The Rent Review Specialist
Investment
Property Market (Real Estate)
The property market, sometimes known as "real estate”, comprises the human-made surroundings that provide the setting for human activity, ranging from individual buildings, to villages, towns and cities with supporting infrastructure.
Property is product that is constructed of human-made and/or natural materials: for example, stone, clay, brick, slate, timber, steel, plastic, etc. Building construction disciplines include architecture, civil engineering, building contracting, surveying, energy performance advisers, interior designers and so on. For purpose of this website, the definition of property includes undeveloped land and parts of the building.
A property can last for years - built in the 1130s the Manor at Hemingford Grey is one of the oldest continuously inhabited houses in Britain and much of the original house remains intact; in Herefordshire, Hellens Manor was granted in 1096 and is a living monument to much of England's history - but whilst there are many ancient properties around the country still standing and in regular use, the notable building booms include the Tudor period (1485-1603) (on vast tracts of land following dissolution of the monasteries); Elizabethan (1533-1603) (early Renaissance); Georgian (1720-1840); Regency early-19th century; Victorian (1827-1901) with expansion brought about by the Industrial Revolution, railway network, trams; Edwardian (1901-1918), and particularly in Greater London and provincial cities, during the 1930s, 1950s, 1970s-2000s, and the present day.
The individual character and street-scape of cities, towns and villages is personified by the dominant architectural styles and age of their properties. There is also sometimes a marked difference between the public sector and private sector properties, particularly in residential property. During the 1920s and 1930s, the demolition of old 'slum' properties and the moving of tenants onto new Council estates led to the construction of large tower blocks of flats for social housing. The development and expansion of towns and cities is reflected in the story of shopping throughout the ages.
The main attraction of the UK property market, particularly for overseas investors, is its organisation, sophistication and transparency: the choice of property available, the supply of buyers and the legal and property valuation system; also the UK is well served by domestic and international banks, creating a competitive environment for funding.
Although many reputable organisations carry out research into the state of the property market at any time, in fact there is no single property market as such. Since property is an illiquid asset, the market value of each property depends upon much the actual buyer would pay and saleability upon finding one buyer to become the legal owner (albeit the actual buyer is not necessarily just one person or entity). So, when you invest in the property market, it is wrong to try to assess the direction of the market as a whole, there is no level playing-field: property is not homogeneous, everything that can be known about a particular property is not necessarily available, all buyers and sellers do not have complete information on the prices being asked and offered in other parts of the market, barriers to entry or leaving are restricted.
The property market is not a ‘perfect’ market, and that 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.
Although property transactions are independent of one another, the legislation, rules, regulations and the interpretation of transactions between owners/vendors (sellers), purchasers (buyers), landlord and tenants, and mortgagees, comes under property law, an area of law that governs the various forms of ownership in real property (land and immoveable property).
Property is product that is constructed of human-made and/or natural materials: for example, stone, clay, brick, slate, timber, steel, plastic, etc. Building construction disciplines include architecture, civil engineering, building contracting, surveying, energy performance advisers, interior designers and so on. For purpose of this website, the definition of property includes undeveloped land and parts of the building.
A property can last for years - built in the 1130s the Manor at Hemingford Grey is one of the oldest continuously inhabited houses in Britain and much of the original house remains intact; in Herefordshire, Hellens Manor was granted in 1096 and is a living monument to much of England's history - but whilst there are many ancient properties around the country still standing and in regular use, the notable building booms include the Tudor period (1485-1603) (on vast tracts of land following dissolution of the monasteries); Elizabethan (1533-1603) (early Renaissance); Georgian (1720-1840); Regency early-19th century; Victorian (1827-1901) with expansion brought about by the Industrial Revolution, railway network, trams; Edwardian (1901-1918), and particularly in Greater London and provincial cities, during the 1930s, 1950s, 1970s-2000s, and the present day.
The individual character and street-scape of cities, towns and villages is personified by the dominant architectural styles and age of their properties. There is also sometimes a marked difference between the public sector and private sector properties, particularly in residential property. During the 1920s and 1930s, the demolition of old 'slum' properties and the moving of tenants onto new Council estates led to the construction of large tower blocks of flats for social housing. The development and expansion of towns and cities is reflected in the story of shopping throughout the ages.
The main attraction of the UK property market, particularly for overseas investors, is its organisation, sophistication and transparency: the choice of property available, the supply of buyers and the legal and property valuation system; also the UK is well served by domestic and international banks, creating a competitive environment for funding.
Although many reputable organisations carry out research into the state of the property market at any time, in fact there is no single property market as such. Since property is an illiquid asset, the market value of each property depends upon much the actual buyer would pay and saleability upon finding one buyer to become the legal owner (albeit the actual buyer is not necessarily just one person or entity). So, when you invest in the property market, it is wrong to try to assess the direction of the market as a whole, there is no level playing-field: property is not homogeneous, everything that can be known about a particular property is not necessarily available, all buyers and sellers do not have complete information on the prices being asked and offered in other parts of the market, barriers to entry or leaving are restricted.
The property market is not a ‘perfect’ market, and that 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.
Although property transactions are independent of one another, the legislation, rules, regulations and the interpretation of transactions between owners/vendors (sellers), purchasers (buyers), landlord and tenants, and mortgagees, comes under property law, an area of law that governs the various forms of ownership in real property (land and immoveable property).
Investment - Performance
Performance is the action or process of carrying out or accomplishing an action, task or function. The physical form of an investment is the medium or ‘vehicle’ for the performance. The form may not have been designed for the purpose; it may have been adapted, altered, or improved, but no matter the original shape essentially the medium is the store of value.
Often, choice of medium is based on myth, a widely held or false belief or idea. Generally, for example, cash on deposit at a bank or building society is not regarded a positive investment; even though, arguably, cash on deposit is the most secure investment. It is secure, because you can take out (withdraw) your money (almost) immediately; and the capital amount is almost certain to increase, because it is likely interest would be paid on the capital and can left on deposit for compounding (interest paid on interest). Even if the rate of interest were considered derisory, compared with other forms of investment, nevertheless interest would normally be credited on a daily basis, so you can calculate how much your investment is worth at any time.
Although rarely considered a positive investment, cash is the absolute of investment performance. Since the cash remains undiminished, cash on deposit is (relatively) secure, so interest on cash deposits, or the yield on gilt-edged stock (which, as government bonds, are considered secure), is used as the benchmark for other forms of investment.
Often, choice of medium is based on myth, a widely held or false belief or idea. Generally, for example, cash on deposit at a bank or building society is not regarded a positive investment; even though, arguably, cash on deposit is the most secure investment. It is secure, because you can take out (withdraw) your money (almost) immediately; and the capital amount is almost certain to increase, because it is likely interest would be paid on the capital and can left on deposit for compounding (interest paid on interest). Even if the rate of interest were considered derisory, compared with other forms of investment, nevertheless interest would normally be credited on a daily basis, so you can calculate how much your investment is worth at any time.
Although rarely considered a positive investment, cash is the absolute of investment performance. Since the cash remains undiminished, cash on deposit is (relatively) secure, so interest on cash deposits, or the yield on gilt-edged stock (which, as government bonds, are considered secure), is used as the benchmark for other forms of investment.
Investment - Stock Market - REIT
Investing directly requires skills that may not be available to the investor: it also requires the availability of the desired proposition. Buying shares in a property company whose property investment and/or property development strategy is often a better bet both in the short and/or long term because the company is often better placed to procure the properties in the first place, and may already own them.
Whether best to invest directly or indirectly by buying shares in a property company is an interesting question.
Property companies whose shares are quoted on a stock market are basically companies that have floated on the stock market in order to raise money to buy the sort of property the directors have their sights on, in exchange for cheap money in the form of shares in the company.
It is cheap money because there is no obligation to pay a dividend, although many companies do and for as long as they can afford to.
Basically, when you buy shares in a quoted property company, you are paying others to buy and manage property that you might not have bought or couldn’t afford, in return for which you might get a dividend and capital growth.
Stock-picking - which companies to invest in - includes an ability to read company accounts. For property companies, the bottom-line is tangible net asset value (“NAV”) so for that it is also necessary to appraise the valuation and assess the valuer. Never be scared to think valuations might be dubious. Many valuers are more conservative or optimistic than others, the calibre of the portfolio can make a difference to saleability at any point in time. Also, watch out for the ‘collection’ value where a premium value has been attributed to the NAV for the opportunity to acquire a collection of properties in one place.
Remember NAV is the total net asset value of the portfolio as a whole. If the ‘rubbish’ outnumbers the ‘gems’ then that could depress the overall NAV.
With smaller quoted property companies, beware those where the directors have a controlling interest. If they decide to take the company private, their offer might be a lot lower than how much outside shareholders would expect. Also, beware of smaller companies where the directors’ salaries, options and compensatory package is disproportionate. How much a director of a quoted property company should be paid when often the bulk of the work is done by others to whom fees and commissions might also be paid begs the question “what is the director doing for the money?”
Generally, shares in quoted property companies are priced at a discount to NAV. Occasionally the share price is at a premium to NAV and that can happen when the prospects for growth are not reflected in the NAV, maybe comparable transactions at the NAV valuation date would if the valuation were carried out at a later date result in a higher NAV, or maybe there is talk of bid for the company whereby the opportunity to acquire a portfolio is the attraction. In my opinion, quoted property companies whose share prices are at a premium to the last reported NAV (assuming the date of NAV is recent) come under my heading of “high risk” because there is no telling whether the higher share price is in sync with valuation reality or Stock Market investor sentiment.
Where the share price is substantially below the last reported NAV, reasons include controlling interest in the company by director(s), low-grade assets, and so on. I do not think there is a rule-of-thumb as to what would be reasonably considered a safe discount to buy at, because the attitude towards safety varies. Sometimes investor quest is yield, other times capital growth, and others times a bit of both. The challenge is to estimate whether the share prices of many quoted property companies are too high, too low, or about right. Personally, I think the only way to answer that is to ignore commentators and evaluate the NAV yourself: that can be done by appraising the assets in the company's portfolio (information probably in the accounts on the website) and considering whether you'd buy them, or not.
Personally, for companies whose assets come under the heading of “run of the mill” and perhaps yield around 8.5-12% I should want share price about 50-60% NAV (net asset value). For companies whose assets are undoubtedly prime, important, and would surely attract considerable if interest if offered for sale in the market whether individually or as portfolio then I should want share price around 10-25% NAV. For companies whose share price exceeds the last reported NAV for no reason other than “collection value” I avoid. “Collection value” is a way of inflating share price to a level that effectively can make the company bid-proof and help safeguard the directors and managers’ careers.
Beware companies whose directors are prone to justifying holdings or recent purchases by reference to what it would cost to build the property today. That a property has been bought for less than its replacement cost does not in itself make the purchase price cheap: the point is that if it would cost less to build than its market value it would make no sense to build it! There are hundreds if not thousands of properties that have outlived their shelf-life and continue to exist for no reason other than not having been demolished or redeveloped.
Real Estate Investment Trust (“REIT”) originated in the 1880s and a time when investors could avoid ‘double tax’ or a tax at corporate and individual level. In the 1930s, the tax benefit was removed causing investors to pay ‘double tax’. Nowadays, REIT is a tax designation for a corporate entity investing in retail estate. The purpose of the designation is to reduce or eliminate corporate income taxes. In return, REITs are required to distribute 90% of their taxable income to investors. REITs can be publicly or privately held; and public REITS may be listed on public stock exchanges.
In the UK, the rules for REITs were enacted in the Finance Act 2006 and REITS came into being in January 2007. I think the timing of the conversion date for becoming a REIT was politically motivated. There was considerable untaxed value in property assets and the Labour government was intent upon extracting potential tax. When REIT were first introduced into the UK, in my opinion the companies that converted overpaid because their assets were revalued and tax paid on the book value of the increase at that time, around the peak of the market. That the companies that rushed to convert saw no harm in destroying shareholder value struck me as curious because no one seem to mind.
Although REITs can be tax-efficient, because the property company pays no corporation or capital gains tax on the profits made from property investment, that presupposes there are profits made from the property investment activities. Where properties are held for development, the investment potential may take years to come to fruition.
I am sceptical whether REITS are run for shareholders, so much as for their directors and managers! Of course, some professional advisers enthuse about REITS - for example, there are currently 22 REITS owning approximately £40Bn of property, approximately 80% of all property held by UK companies - presumably (dare I say it) because they are on the receiving end of lucrative fees, or regards REITS as the vehicle for new types of investment (in other words, selling from the outside in). As for yield on shares, the same appraisal criteria is necessary; for example: is the prevailing share price a good value reflection of the net asset value, how reliable in the NAV, how sustainable long-term is the dividend and whether there that much scope for increase?
For more information about REIT, the British Property Federation has a website.
Many quoted property companies are better at property than company management. Consider, for example, Land Securities plc: its portfolio is undoubtedly prime and its people adept at realising potential, but in my opinion how it manages the company for shareholders leaves a lot to be desired, such as embarking upon a share buy-back programme costing about £570 million in 2000 and more buy-back again in 2007 when the share price was around £17.20 (today it’s about £8.00, and at 30 September 2011 adjusted NAV £8.63), and converting to a REIT at the height of the market thereby paying tax on peak prices. Had that money not been wasted, Land Securities might not have needed a deep-discount rights issue (eight shares for five at £2.70) to raise £755M in 2009, and to reset the dividend.
Unlike investing on the Stock Market where investors own a share of the company, the performance of which is largely in the hands of the directors and their choice of managers and/or advisers, a property is what a company or person leases for its business purposes.
The main attraction of property is that the payer of the investor’s return on capital - the tenant - is under a legally-binding contract to pay, whether or not the tenant’s business is profitable. Furthermore, a feature of business tenancies in England and Wales is the “upward-only” rent review: although that does not mean the rent must go up at review, it does mean the rent payable cannot go down. Although upward-only review can cause problems for tenants, and there is talk of legislation, reviews are for the most part still upward-only, or on terms that compensate the landlord for the loss of certainty.
In the shop property market, each property is unique, so part of the market value will depend upon the attitude of investors for the type of investment at the time the proposition is for sale. Property transactions are one-to-one. Although interest rates play a part, for rent to have to cover interest on borrowing is not as important as the other determining factors: whether rent is likely to increase, scope for capital growth or angles to improve value.
The other part of the market value is the effect on rent of the business plan of the tenant in occupation. Although in business tenancy law, and subject to the guidelines for rent review in the actual lease, any effect on rent of the tenant’s occupation of the premises or any goodwill attaching to the premises by reason of the tenant’s occupation is usually ignored, neither of those ‘disregards’ applies to the capital value of the property. Consequently whether the tenant can afford the shop and whether that affordability is enduring so much so that on expiry of the tenancy the tenant would want to renew and for a long period of time are factors that can make an appreciable difference to the value of the investment. Where many investors go wrong is in assuming the tenant is bound to want to continue in occupation and/or renew.
Whether best to invest directly or indirectly by buying shares in a property company is an interesting question.
Property companies whose shares are quoted on a stock market are basically companies that have floated on the stock market in order to raise money to buy the sort of property the directors have their sights on, in exchange for cheap money in the form of shares in the company.
It is cheap money because there is no obligation to pay a dividend, although many companies do and for as long as they can afford to.
Basically, when you buy shares in a quoted property company, you are paying others to buy and manage property that you might not have bought or couldn’t afford, in return for which you might get a dividend and capital growth.
Stock-picking - which companies to invest in - includes an ability to read company accounts. For property companies, the bottom-line is tangible net asset value (“NAV”) so for that it is also necessary to appraise the valuation and assess the valuer. Never be scared to think valuations might be dubious. Many valuers are more conservative or optimistic than others, the calibre of the portfolio can make a difference to saleability at any point in time. Also, watch out for the ‘collection’ value where a premium value has been attributed to the NAV for the opportunity to acquire a collection of properties in one place.
Remember NAV is the total net asset value of the portfolio as a whole. If the ‘rubbish’ outnumbers the ‘gems’ then that could depress the overall NAV.
With smaller quoted property companies, beware those where the directors have a controlling interest. If they decide to take the company private, their offer might be a lot lower than how much outside shareholders would expect. Also, beware of smaller companies where the directors’ salaries, options and compensatory package is disproportionate. How much a director of a quoted property company should be paid when often the bulk of the work is done by others to whom fees and commissions might also be paid begs the question “what is the director doing for the money?”
Generally, shares in quoted property companies are priced at a discount to NAV. Occasionally the share price is at a premium to NAV and that can happen when the prospects for growth are not reflected in the NAV, maybe comparable transactions at the NAV valuation date would if the valuation were carried out at a later date result in a higher NAV, or maybe there is talk of bid for the company whereby the opportunity to acquire a portfolio is the attraction. In my opinion, quoted property companies whose share prices are at a premium to the last reported NAV (assuming the date of NAV is recent) come under my heading of “high risk” because there is no telling whether the higher share price is in sync with valuation reality or Stock Market investor sentiment.
Where the share price is substantially below the last reported NAV, reasons include controlling interest in the company by director(s), low-grade assets, and so on. I do not think there is a rule-of-thumb as to what would be reasonably considered a safe discount to buy at, because the attitude towards safety varies. Sometimes investor quest is yield, other times capital growth, and others times a bit of both. The challenge is to estimate whether the share prices of many quoted property companies are too high, too low, or about right. Personally, I think the only way to answer that is to ignore commentators and evaluate the NAV yourself: that can be done by appraising the assets in the company's portfolio (information probably in the accounts on the website) and considering whether you'd buy them, or not.
Personally, for companies whose assets come under the heading of “run of the mill” and perhaps yield around 8.5-12% I should want share price about 50-60% NAV (net asset value). For companies whose assets are undoubtedly prime, important, and would surely attract considerable if interest if offered for sale in the market whether individually or as portfolio then I should want share price around 10-25% NAV. For companies whose share price exceeds the last reported NAV for no reason other than “collection value” I avoid. “Collection value” is a way of inflating share price to a level that effectively can make the company bid-proof and help safeguard the directors and managers’ careers.
Beware companies whose directors are prone to justifying holdings or recent purchases by reference to what it would cost to build the property today. That a property has been bought for less than its replacement cost does not in itself make the purchase price cheap: the point is that if it would cost less to build than its market value it would make no sense to build it! There are hundreds if not thousands of properties that have outlived their shelf-life and continue to exist for no reason other than not having been demolished or redeveloped.
Real Estate Investment Trust (“REIT”) originated in the 1880s and a time when investors could avoid ‘double tax’ or a tax at corporate and individual level. In the 1930s, the tax benefit was removed causing investors to pay ‘double tax’. Nowadays, REIT is a tax designation for a corporate entity investing in retail estate. The purpose of the designation is to reduce or eliminate corporate income taxes. In return, REITs are required to distribute 90% of their taxable income to investors. REITs can be publicly or privately held; and public REITS may be listed on public stock exchanges.
In the UK, the rules for REITs were enacted in the Finance Act 2006 and REITS came into being in January 2007. I think the timing of the conversion date for becoming a REIT was politically motivated. There was considerable untaxed value in property assets and the Labour government was intent upon extracting potential tax. When REIT were first introduced into the UK, in my opinion the companies that converted overpaid because their assets were revalued and tax paid on the book value of the increase at that time, around the peak of the market. That the companies that rushed to convert saw no harm in destroying shareholder value struck me as curious because no one seem to mind.
Although REITs can be tax-efficient, because the property company pays no corporation or capital gains tax on the profits made from property investment, that presupposes there are profits made from the property investment activities. Where properties are held for development, the investment potential may take years to come to fruition.
I am sceptical whether REITS are run for shareholders, so much as for their directors and managers! Of course, some professional advisers enthuse about REITS - for example, there are currently 22 REITS owning approximately £40Bn of property, approximately 80% of all property held by UK companies - presumably (dare I say it) because they are on the receiving end of lucrative fees, or regards REITS as the vehicle for new types of investment (in other words, selling from the outside in). As for yield on shares, the same appraisal criteria is necessary; for example: is the prevailing share price a good value reflection of the net asset value, how reliable in the NAV, how sustainable long-term is the dividend and whether there that much scope for increase?
For more information about REIT, the British Property Federation has a website.
Many quoted property companies are better at property than company management. Consider, for example, Land Securities plc: its portfolio is undoubtedly prime and its people adept at realising potential, but in my opinion how it manages the company for shareholders leaves a lot to be desired, such as embarking upon a share buy-back programme costing about £570 million in 2000 and more buy-back again in 2007 when the share price was around £17.20 (today it’s about £8.00, and at 30 September 2011 adjusted NAV £8.63), and converting to a REIT at the height of the market thereby paying tax on peak prices. Had that money not been wasted, Land Securities might not have needed a deep-discount rights issue (eight shares for five at £2.70) to raise £755M in 2009, and to reset the dividend.
Unlike investing on the Stock Market where investors own a share of the company, the performance of which is largely in the hands of the directors and their choice of managers and/or advisers, a property is what a company or person leases for its business purposes.
The main attraction of property is that the payer of the investor’s return on capital - the tenant - is under a legally-binding contract to pay, whether or not the tenant’s business is profitable. Furthermore, a feature of business tenancies in England and Wales is the “upward-only” rent review: although that does not mean the rent must go up at review, it does mean the rent payable cannot go down. Although upward-only review can cause problems for tenants, and there is talk of legislation, reviews are for the most part still upward-only, or on terms that compensate the landlord for the loss of certainty.
In the shop property market, each property is unique, so part of the market value will depend upon the attitude of investors for the type of investment at the time the proposition is for sale. Property transactions are one-to-one. Although interest rates play a part, for rent to have to cover interest on borrowing is not as important as the other determining factors: whether rent is likely to increase, scope for capital growth or angles to improve value.
The other part of the market value is the effect on rent of the business plan of the tenant in occupation. Although in business tenancy law, and subject to the guidelines for rent review in the actual lease, any effect on rent of the tenant’s occupation of the premises or any goodwill attaching to the premises by reason of the tenant’s occupation is usually ignored, neither of those ‘disregards’ applies to the capital value of the property. Consequently whether the tenant can afford the shop and whether that affordability is enduring so much so that on expiry of the tenancy the tenant would want to renew and for a long period of time are factors that can make an appreciable difference to the value of the investment. Where many investors go wrong is in assuming the tenant is bound to want to continue in occupation and/or renew.
Investment - indirect
Whether you invest direct or through a property fund manager, the same principles and the same approach to appraisal will apply. The fundamental question is whether the property has the potential to become an investment, or whether you are simply buying a property that is or could be let.
In my opinion, property funds are the ‘first-time buyers’ of the institutional property market. A property fund is a product of the financial services industry and is designed for the express purpose of generating fees for fund managers and shareholders of the parent company. When the mood of the moment (market momentum) is for commercial property, funds are launched, investors lured, and properties bought, regardless. As soon as the mood changes, and investors want out, the funds either put a stop to that or reduce the value of the investor’s holding. You might not think there is anything wrong with that, but in my opinion, it shows a lack of foresight to buy on the mood of the moment because by then prices would have risen already.
Although property fund hype is that it is better to pool relatively small sums of money so as to afford more, (an approach that ensnares private investors hook-line-and-sinker) that view is only true when what the fund buys is worth buying. Generally, as I have said, what funds buy is rarely worth buying. Few institutional investors are shrewd: most are under the impression that because they are institutional they are better equipped to appraise propositions, but that is not necessarily so. At every entry point to the market, and in every price range, there are some that know what they are doing, and some that think they do, and plenty that really have no idea but don’t want to admit it.
In 1984, in my newsletter I quoted Hugh Jenkins of the National Coal Board Pension Fund saying of chartered surveyors “(they) will be continue to be regarded with cynicism, so far as their professional capabilities are concerned, as long as they cling to gut feeling about growth prospects without being able to back them up with fundamental research.” When I suggested the modern concept of professionalism removes initiative, several advisers on motivation and corporate strategy agreed with me. Gut-feeling is an essential ingredient in the evaluation of research. You can only draw conclusions from information if you can adopt a broad view. It is not the result of research which provides a span of information, but the questions gut-feeling invite you to ask. Furthermore, since many fund managers are comparatively young, with no real experience of the market long-term, let alone much if any experience of having started a business from scratch, they can suffer from over-reliance of what they are told and their interpretation. In other words, you are not actually investing in property through anyone that actually knows what they doing, so much as being led to believe they do!
Research minimises risk in the hope that, while short term deals may be lost, the long term might bring substantial reward. But limitations of research can bring their own problems. It is a feature of professionalism that the combination of knowledge and experience clashes with logic, except in cases of absolute certainty. If you have to invest, then you are going to become increasingly frustrated if your adviser’s research tells you not to buy, when all about you, others are busy spending and getting all the kudos and excitement, That does not make the advice wrong, since investment is a waiting game (which means it’s boring), but it does nothing for the sale of lucrative financial products, which is why funds overpay.
In a downturn, property funds are very good at blaming the state of the market, but the state of the property fund is a reflection of the attitudes and policies that drove the fund to buy the investments in the first place. What one has to realise, I suggest, is that just because property funds are managed by people that one would reasonably must surely know what they are doing doesn’t mean they do.
Having said all that I am not scathing of all property funds; I think there are some that are obviously have their wits about them. The question is whether you, whose money is wanted, are able to sort the wheat from the chaff.
In my opinion, property funds are the ‘first-time buyers’ of the institutional property market. A property fund is a product of the financial services industry and is designed for the express purpose of generating fees for fund managers and shareholders of the parent company. When the mood of the moment (market momentum) is for commercial property, funds are launched, investors lured, and properties bought, regardless. As soon as the mood changes, and investors want out, the funds either put a stop to that or reduce the value of the investor’s holding. You might not think there is anything wrong with that, but in my opinion, it shows a lack of foresight to buy on the mood of the moment because by then prices would have risen already.
Although property fund hype is that it is better to pool relatively small sums of money so as to afford more, (an approach that ensnares private investors hook-line-and-sinker) that view is only true when what the fund buys is worth buying. Generally, as I have said, what funds buy is rarely worth buying. Few institutional investors are shrewd: most are under the impression that because they are institutional they are better equipped to appraise propositions, but that is not necessarily so. At every entry point to the market, and in every price range, there are some that know what they are doing, and some that think they do, and plenty that really have no idea but don’t want to admit it.
In 1984, in my newsletter I quoted Hugh Jenkins of the National Coal Board Pension Fund saying of chartered surveyors “(they) will be continue to be regarded with cynicism, so far as their professional capabilities are concerned, as long as they cling to gut feeling about growth prospects without being able to back them up with fundamental research.” When I suggested the modern concept of professionalism removes initiative, several advisers on motivation and corporate strategy agreed with me. Gut-feeling is an essential ingredient in the evaluation of research. You can only draw conclusions from information if you can adopt a broad view. It is not the result of research which provides a span of information, but the questions gut-feeling invite you to ask. Furthermore, since many fund managers are comparatively young, with no real experience of the market long-term, let alone much if any experience of having started a business from scratch, they can suffer from over-reliance of what they are told and their interpretation. In other words, you are not actually investing in property through anyone that actually knows what they doing, so much as being led to believe they do!
Research minimises risk in the hope that, while short term deals may be lost, the long term might bring substantial reward. But limitations of research can bring their own problems. It is a feature of professionalism that the combination of knowledge and experience clashes with logic, except in cases of absolute certainty. If you have to invest, then you are going to become increasingly frustrated if your adviser’s research tells you not to buy, when all about you, others are busy spending and getting all the kudos and excitement, That does not make the advice wrong, since investment is a waiting game (which means it’s boring), but it does nothing for the sale of lucrative financial products, which is why funds overpay.
In a downturn, property funds are very good at blaming the state of the market, but the state of the property fund is a reflection of the attitudes and policies that drove the fund to buy the investments in the first place. What one has to realise, I suggest, is that just because property funds are managed by people that one would reasonably must surely know what they are doing doesn’t mean they do.
Having said all that I am not scathing of all property funds; I think there are some that are obviously have their wits about them. The question is whether you, whose money is wanted, are able to sort the wheat from the chaff.
Investment
Investment is about becoming better off, financially, and whatever you invest in is known as an 'asset'. (Whether an asset goes up (appreciates) or down (depreciates) in value doesn't make it less of an asset. Whether it can turn into a liability is a separate issue!
Investments are categorised as liquid or illiquid. Cash and cash-equivalent assets are 'liquid' investments. With a ‘liquid‘ investment you have (immediate) access, either to buy or sell or withdraw funds.
In finance, an investment strategy is a set of rules, behaviours or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximise expected returns by investing in risky assets, others will prefer to minimise risk, but most will select a strategy somewhere in between. Passive strategies are often used to minimise transaction costs, and active strategies such as market timing are an attempt to maximise returns. One of the better-known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods of volatility or decline. A purely passive variant of this strategy is indexing, where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, in a mutual fund called an index fund or an exchange-traded fund (ETF). This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.
Cash is a liquid form of money, also known currency - notes, coins.
Cash is traditionally regarded a negative investment, because cash offers no scope for capital appreciation because, by virtue of inflation, the spending power of the capital will diminish. Even so, interest can mount up so it is important, when considering alternatives to cash, to allow for costs.
For example, if you were to deposit £500,000 at 3.5% pa fixed for 5 years, then after 1 year you would have £517,500. After year 2 you would have £535,612, after the 3rd year £554,358, 4th year £573,761 and by the end of 5th year £593,843. Whereas if you were to spend £500,000 on a property (yielding 3.5% pa) and sell after 5 years then, assuming no change in rent, you would also have £593,843 but you would lose approximately £30,000 in buying and selling costs and Stamp Duty alone; and that does not include non-recoverable ownership expenses over the 5 year period.
Since property is an asset, it provides a mortgageable security. A difference between cash on deposit and buying a property is gearing, whereby it is possible to borrow against the security of the asset (including any rental income) and buy a higher-priced property than the bare cash alone, but the costs of borrowing, including likely requirement for the value of the property to exceed the amount of loan by a specified percentage, creates a burden of responsibility over which the borrower may have no control. For example, if the loan must not fall below 80% of the value of the property, then any reduction in that value could breach the loan covenant. To remedy the breach would require either the borrower injecting more equity (if funds were available), or the lender restructuring the loan agreement if so minded; or the lender requiring early repayment of the loan or repossessing to get as much as possible of the loan repaid. Restructuring presupposes the lender would be relaxed and the borrower could afford to pay differential terms. The snag with repossession is not only that the borrower could lose out in loss of equity, but also the investment potential would end up with someone else.
With gearing, it is important to remember there is no correlation between a higher-priced property and higher-value. A higher-priced property is simply the price that the market at the time places on the proposition. Whether value would be more or less depends upon the price and the potential. For example, in the institutional investment market, comprising life insurance companies, investment trusts, pension funds, property funds, sovereign investors, and others that are responsible for investing other people’s money, there is normally a minimum lot size for a proposition, the amount for which may be out of reach for other investors. The amount of minimum is usually taken to mean including specific criteria that in the opinion of the institutional investor would only likely to be found in that price range. Whether the scope for rental and/or capital growth is more likely is questionable: the institutional investors is just as likely to get it wrong as any other investor. You only have to read the excuses dished out by property fund managers as to why the values of their portfolios have collapsed to realise that!
Even if you never sell, even if you were to keep the property to pass on through the generations, it does not follow it would necessarily go up in value once all costs and adjustments are accounted for. A property would go only up in value and become an investment when its value increases by more than costs and adjustments and at least maintain that level of increase during your period of ownership.
Over 5 or 10 years, the likelihood of no growth on property might be thought remote. However, because the property market is imperfect - with no certainty the property would sell for what it is valued at - prices are volatile, investors are fickle and there is no correlation between rents and inflation. All in all, profit is about timing: when to buy and equally when to sell.
Although I should expect many people to disagree with my definition of investment, it seems to me that to ignore the costs, loss of interest, inflation and tax is delusion. I think that if you are going to run the risk of using cash, and possibly borrowing to buy a shop property for investment, then you should reasonably expect a reward to compensate for the risk. Running hard just to stand still is not, in my opinion, a particularly productive use of resources. Although a property has to belong to someone, I should like to think that, by the time you have read Shop Investment you would appreciate the difference between owning property that just happens to be let, and being a successful investor.
Similarly, although capital value* fluctuates, stocks, shares and bonds are also considered liquid, because the ‘money’ markets are structured for almost instant liquidity. [*The value of the investment is known as its 'capital value'] Even so, the capital value can fluctuate because the stock market is volatile, so stocks, bonds and shares are riskier.
With cash on deposit, it is unlikely you could lose your capital and all UK regulated savings accounts are covered by the Financial Investors Compensation Scheme, a government-backed scheme providing investor protection up to a set amount.
Compensation limits vary - information can be found at http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/ - so many people like to spread the cash around numerous regulated organisations in order to ensure maximum protection for deposits; even so it is generally considered remote for the likelihood of a UK regulated financial organisation to fail.
Unlike cash, and cash-equivalents, property is an illiquid asset. An illiquid asset is one that cannot be readily converted into cash (or cash-equivalent) quickly and with minimum loss of value. Furthermore, depending upon the form of the illiquid asset, it may only be possible to cash an illiquid investment by selling it to someone else. When an illiquid investment produces an income, it may be possible to mortgage the income secured against the value of the asset.
There are practical advantages of liquid over illiquid assets. Liquid assets are portable. Money may be defined as any good or tokens that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The use of money provides an easier alternative to barter: in a modern, complex economy bartering is considered inefficient because it requires a coincidence of wants and an agreement that the needs are of equal value before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
As an illiquid investment, property is high-risk. That does not mean the risk can never be low or minimal, simply there is no guarantee the market value of the property could be realised when the cash is required. To do so would require the certainty of a buyer at that price, completing the purchase and transferring the money on that required date.
With an illiquid investment, risk is not only about what you could lose in terms of how the investment performs, but also whether you could get your money back at any time. Performance is a matter of skill and judgement. The only way to get your money back is to be certain someone else would buy the investment at any time in the future for at least the same price as you paid.
Where many inexperienced investors go wrong when buying is not thinking whether someone else would pay the same. It’s no good thinking, for example, that since there were other bidders at the auction and you only paid slightly more than the under-bidder, when you want to sell there is sure to be as much interest. Auction prices are not representative of market value: all they represent is how much someone paid on the day of the auction.
Investments are categorised as liquid or illiquid. Cash and cash-equivalent assets are 'liquid' investments. With a ‘liquid‘ investment you have (immediate) access, either to buy or sell or withdraw funds.
In finance, an investment strategy is a set of rules, behaviours or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximise expected returns by investing in risky assets, others will prefer to minimise risk, but most will select a strategy somewhere in between. Passive strategies are often used to minimise transaction costs, and active strategies such as market timing are an attempt to maximise returns. One of the better-known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods of volatility or decline. A purely passive variant of this strategy is indexing, where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, in a mutual fund called an index fund or an exchange-traded fund (ETF). This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.
Cash is a liquid form of money, also known currency - notes, coins.
Cash is traditionally regarded a negative investment, because cash offers no scope for capital appreciation because, by virtue of inflation, the spending power of the capital will diminish. Even so, interest can mount up so it is important, when considering alternatives to cash, to allow for costs.
For example, if you were to deposit £500,000 at 3.5% pa fixed for 5 years, then after 1 year you would have £517,500. After year 2 you would have £535,612, after the 3rd year £554,358, 4th year £573,761 and by the end of 5th year £593,843. Whereas if you were to spend £500,000 on a property (yielding 3.5% pa) and sell after 5 years then, assuming no change in rent, you would also have £593,843 but you would lose approximately £30,000 in buying and selling costs and Stamp Duty alone; and that does not include non-recoverable ownership expenses over the 5 year period.
Since property is an asset, it provides a mortgageable security. A difference between cash on deposit and buying a property is gearing, whereby it is possible to borrow against the security of the asset (including any rental income) and buy a higher-priced property than the bare cash alone, but the costs of borrowing, including likely requirement for the value of the property to exceed the amount of loan by a specified percentage, creates a burden of responsibility over which the borrower may have no control. For example, if the loan must not fall below 80% of the value of the property, then any reduction in that value could breach the loan covenant. To remedy the breach would require either the borrower injecting more equity (if funds were available), or the lender restructuring the loan agreement if so minded; or the lender requiring early repayment of the loan or repossessing to get as much as possible of the loan repaid. Restructuring presupposes the lender would be relaxed and the borrower could afford to pay differential terms. The snag with repossession is not only that the borrower could lose out in loss of equity, but also the investment potential would end up with someone else.
With gearing, it is important to remember there is no correlation between a higher-priced property and higher-value. A higher-priced property is simply the price that the market at the time places on the proposition. Whether value would be more or less depends upon the price and the potential. For example, in the institutional investment market, comprising life insurance companies, investment trusts, pension funds, property funds, sovereign investors, and others that are responsible for investing other people’s money, there is normally a minimum lot size for a proposition, the amount for which may be out of reach for other investors. The amount of minimum is usually taken to mean including specific criteria that in the opinion of the institutional investor would only likely to be found in that price range. Whether the scope for rental and/or capital growth is more likely is questionable: the institutional investors is just as likely to get it wrong as any other investor. You only have to read the excuses dished out by property fund managers as to why the values of their portfolios have collapsed to realise that!
Even if you never sell, even if you were to keep the property to pass on through the generations, it does not follow it would necessarily go up in value once all costs and adjustments are accounted for. A property would go only up in value and become an investment when its value increases by more than costs and adjustments and at least maintain that level of increase during your period of ownership.
Over 5 or 10 years, the likelihood of no growth on property might be thought remote. However, because the property market is imperfect - with no certainty the property would sell for what it is valued at - prices are volatile, investors are fickle and there is no correlation between rents and inflation. All in all, profit is about timing: when to buy and equally when to sell.
Although I should expect many people to disagree with my definition of investment, it seems to me that to ignore the costs, loss of interest, inflation and tax is delusion. I think that if you are going to run the risk of using cash, and possibly borrowing to buy a shop property for investment, then you should reasonably expect a reward to compensate for the risk. Running hard just to stand still is not, in my opinion, a particularly productive use of resources. Although a property has to belong to someone, I should like to think that, by the time you have read Shop Investment you would appreciate the difference between owning property that just happens to be let, and being a successful investor.
Similarly, although capital value* fluctuates, stocks, shares and bonds are also considered liquid, because the ‘money’ markets are structured for almost instant liquidity. [*The value of the investment is known as its 'capital value'] Even so, the capital value can fluctuate because the stock market is volatile, so stocks, bonds and shares are riskier.
With cash on deposit, it is unlikely you could lose your capital and all UK regulated savings accounts are covered by the Financial Investors Compensation Scheme, a government-backed scheme providing investor protection up to a set amount.
Compensation limits vary - information can be found at http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/ - so many people like to spread the cash around numerous regulated organisations in order to ensure maximum protection for deposits; even so it is generally considered remote for the likelihood of a UK regulated financial organisation to fail.
Unlike cash, and cash-equivalents, property is an illiquid asset. An illiquid asset is one that cannot be readily converted into cash (or cash-equivalent) quickly and with minimum loss of value. Furthermore, depending upon the form of the illiquid asset, it may only be possible to cash an illiquid investment by selling it to someone else. When an illiquid investment produces an income, it may be possible to mortgage the income secured against the value of the asset.
There are practical advantages of liquid over illiquid assets. Liquid assets are portable. Money may be defined as any good or tokens that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The use of money provides an easier alternative to barter: in a modern, complex economy bartering is considered inefficient because it requires a coincidence of wants and an agreement that the needs are of equal value before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
As an illiquid investment, property is high-risk. That does not mean the risk can never be low or minimal, simply there is no guarantee the market value of the property could be realised when the cash is required. To do so would require the certainty of a buyer at that price, completing the purchase and transferring the money on that required date.
With an illiquid investment, risk is not only about what you could lose in terms of how the investment performs, but also whether you could get your money back at any time. Performance is a matter of skill and judgement. The only way to get your money back is to be certain someone else would buy the investment at any time in the future for at least the same price as you paid.
Where many inexperienced investors go wrong when buying is not thinking whether someone else would pay the same. It’s no good thinking, for example, that since there were other bidders at the auction and you only paid slightly more than the under-bidder, when you want to sell there is sure to be as much interest. Auction prices are not representative of market value: all they represent is how much someone paid on the day of the auction.
Growth
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
Footfall
Footfall is pedestrian flow, the number of people that walk past the shop on a regular basis. In my opinion, there are two types of footfall: the first stems from fixed attractions, the second from what I describe as ‘magnetic’ retailers, more popularly known as ‘destination’ retailers, (albeit destination retailers are not quite the same).
A fixed attraction is anything that is capable of attracting people regardless, for example a bus terminus, railway station, a public car park, library, a tourist attraction such as a historic building or museum, a church or cathedral, an office building or industrial complex where a large number of people work, a seaside resort, open countryside, national park, and so on. All built-up and many rural areas have their own fixed attractions and the popularity for footfall would depend upon the attraction.
All retailers are capable of creating and maintaining goodwill in their dealings with customers but a ‘magnetic’ retailer is so good at goodwill that the impact of the reputation and level of esteem will radiate and attract or draw customers to that retailer from far and wide. In retailing, a distinction may be made between dependent and magnet or destination retailers. Provided the location is accessible, it doesn’t usually matter where destination retailer is based, people will travel often long distance to shop there. For an ordinary retailer whose attraction is not especially magnetic, such retailers are more dependent upon the continuing existence of footfall generated by others. For such retailers, the trading position is therefore more critical. For magnetic and destination retailers the proximity of other retailers is unimportant.
Fixed attraction footfall may not be enough to support a retail business profitably, because rarely would the retailer have any control over the type of people drawn to the fixed attraction. The potential to be obtained from a trading position that includes a magnetic retailer is easier to gauge because the type of products/goods/services offered by the magnetic retailer are likely to suit particular segments or sectors of the consumer market and determine the spending power of the target customer.
A difficulty for the non-magnetic or not-especially-magnetic retailer is whether the magnetic retailer can be relied upon to remain in the trading position for the duration of the non-magnetic retailer’s business tenancy commitments. A non-magnetic retailer that commits, for example, to a term of 10 without a break-clause will have to be confident that the attraction of the trading position would remain at least constant and certainly no worse for the entire period. If the trading position were to deteriorate during that period of time then it is possible the non-magnetic retailer could become stuck or locked into to an unprofitable trading position and unsaleable business commitment.
I have said that an investor owns the property, not the tenant’s business so the fact the tenant may have got it wrong is in theory nothing to do with the landlord. In practice, the landlord can also lose out because of whether the property would let to another tenant for at least the same rent as the rent the failed tenant had agreed.
When appraising a trading position, the investor must be careful not to fall into the trap of jumping to the wrong conclusion (a possibility made likely as a result of the actual tenant’s comments, for example) by confusing the planning Use Class for the shop, the permitted use in the lease to the actual tenant, and that particular tenant’s style or way of going about running its business within that permitted use. It is important to recognise there is and can be a difference between the actual tenant’s experience of the trading position based upon how that particular tenant has chosen to attract footfall, and the nature and calibre of the footfall itself.
For example, it is by no means unusual for retailers to make pronouncements about the state of the market as a whole as if their subjective experience should be construed representative of shopper behaviour. No retailer has such a monopoly that it can ever be 100% certain that its own experience based upon how it goes about attracting and generating customers is necessarily representative. From the investor’s perspective, as owner of the property, the test of the trading position is not only the experience of the actual tenant but also the potential of the tradition for other retailers and different types of business.
Generally, a regional/national multiple retailer, a specialist destination retailer, a department store and a chain store are likely to be more magnet than a local or independent shopkeeper. Local and independent retailers and shopkeepers are often magnetic to a limited extent, depending upon their reputation in the local community but in the context of an investment proposition the competitive pressures on retailing generally are likely to be more burdensome for the smaller retailer.
When shop investments are offered for sale and whether or not the actual tenant is a multiple retailer, it is common for details of the proposition to highlight trading names of other multiple retailers and large companies in the vicinity. Boosting the attraction of the investment proposition by reference to the nearby presence of well-known retailers is designed to trap the unwary. The question is how many of the nearby multiple retailers would be interested in opening a shop in that trading position if it or the other multiple retailers were not already there. What the investor is unlikely to know (unless exceptionally well-advised and even then not 100% sure) is how many of the multiple retailers in the vicinity are planning or intending to assign their leases or not renew on expiry. When the existing landlord gets winds of the tenant’s intention and depending upon the time-scale the more cunning landlord will sell the investment well before the tenant moves on.
I introduced a test of a trading position in decline when I applied what is known as the knock-on effect of comparable evidence. Basically, what happens is that when rent at review are increased to a level at which it becomes uneconomical for a multiple retailer that retailer will either assign or sub-let the tenancy and relocate to a better trading position (which on the face of it may not be cheaper but is more profitable for that particular retailer) or close down the branch. If when the tenancy is assigned or sub-let or the landlord offers the shop to let on a new lease and the new tenant is not a multiple retailer, often the rent that the new tenant agrees will exacerbate the rents in the trading position, and add to the uneconomical level. Also it is unlikely a tenant of lesser reputation will contribute much if anything to the creation of passing trade. As time passes, the number of multiple retailers in the vicinity drops until the trading position becomes the sole territory of non-magnetic retailers. Often the complaints by local shopkeepers about rents and business rates (business rates are based on Rateable Values in turn calculated by reference to rents) are a legacy of an ex-multiple retailer trading position.
Of course, the same applies in reverse. A trading position will often improve for all manner of reasons, such as a new fixed attraction, the entrance to a new shopping centre, or a letting to a magnetic retailer in the sector of the market where there is a lot of customer spillage or excess for others retailers nearby.
Generally, it is very difficult if not impossible to restore the popularity of a trading position once the rot has set in. It is vicious circle: once people get used to shopping elsewhere what remains of the footfall can give the impression of no shops worth bothering with. Moreover, and although it may not be politically correct to say so, there is nevertheless a reluctance amongst many people when shopping to want to mix and mingle for all and sundry.
A fixed attraction is anything that is capable of attracting people regardless, for example a bus terminus, railway station, a public car park, library, a tourist attraction such as a historic building or museum, a church or cathedral, an office building or industrial complex where a large number of people work, a seaside resort, open countryside, national park, and so on. All built-up and many rural areas have their own fixed attractions and the popularity for footfall would depend upon the attraction.
All retailers are capable of creating and maintaining goodwill in their dealings with customers but a ‘magnetic’ retailer is so good at goodwill that the impact of the reputation and level of esteem will radiate and attract or draw customers to that retailer from far and wide. In retailing, a distinction may be made between dependent and magnet or destination retailers. Provided the location is accessible, it doesn’t usually matter where destination retailer is based, people will travel often long distance to shop there. For an ordinary retailer whose attraction is not especially magnetic, such retailers are more dependent upon the continuing existence of footfall generated by others. For such retailers, the trading position is therefore more critical. For magnetic and destination retailers the proximity of other retailers is unimportant.
Fixed attraction footfall may not be enough to support a retail business profitably, because rarely would the retailer have any control over the type of people drawn to the fixed attraction. The potential to be obtained from a trading position that includes a magnetic retailer is easier to gauge because the type of products/goods/services offered by the magnetic retailer are likely to suit particular segments or sectors of the consumer market and determine the spending power of the target customer.
A difficulty for the non-magnetic or not-especially-magnetic retailer is whether the magnetic retailer can be relied upon to remain in the trading position for the duration of the non-magnetic retailer’s business tenancy commitments. A non-magnetic retailer that commits, for example, to a term of 10 without a break-clause will have to be confident that the attraction of the trading position would remain at least constant and certainly no worse for the entire period. If the trading position were to deteriorate during that period of time then it is possible the non-magnetic retailer could become stuck or locked into to an unprofitable trading position and unsaleable business commitment.
I have said that an investor owns the property, not the tenant’s business so the fact the tenant may have got it wrong is in theory nothing to do with the landlord. In practice, the landlord can also lose out because of whether the property would let to another tenant for at least the same rent as the rent the failed tenant had agreed.
When appraising a trading position, the investor must be careful not to fall into the trap of jumping to the wrong conclusion (a possibility made likely as a result of the actual tenant’s comments, for example) by confusing the planning Use Class for the shop, the permitted use in the lease to the actual tenant, and that particular tenant’s style or way of going about running its business within that permitted use. It is important to recognise there is and can be a difference between the actual tenant’s experience of the trading position based upon how that particular tenant has chosen to attract footfall, and the nature and calibre of the footfall itself.
For example, it is by no means unusual for retailers to make pronouncements about the state of the market as a whole as if their subjective experience should be construed representative of shopper behaviour. No retailer has such a monopoly that it can ever be 100% certain that its own experience based upon how it goes about attracting and generating customers is necessarily representative. From the investor’s perspective, as owner of the property, the test of the trading position is not only the experience of the actual tenant but also the potential of the tradition for other retailers and different types of business.
Generally, a regional/national multiple retailer, a specialist destination retailer, a department store and a chain store are likely to be more magnet than a local or independent shopkeeper. Local and independent retailers and shopkeepers are often magnetic to a limited extent, depending upon their reputation in the local community but in the context of an investment proposition the competitive pressures on retailing generally are likely to be more burdensome for the smaller retailer.
When shop investments are offered for sale and whether or not the actual tenant is a multiple retailer, it is common for details of the proposition to highlight trading names of other multiple retailers and large companies in the vicinity. Boosting the attraction of the investment proposition by reference to the nearby presence of well-known retailers is designed to trap the unwary. The question is how many of the nearby multiple retailers would be interested in opening a shop in that trading position if it or the other multiple retailers were not already there. What the investor is unlikely to know (unless exceptionally well-advised and even then not 100% sure) is how many of the multiple retailers in the vicinity are planning or intending to assign their leases or not renew on expiry. When the existing landlord gets winds of the tenant’s intention and depending upon the time-scale the more cunning landlord will sell the investment well before the tenant moves on.
I introduced a test of a trading position in decline when I applied what is known as the knock-on effect of comparable evidence. Basically, what happens is that when rent at review are increased to a level at which it becomes uneconomical for a multiple retailer that retailer will either assign or sub-let the tenancy and relocate to a better trading position (which on the face of it may not be cheaper but is more profitable for that particular retailer) or close down the branch. If when the tenancy is assigned or sub-let or the landlord offers the shop to let on a new lease and the new tenant is not a multiple retailer, often the rent that the new tenant agrees will exacerbate the rents in the trading position, and add to the uneconomical level. Also it is unlikely a tenant of lesser reputation will contribute much if anything to the creation of passing trade. As time passes, the number of multiple retailers in the vicinity drops until the trading position becomes the sole territory of non-magnetic retailers. Often the complaints by local shopkeepers about rents and business rates (business rates are based on Rateable Values in turn calculated by reference to rents) are a legacy of an ex-multiple retailer trading position.
Of course, the same applies in reverse. A trading position will often improve for all manner of reasons, such as a new fixed attraction, the entrance to a new shopping centre, or a letting to a magnetic retailer in the sector of the market where there is a lot of customer spillage or excess for others retailers nearby.
Generally, it is very difficult if not impossible to restore the popularity of a trading position once the rot has set in. It is vicious circle: once people get used to shopping elsewhere what remains of the footfall can give the impression of no shops worth bothering with. Moreover, and although it may not be politically correct to say so, there is nevertheless a reluctance amongst many people when shopping to want to mix and mingle for all and sundry.
Commercial Property
The economy is the wealth and resources of a country or region, normally in terms of the production and consumption of goods and services. In England and Wales, the commercial property market is a major sector of the economy and provides the physical accommodation for almost all industries, places of work, shopping and leisure. As an asset class, the ownership of commercial property is a significant investment for the pensions industry.
In common with residential property, commercial property is transparent, with an established legal framework and recognised valuation system. However, unlike residential property, the commercial property market is largely unregulated. Commercial property is predominantly a business-to-business market, where the legal relationship between landlord and tenant is based upon a commercial contract, (popularly known as a 'lease'). With a commercial contract the parties are deemed to know what they are doing.
The commercial property market is largely self-regulating. The majority of advisers are qualified, answerable to professional organisations and codes of conduct. A Code for Leasing Business Premises has been drawn up and which although voluntary (if only through fear of political intervention) is generally adopted by major landlords. Occupiers too have various representative bodies such as the Property Managers Association and the British Retail Consortium. And, although the value of the commercial property market has been estimated at £700Bn, of which approximately half is owned by occupiers and the remainder by investors/landlords, the number of different advisers and active participants in the market is relatively small so that in itself serves to keep things in order.
Unlike residential property, where transactional attitudes revolve around personal life-style and aspiration, in the commercial property market the relationship between occupiers (including tenants) and property is inextricably linked to marketing. Whether owner-occupier or tenant, the property is intended to complement the corporate image of the business of occupier or tenant at the date of the commitment.
A corporate image is the public face of a business: often the generally accepted image of what the company stands for, it is a form of promotion to suggest a mental image to the customer; and generally where a company is concerned about image, the company will often spend a considerable amount of money and time to ensure the overall standard of presentation. [A corporate image is not just tangible, it also includes intangibles: for example, how it treats employees, customers, suppliers and advisers, and anyone connected with the business, including landlords. For many businesses, the required property will include a style of architecture, layout and design; and for retailers, a feature of the retail sector is the trading position, including the impact of any changes in the locality on the tradition position.]
Commercial property continues to evolve. Unlike residential property where architectural styles and fashions of the time can come under the heading of 'heritage' to be preserved at all cost, and as listed buildings, commercial properties that have reached the end of their useful life or where the size, layout and configuration is obsolete are more likely to be refurbished or demolished and redeveloped, unless of historic importance. Even then, it is possible the external facade would be preserved, whilst all the innards stripped out and rebuilt to modern standards. Consequently, the age and construction of the property might not considered that significant between landlord and tenant because any onerous obligations for repair, maintenance and decoration could be circumvented by the provisions of a tenancy.
The commercial property market encompasses all property that is used or could be used for a business purpose. The business does not have to have a profit motive, but a fine-line exists between a hobby and a business. In the Landlord and Tenant Act 1954 Part II, one of the statutes governing tenanted commercial property, the definition of “business” includes a trade, profession or employment and any activity carried on by a body of persons corporate or unincorporate. That definition has been held to cover a sports club, but not to extend to a Sunday school as a spare time activity in the tenant's home, and taking in a few lodgers has been held to be outside the definition. Also, the premises need not be the place where the business is carried on. Although commercial property excludes residential property in itself, it is by no means unusual residential property to form part of commercial premises and so be subject to the law relating to commercial property and business tenancies.
The commercial property market is everything that is not residential or agricultural. Retail or shop property is a sector of the commercial property market and all buildings that are used or could, with planning permission, be used for any type of retailing including retail warehouses, retail showrooms, restaurants and financial and professional services and that fall into Class A of the Town and Country Planning (Use Classes) Order 1987 (as amended) are in the category of shop property.
In common with residential property, commercial property is transparent, with an established legal framework and recognised valuation system. However, unlike residential property, the commercial property market is largely unregulated. Commercial property is predominantly a business-to-business market, where the legal relationship between landlord and tenant is based upon a commercial contract, (popularly known as a 'lease'). With a commercial contract the parties are deemed to know what they are doing.
The commercial property market is largely self-regulating. The majority of advisers are qualified, answerable to professional organisations and codes of conduct. A Code for Leasing Business Premises has been drawn up and which although voluntary (if only through fear of political intervention) is generally adopted by major landlords. Occupiers too have various representative bodies such as the Property Managers Association and the British Retail Consortium. And, although the value of the commercial property market has been estimated at £700Bn, of which approximately half is owned by occupiers and the remainder by investors/landlords, the number of different advisers and active participants in the market is relatively small so that in itself serves to keep things in order.
Unlike residential property, where transactional attitudes revolve around personal life-style and aspiration, in the commercial property market the relationship between occupiers (including tenants) and property is inextricably linked to marketing. Whether owner-occupier or tenant, the property is intended to complement the corporate image of the business of occupier or tenant at the date of the commitment.
A corporate image is the public face of a business: often the generally accepted image of what the company stands for, it is a form of promotion to suggest a mental image to the customer; and generally where a company is concerned about image, the company will often spend a considerable amount of money and time to ensure the overall standard of presentation. [A corporate image is not just tangible, it also includes intangibles: for example, how it treats employees, customers, suppliers and advisers, and anyone connected with the business, including landlords. For many businesses, the required property will include a style of architecture, layout and design; and for retailers, a feature of the retail sector is the trading position, including the impact of any changes in the locality on the tradition position.]
Commercial property continues to evolve. Unlike residential property where architectural styles and fashions of the time can come under the heading of 'heritage' to be preserved at all cost, and as listed buildings, commercial properties that have reached the end of their useful life or where the size, layout and configuration is obsolete are more likely to be refurbished or demolished and redeveloped, unless of historic importance. Even then, it is possible the external facade would be preserved, whilst all the innards stripped out and rebuilt to modern standards. Consequently, the age and construction of the property might not considered that significant between landlord and tenant because any onerous obligations for repair, maintenance and decoration could be circumvented by the provisions of a tenancy.
The commercial property market encompasses all property that is used or could be used for a business purpose. The business does not have to have a profit motive, but a fine-line exists between a hobby and a business. In the Landlord and Tenant Act 1954 Part II, one of the statutes governing tenanted commercial property, the definition of “business” includes a trade, profession or employment and any activity carried on by a body of persons corporate or unincorporate. That definition has been held to cover a sports club, but not to extend to a Sunday school as a spare time activity in the tenant's home, and taking in a few lodgers has been held to be outside the definition. Also, the premises need not be the place where the business is carried on. Although commercial property excludes residential property in itself, it is by no means unusual residential property to form part of commercial premises and so be subject to the law relating to commercial property and business tenancies.
The commercial property market is everything that is not residential or agricultural. Retail or shop property is a sector of the commercial property market and all buildings that are used or could, with planning permission, be used for any type of retailing including retail warehouses, retail showrooms, restaurants and financial and professional services and that fall into Class A of the Town and Country Planning (Use Classes) Order 1987 (as amended) are in the category of shop property.
Asset Management
An asset is something, a quality, or a person, of use or value.
An asset is something owned by a person or business that is regarded as having value. An asset can appreciate (go up in value), or it can depreciate (go down in value). An asset will have three values: intrinsic value, scrap value, and artificial value.
Intrinsic value is the price/cost of the materials and workmanship for making of the asset. Scrap value is the value of whatever the asset is made of.
Artificial value is how much someone would be willing to pay, regardless of the intrinsic or scrap values. How much more or less would depend upon supply and demand. Generally, the supply of assets that would attract artificial value is limited and often scarcity maintains an artificial value.
Value itself is generally a matter of opinion, what the market would bear, and the nature of the transaction.
An asset is something owned by a person or business that is regarded as having value. An asset can appreciate (go up in value), or it can depreciate (go down in value). An asset will have three values: intrinsic value, scrap value, and artificial value.
Intrinsic value is the price/cost of the materials and workmanship for making of the asset. Scrap value is the value of whatever the asset is made of.
Artificial value is how much someone would be willing to pay, regardless of the intrinsic or scrap values. How much more or less would depend upon supply and demand. Generally, the supply of assets that would attract artificial value is limited and often scarcity maintains an artificial value.
Value itself is generally a matter of opinion, what the market would bear, and the nature of the transaction.
Yield Compression
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Yield and Pricing
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.