Ever since property started being thought of as a business, rather than a game – although why when one is not a full-time investor property should be thought of as a business is beyond me – the need for critical thinking has become more of a pre-requisite than ever before.
The starting point for critical thinking should be knowledge of the market. While rent review and business tenancy law is not confined to shop property, I have more practical experience and understanding of applying the principles and subtly to the retail property market (Use Class A1-A5 and B8 trade counters) ) than other use classes, so whenever I write about commercial property I have difficulty in encompassing comments and opinions to the whole of the commercial property market. Thereafter, although my brief for this blog is to write about commercial property, I am from now on going to stick to what I know best.
With auction having overtaken private treaty as the primary route for transaction in shop property, for buyers the ability to be emotionally detached when appraising a proposition is vital. Emotional detachment is not easy at the best of times. When under-pressure of the forthcoming auction date, the approximately 6 to 8 weeks beforehand in which to make up your mind can be challenging.
In my experience, private investors generally do not have what it takes to fathom the depths immediately. Ignore the macro-economy, successful investment in shop property is about the micro issues and judicious choice. It is no good looking at the situation from the shallow end and thinking that’s all there is to it: all that’s in the shallows is the gloss and the hype, the superficial stuff, such as address, name/renown of tenant, outline of lease terms, brief details of the property.
Assessing simply by looking at a photograph of the property cannot tell you what you need to know. Or rather, since I cannot tell you what you need to know, what needs to be known. Studying the photograph in a way of an enquiring mind is harder when the photograph(s) do not include the back of the property or much of the surroundings. Internal inspection is best: the state of repair and condition in which the tenant keeps the property generally can be assessed quickly. With some investment propositions, banks for example, prospective buyers are limited to set viewing days when, instead of being allowed to wander around at leisure and take however long you like, the inspection time is limited.
Most investors have their own criteria for what constitutes due diligence. For example, whether rent is up to date; is the tenant, if a company, active or dormant. My questions include (but are not limited to) who is selling and why. Since investment potential is based not only upon the specifics of the proposition itself, but also the effect if any of external influences, the identity of neighbouring retailers is integral to the prospects for the trading position. Even though I have one of the largest privately-owned databases of shop property, I rarely receive enquiries from prospective investors wanting to find out whether any shops nearby are on the market. I like to think it’s because I’m under the investment market’s radar, but I have my suspicions that investors generally aren’t too bothered about what might be going on nearby, instead assuming that if the property became vacant then it would relet readily. That view may be valid when the passing rent is at or below the market rent, but sometimes the passing rent is too high, which could mean that on expiry of the lease the rent would do down or the tenant not renew. Buying an investment let at £x only to have to concede £x minus a few years later is not my idea of an investment, but no accounting for taste!
I keep on saying this, but in my opinion the majority of shop properties that come up for sale nowadays are ex-growth. The ex-growrth may not be immediately apparent, it may take a few years to become evident. The reason, I have examined before, is accelerating. The polarisation of shopping locations, between those that have what it takes to support and maintain a thriving shopping centre and those that do not, has shifted into a higher gear. It doesn’t matter how much excess demand for investments spills over from the hot spots, the gap in the connection between investment activity and underlying rental growth has stretched too far to be bridged. Speaking of which, a long time ago I said that the middle-classes as a ‘bridge’ between rich and poor would wash away within 20 years. Time up. Middle-class discretionary expenditure has been squeezed left, right and centre. With not enough money to go around to profitably support all the retailers, there is so much competition for custom that the only way forward-thinking retailers can continue to be profitable is to ditch under-performing branches and focus on their best shops and on-line.
The adage ‘buy land, they don’t make it anyone’ is mistaken. Land can be recycled with new developments that draw trade from traditional positions. Nowadays, the most valuable real estate is not that prime property in the best location, but a website domain costing about £25 a year for viewing on a computer screen. Transactional websites are the equivalent of mail order catalogues, without the cost of printing or circulation to a limited mailing list. With click-and-collect, no matter how unprofitable for physical retailers, customers are not going to go shopping whilst out and about like they used to. In any event, take no notice of retail monitors, it is not footfall that forward-thinking retailers are after, but profitable customers.
Fortunately for most landlords, there are not that many forward-thinking retailers. Mostly, retailers, being resistant to change, are slow to respond. They leave it too late to get rid of under-performing branches. One reason is economy of scale. With fewer branches, a multiple retailer is less likely to want a substantial inventory of stock. Many retailers are gamblers, in hope of better things to come. For many, the Christmas period is when most of the profit is made, which is why branch closures (and administrations) are usually announced after the seasonal figures have been digested.
Profitable customers, as I’ve written about in my newsletters, do not, as a rule, want to mix with all and sundry. Not much fun to have to weave in and out of unruly youths and/or drunks on the streets. On the streets, well-dressed and/or well-mannered people nowadays can stand out like a sore thumb. It doesn’t matter how much love and care a quality retailer pours into its shop-fitting on the ‘high street’ when its effort is undermined by scruffy surroundings. Hence, the appeal for multiple retailers of purpose-built shopping centres where the management of the investment is under direct control of a single landlord. Not so in the public arena where there can be lots of different landlords and the best hoped for is that the Local Authority has enough money to maintain obligation towards the ‘high street’. Visit Ledbury, for example, where only part of the main shopping street was recently resurfaced, the remainder described as a farm track.
Since overt discrimination is against the law, profitable customers exercise their prejudices by associating with and being supporting of those retailers that satisfy the customers’ standards. Where people choose to shop is generally pre-meditated. Why a particular retailer is singled out, despite the competition, the answer to be sure is that amongst the reasons the customer would cite is at least one if not more that would be considered politically incorrect. So what?
For landlords, the question is what effect if any would the presence of ‘undesirable’ street-scenes have on the landlord’s investment. The short answer is nil rental growth. Generally, the only demand for shops in undesirable trading positions stems from high volume/ low margin retailers whose business model does not include paying the landlord any more than necessary.
It is evident that better propositions with ongoing growth prospects are rarely for sale on the market. Why sell a winner when the likelihood of replacement is zilch. Much easier to buy a loser, there are many more to choose from, and aim to profit from the difference between mortgage interest and rental income and for asset gain capitalising on investment market sentiment. Nothing wrong with that, provided you sell before the sentiment fades. When you buy-to-hold, for many investors hold is usually for the term of the mortgage, the risk of nil growth for the duration or at the time of proposed sale would leave you exposed to higher interest payments along the way and not being able to recoup your equity should yields rise closer to the reversion.
When to sell? The best time is when everyone is buying. In a rising market most investors become so convinced they can’t go wrong that, metaphorically-speaking, they buy with their eyes shut. The worst time is when they wake up and realise that investing in shop property is not a dead cert. In a rising market hanging on to the last moment before selling is challenging: ‘subject to contract’ sees to that. The way things are going in the global financial markets, it won’t take much for the UK shop investment market to come to its senses.