An alternative investment, property is an alternative to cash and other liquid forms of investment. Arguably, commercial property is more of an alternative than residential because commercial is more tenant-oriented. Normally, selling a residential property with vacant possession fetches more than if let: whereas with commercial property it is normally the other way round.
Cash buyer or borrower, a time will come when you will want to take your profits. Either from selling or (re-)mortgaging the equity or disposing of your interest in a tax advantageous way. Even if that time were not in your own life-time, it will in any event arrive when the direction your investment is taking differs from where the market for the type of property is going.
Investors can buy and sell and tenants come and go to their heart’s content but activity counts for little without rental growth. Rental growth in the market for the type of property is fuelled by tenant demand. What tenants want, the suitability of the building, the location, its age and construction, are amongst the deciding factors. What looks good to an investor might not look so good to a tenant. Market heading in another direction is inevitable. The market is dynamic: day-after day, year after year, from subtle variations to discernible shifts to radical structural changes. It can be challenging to remain in sync, let alone keep up. As for anticipating, judicious choice of proposition to begin with is only the start. Unless you monitor your investment’s performance regularly and have some realistic measure for comparison, chances are that you could miss out.
Inflation is a popular measure: property has a reputation as a long-term hedge against inflation. Inflation and market rent are not linked. Expecting a rent on review to market rent to at least keep up with inflation could be wishful-thinking. It is not only rental income that in real terms can change with the passage of time, capital value can vary also, often substantially depending on purchase price and date of purchase. Assuming market value at date of purchase, whether that value is sustainable depends upon investment market sentiment unchanging (or evening out) between purchase and resale dates. Investor sentiment is also subject to demand, the appeal of the proposition to other investors.
For many private landlords, investment is a passive pursuit. To an experienced professional adviser, the ‘armchair’ investor has some amateurish characteristics: indecisive, dislike of costs, slow to respond but jumping to conclusions. Tenant identity highly prized, the better the covenant the less the hassle, is worth paying a premium price for. But even amongst full-time investors, the one thing that is likely to escape notice is quite possibly the most important. Usually, the tenant’s intention for occupation duration of the property is not communicated in advance. For a landlord, it can come as a shock to be told that the tenant’s request for something or disinterest in renewing occupancy or on the same terms as before could affect the value of the investment.
The ability of tenants to determine the direction of the market should never be underestimated. For the landlord, the property advantages and disadvantages can be assessed, but when the investment purchase price is linked to tenant covenant, what the tenant (including the privity tenant) is considering and planning is more important. For a forward-thinking landlord, keeping tabs on the investment includes a watchful eye on the market sector in which the tenant operates. A classic example is the banks. Over the years, hundreds of buildings let to banks have been sold, often on sale-and-leaseback, to inexperienced buyers who have discovered that not only has there been little or no scope of increase at rent review but also bank branch closures may not just affect the landlords themselves, there might be dire consequences for the shopping locality too.
The inherent risk of illiquidity of property might be lessened by an active market, relaxed bank lending criteria and expeditious conveyancing, but illiquidity exists for a reason: to prevent buyers from allowing enthusiasm to cloud judgement. Judgement involves deciding on the balance of probabilities. When the purchase price is geared to the investment value of the tenant’s covenant, and whether or not the choice of investment pays sufficient heed to property fundamentals, in particular the terms and conditions of an existing lease, a critical factor to be included in investor appraisal is the direction of the market in which the tenant operates.
A strategy is not a plan. A strategy is a series of steps for achieving a plan. When the plan is to sell the investment at some time, steps must be taken beforehand to enhance the marketability. The proposition must be got ready for selling. A combination of keen demand and high prices especially at auction bring out the better properties but many sellers particularly at auction are not selling for the sake of it, but to cash in on investor gullibility.
The best time to sell a commercial property investment is before the change in direction becomes obvious. Wanting tangible evidence before taking action is one of the best ways to come unstuck. By the time evidence emerges, it is often too late. Much commercial property investment on the market nowadays is so overworked and over-priced by sentiment that virtually all of the potential for long-term investment performance has been eradicated. Even if you disagree and reckon there is good value for money still to be found, when buying in the prevailing market for long-term investment it has surely become even more important to ensure that the tenant is keeping up with the direction in which the tenant’s business market is heading, otherwise the landlord is at risk of over-paying and non-recoverable costs.©LandlordZONE® – legal content applies primarily to England and is not a definitive statement of the law, always seek professional advice.