Predicting the next commercial property market crash is not something to do for the fun of it, but to enable forward-thinking investors to bide their time in readiness for the next buying opportunity. Since a difference exists between a rentable property and investment-performance, forward-thinking investors understand that the ingredients for rental and capital growth are synchronised, rather than separate issues.
Normally, it helps for prediction when all the signs are pointing in the same direction. This time things are different. While ‘things are different’ is par for the course whenever the subject of commercial property prices rears its head, normally things are not really that different, because all the signs are pointing in the same direction.
That all the signs are not pointing in the same direction at present does not mean they won’t converge in due course. That presupposes there are enough imperfections in the market yet to be ironed-out. However, I do not think that is the case. I think the market is closer to perfect than it has even been which rather suggests that opportunity for profit is hard to come by. A perfect market is not good for investors because everything that is known about the proposition is already priced in: ignoring that will lead to overpaying. It is true that higher yields to be found outside the hotspots are encouraging investors to ripple out their spending but that is a search for yield, there is no evidence that rents are following suit.
What I think is happening is that instead of the whole of the market crumbling, only some sectors and sectors are going to suffer. That scenario is a consequence of polarisation: an on-going process that is causing an insurmountable gap between propositions that have what it takes and those that do not. Investors might hope to bridge the gap with logical reasoning as they seek to reinforce buying and holding decisions, but tenants do not think logically to the exclusion of feeling. There is a noticeable gap between the investment outlook and tenant reality. Inevitably, tenants will come up with all sorts of reasons so they can get away with minimising their liabilities but it is unwise I suggest to regard tenant-comments as mere ploys.
Investors are relating the value of the proposition to the cost of finance, whereas tenants are relating the relevance of the property to target customers. Offices and industrial property usage tends to be hidden from investor viewpoints because commercial occupiers tend to cater for a wider geographical spread of customers. With retailing, the dysfunction is more obvious. Many shopping locations are clearly busy but footfall does not convert into rising rents. In 2014, almost three times the 2013 total number of shops closed down. Judging by the fascia names of leasehold shops on the market, the rate of closure is not confined to multiple retailers pruning branches but also to independent local business calling it a day as well.
Property is an alternative investment (an alternative to cash) and property and finance are linked-closely: a ready supply of credit is the lifeblood of the property market. Remove borrowers from the equation and the market becomes dependent upon cash buyers. That doesn’t mean activity grinds to a halt, but reduced demand results in cautious appraisal, lower prices and hence higher yields. Generally investors that spend like there’s no tomorrow are likely to be borrowers, because what borrowing does is shield a borrower from what is entailed in saving enough cash to buy outright. A few thousand pounds in loan fees, bank valuation reports, and so on, are regarded as necessities in the scheme of things, even though the extra cost of borrowing increases the purchase price and reduces the yield.
Self-inflicted pressure by borrowing investors wanting to participate in the market and the momentum rubs off on the relationship between landlord and tenant, and can lead to a split in direction. Tenants are expected to agree increases in rent to enable the investment to keep pace with the investor’s expectations for performance. The property system may be accommodating, but tenants are not. When premises are considered too expensive or a landlord is unreasonable, tenants decline or find an escape route. At all levels and all sectors of the market, there are cut-off points where the economics of the proposition make no sense to the tenant, even though from the landlord’s perspective the proposition appears attractive.
It is said that if you cannot stand the heat then get out of the kitchen, but ability to withstand extremes of temperature depends upon how well-equipped and fit you are. In my opinion, the majority of commercial properties that have come up for sale by auction and private treaty in recent years are unlikely to prove good investments over the long-term. The tenants will pay the rent and some honour the lease covenants, but mostly the only growth will come from yield compression and active management. Yield compression only works when a high yield to start with can then be sold at a low yield, while active management is not something that most properties offer any scope for. Hence, the most likely scenario for most investors is having participated in the property market’s equivalent of musical chairs or playing pass the parcel: in many cases from a shrewd seller to a gullible buyer.
The cracks of a crash impending are already showing and how you respond to this warning depending upon whether you are the sort that knows and would agree with me, or one of those people that requires tangible evidence before taking action. I may be right for the wrong reasons but by the time the evidence emerges, it is often too late to do anything and invariable more expensive than getting out before the crash.
The Rent Review Specialist