conversation about a buyer hesitating whether to buy a large portfolio for several million pounds. Next morning, the dealer contacted the seller and within hours had exchanged contracts. I suggested my father’s office to manage the properties that passed through this dealer’s hands: it proved a successful relationship while it lasted, despite my father being more accustomed to the definition of investment as meaning years rather than days and weeks.
Harrow office was autonomous, with an overdraft. After the manager left, I head-hunted someone locally respected from another agent and with the chartered surveyor for surveys, we were all made equity partners. I was 23 and single, my colleagues in their 30s and married with young children, my father in his 50s with my mother and my sister. My father was not a wealthy man in his own right: amongst his wider family were cousins whom I was told had had Rolls-Royces and chauffeurs pre-war, but his own circumstances were much more modest.
My father’s main assets were academic giftedness, never spending a penny of capital, and only living off income: I have never managed to emulate those achievements! My father wasn’t involved with the running of the Harrow office on a daily basis and we three were left to our own devices. It was decided, I don’t remember being consulted, we should each contribute equally to the total revenue. I think that was one of the factors contributing to the failure of the partnership.
My work was longer-term and wishful thinking, theirs short turnaround and certain. Ups-and-downs, interrogation and often stressful, in 1975, my relationship with the others having become untenable, I resigned to set up on my own. The split was backdated: required to reimburse expenses I’d incurred whilst under the same roof. I also bought my car from them for the princely sum of £1100 which is the only time in my life when thanks to the devaluation of the Deutsche Mark the value of a second-hand car increased when I sold it a year later.
Shortly before I set up on my own, I’d had a good year, all my long-term jobs having reached fruition so wanting a place of my own to live in I’d bought a house on Harrow-on-the Hill, a terraced 2-up-2-down in need of modernisation. I paid £9800 with £9000 mortgage from a building society. The property needed a lot spending on it to make it habitable and I got an improvement grant from the Council which I later had to repay in full because I forgot that I couldn’t sell the property for 5 years.
I didn’t have much in the way of savings, having to reimburse my ex-partners which I paid in instalments, and the cost of setting up on my own, it was a struggle. The first year on my own I earned £975 after tax; my accountant enquired whether it was worth it.
To be continued…
Valuation and Over-Paying
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
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
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
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: firstly, because the relationship between landlord and tenant rests on a legally-binding contract, there is the potential for both capital and rental growth. Secondly, unlike the Stock Market where in the scheme of things individual private investors have little or no influence over the company’s performance, the property market offers the thought of being in control.
I emphasise ‘thought’ because landlords are not actually in as much control as they might like to think. The landlord owns the building, not the tenant’s business and tenants are not obliged to keep the landlord informed as regarding the intention for the business. All that a tenant is obliged to do is comply with the terms and conditions of the lease and even that the terms and conditions would be subject to any overriding legislation and/or business tenancy case-law. For example, a shop let to multiple retailer which might be thought a secure investment and hence command a higher capital value could fall in valley simply by the multiple retailer deciding to close the branch and assigning the tenancy or subletting the premises to a nobody.
Stocks and shares and property are forms of illiquid investment, but the stock market for the most part less so since buying and selling can be transacted within seconds, with middle-men, or market-makers, to take up the slack whenever demand and supply fluctuate. With property, however, there are no market-makers as such; to buy and sell a property requires a seller and a buyer, and to transact at the desired price requires a seller or buyer at that price.
With stocks and shares, share prices are published and during market hours a trade can be executed at or around the published price. It’s not like that with property: no published prices in advance, no certainty that what someone got for a particular property would result in at least the same price for a virtually identical property paid by someone else. As for value, some say that’s whatever the property fetches but actually the price could simply be a measure of worth for the buyer: otherwise, the market value is based upon one person’s opinion; an informed opinion provided by a professional, but an opinion nevertheless.
Despite the underlying value of property being anyone’s guess, another layer of value is added to be on the safe side. The income from a property let to a good covenant on a long lease also constitutes an investment. All other factors remaining constant, the best time to sell the investment layer is when the end of the lease is so far off that it becomes impossible for mere mortals to predict what would happen by then. For the same reason, it is also the worst time to buy, but that doesn’t stop investors piling in regardless. Because it is easier to mortgage a property let on a long lease and because the total income, ignoring any reviews, is known in advance, the present value of that income can be calculated.
The attraction and value of that present value fluctuates according to confidence in the investment market. Investment confidence varies with bank lending criteria. The easier and cheaper it is to borrow, the more risk may be taken, the higher the price. Conversely, the harder, the more expensive, the less risk, the lower the price.
A paradox of investment-thinking is the difference in attitude between experienced professional investors and everyone else. EPIs focus on the bottom-line: the worst scenario. Challenging at the best of times, protecting the bottom-line is not easy when wanting to invest at a time of improving sentiment. Sentiment is a measure of confidence. Increasing confidence attracts more investors and in turn becomes a virtuous circle, onwards and upwards. Momentum investing is like playing the game of musical chairs: you hope there’ll be somewhere to sit when the music stops. The property game is not limited to a few seats. Widespread availability of propositions enables investors to venture further afield. Outside the hot spots, yields are generally higher not because those places are necessarily neglected through oversight but that growth is hard to come by or non-existent. Despite lower prices, often there is considerably more risk.
On paper it makes sense to capitalise on the difference between the cost of borrowing and the yield obtainable. In practice, it may not make sense at all. A common failing is overestimating the growth potential and underestimating the cost of achieving growth. Often, both factors are symptomatic of tenant-covenant fixation.
Play your cards right and a great deal of money can be made from trading in momentum. Investing for ever requires a different mind-set. Not only a question of timing but also whether the initial yield would be sustainable. After an investment is bought, the investor becomes a landlord and experiences the reality of asset management. A test of performance is the rent review or lease renewal. Naturally, investors/landlords desire a return on capital that is commensurate with their expectations, but at rent review (assuming to market rent) or lease renewal the actual landlord’s aspirations are irrelevant and depending upon skill of the tenant’s advisers could result in less than expected. Moreover, a lot can happen to the whereabouts and/or to a property as time passes: the economy might improve but not rub off on a particular property. To cap it all, the tenant might go broke and the new tenant an inferior covenant.
Whatever the reason for the purchase price, whether sellers offering higher yields for the sole purpose of achieving the highest possible price or high prices bringing out better properties that would otherwise not be sold so commanding scarcity value, any difference between the fundamental value and the investment layer reflects buyers chasing rainbows.
I emphasise ‘thought’ because landlords are not actually in as much control as they might like to think. The landlord owns the building, not the tenant’s business and tenants are not obliged to keep the landlord informed as regarding the intention for the business. All that a tenant is obliged to do is comply with the terms and conditions of the lease and even that the terms and conditions would be subject to any overriding legislation and/or business tenancy case-law. For example, a shop let to multiple retailer which might be thought a secure investment and hence command a higher capital value could fall in valley simply by the multiple retailer deciding to close the branch and assigning the tenancy or subletting the premises to a nobody.
Stocks and shares and property are forms of illiquid investment, but the stock market for the most part less so since buying and selling can be transacted within seconds, with middle-men, or market-makers, to take up the slack whenever demand and supply fluctuate. With property, however, there are no market-makers as such; to buy and sell a property requires a seller and a buyer, and to transact at the desired price requires a seller or buyer at that price.
With stocks and shares, share prices are published and during market hours a trade can be executed at or around the published price. It’s not like that with property: no published prices in advance, no certainty that what someone got for a particular property would result in at least the same price for a virtually identical property paid by someone else. As for value, some say that’s whatever the property fetches but actually the price could simply be a measure of worth for the buyer: otherwise, the market value is based upon one person’s opinion; an informed opinion provided by a professional, but an opinion nevertheless.
Despite the underlying value of property being anyone’s guess, another layer of value is added to be on the safe side. The income from a property let to a good covenant on a long lease also constitutes an investment. All other factors remaining constant, the best time to sell the investment layer is when the end of the lease is so far off that it becomes impossible for mere mortals to predict what would happen by then. For the same reason, it is also the worst time to buy, but that doesn’t stop investors piling in regardless. Because it is easier to mortgage a property let on a long lease and because the total income, ignoring any reviews, is known in advance, the present value of that income can be calculated.
The attraction and value of that present value fluctuates according to confidence in the investment market. Investment confidence varies with bank lending criteria. The easier and cheaper it is to borrow, the more risk may be taken, the higher the price. Conversely, the harder, the more expensive, the less risk, the lower the price.
A paradox of investment-thinking is the difference in attitude between experienced professional investors and everyone else. EPIs focus on the bottom-line: the worst scenario. Challenging at the best of times, protecting the bottom-line is not easy when wanting to invest at a time of improving sentiment. Sentiment is a measure of confidence. Increasing confidence attracts more investors and in turn becomes a virtuous circle, onwards and upwards. Momentum investing is like playing the game of musical chairs: you hope there’ll be somewhere to sit when the music stops. The property game is not limited to a few seats. Widespread availability of propositions enables investors to venture further afield. Outside the hot spots, yields are generally higher not because those places are necessarily neglected through oversight but that growth is hard to come by or non-existent. Despite lower prices, often there is considerably more risk.
On paper it makes sense to capitalise on the difference between the cost of borrowing and the yield obtainable. In practice, it may not make sense at all. A common failing is overestimating the growth potential and underestimating the cost of achieving growth. Often, both factors are symptomatic of tenant-covenant fixation.
Play your cards right and a great deal of money can be made from trading in momentum. Investing for ever requires a different mind-set. Not only a question of timing but also whether the initial yield would be sustainable. After an investment is bought, the investor becomes a landlord and experiences the reality of asset management. A test of performance is the rent review or lease renewal. Naturally, investors/landlords desire a return on capital that is commensurate with their expectations, but at rent review (assuming to market rent) or lease renewal the actual landlord’s aspirations are irrelevant and depending upon skill of the tenant’s advisers could result in less than expected. Moreover, a lot can happen to the whereabouts and/or to a property as time passes: the economy might improve but not rub off on a particular property. To cap it all, the tenant might go broke and the new tenant an inferior covenant.
Whatever the reason for the purchase price, whether sellers offering higher yields for the sole purpose of achieving the highest possible price or high prices bringing out better properties that would otherwise not be sold so commanding scarcity value, any difference between the fundamental value and the investment layer reflects buyers chasing rainbows.