Commercial property, as with all types of property, is an illiquid asset whose highest value depends on the availability of a ready supply of credit. Cash buyers are sought-after but availability of debt eases illiquidity by allowing more people to participate, increasing the volume of activity in the market. At any point in time, the prosperity and value of the commercial property market depends upon bank lending criteria.
When a bank loan is involved, the market prosperity depends upon how far valuation surveyors are willing to stick their metaphorical neck out when assessing for the lender the market value of the property being offered as security for the loan. Market value of the property is its vacant possession value which in turn is based upon the estimated rental value on a new lease. Market value of the property as an investment is the capital value of the current rental income and reversionary prospects, the rent itself based on the terms and conditions of the lease for the particular property. Unlike buyers that can pay whatever they like and unlike the banks that can relax criteria for preferred borrowers, it is the neck of valuation surveyors that is on the line should the market become unstable.
Market instability is not event-oriented, but on-going. Events arising, including shocks to the system are concentrated forms of instability. In England and Wales, where property transactions are ‘subject to contract’ which implies a time-lag, whenever a property is offered for sale, the seller needs the state of the market to remain constant between the decision to offer the property for sale and exchange of contracts, at least, and completion. In a rising market, where the property value might increase between the initial acceptance offer and exchange of contracts, the seller has to consider whether upping the price to the buyer or withdrawing from the transaction in the hope of procuring a higher price from another party is worth the risk. Conversely, in a falling market, the buyer has to consider whether the initial offer is too high as the transaction proceeds and whether to renegotiate the price before exchange. Considering how much can be at stake hanging by the thread of ‘subject to contract’ content to allow the transaction to take its course is a tribute to the honour amongst sellers and buyers; either that or the cost of selling and buying, chopping and changing, is the underlying deterrent.
Ongoing instability is a reflection of people’s uncertainty of the future. Trusting intuition is the guide, but feelings can be dismissed as vague when compared to the desire for evidence. When desire for evidence is paramount, the only way to remain convinced of what the future holds is to base decisions on logic. Logic builds on past experience. By reference to evidence of what is happening in the market, it becomes reasonable to assume the prevailing state will continue for the foreseeable future.
Whether a state is sufficiently influential depends upon vested interests. Larger banks, knocked out of shape by the 2008 crisis, are still getting their act together, but have had to relax earlier more stringent lending criteria to ensure their core business, making a profit out of other people’s money, does something to please shareholders. Loan rates geared to LIBOR do not really provide enough of a margin for long-term sustainability, but what can one do when Base Rate is just 0.5% and any increase in interest rates, despite being good for savers, would apparently plunge the indebted into dire straits. Substantial amounts of money are lent on any property whose investment characteristics stack up on paper and tick all the boxes. Aided and abetted by valuation surveyors, whose primary source of evidence nowadays are auction prices, the prosperity of the market depends upon the virtuous circle of buyers coming back for more; and, behind the-scenes, the art and skill of juggling all the balls in the air.
In many places, including London, rental growth can mostly only be achieved through a manipulative process, politely known as pro-active management. Resistance by tenants to not pay any more than necessary reflects the fact that earned profits are hard to make. At macro-level, economic prosperity is a numbers-game. Numbers are factual, no room for emotion. At micro-level, where livelihoods and the business survival is at stake, prosperity is emotional. Many tenants, having strayed from what it means to be a tenant are overstretched financially with personal commitments and in the firing line of reality stuck between the infrastructural changes in their market-place and the total property costs commitment. It doesn’t help long-term sustainability that the system is loaded in favour of surveyors, whose reliance on evidence, has been latched upon by the indifferent
In this transitionary stage, between how rents have always been determined and how they should be set for long-term sustainability, investment in property has gone ex-growth and is now in a world of its own, investment in investment. To classify an income-producing property as an investment is too simplistic. The goal of investment is to be better off. Rent covering the cost of a loan is not enough: adjusting for inflation, allowing for holding and management costs, loss of interest on equity, and allowing for tax on capital gain, there has be a surplus. The investment appraisal question is not whether there is rental income, but whether any increase in rent would be accommodated by the tenant and more importantly for how long. For example, a property let for 20 years with 5 yearly rent reviews to a well-known tenant is a mortgageable asset, but loan-security depends upon that particular tenant remaining in occupation for the duration of the mortgage. Unless the property offers scope for redevelopment, in which case vacant possession would probably be wanted, whether an investment bought now would pass the test of performance, to have risen in value, will only be known in future. Buying to sell on so as to capitalise on market sentiment is okay: nothing wrong with trading, but let’s be honest, not really property investment, it’s simply investment in investment.
The Rent Review Specialist