Let’s face it, if you took my advice then you’d never buy anything! Which is what a client used to tell me before mentioning he’d bought another shop property and would like me to advise on how best to realise its potential.
Before buying a shop property for investment, it’s important to identify its potential, otherwise you could over-pay. Most shop properties do not have any more potential than exists already. The shop is where it is and that’s that. The price is whatever the market would bear at the time. Any capital growth is only likely to be investment market sentiment-led, any rental growth demand-driven.
Investment market sentiment starts as a sign of confidence amongst shrewd professional landlords which, provided the wind is in the right direction, can soon stimulate the rest of the market into a mad dash, known as ‘yield compression’. Historically, the yield for rack-rented shop properties averaged about 10% in secondary trading positions “south of Watford” and 12%+ everywhere else. Lower yields circa 5-7% reflected prime and recognised growth locations. The tendency for yield to reflect the cost of borrowing is a relatively recent phenomenon which has the effect of distorting the value of the property by making a 10% investment, for example, look cheap. That’s what happened in the run-up to the 2008 crash and during the past few years picked up where it left off. An avalanche of cash from UK and overseas investors combined with low interest rates and a willingness of lenders to risk making the same mistakes as before has fuelled a mad dash that, having inflated prices in the London area, is spilling out into the provinces. For landlords with sizeable portfolios and into pruning ex-growth (also known as ‘recycling capital’) a ready supply of buyers falling over themselves to buy anything that comes along is just what is needed.
From a buyer’s perspective, one would reasonably expect the choice of proposition to be carefully considered. If you’re in the market to buy an investment then the last thing you want to find yourself doing is over-paying. Over-paying is one of those experiences that is difficult to define with any certainty at the time. How are you going to know whether you’ve overpaid to begin with? When the market is active, with no signs of the momentum slowing, who’s to say that today’s price isn’t going to seem like a bargain in years to come? Good question and I for one wouldn’t want to answer in general terms, but I’d feel very confident with my answer if given a specific proposition to base the answer on.
Specific proposition appraisal remembers that each property is unique – also. there are three sides to the story. A standard shop in a ‘high street’ parade, for example, might not display quantifiable or measurable differences in positioning, layout, construction, and lease terms so far as surveyors and investors are concerned, but there are bound to be subtle differences from a tenant perspective when one looks carefully. It is easy to find fault but harder for landlords to emotionally accept that the faults are of any consequence. When appraising a shop investment, it doesn’t matter who the tenant is now: what matters more is whether the premises would let to at least the same calibre of tenant if the premises were available to let now, and equally at least the same rent and for the same duration. Any deviation from those parameters is likely to result in overpaying.
Potential for capital growth as a consequence of yield compression hinges on the purchase price. There’s a demand difference between buying at 10% to resell at 5% and buying at 5% to resell at 3% or less. The 10% to 5% range includes a greater margin for error and adverse shifts in sentiment. At much lower yields to begin with and the margin for error increases.
I have no doubt that the shop property investment market is currently in a bubble. The question is how much more inflation (hot air) the bubble can accommodate before it bursts. If you work on the principle that demand spilling over into the provinces is relieving the pressure by absorbing the excess, thereby keeping a lid on prices in the hot spots, the answer is when prices in the provinces are also overinflated. The point at which to cash in your chips and quit while ahead is when there are signs of cooling off in the hot spots. It is also useful to monitor the identity of the buyers: well-known investors selling to unknown buyers is another warning sign.
As for rental-growth, it is important to distinguish between shop property whose demand is occupier-led and rental-driven. Occupier-led is for property in positions that are corporate image oriented, needing little or no passing trade to speak of. The property is a base for the occupier’s business. The wording of the rent review clause in an occupier-led position must be carefully thought out if rental growth were required. With passing trade positions, demand is more likely to be competitive which, provided demand and supply out of sync, results in rent level changes. Over-supply for falling rent, under-supply for rising rent.
The third side of the story, (which might also be considered holistic) is the rental growth equivalent of yield compression: namely, about prospects for the town and trading position versus competitive factors and influences. Some towns, some trading positions, some retailers, have got what it takes to attract more than enough passing trade, for some to spill over and benefit everyone nearby. Others have not. Other towns and trading positions are past their shelf-life, some have lost out completely and fallen by the wayside. What an investor cannot know, at least not without insider knowledge, is which of the more magnetic retailers in the location are likely to shut up shop and relocate. To borrow from ‘you can’t judge a book by looking at the cover’, one cannot judge a trading position by looking at the multiple retailers on the frontages. All that the presence of multiple retailers tells you is that at some time those retailers thought that position a good place for them to be. Unless you are privy to confidences, what you cannot know is whether those retailers are still thinking like that?
There were too many shops before the arrival and rapid growth of transactional websites which has intensified competition and increased pressure on operating margins. Investors piling into shop property on the assumption that the internet is simply another outlet for retailers overlooks the fact that the revolution has only just begun. Thanks to surveyors, including people like me, retail property costs and tenancy liabilities are being reduced left right and centre. With a paucity of rental evidence to justify rental growth, the squeaks of landlords losing out are eeking now. In future, the squeaks won’t be limited to tenants, they’ll include investors who’ve overpaid for the property and cannot afford to sell at a loss. Overestimating potential is the road to ruin.