Despite evidence that many shrewder landlords are selling up while the going is good, the booming market in retail property investments is showing no overt signs of abating. Money to invest is one thing, but money to provide a return on capital is another so it is time to wonder how those tenants that are just about keeping their heads above water are going to manage when their own rents come up for review.
A few retailers having got what it takes are a powering ahead, but most do not, so are not. Most retailers are just about managing to stay afloat by using all manner of ways to minimise tenancy liabilities. Although it is fascinating to observe just how much money multiple retailers can conjure up out of thin air when they put their corporate minds to it, the reality is that cost-cutting and cost-saving initiatives are bound to be short-lived because ultimately the only way to grow is to sell more.
To sell more, the challenge for all retailers is the same: either to get more of their existing customers to spend more or attract new customers, or a combination of both. Getting existing customers to spend more is the least expensive option, but may be a pointless exercise when those customers do not have much more to spend. Attracting new customers requires those customers to be dissatisfied with where they spend at present.
Wanting retailers to be profitable by helping them to grow should be the goal of landlords, but often it is not. Many landlords are only interested in extracting as much rent as they can out of the tenant’s business to increase the value of the landlord’s interest and cash in by selling into the booming investment market. At rent review, the landlord’s expectation for market rent will often differ from what the tenant could afford and although, per business tenancy law, the tenant’s ability to afford the market rent is irrelevant that doesn’t mean the tenant would give in easily. On the contrary, the landlord is likely to have a fight on his hands. So, because fights involving business tenancies are a war of words, the cost of fighting for every penny can become disproportionate. In such situations where the landlord is intent regardless, ironically the psychology of selling the investment as reversionary is often overlooked.
A reversionary investment is one where the passing rent is below the market rent, which means that at next review there is something to go for. Instead of being a straight yield on actual rent receivable, the value of the investment is calculated by adding the capital value of the existing rent for the number of years to the next review to the estimated rental value deferred by that number of years.
When the investment market is flat and little demand, investors prefer certainty with the income stream known in advance. When the investment market is active and booming, investors are more willing to take risks so will accept a lower yield to begin with in exchange for the prospect of better things to come.
Because of how reversionary investments are valued, there might be hardly any difference in capital value between (1) a property that is let on a rack rent (full market rent) with no review for some time and (2) where the rent is below market rent and with a rent review in the near future. From the investment market’s perspective, the prospect of something to go for is often enough to whet the investor appetite, thereby avoiding any need by the existing landlord to increase the running yield before putting the property on the market for sale.
The use of reversionary investments is a good way to off-load the problem of tenant resistance to any increase in rent onto the market, without the seller losing out. Buyers that fall into the trap of thinking there must be something to go for at the forthcoming rent review only to discover that there is not only have themselves to blame. When the investor takes out a loan for the purchase, the caveats that bank valuation reports are full of are there for a reason!
A student of psychology would surely find it interesting to research how many private investors do fall into the trap of thinking something to go for when buying reversionary investments and how many succeed in getting enough of an increase to make the exercise worthwhile. The thought of something to go for is itself a mystery, since it rather suggests the buyer did not think the previous landlord took advice on what the rent might be before selling, or perhaps the buyer considers himself better at procuring an increase? Whatever the reason, the new landlord takes over not where the previous landlord left off in a benign way, but dives straight into a costly fight with the tenant.
Costly fights with tenants require the skilled exploration of new angles, different interpretations of the lease, and negotiating psychologies. Generally, tenants prefer stability in relationships with their landlords so can find it a nuisance to have to adjust to a new landlord, especially one wanting a better return on capital and that will stoop at nothing for conquest.
In some trading positions, an increase is justified, the previous landlord’s reason for selling nothing to do with the property itself, but generally the scope for capital gain may be more expensive to obtain by operation of rent review than selling the proposition and investing in something which definitely has something to go for. That is, if in the current market, such propositions can still be found.
The Rent Review Specialist