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Valuation and Over-Paying
01/March/2014
I want to dispel a widely held notion, the strong belief in which leads to investors overpaying for shop property. It is a notion that has contributed to substantial over-valuation (along with over-mortgaging by the banks and other lenders) of shop property investments for more than three decades.
When you buy a shop property for investment, you are not buying into the existing or proposed tenant's business: the only thing you own is the property itself. That is all. How the tenant chooses to run its business, the prospects for the business including the market sector the tenant's business serves, are nothing to do with you. You are buying the property and whether it is the entire building or part of a building, that is all. Therefore, the identity of the tenant makes no difference whatsoever to the value of the property. The only relevance of what is known as the 'covenant' of the tenant that makes a difference is the chances of rent on time and other requirements of the occupancy honoured throughout the term of the lease. Therefore, if you pay a higher price because the shop property is let to a well-known covenant, then that 'premium' adds to the risk and may not be recoverable when you want to sell.
To understand why even though there is no link between the value of the property and the tenant's covenant nevertheless a strong connection is made, it is necessary to go back to events in the shop property market during the mid-1970s. In 1972, all Asians were expelled from Uganda by Idi Amin, the president of Uganda at that time. Those holding British passports came to Britain. Many had been businesspeople in Africa and rebuilt up their lives in Britain. Some became retailers while others found suitable employment.
An explosive growth in demand for shops and retail businesses led to a widespread change in attitude. Before the immigration-influx, I think it fair to say many 'white' shopkeepers were living off their laurels, for example half-day closing during the week was the norm, trading times out of kilter with an increasingly cosmopolitan society. Asian shops, the ubiquitous 'Mr Patel', opened longer hours, closing at 10pm rather than 5.30pm, and extended the shopping week to include all day Sunday. Prices obtainable in the market for selling going-concern businesses also rose. In the newsagent, confectioner, tobacconist sector, ("CTN"), it was said a 'white' buyer would pay ten times turnover, but an 'Asian' buyer would pay fifteen times turnover. The difference in price was accounted for by removing staff costs and so on, because the Asian family would work in the shop. Strictly, it shouldn't make any difference to price payable that savings can be made from being more operationally efficient, but I do not think that was the agenda. It was not so much about wanting more income, so much as wanting more capital. By modernising the business, turnover could be increased and the business re-sold for a profit. It also gave the Asian family an opportunity to establish 'roots' in the wider community.
(The presence of Asian shopkeepers in Britain was by no means new. The earliest origins of settlement of South Asians in Great Britain is uncertain, perhaps the Middle Ages. By the late 19th/early 20th centuries there were approximately 70,000 South Asians in Britain and following World War II and the break-up of the British Empire, immigration increased throughout the 1950s and 1960s as citizens of Commonwealth countries and former Caribbean colonies moved to Britain. Following restrictions on primary immigration, much of the subsequent growth in the British Asian community has come from the births of second and third-generation Asian Britons. As time passes, the formation and development of community can alter the demographics. Southall, in north-west Greater London, for example, is a case in point. In 1950, the first group of South Asians arrived in Southall, reputedly recruited to work in a factory owned by a former British Army officer. With the closeness of expanding employment opportunities such as Heathrow Airport, nowadays over 55% of Southall's population of 70,000 is Indian/Pakistani, Southall has one of the largest Sikh Temples outside India and Southall contains the largest Asian shopping centre in the London area.)
An attraction of English property law is freehold ownership. As the ultimate owner of the property, freehold provides both physical and emotional security. Owning shop property freehold can contribute to status in community and business. As anyone that has tried to buy shop property for investment will testify, it is not an easy step. The first hurdle is convincing commercial property agencies you are serious! It's not that surveyors were impossible to deal with, simply they have regular buyers and saw no reason to give newcomers a bite of the cherry. Also, many established surveyors can't be bothered with inexperienced investors. Then there is a question of credibility. Unless you pay the asking price or your offer is very close, you risk being considered a time-waster. Similarly, if you mess about and delay exchange of contract and/or fail to complete. Moreover, there may be a language barrier. Even if you fulfil the criteria, there is no certainty of being offered anything with potential. The solution is to buy at property auctions. Property auctions lend themselves to anonymity. Property auctions have long been popular with people of all nationalities, but before the mid-1970s there was a greater tacit understanding of shop valuation methodology. What the new wave of investors did not appreciate (or at least not give an impression) was that, in principle, a high yield suggests a shop property where little or no capital growth is expected, conversely a low-yield offers prospects for growth. In any event, because the cost of borrowing money is the same nationwide, it made no sense to be able to buy a shop property investment yielding say 12% for a lower price pro-rata than a shop property showing 7%. Hence, what began to happen and rapidly gathered steam, until the influence of the change in approach became the 'norm', was for shop properties having little or no growth prospects to go up price which in turn led to an increase in price for properties with growth prospects.
Finance plays a pivotal role in the commercial property market. It is said that property investment is more about finance than property. When a buyer wants to mortgage an investment property, or needs a mortgage in order to buy the property in the first place, ways to repay the mortgage include the borrower's other sources of income and whether the yield on the property exceeds the instalment for payment of the mortgage. Whilst a lender will assess the credit-worthiness of the borrower, a lender is not normally interested in the prospects for the investment: all a mortgagee cares about is whether the borrower could honour the requirements of the mortgage, or in the event of default the property could be sold to repay the loan. The fact that high-yielding investments are more risky is of no consequence to the lender, and may in fact be considered more secure simply because of a higher yield. In effect, thanks to their mortgage criteria, what the banks have imposed on buyers of shop property is the equivalent of a business plan, whereby never mind whether the shop property constitutes an investment, all that matters is that the financial side of things stack up.
What stemmed from inexperience became the 'norm' thanks to mortgage valuation surveyors. The task of a mortgage valuation surveyor, often a chartered surveyor, is to give an opinion of the market value of the property. However, the market value of a property is only the value of the property itself. It is not the value of the investment. The investment comprises the property and any existing or proposed 'tenancy' involving that property. So, since the value of the investment can vary depending upon terms of the tenancy, arguably a valuation surveyor should make that clear in the report, otherwise there is the risk the banks could be misled into thinking lending on the property is more secure than it is.
The fact that a layer of variable value can be added to the intrinsic value of a property is not something lost on sellers. The marketing of commercial property for investment involves very sophisticated and shrewd techniques. For example, one of the most obvious ways to maximise the price is to create an investment that is readily mortgageable. When selling a shop property investment, the seller is not interested in the value of the property as such, but how much the property and all that comes with it is likely to fetch in the market. It is the existence of that subtle difference for which the inexperienced investor can pay a hefty price. Selling a shop property for investment is no different to any other form of selling. Dress it up to look its best and hope the buyer doesn't spot what's wrong. Any complaints afterwards can be met by caveat emptor: the buyer alone is responsible for checking the quality and suitability of goods before making the purchase. Moreover, unlike products and services where the seller might be concerned to safeguard reputation for future custom, a seller of shop property is unlikely to care a jot about goodwill.
Although the seller of shop property is unlikely to care about goodwill, the seller's agents are mindful of their reputation in the market. To maximise the selling process whilst attempting to minimise the repercussions of overpayment, auctioneers have, for some time, highlighted the financial status of the tenant in the auction catalogue, for example the retailer's number of branches, latest turnover and profit figures.
Covenant and early review lots are guaranteed to fetch top prices. In the details, much emphasis is given to the date of review, with the estimated rental value suggested, either by having issued the rent review notice quoting a very high proposal, or by stating the vendor's opinion of rental value, or by citing a brief mention of a nearby new letting.
Pre-occupation with quality of covenant has driven investment yields down to levels which, for the type of property, is more commonly expected for prime propositions, offering assured long-term growth!
Consequently, what has happened is that not only has the way shop property is valued disconnected from fundamental principles, but also the banks and vested interests have create a market that is completely divorced from the reality of property itself. The test of that claim is easy to pass, for example: imagine two shop properties, next door to each other, both shops identical size, layout, etc, both let for 20 years at the same rent with rent reviews at five yearly intervals. One shop is let to a national multiple retailer with dozens of branches, the other to a local shopkeeper with just that one shop. Both properties are offered for sale by auction on the same date by the same auctioneer. What's the betting the shop let to the multiple retailer would fetch a higher price?
In my opinion, it is not up to valuation surveyors to insist banks lend only on the value of the property, as distinct from the market value of the investment. That decision is for the banks alone. However, I do consider valuation surveyors have a duty of care to ensure the banks understand there is a difference which might not necessarily be allowed for in the 'forced' sale valuation. A definition of 'forced sale' valuation is "the highest price which a property can reasonably be expected to bring, if offered for sale without the consent or concurrence of the owner by virtue of judicial process, in what may be a restricted market place, within a restricted time frame, to a prudent, willing and able purchaser who may have limited knowledge about the property, its uses and capability." If the forced sale valuation is a percentage of the market value of the property then in my opinion the mortgage is likely to be more secure, than if the forced sale value is the valuation of the investment.
When you buy a shop property for investment, you are not buying into the existing or proposed tenant's business: the only thing you own is the property itself. That is all. How the tenant chooses to run its business, the prospects for the business including the market sector the tenant's business serves, are nothing to do with you. You are buying the property and whether it is the entire building or part of a building, that is all. Therefore, the identity of the tenant makes no difference whatsoever to the value of the property. The only relevance of what is known as the 'covenant' of the tenant that makes a difference is the chances of rent on time and other requirements of the occupancy honoured throughout the term of the lease. Therefore, if you pay a higher price because the shop property is let to a well-known covenant, then that 'premium' adds to the risk and may not be recoverable when you want to sell.
To understand why even though there is no link between the value of the property and the tenant's covenant nevertheless a strong connection is made, it is necessary to go back to events in the shop property market during the mid-1970s. In 1972, all Asians were expelled from Uganda by Idi Amin, the president of Uganda at that time. Those holding British passports came to Britain. Many had been businesspeople in Africa and rebuilt up their lives in Britain. Some became retailers while others found suitable employment.
An explosive growth in demand for shops and retail businesses led to a widespread change in attitude. Before the immigration-influx, I think it fair to say many 'white' shopkeepers were living off their laurels, for example half-day closing during the week was the norm, trading times out of kilter with an increasingly cosmopolitan society. Asian shops, the ubiquitous 'Mr Patel', opened longer hours, closing at 10pm rather than 5.30pm, and extended the shopping week to include all day Sunday. Prices obtainable in the market for selling going-concern businesses also rose. In the newsagent, confectioner, tobacconist sector, ("CTN"), it was said a 'white' buyer would pay ten times turnover, but an 'Asian' buyer would pay fifteen times turnover. The difference in price was accounted for by removing staff costs and so on, because the Asian family would work in the shop. Strictly, it shouldn't make any difference to price payable that savings can be made from being more operationally efficient, but I do not think that was the agenda. It was not so much about wanting more income, so much as wanting more capital. By modernising the business, turnover could be increased and the business re-sold for a profit. It also gave the Asian family an opportunity to establish 'roots' in the wider community.
(The presence of Asian shopkeepers in Britain was by no means new. The earliest origins of settlement of South Asians in Great Britain is uncertain, perhaps the Middle Ages. By the late 19th/early 20th centuries there were approximately 70,000 South Asians in Britain and following World War II and the break-up of the British Empire, immigration increased throughout the 1950s and 1960s as citizens of Commonwealth countries and former Caribbean colonies moved to Britain. Following restrictions on primary immigration, much of the subsequent growth in the British Asian community has come from the births of second and third-generation Asian Britons. As time passes, the formation and development of community can alter the demographics. Southall, in north-west Greater London, for example, is a case in point. In 1950, the first group of South Asians arrived in Southall, reputedly recruited to work in a factory owned by a former British Army officer. With the closeness of expanding employment opportunities such as Heathrow Airport, nowadays over 55% of Southall's population of 70,000 is Indian/Pakistani, Southall has one of the largest Sikh Temples outside India and Southall contains the largest Asian shopping centre in the London area.)
An attraction of English property law is freehold ownership. As the ultimate owner of the property, freehold provides both physical and emotional security. Owning shop property freehold can contribute to status in community and business. As anyone that has tried to buy shop property for investment will testify, it is not an easy step. The first hurdle is convincing commercial property agencies you are serious! It's not that surveyors were impossible to deal with, simply they have regular buyers and saw no reason to give newcomers a bite of the cherry. Also, many established surveyors can't be bothered with inexperienced investors. Then there is a question of credibility. Unless you pay the asking price or your offer is very close, you risk being considered a time-waster. Similarly, if you mess about and delay exchange of contract and/or fail to complete. Moreover, there may be a language barrier. Even if you fulfil the criteria, there is no certainty of being offered anything with potential. The solution is to buy at property auctions. Property auctions lend themselves to anonymity. Property auctions have long been popular with people of all nationalities, but before the mid-1970s there was a greater tacit understanding of shop valuation methodology. What the new wave of investors did not appreciate (or at least not give an impression) was that, in principle, a high yield suggests a shop property where little or no capital growth is expected, conversely a low-yield offers prospects for growth. In any event, because the cost of borrowing money is the same nationwide, it made no sense to be able to buy a shop property investment yielding say 12% for a lower price pro-rata than a shop property showing 7%. Hence, what began to happen and rapidly gathered steam, until the influence of the change in approach became the 'norm', was for shop properties having little or no growth prospects to go up price which in turn led to an increase in price for properties with growth prospects.
Finance plays a pivotal role in the commercial property market. It is said that property investment is more about finance than property. When a buyer wants to mortgage an investment property, or needs a mortgage in order to buy the property in the first place, ways to repay the mortgage include the borrower's other sources of income and whether the yield on the property exceeds the instalment for payment of the mortgage. Whilst a lender will assess the credit-worthiness of the borrower, a lender is not normally interested in the prospects for the investment: all a mortgagee cares about is whether the borrower could honour the requirements of the mortgage, or in the event of default the property could be sold to repay the loan. The fact that high-yielding investments are more risky is of no consequence to the lender, and may in fact be considered more secure simply because of a higher yield. In effect, thanks to their mortgage criteria, what the banks have imposed on buyers of shop property is the equivalent of a business plan, whereby never mind whether the shop property constitutes an investment, all that matters is that the financial side of things stack up.
What stemmed from inexperience became the 'norm' thanks to mortgage valuation surveyors. The task of a mortgage valuation surveyor, often a chartered surveyor, is to give an opinion of the market value of the property. However, the market value of a property is only the value of the property itself. It is not the value of the investment. The investment comprises the property and any existing or proposed 'tenancy' involving that property. So, since the value of the investment can vary depending upon terms of the tenancy, arguably a valuation surveyor should make that clear in the report, otherwise there is the risk the banks could be misled into thinking lending on the property is more secure than it is.
The fact that a layer of variable value can be added to the intrinsic value of a property is not something lost on sellers. The marketing of commercial property for investment involves very sophisticated and shrewd techniques. For example, one of the most obvious ways to maximise the price is to create an investment that is readily mortgageable. When selling a shop property investment, the seller is not interested in the value of the property as such, but how much the property and all that comes with it is likely to fetch in the market. It is the existence of that subtle difference for which the inexperienced investor can pay a hefty price. Selling a shop property for investment is no different to any other form of selling. Dress it up to look its best and hope the buyer doesn't spot what's wrong. Any complaints afterwards can be met by caveat emptor: the buyer alone is responsible for checking the quality and suitability of goods before making the purchase. Moreover, unlike products and services where the seller might be concerned to safeguard reputation for future custom, a seller of shop property is unlikely to care a jot about goodwill.
Although the seller of shop property is unlikely to care about goodwill, the seller's agents are mindful of their reputation in the market. To maximise the selling process whilst attempting to minimise the repercussions of overpayment, auctioneers have, for some time, highlighted the financial status of the tenant in the auction catalogue, for example the retailer's number of branches, latest turnover and profit figures.
Covenant and early review lots are guaranteed to fetch top prices. In the details, much emphasis is given to the date of review, with the estimated rental value suggested, either by having issued the rent review notice quoting a very high proposal, or by stating the vendor's opinion of rental value, or by citing a brief mention of a nearby new letting.
Pre-occupation with quality of covenant has driven investment yields down to levels which, for the type of property, is more commonly expected for prime propositions, offering assured long-term growth!
Consequently, what has happened is that not only has the way shop property is valued disconnected from fundamental principles, but also the banks and vested interests have create a market that is completely divorced from the reality of property itself. The test of that claim is easy to pass, for example: imagine two shop properties, next door to each other, both shops identical size, layout, etc, both let for 20 years at the same rent with rent reviews at five yearly intervals. One shop is let to a national multiple retailer with dozens of branches, the other to a local shopkeeper with just that one shop. Both properties are offered for sale by auction on the same date by the same auctioneer. What's the betting the shop let to the multiple retailer would fetch a higher price?
In my opinion, it is not up to valuation surveyors to insist banks lend only on the value of the property, as distinct from the market value of the investment. That decision is for the banks alone. However, I do consider valuation surveyors have a duty of care to ensure the banks understand there is a difference which might not necessarily be allowed for in the 'forced' sale valuation. A definition of 'forced sale' valuation is "the highest price which a property can reasonably be expected to bring, if offered for sale without the consent or concurrence of the owner by virtue of judicial process, in what may be a restricted market place, within a restricted time frame, to a prudent, willing and able purchaser who may have limited knowledge about the property, its uses and capability." If the forced sale valuation is a percentage of the market value of the property then in my opinion the mortgage is likely to be more secure, than if the forced sale value is the valuation of the investment.
Chasing Rainbows
20/February/2014
Unlike investing in stocks and shares where the volatility of share prices and uncertainty of dividends can lead to long term buy and lose, investment in property offers two advantages: 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.
Yield and Pricing
01/June/1985
The current trend for private investors in the retail market to be more concerned with short term gain than long term income is worrying.
Participants seem to have overlooked the fact that the essence in capital gain to date owes more to previous levels of inflation than to design. And even if high inflation does return, the retailing revolution will stultify any likelihood of a repeat boom.
Many new investors believe that rental value reflects expected investment yield, based upon the price they have paid. In fact, investment value is calculated by reference to the level of rent and not vice versa. However, high prices paid for some investments can only reflect a very optimistic view of rental value. With the exception of property formerly owned by notedly cautious landlords, the idea that the previous owner must have agreed too low a rent, especially if set during the period 1981-1983, is too simplistic. By having always to aim for the top rental on review, to cover purchasing expectations, any failure to achieve the objective rubs off on the relationship with the valuer whose advice is dismissed as 'negative.'
The tenant becomes saddled with a difficult landlord and often with a rental commitment far above the economics of his business. In the open market, cyclical change is inevitable, but in the quest for short term gain, while the loss of one particular tenant may not matter, it is the collective effect of the pressure for high rents which radically affects long term stability, since there cannot be capital gain without security of income.
In the past, their owners' low inflation investment values have had a useful way of adjusting to mistakes, but with changes in the pattern of retailing, and high interest rates, the margin for error now is very small.
The investor who overpays, through ignorance or greed, only to find that the resultant yield, following review, is well below comfortable resale price will have to fund the shortfall somehow. While it is churlish to insist upon strict consideration of investment criteria, since the pressure to use substantial borrowing facilities dominates the market, the problem is unlikely to grow.
Participants seem to have overlooked the fact that the essence in capital gain to date owes more to previous levels of inflation than to design. And even if high inflation does return, the retailing revolution will stultify any likelihood of a repeat boom.
Many new investors believe that rental value reflects expected investment yield, based upon the price they have paid. In fact, investment value is calculated by reference to the level of rent and not vice versa. However, high prices paid for some investments can only reflect a very optimistic view of rental value. With the exception of property formerly owned by notedly cautious landlords, the idea that the previous owner must have agreed too low a rent, especially if set during the period 1981-1983, is too simplistic. By having always to aim for the top rental on review, to cover purchasing expectations, any failure to achieve the objective rubs off on the relationship with the valuer whose advice is dismissed as 'negative.'
The tenant becomes saddled with a difficult landlord and often with a rental commitment far above the economics of his business. In the open market, cyclical change is inevitable, but in the quest for short term gain, while the loss of one particular tenant may not matter, it is the collective effect of the pressure for high rents which radically affects long term stability, since there cannot be capital gain without security of income.
In the past, their owners' low inflation investment values have had a useful way of adjusting to mistakes, but with changes in the pattern of retailing, and high interest rates, the margin for error now is very small.
The investor who overpays, through ignorance or greed, only to find that the resultant yield, following review, is well below comfortable resale price will have to fund the shortfall somehow. While it is churlish to insist upon strict consideration of investment criteria, since the pressure to use substantial borrowing facilities dominates the market, the problem is unlikely to grow.