Please Note: This Article is 6 years old. This increases the likelihood that some or all of it's content is now outdated.

Unlike residential property, the factors that determine prospects for commercial property growth are much more dependent upon specific tenant demand, rather than demand and supply generally.

For new lettings, the supply of tenants wanting a particular property can vary enormously depending upon the location and type of property. Just because there might be ‘hot spots’ in a locality does not mean that the whole place is wanted. A property that for whatever reason hasn’t quite got what it takes is going to lose out.

Since tenant-demand is the driving force for rental growth, it makes sense to ensure that the property you own or are thinking of buying has all the hallmarks of a property that would be in perennial demand. That is a tall order. The criteria for what constitutes desirability is fickle. What tenants will always want isn’t the same as what a particular tenant would want now. Unless the property possesses enough attributes to offset any negatives, the risk is that the property would not necessarily fetch on any future new letting at least as much as today or previously.

Property bought vacant for letting on a new lease and creating an investment from scratch differs from property that is already let. It is not only a difference in immediate income, there is also a difference in valuation approach that can result in thinking the property more valuable than it is.

- Advertisement -

For a proposition to become an investment, a property physically available to let needs a tenant; otherwise it’s simply a vacant property with potential. With rent review during the lease and for market rent on lease renewal, it is not necessary to identify who would want the premises, since within the rental valuation system are hypothetical assumptions, but because a hypothesis would apply at rent review doesn’t mean that the hypothesis would apply if the premises were physically available to let.

That situation is all too common with ready-made investments, where the property is bought with an existing tenant. Assuming the latest rent review was agreed or ascertained to valuation criteria, the existence of the hypothetical assumption that is reflected in the passing rent would not apply if the premises were physically available to let with vacant possession. That’s not the same as saying the market has changed for the worse so the rent has fallen since the last review. What it amounts to is that the rent on review was higher thanks to the hypothesis.

Whether the seller of an investment would be sympathetic to the idea that the proposition is let at more than it might otherwise fetch and agree a lower price is doubtful. Therefore, when you buy a ready-made investment, it is important to be aware that the rent passing could be more than the premises would fetch if offered to let in the market, all other factors remaining constant. Short of ignoring the rent review hypothesis, it is not going to be possible to overcome the difference between the rent on review and the rent the premises would fetch if exposed to the open market. Hence, the need for judicious choice of investment.

Amongst the differences between a review to open market rent and a letting in the open market is evidence. At rent review, there is a preference for evidence which may be available or a paucity. There is no need for evidence in the open market for a new letting because the premises are unlet. The test, therefore, of whether the asking rent on a new letting is correct is determined by an offer that completes.

In locations and for types of property where demand exceeds supply, the market rent is likely to be higher than the passing rent, unless the passing rent is inflated for whatever reason or historic. The expectation for rental growth has a sound basis.

Despite the desire for the rent on review to be the open market rent, it is common for the rent agreed or ascertained to be less than the rent that would be obtained if the premises were physically available to let. The difference is partly explained by a school of thought amongst some surveyors that the landlord is spared the cost and uncertainty of physically having to relet the premises so why should the full rent be set; and by the need, in most cases, for evidence which, in conjunction with the terms and conditions of the lease, may result in a more conservative approach, the open market untested. To be able to demonstrate a higher rent at rent review than the evidence would support without evidence is challenging, if not futile.

Expectations for rental growth at rent review lie between the two extremes of unrealistic and realistic. Frequently, the unrealistic is based upon assumptions that bear no relationship to how rent reviews are done, let alone what the lease says. A common unrealistic expectation is that the rent has not been increased for years, invariably the landlord did not implement the last review, so now that the economy has picked up the tenant should pay more. It is rare for tenants to agree but tenant resistance doesn’t prevent landlords from being intent regardless.

The realistic is more likely to be based on the terms of the lease and the valuation hypotheses. Tenants are more likely to respond constructively to proposals that allow for rights than if they feel they are being bullied by wishful thinking.

The difference in attitude, possibly the difference between negotiation and bartering, will also rub off on the degree of success the landlord will experience with the property. Where the tenant’s negotiating rights are respected, the proposal is less likely to pitched excessively and the landlord’s expectations for rental growth more likely to be achievable.

Michael Lever
The Rent Review Specialist
Established 1975

Please Note: This Article is 6 years old. This increases the likelihood that some or all of it's content is now outdated.
Subscribe to LandlordZONE

LEAVE A REPLY

Please enter your comment!
Please enter your name here