Whether better to invest in quoted property companies on the Stock Market or property direct is a matter for debate: each has advantages and disadvantages and subjectively often boils down to personal preference: whether to be in control or allow others to choose and manage. Certainly, at present, I’d advise avoiding prop-co shares, I see no point in paying a premium over net asset value. Premia prices are good for those shareholders whose shares one is buying, but not if you’re a buyer and wondering (as I do) where is the growth coming from to offset the risk of overpaying? And even if the answer to that is made to sound convincing, what faith can you have in advisers that are not involved at the sharp end of the commercial property market?
The main difference between investing on the Stock Market and direct property investment is liquidity. Whether buying or selling stocks and shares, transactions can usually be done within minutes, completion within a few days. Sometimes, the availability of the number of shares required or a buyer at an offer price might not be immediately available, but generally any delay is short-lived. With matched-bargains, the delay can be longer unless at a mutually-acceptable price.
Not so with property. Properly is an illiquid asset whose market value depends upon the availability of a buyer at that price. Finding a buyer is the job for estate agents or auctioneers, or for those that begrudge paying commission or a fee for oneself. Whatever the means of procurement, there is no certainty that when you want to sell a buyer can be found at the valuation figure or at a price you’d accept.
Unlike investing in the Stock Market, where transaction costs are relatively low, the costs of buying and selling property are often substantial. Also, unlike the Stock Market where a quoted bid (selling) or offer (buying) price is normally available at any time during market trading hours, it’s not possible for an investor to be able to get more than an approximation of how much a property might fetch. A professional valuation is merely an informed opinion, not a guarantee. Consequently, also because property is generally considered a long-term investment, most buyers do not have in mind to sell for the sake of it.
Generally, at least in my experience, private investors are not as interested in the market value of the property as they are in the rental income and rental growth potential. The upward-only rent review, notwithstanding the correct definition of the terminology, is so ingrained in investor-thinking that come the review date and most landlords are expecting an increase. However, indifference to market value should only really apply to investors without mortgage. For everyone else to imagine themselves immune from market forces is a delusion of grandeur. For a borrower, regular valuations enable the landlord to pre-empt whether a mortgagee is likely be concerned. (As I said in my last blog, mortgagees are concerned about breach of the loan-to-value (LTV) covenant.) But, what valuations do not guarantee is that if the property were physically offered for sale then a buyer would be forthcoming at the valuation figure. To be sure of that, the landlord would have to sell before the market for that type of property is on the turn.
In England and Wales, where conveyancing is normally ‘subject to contract’, buying and selling property is a relatively slow process. Having found a buyer, the seller hopes that nothing untoward will arise before contracts are exchanged and thereafter nothing untoward to delay completion. For a seller desperate for cash, the time between acceptance of offer and exchange of contracts and then exchange and completion can seem like an eternity. The quick sale, where a lower price is agreed in exchange for early exchange of contract and sooner completion isn’t always factored into thinking, even though the one thing no seller can be certain of is that market sentiment would remain unchanged between when the property is offered for sale and exchange of contracts.
Because it can take some time, weeks, sometimes months for complex transactions, to get to exchange of contracts, shrewd sellers tend to sell well before the market turns. The one thing a well-advised seller will want to avoid is any possibility the buyer would think twice about going ahead. By leaving something for the next man, so to speak, the seller is dangling a carrot for the buyer.
Carrot-dangling isn’t something that most buyers are aware of: easily fooled into thinking reason given for sale is genuine, in the absence of tangible evidence there is nothing for the average buyer to go on, so the buyer, who really ought to be shrewder than the seller but usually isn’t, will fall into the trap of overpaying. Naturally, a market is full of mixed messages. So if you don’t have enough know-how to make up your own mind, then the person from whom you take advice should be emotionally detached from your decision, otherwise you risk being influenced in a way that can differ from the direction in the market is going.
Since it can take some time for the commercial property investment market to respond to what is happening in the wider world, timing is critical. Liquidity can dry up overnight: the banks do not have to borrow from one another, wholesale money markets can become expensive. Central Banks hints of rising interest rates fuels caution. Buying at auction is often risker than by private treaty. At auction, your bid, if successful, results in the fall of the hammer and exchange of contracts. Between receiving the catalogue and bidding at auction is about 6 weeks, which in a rising market is an advantage for the seller, but for buyers speed in an impending downturn can result in overestimated bidding. The closer prices get to the peak of the market, the slower you should make up your mind what or whether to buy. Biding your time can reap rich rewards.
How do you know prices are close or at the peak? Take my word for it, they are. For much of 2015 buyers have been overpaying for all types of property without realising it. Yield compared to borrowing interest rates is not a reliable guide. In my opinion, it’s a mistake to ignore what is happening in the wider financial world. To assess property prices on their own merits as if the property market operates in splendid isolation is blinkered-thinking. Partly to let themselves off the hook, but also to encourage investors to think ahead, most valuation surveyors state that that at least 6 months would be required to effect a sale at their valuation figure.
In a rising market where are no signs of anything untoward on the horizon, 6 months is of no consequence: buyers can be found and transactions completed within a few weeks. But generally the signs of change are intangible, undercurrents that cannot be superficially sensed or readily detected until the storm has brewed. By then obtaining the valuation price is often too late.
For investors that have no intention of selling or buying for pension beyond their foreseeable future, overpaying on purchase price can be dismissed as just one of those things which soon becomes forgotten about as time passes. Not by lenders, of course, for whom LTV is the benchmark. So, to prepare for the periodic review where borrower meets bank manager to discuss the loan facility, the prudent investor will have released capital from under-perforning investments in order to reassure the bank of the investor’s liquidity. Another trend, that I have detected from research amongst long-established often secretive investors, is for the opportunity in low interest rates to have been used to satisfy outstanding mortgages in order to boost net asset value. Better to plough surplus income and capital into reinforcing nav than overpaying merely for somethnig more exciting to do.
Something I enjoy is using my multifarious skills to help clients enjoy long-term consistent success, which is why none of my regular clients are indebted to the extent of any concern about the state of the market. I do however receive instructions from non-regulars, some of whom (not all I hasten to add) that frankly haven’t a clue and whose expectations are unrealistic. I am looking forward to the imminent downturn. It is tedious for experienced advisers, such as myself, to put up with inexperienced landlords whose only interest is to extract blood out of the stone, known as the tenant. When, inevitably, the tenant doesn’t play ball, such investors scream and shout, but all they are doing is trying to dump their emotional baggage onto anyone whom they think they can get away with disrespecting.
Every downturn results in many investors getting their fingers burnt and falling by the wayside. Borrowers who have financially overstretched themselves and whose mortgagees don’t reckon them enough to want to restructure the facility. Others are allowed to struggle on because they have sufficient resources to support the loan, despite breach of LTV and the mortgagees reckoning them more profitable.
Liquidity is not simply about capitalising on money supply: if you are going to take the credit then it should be used wisely, for the good of all. Anything else is bound to lead to failure.