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 This increases the likelihood that some or all of it's content is now outdated.

For the uninitiated, commercial property is a steep learning curve. For the inexperienced landlord, commercial property is like a minefield, full of pitfalls for the unwary. Whereas residential property is a political hot potato, commercial property is a battle of wits. Both markets are unregulated, but with rules and regulations and if not governed by legislation then chances are by case-law. Market participation is not only caveat emptor but also caveat venditor, as exemplified in Rosemary Scott v Southern Pacific Mortgages Ltd [2014]

One difference between a regulated and unregulated market is to do with expectation of what the parties might be getting up to. In a regulated market, everything is above board. In an unregulated market there are hidden agendas galore. A feature of unregulated markets is ease of buying involvement. To get into the property market all you need is money then all you have to do is say yes to the proposition and (assuming the jurisdiction is England and Wales, not Scotland) hope that the ‘subject to contract’ conveyancing doesn’t take too long or the seller get fed up with the delay. Selling is not as easy. You have to find a buyer and where buyers can be found depends upon the type of property and the price range.

Of the three methods for selling – private treaty, tender (sealed bids), and auction – auction has grown in popularity because the procedure includes numerous advantages that are considered essential components for marketing a property. All methods have advantages and disadvantages, but auction offers possibly the most attractive route for selling and the least attractive for buying. An auction creates a sense of urgency. If you cannot buy beforehand then the auction date is the only opportunity to be certain of being able to join in with the bidding. Whether your bid wins is a matter of price.  The downside of urgency is that caution can be thrown aside in the desire to buy. Due diligence costs time and money: the fixation on leaving the auction having bought something is generally more powerful than the feeling of wanting to come away empty-handed.

Auction fever, a state of being carried away by the momentum and excitement that you end up paying more than you wanted, is reflected in the yields that commercial property fetch compared to what can be obtained by private treaty. At auction the yields are frequently lower which is why shrewd investors use auctions for selling, not buying. Since auctions are not necessarily representative of market value, it is surprising how many buyers are willing to pay more than they might otherwise need to. One reason for overpaying is availability: an auction catalogue contains propositions that the average investor might not have the opportunity to buy, otherwise. That’s still no reason to overpay. There is no point in buying an investment if you are unlikely to be any better off once you become the landlord and have to deal with a tenant whose opinion of your expectations differs from the tenant’s reality and/or what the lease says.

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Generally, the calibre of property that is available to naive investors is rarely worth buying. The sort of property that is rarely for sale is rarely available for the simple reason it’s worth keeping. The market is overrun with naive buyers and consequently an increasing number of naive landlords. Symptoms of naivety include not really understanding the terms and conditions of the lease, or granting a new lease with an unworkable rent review, and thinking a resistant tenant is a temporary aberration, that one day the landlord will get the property back and be able to relet it at a higher rent. Living in hope is wishful. The future is not necessarily logical, things might not turn out as one might expect. If the choice of investment is not in tune with the direction in which the market is heading now then the chances of the investment performing would be unlikely.

As an alternative to growth, naive buyers treat the investment as a higher yield than cash on deposit. Rent covers the mortgage and gradually increases the equity in the property. In the end, the interest is unencumbered, but in exchange for a property in a location that’s going nowhere. If you overpaid for the proposition to begin with then the scope for further yield compression would be limited. A shorter lease is only reversionary if the market rent or value would be higher: otherwise, it’s merely a depreciating asset.

It fascinates me how many private investors in the past few years don’t seem to have much idea of what they’ve bought. Since I never think my experience necessarily representative, I conduct informal surveys with other surveyors to gauge whether my experience is unusual. The general feeling amongst experienced surveyors is of a vast amount of money being paid by naive buyers for dud investments.

Pitting inexperienced wits against the system may work where the tenant is weak-willed, but not against the more sophisticated. The banks are not interested in whether the investment is likely to perform; all the banks care about is that the mortgage can be repaid or in default the mortgage valuation surveyor has been sufficiently convincing that the bank would get its money back. Therefore, the investor that ignores experienced advice, preferring instead to rely on anecdotal evidence and uninformed thinking, could be said to be asking for trouble, a form of masochism or self-harm that only personal psychology can explain.

It is only the naive that reject these two question as pointless to ask when considering buying: 1) who is selling, and 2) why. Neither answer is irrelevant. The seller knows more about the proposition than a prospective buyer. If the property were worth keeping then most likely it wouldn’t be on the market for sale. Therefore, if you really must join in, then be careful not to overpay otherwise you could end up stuck in a rut.

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.

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