Any form of investment whose profit-potential depends upon finding someone somewhere to buy it off you, preferably for more than you paid, is risky. What happens if there isn’t anyone? Take the ‘collectibles’ market, whose world-wide transactions are an estimated $200 billion dollars a year, albeit much of the expenditure for the pleasure of collecting and owning rather than any thought of wanting to make a profit. It’s doesn’t matter that most ‘collectibles’ are likely to have little or no value, what matters is how quickly a buyer can come to terms to that reality, and how much can be lost in the process. A good example is the 1990s craze for Beanie Babies, in their time accounting for 10% of eBay’s sales. So successful was the price tag for ‘cute’ and ‘adorable’ that the powerful combination of emotion and limited edition helped make their creator Ty Warner one of the richest men in the world, with an estimated net worth of $2.4 billion. Some BBs continue to be sought after and command high prices, but for the more common ‘little animals stuffed with plastic pellets’ that once might’ve set you back £25-£100 the price range now is no more than retail value.
The first recorded speculative bubble is popularly considered to be “tulip mania” when, at its peak in March 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman. Property is not immune from the same forces that fuel bubbles, and fill reality with hot air. When you buy a property, whether the purchase price is sustainable is not something to take for granted. Whether it matters that blips and occasional set-backs in an otherwise historic upward-only path would or should affect your thinking depends upon whether your expectations for the future are realistic. Just because Mark Twain said “Buy land — they’re not making any more” appeals to common sense doesn’t overcome the fact that, value-wise, the adage is completely false. Land value comes from economic usefulness, in particular access. And since access is a force to be reckoned with in communications, it is a value that is changing all the time.
On one hand, whether the capital appreciation and rental growth that underpins property’s reputation as a hedge against inflation will come your way depends upon the purchase price and the total non-recoverable costs during the period of ownership. On the other hand, the income that property is capable of generating will depend upon tenant demand for the type of property, its suitability and most importantly its location.
The adage ‘location, location, location’ is probably the chief if not the only reason for intrinsic capital appreciation and rental growth. Capital appreciation from yield compression can only run a course: activity starts as a narrow furrow and gradually widens until the bulk of investor demand is absorbed whereupon the cut-off-point is determined by interest rates and comparison with whatever else is available. Unlike yield-compression, which is an investor and owner-occupier only market, intrinsic appreciation also involves developer and tenant thinking.
Location is not only about what the landlord-investor thinks of it but also what a developer and/or tenant thinks of it. Ignoring the tenant’s involvement and instead, as the commercial property investment market has been doing for some time, focussing on enthusiasm for covenant means that the relevance of the location to the wider market can be overlooked. Merely because ‘x’, whose covenant the investment market highly prizes and for which the investor pays a premium, is the tenant now does not mean that that particular tenant would want to continue with the premises when the lease expires. It also does not mean that particular tenant wants the premises now: it might be biding its time for operational reasons. As for the developer, whether the property is in a location that would be worthwhile developing depends upon whether a complementary tenant can be found to help underpin the vision.
When you compare the low yields that auctioneers are getting from “armchair investors” for properties that are unlikely to withstand the test of time with the higher yields that professional investors are getting from propositions that are not for sale at auction, the gap is often wide. There is no doubt that in the room ‘auction fever’ can be virulent. But there is more to it than simply being carried away. For investors that would more likely frequent auction rooms, capital appreciation is geared to yield compression, and the security of rental income tends to be assessed based on the tenant’s financial standing. For investors for whom auctions are more of a turn-off, intrinsic appreciation is the objective, the security of rental income less important than certainty.
The existence of a two-tier market in attitude is enabling professional investors, developers, and property dealers, to capitalise on demand for security of rental income by creating bespoke propositions. Whether buyers at auction care about being subtly duped when at the end of the day they can come away with secure rental income might not matter were it not for the stress caused by a lack of mercy shown by the market when the certainty of capital appreciation and rental growth that might or would otherwise be obtainable fails to materialise.
The Rent Review Specialist