1 - Introduction
Two points to remember: 1) the landlord owns the property, not the tenant’s business; and 2) a difference can exist between the value of the property and the value of the investment.
Two points to remember: 1) the landlord owns the property, not the tenant’s business; and 2) a difference can exist between the value of the property and the value of the investment.
Introduction
All information on Shop Investment is for education purposes only and is not intended a substitute for specific advice. If you want to apply what I say to your particular circumstances, or a particular situation, then you do so entirely at your risk. Every property, every landlord and every tenant is different, so it is impossible to cover every set of circumstances, or eventuality in a generalised way.
Your use of the information on this website assumes you have read the Disclaimer, so please do.
All information is based upon my knowledge and experience of business tenancy law in England and Wales: the last updated date as shown at the foot of each page.
To keep the style of writing friendly, and active, rather than passive or academic, I use ‘you’ rather than ‘one’. However, by ‘you’ I don’t mean you personally, so please don’t think I’m wanting to impose and don’t take anything I might say personally. To use the pronoun ‘she’ whenever I use ‘he’ would make for difficult reading so, rather than refer to people as ‘it’ wherever I use ‘he’ that includes ‘she’ as well. Also, any reference to ‘himself’ includes ‘herself’ and use of ‘he’ or ‘him’ or any other gender-specific word includes ‘she’ or ‘her’ and any feminine equivalent, unless otherwise stated.
References to interest rates and yields are gross, before tax. Interest Base Rates since 1989 may be found on the Michael Lever website at http://www.michaellever.co.uk/therentreviewspecialist/interestrates.html
Rents, prices and values are exclusive of VAT.
Sometimes it may not be possible to limit comment to a particular topic so you may find the same comment(s) elsewhere!
To contact me, please telephone 01531 631892 or email help@michaellever.co.uk
I look forward to helping you in some way.
Michael Lever
PS - To complement the information on Shop Investment, please click here for News and Views
All information on Shop Investment is for education purposes only and is not intended a substitute for specific advice. If you want to apply what I say to your particular circumstances, or a particular situation, then you do so entirely at your risk. Every property, every landlord and every tenant is different, so it is impossible to cover every set of circumstances, or eventuality in a generalised way.
Your use of the information on this website assumes you have read the Disclaimer, so please do.
All information is based upon my knowledge and experience of business tenancy law in England and Wales: the last updated date as shown at the foot of each page.
To keep the style of writing friendly, and active, rather than passive or academic, I use ‘you’ rather than ‘one’. However, by ‘you’ I don’t mean you personally, so please don’t think I’m wanting to impose and don’t take anything I might say personally. To use the pronoun ‘she’ whenever I use ‘he’ would make for difficult reading so, rather than refer to people as ‘it’ wherever I use ‘he’ that includes ‘she’ as well. Also, any reference to ‘himself’ includes ‘herself’ and use of ‘he’ or ‘him’ or any other gender-specific word includes ‘she’ or ‘her’ and any feminine equivalent, unless otherwise stated.
References to interest rates and yields are gross, before tax. Interest Base Rates since 1989 may be found on the Michael Lever website at http://www.michaellever.co.uk/therentreviewspecialist/interestrates.html
Rents, prices and values are exclusive of VAT.
Sometimes it may not be possible to limit comment to a particular topic so you may find the same comment(s) elsewhere!
To contact me, please telephone 01531 631892 or email help@michaellever.co.uk
I look forward to helping you in some way.
Michael Lever
PS - To complement the information on Shop Investment, please click here for News and Views
Remember: Two Points
Investment in shop property can be very rewarding, or it can become an expensive mistake.
As an investment medium, commercial property is not without risk, and whilst the risk, of which there are many, might seem more apparent compared with, for example, offices, factories and warehouses, where building obsolescence is an important factor, the snag with shop property is that the role of shops is inextricably bound up with marketing and the operational aspects of the tenant’s business.
Amongst the things to remember, there are two that should be at the forefront of every landlord and investor’s mind: firstly, the landlord owns the property, not the tenant’s business; and secondly a difference exists between the value of the property and the value of the investment.
To an extent, the secret of successful investment in shop property is about judicious choice. Having the good sense to avoid certain types of propositions no matter how tempting is not only a matter of judgement, but also objective forward-thinking.
Investment in shop property can be very rewarding, or it can become an expensive mistake.
As an investment medium, commercial property is not without risk, and whilst the risk, of which there are many, might seem more apparent compared with, for example, offices, factories and warehouses, where building obsolescence is an important factor, the snag with shop property is that the role of shops is inextricably bound up with marketing and the operational aspects of the tenant’s business.
Amongst the things to remember, there are two that should be at the forefront of every landlord and investor’s mind: firstly, the landlord owns the property, not the tenant’s business; and secondly a difference exists between the value of the property and the value of the investment.
To an extent, the secret of successful investment in shop property is about judicious choice. Having the good sense to avoid certain types of propositions no matter how tempting is not only a matter of judgement, but also objective forward-thinking.
Strategy
Investment is about becoming better off, financially. Strategy is a subjective plan of action or policy designed to achieve the objective.
A strategy comprises two parts: the subjective and the objective. Subjectively, the components include your particular financial circumstances, commitments, life-style, and aspirations.
The objective components include knowledge of the investment medium, whether your choice of investment medium is likely to perform to your expectations, and the proposed time-scale.
The objective components also include external events over which you have little or no control. For example, things that happen as time passes that can reduce the value of money, typically inflation: - an economic term for a general increase in prices, which affects purchasing power; often things generally cost more as time passes so you’ll need more money to buy what you bought before, unless there are cheaper or alternative ways. Another example is tax: the rate and amount of tax payable on any income or capital gain will reduce the net profit.
Another example is that location and/or trading position can improve or deteriorate over time. It is by no means unusual for what starts as a prime proposition to become secondary over the years, or conversely a secondary position to become a prime position. An example of how that situation could arise is the arrival of a new shopping centre development in the town or region, or the relocation of a major retailer. The important thing to remember is that whereas a building is in a fixed place, the relationship between that place and its surroundings is not. Furthermore, the relationship between the retailer and the particular shop is not necessarily fixed.
Investment is about becoming better off, financially. Strategy is a subjective plan of action or policy designed to achieve the objective.
A strategy comprises two parts: the subjective and the objective. Subjectively, the components include your particular financial circumstances, commitments, life-style, and aspirations.
The objective components include knowledge of the investment medium, whether your choice of investment medium is likely to perform to your expectations, and the proposed time-scale.
The objective components also include external events over which you have little or no control. For example, things that happen as time passes that can reduce the value of money, typically inflation: - an economic term for a general increase in prices, which affects purchasing power; often things generally cost more as time passes so you’ll need more money to buy what you bought before, unless there are cheaper or alternative ways. Another example is tax: the rate and amount of tax payable on any income or capital gain will reduce the net profit.
Another example is that location and/or trading position can improve or deteriorate over time. It is by no means unusual for what starts as a prime proposition to become secondary over the years, or conversely a secondary position to become a prime position. An example of how that situation could arise is the arrival of a new shopping centre development in the town or region, or the relocation of a major retailer. The important thing to remember is that whereas a building is in a fixed place, the relationship between that place and its surroundings is not. Furthermore, the relationship between the retailer and the particular shop is not necessarily fixed.
Formulating Strategy
I advise on strategy and am told that is unusual amongst surveyors. For the most part, investors formulate their own strategies and either source propositions by buying direct from sellers, and/or by private treaty, tender and auction and/or ask or retain agents to procure propositions. The snag with doing-it-yourself is that your criteria might not be satisfied by the type of propositions generally available, whereas the advantage in talking things through with an experienced surveyor is to ensure that what you have in mind would be feasible.
Unlike the Stock Market where you can normally buy shares in whatever company you like, the shop property market is not fluid. Many properties never or hardly ever come onto the market and within the rare category are usually snapped up quickly. That leaves the rest and whilst they can be a lot to choose from, the reason they are probably more likely to be available is that their investment prospects are limited.
To formulate strategy, preliminary questions include do you have any experience of commercial property and why do you want to buy a shop investment; why not offices, industrial, leisure or a pub?
Answers might include everyone goes shopping and you can judge for yourself what is happening generally, whereas office, industrial and leisure property is more specialised, buildings often sizeable, so pricey for private investors; construction is prone to obsolescence, leading to capital expenditure for refurbishment; letting subject to longer voids; and while there may be development potential or scope for alternative use such as conversion of offices into flats, rental growth prospects may be limited because occupiers rarely compete for premises.
Although you may be able to judge for yourself what is happening, such observation is often superficial, because you do not know what the tenant is planning (and well-advised or experienced tenants never keep the landlord informed). So if you fancy a shop property investment because you are fed up with the Stock Market then ask yourself why you think you would do any better. If you don’t have what it takes to pick winners on the Stock Market then why do you think you will fare any better in the commercial property market?
If the answer is that you would be in control then think again: although landlords may think they have the upper hand, business tenancy law and valuation can work both ways so control is often in the hands of the tenant.
Negotiating skills, including whether landlord and/or tenant is properly advised, can make or break an investment. True, property has a reputation as a hedge against inflation and many people think they can’t go wrong, but people do: apart from the risk of the tenant going broke and the property unlettable at the same rent, most property investments are depreciating assets, because in calculating profit, before capital gains tax, few people also allow for transaction and management costs, loss of interest on equity and inflation.
I advise on strategy and am told that is unusual amongst surveyors. For the most part, investors formulate their own strategies and either source propositions by buying direct from sellers, and/or by private treaty, tender and auction and/or ask or retain agents to procure propositions. The snag with doing-it-yourself is that your criteria might not be satisfied by the type of propositions generally available, whereas the advantage in talking things through with an experienced surveyor is to ensure that what you have in mind would be feasible.
Unlike the Stock Market where you can normally buy shares in whatever company you like, the shop property market is not fluid. Many properties never or hardly ever come onto the market and within the rare category are usually snapped up quickly. That leaves the rest and whilst they can be a lot to choose from, the reason they are probably more likely to be available is that their investment prospects are limited.
To formulate strategy, preliminary questions include do you have any experience of commercial property and why do you want to buy a shop investment; why not offices, industrial, leisure or a pub?
Answers might include everyone goes shopping and you can judge for yourself what is happening generally, whereas office, industrial and leisure property is more specialised, buildings often sizeable, so pricey for private investors; construction is prone to obsolescence, leading to capital expenditure for refurbishment; letting subject to longer voids; and while there may be development potential or scope for alternative use such as conversion of offices into flats, rental growth prospects may be limited because occupiers rarely compete for premises.
Although you may be able to judge for yourself what is happening, such observation is often superficial, because you do not know what the tenant is planning (and well-advised or experienced tenants never keep the landlord informed). So if you fancy a shop property investment because you are fed up with the Stock Market then ask yourself why you think you would do any better. If you don’t have what it takes to pick winners on the Stock Market then why do you think you will fare any better in the commercial property market?
If the answer is that you would be in control then think again: although landlords may think they have the upper hand, business tenancy law and valuation can work both ways so control is often in the hands of the tenant.
Negotiating skills, including whether landlord and/or tenant is properly advised, can make or break an investment. True, property has a reputation as a hedge against inflation and many people think they can’t go wrong, but people do: apart from the risk of the tenant going broke and the property unlettable at the same rent, most property investments are depreciating assets, because in calculating profit, before capital gains tax, few people also allow for transaction and management costs, loss of interest on equity and inflation.
Performance
Performance is the action or process of carrying out or accomplishing an action, task or function. The physical form of an investment is the medium or ‘vehicle’ for the performance. The form may not have been designed for the purpose; it may have been adapted, altered, or improved, but no matter the original shape essentially the medium is the store of value.
Often, choice of medium is based on myth, a widely held or false belief or idea. Generally, for example, cash on deposit at a bank or building society is not regarded a positive investment; even though, arguably, cash on deposit is the most secure investment. It is secure, because you can take out (withdraw) your money (almost) immediately; and the capital amount is almost certain to increase, because it is likely interest would be paid on the capital and can left on deposit for compounding (interest paid on interest). Even if the rate of interest were considered derisory, compared with other forms of investment, nevertheless interest would normally be credited on a daily basis, so you can calculate how much your investment is worth at any time.
Although rarely considered a positive investment, cash is the absolute of investment performance. Since the cash remains undiminished, cash on deposit is (relatively) secure, so interest on cash deposits, or the yield on gilt-edged stock (which, as government bonds, are considered secure), is used as the benchmark for other forms of investment.
Performance is the action or process of carrying out or accomplishing an action, task or function. The physical form of an investment is the medium or ‘vehicle’ for the performance. The form may not have been designed for the purpose; it may have been adapted, altered, or improved, but no matter the original shape essentially the medium is the store of value.
Often, choice of medium is based on myth, a widely held or false belief or idea. Generally, for example, cash on deposit at a bank or building society is not regarded a positive investment; even though, arguably, cash on deposit is the most secure investment. It is secure, because you can take out (withdraw) your money (almost) immediately; and the capital amount is almost certain to increase, because it is likely interest would be paid on the capital and can left on deposit for compounding (interest paid on interest). Even if the rate of interest were considered derisory, compared with other forms of investment, nevertheless interest would normally be credited on a daily basis, so you can calculate how much your investment is worth at any time.
Although rarely considered a positive investment, cash is the absolute of investment performance. Since the cash remains undiminished, cash on deposit is (relatively) secure, so interest on cash deposits, or the yield on gilt-edged stock (which, as government bonds, are considered secure), is used as the benchmark for other forms of investment.
Categories
Investments are categorised as liquid or illiquid. Cash and cash-equivalent assets are 'liquid' investments. With a ‘liquid‘ investment you have (immediate) access, either to buy or sell or withdraw funds.
Similarly, although capital value fluctuates, stocks, shares and bonds are also considered liquid, because the ‘money’ markets are structured for almost instant liquidity. Even so, the capital value can fluctuate because the stock market is volatile, so stocks, bonds and shares are riskier. With cash on deposit, it is unlikely you could lose your capital and all UK regulated savings accounts are covered by the Financial Investors Compensation Scheme, a government-backed scheme providing investor protection up to a maximum amount. Compensation limits can vary - information can be found at http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/ - so many people like to spread the cash around numerous regulated organisations so as to ensure maximum protection for deposits; even so the likelihood of a UK regulated financial organisation failing is remote.
Unlike cash, and cash-equivalents, property is an illiquid asset. An illiquid asset is one that cannot be readily converted into cash (or cash-equivalent) quickly and with minimum loss of value. Furthermore, depending upon the form of the illiquid asset, it may only be possible to cash an illiquid investment by selling it to someone else. When an illiquid investment produces an income, it may be possible to mortgage the income secured against the value of the asset.
There are practical advantages of liquid over illiquid assets. Liquid assets are portable. Money may be defined as any good or tokens that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The use of money provides an easier alternative to barter: in a modern, complex economy bartering is considered inefficient because it requires a coincidence of wants and an agreement that the needs are of equal value before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
As an illiquid investment, property is high-risk. That does not mean the risk can never be low or minimal, simply there is no guarantee the market value of the property could be realised when the cash is required. To do so would require the certainty of a buyer at that price, completing the purchase and transferring the money on that required date.
With an illiquid investment, risk is not only about what you could lose in terms of how the investment performs, but also whether you could get your money back at any time. Performance is a matter of skill and judgement. The only way to get your money back is to be certain someone else would buy the investment at any time in the future for at least the same price as you paid.
Where many inexperienced investors go wrong when buying is not thinking whether someone else would pay the same. It’s no good thinking, for example, that since there were other bidders at the auction and you only paid slightly more than the under-bidder, when you want to sell there is sure to be as much interest. Auction prices are not representative of market value: all they represent is how much someone paid on the day of the auction.
Investments are categorised as liquid or illiquid. Cash and cash-equivalent assets are 'liquid' investments. With a ‘liquid‘ investment you have (immediate) access, either to buy or sell or withdraw funds.
Similarly, although capital value fluctuates, stocks, shares and bonds are also considered liquid, because the ‘money’ markets are structured for almost instant liquidity. Even so, the capital value can fluctuate because the stock market is volatile, so stocks, bonds and shares are riskier. With cash on deposit, it is unlikely you could lose your capital and all UK regulated savings accounts are covered by the Financial Investors Compensation Scheme, a government-backed scheme providing investor protection up to a maximum amount. Compensation limits can vary - information can be found at http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/ - so many people like to spread the cash around numerous regulated organisations so as to ensure maximum protection for deposits; even so the likelihood of a UK regulated financial organisation failing is remote.
Unlike cash, and cash-equivalents, property is an illiquid asset. An illiquid asset is one that cannot be readily converted into cash (or cash-equivalent) quickly and with minimum loss of value. Furthermore, depending upon the form of the illiquid asset, it may only be possible to cash an illiquid investment by selling it to someone else. When an illiquid investment produces an income, it may be possible to mortgage the income secured against the value of the asset.
There are practical advantages of liquid over illiquid assets. Liquid assets are portable. Money may be defined as any good or tokens that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The use of money provides an easier alternative to barter: in a modern, complex economy bartering is considered inefficient because it requires a coincidence of wants and an agreement that the needs are of equal value before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
As an illiquid investment, property is high-risk. That does not mean the risk can never be low or minimal, simply there is no guarantee the market value of the property could be realised when the cash is required. To do so would require the certainty of a buyer at that price, completing the purchase and transferring the money on that required date.
With an illiquid investment, risk is not only about what you could lose in terms of how the investment performs, but also whether you could get your money back at any time. Performance is a matter of skill and judgement. The only way to get your money back is to be certain someone else would buy the investment at any time in the future for at least the same price as you paid.
Where many inexperienced investors go wrong when buying is not thinking whether someone else would pay the same. It’s no good thinking, for example, that since there were other bidders at the auction and you only paid slightly more than the under-bidder, when you want to sell there is sure to be as much interest. Auction prices are not representative of market value: all they represent is how much someone paid on the day of the auction.
Asset
An asset is something, a quality, or a person, of use or value. For the investment strategy, and the investment medium, and investment performance to work together successfully, the relationship between them must have an understanding of the processes that are necessary to bring about the experience. Essentially, the relationship revolves around the attitude of the investor, and the principles and process of marketing.
An asset is something owned by a person or business that is regarded as having value. An asset can appreciate (go up in value), or it can depreciate (go down in value). An asset will have three values: intrinsic value, scrap value, and artificial value.
Intrinsic value is the price/cost of the materials and workmanship for making of the asset. Scrap value is the value of whatever the asset is made of.
Artificial value is how much someone would be willing to pay, regardless of the intrinsic or scrap values. How much more or less would depend upon supply and demand. Generally, the supply of assets that would attract artificial value is limited and often scarcity maintains an artificial value. As for demand, I talk about that subject in more detail under the heading 'marketing'.
Value itself is generally a matter of opinion, what the market would bear, and the nature of the transaction. Again, I talk about that under the heading 'marketing'.
An asset is something, a quality, or a person, of use or value. For the investment strategy, and the investment medium, and investment performance to work together successfully, the relationship between them must have an understanding of the processes that are necessary to bring about the experience. Essentially, the relationship revolves around the attitude of the investor, and the principles and process of marketing.
An asset is something owned by a person or business that is regarded as having value. An asset can appreciate (go up in value), or it can depreciate (go down in value). An asset will have three values: intrinsic value, scrap value, and artificial value.
Intrinsic value is the price/cost of the materials and workmanship for making of the asset. Scrap value is the value of whatever the asset is made of.
Artificial value is how much someone would be willing to pay, regardless of the intrinsic or scrap values. How much more or less would depend upon supply and demand. Generally, the supply of assets that would attract artificial value is limited and often scarcity maintains an artificial value. As for demand, I talk about that subject in more detail under the heading 'marketing'.
Value itself is generally a matter of opinion, what the market would bear, and the nature of the transaction. Again, I talk about that under the heading 'marketing'.
Creating a Portfolio
Strategy for creating a portfolio is influenced by certain basic consIderations:
1. The amount of available finance and/or borrowing (loan) facilities
A cash buyer is limited to the amount of cash available so the number of propositions that may be bought will vary depending upon the source of the cash and the price-range for the type of proposition required. The amount of cash available must allow for transaction costs (buying and selling) also management and holding expenses during the period of ownership. Not all costs are recoverable from the tenant; in any event, it is often necessary to lay out costs and expenses in advance before they are reimbursed or paid by the tenant.
Borrowing facilities will either be proposition-specific or general facilities, using revolving lines of credit. When buying depends on whether the proposition would fulfil mortgagee criteria, the buyer’s flexibility both for price and type of proposition is likely to be limited. Also, mortgage criteria can change so the sort of proposition that lenders will finance will vary. Generally, it is better to arrange funding that is not proposition-specific, because that would lead to a wider range of opportunities. It can also avoid over-paying because often the sort of proposition that is mortgageable may not result in a successful investment.
2. Familiarity with and accessibility to the geographical area
The proposition should be capable of looking after itself, or at least justify management time. The property should be in an accessible location and in an area where you would feel relaxed if you had to visit the tenant to collect the rent personally. There is no point in buying an investment in some obscure place that hardly anyone has heard of because the number of potential investors will diminish. Up-and-coming locations will often have potential but how long it might take for that potential to materialise ought not be underestimated.
3. Familiarity with the type of investment
You should be able to understand the type of investment you are buying. Most investors choose freeholds, but the yield is usually lower for freehold than with short-term or medium-term or long-term leaseholds.
Because a difference exists between the value of the property and its value as an investment, there is no certainty, depending upon the price paid, that merely because the property is freehold it would necessarily hold or maintain its (investment) value. Furthermore, for reasons I shall explain, all property is a depreciating asset.
A leasehold investment is a depreciating asset so, as the term shortens, the yield increases. That can affect resale, particularly if the occupational rent has not gone up by enough to offset the reduction in capital value. When you buy a leasehold, it is wise, at some stage, to buy in the freehold, if possible, regardless of its technical value (assuming sensible price), because freehold propositions are more popular. With leasehold investments, you may have to provide financial references to show you can support the (ground) rent. The ability to pay the (ground) rent is based upon the investor's personal status, and not upon the profit rent. (Profit rent is the difference between the rent the investor pays the freeholder(superior landlord) and the rent received from underletting the premises.)
On expiry of the contractual term a proposition is said to “revert”. Ownership of the reversion depends upon the interest of the superior landlord. In property law, a leaseholder cannot underlet premises for a period exceeding the duration of the term of that leaseholder’s interest. For example, where the superior landlord is the freeholder and has let the property for 99 years at £100 a year to A and A underlets to B at £25,000 a year, then on expiry of 99 years (assuming all other factors remaining constant) A’s interest in the property as intermediate landlord would end and the freeholder then would become B’s direct landlord. Assuming the lease between the freeholder and A permits assignment, A’s leasehold may have a value that could be sold to another party and that could happen ad infinitum. The freeholder’s interest is subject to the remaining or unexpired term of years to A, and what is known as a short-dated, or medium-dated, or long-dated reversion depends upon how many years are remaining before expiry of A’s lease. The value of a reversion depends not only upon the profit rent but also the demand for the type of proposition. An attraction of medium-long-dated reversions is reasonable certainty of capital growth (assuming all other factors remaining constant) and for investors that do not require income in the short term such propositions are in short supply so the purchase price may be relatively expensive. (In the latter part of the 19th century, many properties were sold on ground leases for 99 years and often at fixed rents: 1998 was the last year for such propositions.)
Medium-long dated reversions, often known as freehold ground rents, are a specialist market. The risk is that a lot can happen between the date of purchase and the reversion and that can affect the profit-potential depending on the purchase price. In the early 1980s, I remember talking with an investor at an auction delighted to have paid £160,000 for £250 a year, reversion in 2004, estimated rental value £25,000 a year. By chance whilst I was inspecting shop premises in the same street in 2005, I saw that the investor’s property was empty and like other shops nearby emblazoned with agents’ ‘to let’ boards at an asking rent of £15,000 a year. Conversely, capital growth can be fabulous. In the late 1980s, for a client, I acquired two long-dated reversions in a popular West London suburb producing £20 a year for the total sum of £30,000. Today, the properties produce approximately £70,000 a year, and the value of the residential accommodation could be enhanced by redevelopment.
Most investors prefer either rack-rented propositions - rack rent is terminology for market rent - or early rent reviews and reversions so that they can improve the rent and/or capital value within their foreseeable future.
4. Management administration
Competent management is essential. Management means administration so if you do not like writing letters or dealing with tenant(s), or don’t really understand what you are doing, do use commercial property managing agents - not residential agents - or instruct an experienced retail property surveyor to assist you. Little things crop up all the time with shop property ownership, ranging from the administration of building insurance to the approval of tenant's requests. A competent managing agent or surveyor should monitor the growth and performance of your asset. Also, a managing agent or surveyor provides a ‘shield’ between landlord and tenant.
5. Yield
Never buy a proposition on yield alone. Yield is more than just the return on your investment: it is also a measure of prospects. Few private investors cost the loss of interest on their own money (equity) and propositions are not always self-funding, so loss of interest must be balanced by the knowledge the investment is an appreciating asset, both income and capital value. Neither rent nor capital growth has to keep pace with inflation and whilst property has a reputation as a long-term hedge against inflation, that does not necessarily apply to all property in all locations.
6. Dealer/trader or Investor
It is said that an investment is a deal that went wrong. The main difference between dealers and investors is that dealers are more interested in turning a profit sooner than later. However, the price a dealer would pay ought not be any different to the price an investor should pay. Just because you might not want to sell the investment as soon as there is a profit to be had does not mean you may overpay to start with. Arguably, exactly the same criteria should be used when appraising the proposition: the only difference is the timing of a re-sale.
7. Property knowledge and know-how
Although property knowledge can be learned, know-how comes from experience. Often, there is a big difference between what should happen and what happens in practice. When you read a lease, for example, the literal meaning of the words and phrases may be different from how those words and phrases apply in practice. Lawyers do their best to put in writing the intention of the parties, but wording and phrasing varies and there is no standard form of lease or set-wording, so no matter what the document says, what you’ve got might not be what you get.
The administration and interpretation of a business tenancy is based on a combination of legislation, business tenancy case-law and rental valuation practice. Some legislation overrides the wording in the documents - for example, any agreement requiring one party to pay the costs in connection with arbitration at rent review is void under the Arbitration Act 1996. Case-law can set a precedent, so merely because nothing was done about the rent review at the time may not mean the landlord has lost the right to do so years later.
Amongst the most common mistakes, in my experience, that landlords are prone to making is a tendency to word notices using their own wording and phrasing, rather than by reference to the documentation. It’s not only landlords: many surveyors ignore the wording and phrasing in the document and instead do their own thing. In a matter I dealt with recently, the landlord instructed a surveyor to handle the rent review whereupon the surveyor served notice without regard to the wording in the document and consequently the landlord lost the right to review the rent.
In outline, the application of business tenancy law and rental valuation can affect both the rent and capital value of an investment. Until recently, it might be thought no real difference, apart from procedure, between negotiation at rent review and lease expiry/renewal, but nowadays the practical differences are numerous. For example, at rent review, the tenant usually has no choice but to pay the same rent as before if the market rent were no greater, whereas on expiry the tenant can quit the premises and leave the landlord with the risk and cost of reletting or otherwise disposing of the premises, or pay a lower rent than might have been passing previously. Where the investment is on mortgage, the outcome of negotiations might also affect the loan requirements and lead to the bank wanting its money back. The distressed loans that banks are nursing are a consequence of the period 2004-2008 when investment was primarily based on yield compression, rather than property fundamentals.
Strategy for creating a portfolio is influenced by certain basic consIderations:
1. The amount of available finance and/or borrowing (loan) facilities
A cash buyer is limited to the amount of cash available so the number of propositions that may be bought will vary depending upon the source of the cash and the price-range for the type of proposition required. The amount of cash available must allow for transaction costs (buying and selling) also management and holding expenses during the period of ownership. Not all costs are recoverable from the tenant; in any event, it is often necessary to lay out costs and expenses in advance before they are reimbursed or paid by the tenant.
Borrowing facilities will either be proposition-specific or general facilities, using revolving lines of credit. When buying depends on whether the proposition would fulfil mortgagee criteria, the buyer’s flexibility both for price and type of proposition is likely to be limited. Also, mortgage criteria can change so the sort of proposition that lenders will finance will vary. Generally, it is better to arrange funding that is not proposition-specific, because that would lead to a wider range of opportunities. It can also avoid over-paying because often the sort of proposition that is mortgageable may not result in a successful investment.
2. Familiarity with and accessibility to the geographical area
The proposition should be capable of looking after itself, or at least justify management time. The property should be in an accessible location and in an area where you would feel relaxed if you had to visit the tenant to collect the rent personally. There is no point in buying an investment in some obscure place that hardly anyone has heard of because the number of potential investors will diminish. Up-and-coming locations will often have potential but how long it might take for that potential to materialise ought not be underestimated.
3. Familiarity with the type of investment
You should be able to understand the type of investment you are buying. Most investors choose freeholds, but the yield is usually lower for freehold than with short-term or medium-term or long-term leaseholds.
Because a difference exists between the value of the property and its value as an investment, there is no certainty, depending upon the price paid, that merely because the property is freehold it would necessarily hold or maintain its (investment) value. Furthermore, for reasons I shall explain, all property is a depreciating asset.
A leasehold investment is a depreciating asset so, as the term shortens, the yield increases. That can affect resale, particularly if the occupational rent has not gone up by enough to offset the reduction in capital value. When you buy a leasehold, it is wise, at some stage, to buy in the freehold, if possible, regardless of its technical value (assuming sensible price), because freehold propositions are more popular. With leasehold investments, you may have to provide financial references to show you can support the (ground) rent. The ability to pay the (ground) rent is based upon the investor's personal status, and not upon the profit rent. (Profit rent is the difference between the rent the investor pays the freeholder(superior landlord) and the rent received from underletting the premises.)
On expiry of the contractual term a proposition is said to “revert”. Ownership of the reversion depends upon the interest of the superior landlord. In property law, a leaseholder cannot underlet premises for a period exceeding the duration of the term of that leaseholder’s interest. For example, where the superior landlord is the freeholder and has let the property for 99 years at £100 a year to A and A underlets to B at £25,000 a year, then on expiry of 99 years (assuming all other factors remaining constant) A’s interest in the property as intermediate landlord would end and the freeholder then would become B’s direct landlord. Assuming the lease between the freeholder and A permits assignment, A’s leasehold may have a value that could be sold to another party and that could happen ad infinitum. The freeholder’s interest is subject to the remaining or unexpired term of years to A, and what is known as a short-dated, or medium-dated, or long-dated reversion depends upon how many years are remaining before expiry of A’s lease. The value of a reversion depends not only upon the profit rent but also the demand for the type of proposition. An attraction of medium-long-dated reversions is reasonable certainty of capital growth (assuming all other factors remaining constant) and for investors that do not require income in the short term such propositions are in short supply so the purchase price may be relatively expensive. (In the latter part of the 19th century, many properties were sold on ground leases for 99 years and often at fixed rents: 1998 was the last year for such propositions.)
Medium-long dated reversions, often known as freehold ground rents, are a specialist market. The risk is that a lot can happen between the date of purchase and the reversion and that can affect the profit-potential depending on the purchase price. In the early 1980s, I remember talking with an investor at an auction delighted to have paid £160,000 for £250 a year, reversion in 2004, estimated rental value £25,000 a year. By chance whilst I was inspecting shop premises in the same street in 2005, I saw that the investor’s property was empty and like other shops nearby emblazoned with agents’ ‘to let’ boards at an asking rent of £15,000 a year. Conversely, capital growth can be fabulous. In the late 1980s, for a client, I acquired two long-dated reversions in a popular West London suburb producing £20 a year for the total sum of £30,000. Today, the properties produce approximately £70,000 a year, and the value of the residential accommodation could be enhanced by redevelopment.
Most investors prefer either rack-rented propositions - rack rent is terminology for market rent - or early rent reviews and reversions so that they can improve the rent and/or capital value within their foreseeable future.
4. Management administration
Competent management is essential. Management means administration so if you do not like writing letters or dealing with tenant(s), or don’t really understand what you are doing, do use commercial property managing agents - not residential agents - or instruct an experienced retail property surveyor to assist you. Little things crop up all the time with shop property ownership, ranging from the administration of building insurance to the approval of tenant's requests. A competent managing agent or surveyor should monitor the growth and performance of your asset. Also, a managing agent or surveyor provides a ‘shield’ between landlord and tenant.
5. Yield
Never buy a proposition on yield alone. Yield is more than just the return on your investment: it is also a measure of prospects. Few private investors cost the loss of interest on their own money (equity) and propositions are not always self-funding, so loss of interest must be balanced by the knowledge the investment is an appreciating asset, both income and capital value. Neither rent nor capital growth has to keep pace with inflation and whilst property has a reputation as a long-term hedge against inflation, that does not necessarily apply to all property in all locations.
6. Dealer/trader or Investor
It is said that an investment is a deal that went wrong. The main difference between dealers and investors is that dealers are more interested in turning a profit sooner than later. However, the price a dealer would pay ought not be any different to the price an investor should pay. Just because you might not want to sell the investment as soon as there is a profit to be had does not mean you may overpay to start with. Arguably, exactly the same criteria should be used when appraising the proposition: the only difference is the timing of a re-sale.
7. Property knowledge and know-how
Although property knowledge can be learned, know-how comes from experience. Often, there is a big difference between what should happen and what happens in practice. When you read a lease, for example, the literal meaning of the words and phrases may be different from how those words and phrases apply in practice. Lawyers do their best to put in writing the intention of the parties, but wording and phrasing varies and there is no standard form of lease or set-wording, so no matter what the document says, what you’ve got might not be what you get.
The administration and interpretation of a business tenancy is based on a combination of legislation, business tenancy case-law and rental valuation practice. Some legislation overrides the wording in the documents - for example, any agreement requiring one party to pay the costs in connection with arbitration at rent review is void under the Arbitration Act 1996. Case-law can set a precedent, so merely because nothing was done about the rent review at the time may not mean the landlord has lost the right to do so years later.
Amongst the most common mistakes, in my experience, that landlords are prone to making is a tendency to word notices using their own wording and phrasing, rather than by reference to the documentation. It’s not only landlords: many surveyors ignore the wording and phrasing in the document and instead do their own thing. In a matter I dealt with recently, the landlord instructed a surveyor to handle the rent review whereupon the surveyor served notice without regard to the wording in the document and consequently the landlord lost the right to review the rent.
In outline, the application of business tenancy law and rental valuation can affect both the rent and capital value of an investment. Until recently, it might be thought no real difference, apart from procedure, between negotiation at rent review and lease expiry/renewal, but nowadays the practical differences are numerous. For example, at rent review, the tenant usually has no choice but to pay the same rent as before if the market rent were no greater, whereas on expiry the tenant can quit the premises and leave the landlord with the risk and cost of reletting or otherwise disposing of the premises, or pay a lower rent than might have been passing previously. Where the investment is on mortgage, the outcome of negotiations might also affect the loan requirements and lead to the bank wanting its money back. The distressed loans that banks are nursing are a consequence of the period 2004-2008 when investment was primarily based on yield compression, rather than property fundamentals.
Pension Planning
A pension is a long-term commitment and tax relief is attractive, but setting-up fees and on-going charges for pension plans can be disproportionately high. I suggest thinking inside the box. The question to ask is: would the proposition be worth buying if there were no tax advantages? Many property investment schemes and plans are sold on tax advantages but unless the property itself makes sense as a long-term investment then I suggest the only likely advantage would be for the scheme promoter and manager of the plan.
Generally, commercial property is a depreciating asset. Since costs of buying (including Stamp Duty) and selling, and non-recoverable expenses during ownership, can be substantial, to get your money back, the value of the property must increase by enough to cover all those costs, plus loss of interest on your equity, plus adjustment for inflation, and allowing for tax on the gain. If, when you want to sell, the value has not increased by at least enough to cover all those costs and adjustments then you would either break-even, or be worse off.
There is a school of thought that treats property investment as an annuity. Provided the tenant is financially stable and likely to remain sound for the duration of the term of the tenancy, buying an investment for yield, regardless of the value of the asset may be lucrative. Even so, it is all too easy to overpay for income. Furthermore, unless the landlord’s interest is leasehold, (in which case the interest would probably revert to the freeholder on expiry (subject to any rights to renew or enfranchise), the property would revert to the landlord on expiry of the tenancy (subject to any rights of the tenant to renew) and any difficulties in reletting or otherwise disposing of the property could cause problems for the landlords.
For a SIPP (self-investment personal pension), generally buying a shop property investment for a pension based on tax advantages is not the best way to go about creating a pension. Unless the purchase is wholly a business-expense, in which case what I am about to say does not apply, the snag with buying property for investment because of the tax advantages can lead to the prospect of getting tax relief ignoring the prospects for the property as an investment itself.
I am sure there are many landlords that over the years since SIPPS were introduced in 2000 nowadays own properties that have fallen in value with no obvious likelihood of going back up to the price paid. Of course, when you are buying long-term, the occasional drop in value is only to be expected, but the question is whether any fall in value can be reasonably expected to be offset by any rise, or whether the ups-and-downs over the period of time simply cancel out each other.
Since most propositions are going to decline over the years, because of the principles of marketing, it is very much a matter of timing: the challenge is to sell and let someone else buy the slack before it becomes obvious that the investment is not going to perform. To some people, the idea of dumping on the unsuspecting might be thought anti-social, but when it’s your money you’re investing why stick around just to be a loser?
The question is: long-term buy and hold, or long-term buy and lose!
A pension is a long-term commitment and tax relief is attractive, but setting-up fees and on-going charges for pension plans can be disproportionately high. I suggest thinking inside the box. The question to ask is: would the proposition be worth buying if there were no tax advantages? Many property investment schemes and plans are sold on tax advantages but unless the property itself makes sense as a long-term investment then I suggest the only likely advantage would be for the scheme promoter and manager of the plan.
Generally, commercial property is a depreciating asset. Since costs of buying (including Stamp Duty) and selling, and non-recoverable expenses during ownership, can be substantial, to get your money back, the value of the property must increase by enough to cover all those costs, plus loss of interest on your equity, plus adjustment for inflation, and allowing for tax on the gain. If, when you want to sell, the value has not increased by at least enough to cover all those costs and adjustments then you would either break-even, or be worse off.
There is a school of thought that treats property investment as an annuity. Provided the tenant is financially stable and likely to remain sound for the duration of the term of the tenancy, buying an investment for yield, regardless of the value of the asset may be lucrative. Even so, it is all too easy to overpay for income. Furthermore, unless the landlord’s interest is leasehold, (in which case the interest would probably revert to the freeholder on expiry (subject to any rights to renew or enfranchise), the property would revert to the landlord on expiry of the tenancy (subject to any rights of the tenant to renew) and any difficulties in reletting or otherwise disposing of the property could cause problems for the landlords.
For a SIPP (self-investment personal pension), generally buying a shop property investment for a pension based on tax advantages is not the best way to go about creating a pension. Unless the purchase is wholly a business-expense, in which case what I am about to say does not apply, the snag with buying property for investment because of the tax advantages can lead to the prospect of getting tax relief ignoring the prospects for the property as an investment itself.
I am sure there are many landlords that over the years since SIPPS were introduced in 2000 nowadays own properties that have fallen in value with no obvious likelihood of going back up to the price paid. Of course, when you are buying long-term, the occasional drop in value is only to be expected, but the question is whether any fall in value can be reasonably expected to be offset by any rise, or whether the ups-and-downs over the period of time simply cancel out each other.
Since most propositions are going to decline over the years, because of the principles of marketing, it is very much a matter of timing: the challenge is to sell and let someone else buy the slack before it becomes obvious that the investment is not going to perform. To some people, the idea of dumping on the unsuspecting might be thought anti-social, but when it’s your money you’re investing why stick around just to be a loser?
The question is: long-term buy and hold, or long-term buy and lose!
Funding
Even if they start by using cash, many purchasers are concerned with the cost of financing property. In my experience, they can often be more concerned with finance than the value of the proposition. This situation typically arises when property is offered at a high yield, compared with interest rates, but not high enough when measured on (traditional) investment criteria.
Commercial mortgages can usually be obtained for between 40-70% of capital value, provided the cost of repaying the mortgage is covered by the rental income.
When a mortgage based on the value of the investment, as distinct from the property, and if the investment value has gone up, it may be possible to remortgage.
Where a rent is subject to early review or the tenancy to expiry (reversion), mortgagees will normally lend only by reference to the rent passing, but subject to the borrower's other resources and the relationship with the lender, it may be possible to extract extra funds in anticipation of the level of increase and its immediate effect on capital value. Once the new rent is established, it may then be possible to re-mortgage so as to release further equity.
The source of finance is important. Since the price of shop property can be substantial and may be beyond the reach of cash buyers, where would the money come from to fuel demand for shop property investments?
The answer is there is plenty of money about. You only have to look at the turnover figures for retailers and other businesses to realise how many GBP billions are in circulation. The criteria for bank lending is judicious choice of borrower. By lending (more) to fewer borrowers, the banks are doing what all forward-thinking businesses have been doing for years: moving away from the mass-market catering for everyone and concentrating on the more profitable customers/borrowers.
The amount of funds and facilities for borrowing determines flexibility. Income can be used to finance mortgage, capital can be released for buying a second investment and so on. If you do not want to borrow, then your purchase would be limited to your own resources, the price range and/or required initial yield, in which case decisions can be harder for fear that something better might turn up. The more you have to invest, the more flexible you can be. Even so, successful investment in shop property is not about spreading the risk, but buying wisely.
A wise investment is one that performs through thick and thin. Property performance is a measure of confidence. At any time the value of a shop investment is what other investors in the market at that time would pay, but how the value is calculated depends upon the terms and provisions of the tenancy and that depends upon the tenant’s agreement or if a dispute has to be resolved then the tenant’s conduct in the aftermath.
Even if they start by using cash, many purchasers are concerned with the cost of financing property. In my experience, they can often be more concerned with finance than the value of the proposition. This situation typically arises when property is offered at a high yield, compared with interest rates, but not high enough when measured on (traditional) investment criteria.
Commercial mortgages can usually be obtained for between 40-70% of capital value, provided the cost of repaying the mortgage is covered by the rental income.
When a mortgage based on the value of the investment, as distinct from the property, and if the investment value has gone up, it may be possible to remortgage.
Where a rent is subject to early review or the tenancy to expiry (reversion), mortgagees will normally lend only by reference to the rent passing, but subject to the borrower's other resources and the relationship with the lender, it may be possible to extract extra funds in anticipation of the level of increase and its immediate effect on capital value. Once the new rent is established, it may then be possible to re-mortgage so as to release further equity.
The source of finance is important. Since the price of shop property can be substantial and may be beyond the reach of cash buyers, where would the money come from to fuel demand for shop property investments?
The answer is there is plenty of money about. You only have to look at the turnover figures for retailers and other businesses to realise how many GBP billions are in circulation. The criteria for bank lending is judicious choice of borrower. By lending (more) to fewer borrowers, the banks are doing what all forward-thinking businesses have been doing for years: moving away from the mass-market catering for everyone and concentrating on the more profitable customers/borrowers.
The amount of funds and facilities for borrowing determines flexibility. Income can be used to finance mortgage, capital can be released for buying a second investment and so on. If you do not want to borrow, then your purchase would be limited to your own resources, the price range and/or required initial yield, in which case decisions can be harder for fear that something better might turn up. The more you have to invest, the more flexible you can be. Even so, successful investment in shop property is not about spreading the risk, but buying wisely.
A wise investment is one that performs through thick and thin. Property performance is a measure of confidence. At any time the value of a shop investment is what other investors in the market at that time would pay, but how the value is calculated depends upon the terms and provisions of the tenancy and that depends upon the tenant’s agreement or if a dispute has to be resolved then the tenant’s conduct in the aftermath.
Cash
Cash is traditionally regarded a negative investment, because cash offers no scope for capital appreciation because, by virtue of inflation, the spending power of the capital will diminish. Even so, interest can mount up so it is important, when considering alternatives to cash, to allow for costs.
For example, if you were to deposit £500,000 at 3.5% pa fixed for 5 years, then after 1 year you would have £517,500. After year 2 you would have £535,612, after the 3rd year £554,358, 4th year £573,761 and by the end of 5th year £593,843. Whereas if you were to spend £500,000 on a property (yielding 3.5% pa) and sell after 5 years then, assuming no change in rent, you would also have £593,843 but you would lose approximately £30,000 in buying and selling costs and Stamp Duty alone; and that does not include non-recoverable ownership expenses over the 5 year period.
Since property is an asset, it provides a mortgageable security. A difference between cash on deposit and buying a property is gearing, whereby it is possible to borrow against the security of the asset (including any rental income) and buy a higher-priced property than the bare cash alone, but the costs of borrowing, including likely requirement for the value of the property to exceed the amount of loan by a specified percentage, creates a burden of responsibility over which the borrower may have no control. For example, if the loan must not fall below 80% of the value of the property, then any reduction in that value could breach the loan covenant. To remedy the breach would require either the borrower injecting more equity (if funds were available), or the lender restructuring the loan agreement if so minded; or the lender requiring early repayment of the loan or repossessing to get as much as possible of the loan repaid. Restructuring presupposes the lender would be relaxed and the borrower could afford to pay differential terms. The snag with repossession is not only that the borrower could lose out in loss of equity, but also the investment potential would end up with someone else.
With gearing, it is important to remember there is no correlation between a higher-priced property and higher-value. A higher-priced property is simply the price that the market at the time places on the proposition. Whether value would be more or less depends upon the price and the potential. For example, in the institutional investment market, comprising life insurance companies, investment trusts, pension funds, property funds, sovereign investors, and others that are responsible for investing other people’s money, there is normally a minimum lot size for a proposition, the amount for which may be out of reach for other investors. The amount of minimum is usually taken to mean including specific criteria that in the opinion of the institutional investor would only likely to be found in that price range. Whether the scope for rental and/or capital growth is more likely is questionable: the institutional investors is just as likely to get it wrong as any other investor. You only have to read the excuses dished out by property fund managers as to why the values of their portfolios have collapsed to realise that!
Even if you never sell, even if you were to keep the property to pass on through the generations, it does not follow it would necessarily go up in value once all costs and adjustments are accounted for. A property would go only up in value and become an investment when its value increases by more than costs and adjustments and at least maintain that level of increase during your period of ownership.
Over 5 or 10 years, the likelihood of no growth on property might be thought remote. However, because the property market is imperfect - with no certainty the property would sell for what it is valued at - prices are volatile, investors are fickle and there is no correlation between rents and inflation. All in all, profit is about timing: when to buy and equally when to sell.
Although I should expect many people to disagree with my definition of investment, it seems to me that to ignore the costs, loss of interest, inflation and tax is delusion. I think that if you are going to run the risk of using cash, and possibly borrowing to buy a shop property for investment, then you should reasonably expect a reward to compensate for the risk. Running hard just to stand still is not, in my opinion, a particularly productive use of resources. Although a property has to belong to someone, I should like to think that, by the time you have read Shop Investment you would appreciate the difference between owning property that just happens to be let, and being a successful investor.
Cash is traditionally regarded a negative investment, because cash offers no scope for capital appreciation because, by virtue of inflation, the spending power of the capital will diminish. Even so, interest can mount up so it is important, when considering alternatives to cash, to allow for costs.
For example, if you were to deposit £500,000 at 3.5% pa fixed for 5 years, then after 1 year you would have £517,500. After year 2 you would have £535,612, after the 3rd year £554,358, 4th year £573,761 and by the end of 5th year £593,843. Whereas if you were to spend £500,000 on a property (yielding 3.5% pa) and sell after 5 years then, assuming no change in rent, you would also have £593,843 but you would lose approximately £30,000 in buying and selling costs and Stamp Duty alone; and that does not include non-recoverable ownership expenses over the 5 year period.
Since property is an asset, it provides a mortgageable security. A difference between cash on deposit and buying a property is gearing, whereby it is possible to borrow against the security of the asset (including any rental income) and buy a higher-priced property than the bare cash alone, but the costs of borrowing, including likely requirement for the value of the property to exceed the amount of loan by a specified percentage, creates a burden of responsibility over which the borrower may have no control. For example, if the loan must not fall below 80% of the value of the property, then any reduction in that value could breach the loan covenant. To remedy the breach would require either the borrower injecting more equity (if funds were available), or the lender restructuring the loan agreement if so minded; or the lender requiring early repayment of the loan or repossessing to get as much as possible of the loan repaid. Restructuring presupposes the lender would be relaxed and the borrower could afford to pay differential terms. The snag with repossession is not only that the borrower could lose out in loss of equity, but also the investment potential would end up with someone else.
With gearing, it is important to remember there is no correlation between a higher-priced property and higher-value. A higher-priced property is simply the price that the market at the time places on the proposition. Whether value would be more or less depends upon the price and the potential. For example, in the institutional investment market, comprising life insurance companies, investment trusts, pension funds, property funds, sovereign investors, and others that are responsible for investing other people’s money, there is normally a minimum lot size for a proposition, the amount for which may be out of reach for other investors. The amount of minimum is usually taken to mean including specific criteria that in the opinion of the institutional investor would only likely to be found in that price range. Whether the scope for rental and/or capital growth is more likely is questionable: the institutional investors is just as likely to get it wrong as any other investor. You only have to read the excuses dished out by property fund managers as to why the values of their portfolios have collapsed to realise that!
Even if you never sell, even if you were to keep the property to pass on through the generations, it does not follow it would necessarily go up in value once all costs and adjustments are accounted for. A property would go only up in value and become an investment when its value increases by more than costs and adjustments and at least maintain that level of increase during your period of ownership.
Over 5 or 10 years, the likelihood of no growth on property might be thought remote. However, because the property market is imperfect - with no certainty the property would sell for what it is valued at - prices are volatile, investors are fickle and there is no correlation between rents and inflation. All in all, profit is about timing: when to buy and equally when to sell.
Although I should expect many people to disagree with my definition of investment, it seems to me that to ignore the costs, loss of interest, inflation and tax is delusion. I think that if you are going to run the risk of using cash, and possibly borrowing to buy a shop property for investment, then you should reasonably expect a reward to compensate for the risk. Running hard just to stand still is not, in my opinion, a particularly productive use of resources. Although a property has to belong to someone, I should like to think that, by the time you have read Shop Investment you would appreciate the difference between owning property that just happens to be let, and being a successful investor.
Entering a market
When entering a market, it is useful to consider with whom you are likely to be dealing and encountering.
Unlike residential property, where generally the market revolves amount local estate agents and a few big firms, the commercial property market is small and the shop property market smaller. Not all agents/surveyors in commercial property deal with shops. Although local generalist estate agents/surveyors deal with shops, rarely are those shops in primary locations. Generally ‘High Street’ shops and buildings with retail use, such as supermarkets, retail warehouses, factory outlets and trade counters, are handled by city agencies and niche specialists. So a local surveyor may not have enough experience of acting for tenants or landlords outside the immediate locality to be able to appraise shop investments.
The tenant’s surveyor may not be based in the same area as the tenant. In fact, most larger retailers have in-house property departments and retailers often use surveyors based nowhere near the premises. It does not follow that because you might think it makes sense to instruct a surveyor local to the shop, the tenant would. On the contrary, an outsider will usually be able to approach the matter objectively and in fact many tenants dislike using a surveyor who is or might be pally with the landlord’s surveyor, because they feel they would not get a good deal.
Successful relationships with professional advisers are based upon the client’s trust in the adviser’s advice and the adviser’s opinion of the client. It can take time to develop rapport and, although one assumes investors are intelligent, an experienced surveyor may find that explaining the subtly of shop property investment to someone having little or no experience of business tenancies, let alone the principles of marketing, requires considerable patience. Shop property investment and business tenancy law is complex at the best of times, but inexperience can give rise to over-cautious and/or over-critical receptiveness, wrong questions asked for example, what of performance indices, returns available elsewhere and whether price is relative to the cost of borrowing. Often, difficulties can arise in communication not because there is anything wrong with the advice, but that the surveyor has not found a way to manage client expectations.
Consequently, unless you have a substantial amount to invest, with finance arranged, and are prepared to pay for and act on advice many experienced surveyors cannot be bothered with private investors. Because there is so much money about, long-standing clients with investment requirements take priority over newcomers. Consequently, relatively experienced private investors are likely to attend auctions where they can bid for whatever they like.
Most surveyors serve the property market, but the market is not inanimate, but comprises people. So another problem for surveyors is that unlike the Stock Market where an investor is buying a share of a company’s business, it is vital the investor emotionally accepts that usually, when buying a shop property investment, the investor is not buying into the tenant’s business, but the property in or from which the tenant-retailer trades. Rational acknowledgment is not enough. From experience acting for tenants at rent review, I find that landlords can tend to think that, when the tenant is doing well, the tenant should pay more. Although the same would apply in reverse, a landlord that does not want to try to increase the rent because the tenant is not doing well is making a judgement that is nothing to do with a review. What an investor must understand is that for credibility the surveyor’s approach to tenancy management must be objective. I am not suggesting surveyors know it all, but the point is that if the investor’s expectations are out of sync with reality then the surveyor’s job becomes impossible.
It is also important, with respect, to avoid micro-managing the adviser because that will stifle creativity. In my opinion, there is no point in a landlord instructing an experienced surveyor for the landlord to dictate to that surveyor how the surveyor should deal with the matter. Experienced surveyors, particularly, are not messengers, they are advisers and for a successful relationship to form it should also be allowed to blossom.
When entering a market, it is useful to consider with whom you are likely to be dealing and encountering.
Unlike residential property, where generally the market revolves amount local estate agents and a few big firms, the commercial property market is small and the shop property market smaller. Not all agents/surveyors in commercial property deal with shops. Although local generalist estate agents/surveyors deal with shops, rarely are those shops in primary locations. Generally ‘High Street’ shops and buildings with retail use, such as supermarkets, retail warehouses, factory outlets and trade counters, are handled by city agencies and niche specialists. So a local surveyor may not have enough experience of acting for tenants or landlords outside the immediate locality to be able to appraise shop investments.
The tenant’s surveyor may not be based in the same area as the tenant. In fact, most larger retailers have in-house property departments and retailers often use surveyors based nowhere near the premises. It does not follow that because you might think it makes sense to instruct a surveyor local to the shop, the tenant would. On the contrary, an outsider will usually be able to approach the matter objectively and in fact many tenants dislike using a surveyor who is or might be pally with the landlord’s surveyor, because they feel they would not get a good deal.
Successful relationships with professional advisers are based upon the client’s trust in the adviser’s advice and the adviser’s opinion of the client. It can take time to develop rapport and, although one assumes investors are intelligent, an experienced surveyor may find that explaining the subtly of shop property investment to someone having little or no experience of business tenancies, let alone the principles of marketing, requires considerable patience. Shop property investment and business tenancy law is complex at the best of times, but inexperience can give rise to over-cautious and/or over-critical receptiveness, wrong questions asked for example, what of performance indices, returns available elsewhere and whether price is relative to the cost of borrowing. Often, difficulties can arise in communication not because there is anything wrong with the advice, but that the surveyor has not found a way to manage client expectations.
Consequently, unless you have a substantial amount to invest, with finance arranged, and are prepared to pay for and act on advice many experienced surveyors cannot be bothered with private investors. Because there is so much money about, long-standing clients with investment requirements take priority over newcomers. Consequently, relatively experienced private investors are likely to attend auctions where they can bid for whatever they like.
Most surveyors serve the property market, but the market is not inanimate, but comprises people. So another problem for surveyors is that unlike the Stock Market where an investor is buying a share of a company’s business, it is vital the investor emotionally accepts that usually, when buying a shop property investment, the investor is not buying into the tenant’s business, but the property in or from which the tenant-retailer trades. Rational acknowledgment is not enough. From experience acting for tenants at rent review, I find that landlords can tend to think that, when the tenant is doing well, the tenant should pay more. Although the same would apply in reverse, a landlord that does not want to try to increase the rent because the tenant is not doing well is making a judgement that is nothing to do with a review. What an investor must understand is that for credibility the surveyor’s approach to tenancy management must be objective. I am not suggesting surveyors know it all, but the point is that if the investor’s expectations are out of sync with reality then the surveyor’s job becomes impossible.
It is also important, with respect, to avoid micro-managing the adviser because that will stifle creativity. In my opinion, there is no point in a landlord instructing an experienced surveyor for the landlord to dictate to that surveyor how the surveyor should deal with the matter. Experienced surveyors, particularly, are not messengers, they are advisers and for a successful relationship to form it should also be allowed to blossom.
VAT
Land and buildings, such as freehold sales, leasing or renting, are normally exempt from Value Added Tax (VAT). (For VAT purposes, the definition of “land” includes buildings.)
It is possible to opt to tax a commercial property for VAT, in which case VAT would be added to the rent(s) and any VAT on allowable management expenses reclaimable.
It is not compulsory to opt to tax a commercial property for VAT, but if you do then you would have to keep proper accounting records to satisfy compliance with HMRC. Once registered, it is only possible to deregister after you have owned the property for at least 20 years. If you sell the property then the buyer can deregister if he wants.
Regardless of any VAT registration threshold (based on turnover), some types businesses are unable to recover part or all VAT on their business expenditure: for example, banks, betting offices, funeral directors. If you have a property let to a bank, it is generally better to not opt to tax the property because the tenant would otherwise not be able to recover all the VAT, which means the property would be more expensive to lease.
Residential property is normally exempt from VAT so if for example there is a flat above the shop but the whole of the property is let to the shop tenant then the landlord would have to apportion the amount of rent attributable to the flat and not charge VAT on that amount.
You can find out more about opting to tax land and buildings by visiting HMRC website
Land and buildings, such as freehold sales, leasing or renting, are normally exempt from Value Added Tax (VAT). (For VAT purposes, the definition of “land” includes buildings.)
It is possible to opt to tax a commercial property for VAT, in which case VAT would be added to the rent(s) and any VAT on allowable management expenses reclaimable.
It is not compulsory to opt to tax a commercial property for VAT, but if you do then you would have to keep proper accounting records to satisfy compliance with HMRC. Once registered, it is only possible to deregister after you have owned the property for at least 20 years. If you sell the property then the buyer can deregister if he wants.
Regardless of any VAT registration threshold (based on turnover), some types businesses are unable to recover part or all VAT on their business expenditure: for example, banks, betting offices, funeral directors. If you have a property let to a bank, it is generally better to not opt to tax the property because the tenant would otherwise not be able to recover all the VAT, which means the property would be more expensive to lease.
Residential property is normally exempt from VAT so if for example there is a flat above the shop but the whole of the property is let to the shop tenant then the landlord would have to apportion the amount of rent attributable to the flat and not charge VAT on that amount.
You can find out more about opting to tax land and buildings by visiting HMRC website
TAX
It is suggested that few surveyors understand tax and property and I am no exception, so I advise you to consult your accountant. The lack of understanding by surveyors, so I am told, is to do with the legitimate ways to avoid and minimise liability.
Generally, investors own property in their own names, and/or through a limited company (ltd or plc) and/or through a trust or charity.
In outline, as I understand, (also based on information on HMRC website), there are two types of tax applicable to property: income Tax and Capital Tax, and for each tax there are various allowances and means by which one can qualify for tax relief.
Income and Revenue comprises rent(s) and other receivables (amounts payable by the tenant) upon which there is some profit element.
Every individual has an annual income tax allowance. Income Tax rates vary according to taxable income bands. At present, the starting rate is 10%, the basic rate 20%, higher rate 40%, and for taxable income over £150,000 additional rate 50%.
Capital tax operates in several ways: Capital Gains Tax (CGT), InheritanceTax (IHT) replacing Capital Transfer Tax (CTT), Stamp Duty Land Tax (SDLT) and Capital Allowances
Capital Gains Tax is a tax on the profit or gain you make when you sell or otherwise ‘dispose of’ an asset. You usually dispose of an asset when you cease to own it: for example, if you sell it, give it away as a gift, transfer it to someone else or exchange it for something else.
(For a sole trader or a partner in a partnership and whose trade is in property, the sole/partner will pay Income Tax rather than Capital Gains Tax on any profits make when the property is sold or otherwise disposed of. That may include a one-off purchase and sale of a property. If the property trading business is carried on by a limited company - in which the person may be a director or shareholder - any profits on properties disposed of form part of the total profits of the company on which it pays Corporation Tax.)
For individuals, CGT is charged at a rate of 18%, or 28% for people paying more than the basic rate of income tax. Every individual has an annual capital gains tax allowance. Capital losses can be set against capital gains in other holdings before taxation.
For companies, chargeable gains are subject to corporation tax, and companies may claim an indexation allowance to offset the effect of inflation.
The valuation date for the calculation for CGT is either 31 March 1982 or the date of purchase, whichever the sooner, and the calculation based on the difference between the purchase price net of allowable costs at the date of purchase or the market value at 31 March 1982 whichever appropriate, and the proceeds net of allowance costs as at the date of sale. For IHT and probate, the valuation is the date of death, but IHT may be adjusted if the sale price within 6 months or so of the date of death differs from the value agreed for probate.
Agreeing the value for tax with HMRC is a three-stage process. In the first instance, I advise you to obtain a written report and valuation from an experienced surveyor. I am frequently instructed to provide CGT and probate valuations and my reports are accepted by HMRC. The report and valuation should accompanying the tax return: it is useful for the HMRC to read how the value has been arrived at. If HMRC accepts the value then the second and third stages would not apply and the matter can progress to tax computation. If not and the second stage arises, HMRC and the surveyor would consult and agree the market value. In my experience, a comprehensive report showing how the value has been arrived at, including information taken into account, is a sure way to avoid the second-stage or at least minimise the consequences. If the tax-payer has not obtained a surveyor’s report but simply entered a figure on the tax return then the risk of HMRC querying the figure is increased. In my experience, generally, where HMRC has queried the figure, an unrepresented tax-payer is unlikely to be as successful in reaching favourable agreement. The third-stage only applies if HMRC and the surveyor were unable to agree the market value, in which case the matter would be referred to a tax tribunal or court.
SDLT (replaces Stamp Duty) may become payable when all or part of an interest in land or property is transferred from one person to another if anything of monetary value is given in exchange. Anything of monetary value that is given in exchange for the property is referred to as the 'consideration'. This can be cash or another type of payment. It can also include the value of any outstanding mortgage that the buyer takes over. SDLT may be charged on the consideration.
SDLT may also be payable on the purchase price/lease premium of commercial property. At present, the rate up to £150,000 (rent under £1000 pa), is zero; up to £150,000 (annual rent £1000 or more) rate is 1%, over £150,000 to £250,000, rate is 1%, over £250,000 to £500,000 rate is 3%, over £500,000 rate is 4%
With a new lease, SDLT may be payable either on the amount of the premium or the amount of any rent due (over the term of the lease). Generally, on grant of lease, the tenant pays the SDLT. However, the effect of the amount of SDLT may figure in the negotiations.
Tax relief for capital allowances - plant and machinery, including landlord’s fixtures and fittings - requires specialist advice.
It is suggested that few surveyors understand tax and property and I am no exception, so I advise you to consult your accountant. The lack of understanding by surveyors, so I am told, is to do with the legitimate ways to avoid and minimise liability.
Generally, investors own property in their own names, and/or through a limited company (ltd or plc) and/or through a trust or charity.
In outline, as I understand, (also based on information on HMRC website), there are two types of tax applicable to property: income Tax and Capital Tax, and for each tax there are various allowances and means by which one can qualify for tax relief.
Income and Revenue comprises rent(s) and other receivables (amounts payable by the tenant) upon which there is some profit element.
Every individual has an annual income tax allowance. Income Tax rates vary according to taxable income bands. At present, the starting rate is 10%, the basic rate 20%, higher rate 40%, and for taxable income over £150,000 additional rate 50%.
Capital tax operates in several ways: Capital Gains Tax (CGT), InheritanceTax (IHT) replacing Capital Transfer Tax (CTT), Stamp Duty Land Tax (SDLT) and Capital Allowances
Capital Gains Tax is a tax on the profit or gain you make when you sell or otherwise ‘dispose of’ an asset. You usually dispose of an asset when you cease to own it: for example, if you sell it, give it away as a gift, transfer it to someone else or exchange it for something else.
(For a sole trader or a partner in a partnership and whose trade is in property, the sole/partner will pay Income Tax rather than Capital Gains Tax on any profits make when the property is sold or otherwise disposed of. That may include a one-off purchase and sale of a property. If the property trading business is carried on by a limited company - in which the person may be a director or shareholder - any profits on properties disposed of form part of the total profits of the company on which it pays Corporation Tax.)
For individuals, CGT is charged at a rate of 18%, or 28% for people paying more than the basic rate of income tax. Every individual has an annual capital gains tax allowance. Capital losses can be set against capital gains in other holdings before taxation.
For companies, chargeable gains are subject to corporation tax, and companies may claim an indexation allowance to offset the effect of inflation.
The valuation date for the calculation for CGT is either 31 March 1982 or the date of purchase, whichever the sooner, and the calculation based on the difference between the purchase price net of allowable costs at the date of purchase or the market value at 31 March 1982 whichever appropriate, and the proceeds net of allowance costs as at the date of sale. For IHT and probate, the valuation is the date of death, but IHT may be adjusted if the sale price within 6 months or so of the date of death differs from the value agreed for probate.
Agreeing the value for tax with HMRC is a three-stage process. In the first instance, I advise you to obtain a written report and valuation from an experienced surveyor. I am frequently instructed to provide CGT and probate valuations and my reports are accepted by HMRC. The report and valuation should accompanying the tax return: it is useful for the HMRC to read how the value has been arrived at. If HMRC accepts the value then the second and third stages would not apply and the matter can progress to tax computation. If not and the second stage arises, HMRC and the surveyor would consult and agree the market value. In my experience, a comprehensive report showing how the value has been arrived at, including information taken into account, is a sure way to avoid the second-stage or at least minimise the consequences. If the tax-payer has not obtained a surveyor’s report but simply entered a figure on the tax return then the risk of HMRC querying the figure is increased. In my experience, generally, where HMRC has queried the figure, an unrepresented tax-payer is unlikely to be as successful in reaching favourable agreement. The third-stage only applies if HMRC and the surveyor were unable to agree the market value, in which case the matter would be referred to a tax tribunal or court.
SDLT (replaces Stamp Duty) may become payable when all or part of an interest in land or property is transferred from one person to another if anything of monetary value is given in exchange. Anything of monetary value that is given in exchange for the property is referred to as the 'consideration'. This can be cash or another type of payment. It can also include the value of any outstanding mortgage that the buyer takes over. SDLT may be charged on the consideration.
SDLT may also be payable on the purchase price/lease premium of commercial property. At present, the rate up to £150,000 (rent under £1000 pa), is zero; up to £150,000 (annual rent £1000 or more) rate is 1%, over £150,000 to £250,000, rate is 1%, over £250,000 to £500,000 rate is 3%, over £500,000 rate is 4%
With a new lease, SDLT may be payable either on the amount of the premium or the amount of any rent due (over the term of the lease). Generally, on grant of lease, the tenant pays the SDLT. However, the effect of the amount of SDLT may figure in the negotiations.
Tax relief for capital allowances - plant and machinery, including landlord’s fixtures and fittings - requires specialist advice.
Indirect Investment
Whether you invest direct or through a property fund manager, the same principles and the same approach to appraisal will apply. The fundamental question is whether the property has the potential to become an investment, or whether you are simply buying a property that is or could be let.
In my opinion, property funds are the ‘first-time buyers’ of the institutional property market. A property fund is a product of the financial services industry and is designed for the express purpose of generating fees for fund managers and shareholders of the parent company. When the mood of the moment (market momentum) is for commercial property, funds are launched, investors lured, and properties bought, regardless. As soon as the mood changes, and investors want out, the funds either put a stop to that or reduce the value of the investor’s holding. You might not think there is anything wrong with that, but in my opinion, it shows a lack of foresight to buy on the mood of the moment because by then prices would have risen already.
Although property fund hype is that it is better to pool relatively small sums of money so as to afford more, (an approach that ensnares private investors hook-line-and-sinker) that view is only true when what the fund buys is worth buying. Generally, as I have said, what funds buy is rarely worth buying. Few institutional investors are shrewd: most are under the impression that because they are institutional they are better equipped to appraise propositions, but that is not necessarily so. At every entry point to the market, and in every price range, there are some that know what they are doing, and some that think they do, and plenty that really have no idea but don’t want to admit it.
In 1984, in my newsletter I quoted Hugh Jenkins of the National Coal Board Pension Fund saying of chartered surveyors “(they) will be continue to be regarded with cynicism, so far as their professional capabilities are concerned, as long as they cling to gut feeling about growth prospects without being able to back them up with fundamental research.” When I suggested the modern concept of professionalism removes initiative, several advisers on motivation and corporate strategy agreed with me. Gut-feeling is an essential ingredient in the evaluation of research. You can only draw conclusions from information if you can adopt a broad view. It is not the result of research which provides a span of information, but the questions gut-feeling invite you to ask. Furthermore, since many fund managers are comparatively young, with no real experience of the market long-term, let alone much if any experience of having started a business from scratch, they can suffer from over-reliance of what they are told and their interpretation. In other words, you are not actually investing in property through anyone that actually knows what they doing, so much as being led to believe they do!
Research minimises risk in the hope that, while short term deals may be lost, the long term might bring substantial reward. But limitations of research can bring their own problems. It is a feature of professionalism that the combination of knowledge and experience clashes with logic, except in cases of absolute certainty. If you have to invest, then you are going to become increasingly frustrated if your adviser’s research tells you not to buy, when all about you, others are busy spending and getting all the kudos and excitement, That does not make the advice wrong, since investment is a waiting game (which means it’s boring), but it does nothing for the sale of lucrative financial products, which is why funds overpay.
In a downturn, property funds are very good at blaming the state of the market, but the state of the property fund is a reflection of the attitudes and policies that drove the fund to buy the investments in the first place. What one has to realise, I suggest, is that just because property funds are managed by people that one would reasonably must surely know what they are doing doesn’t mean they do.
Having said all that I am not scathing of all property funds; I think there are some that are obviously have their wits about them. The question is whether you, whose money is wanted, are able to sort the wheat from the chaff.
Whether you invest direct or through a property fund manager, the same principles and the same approach to appraisal will apply. The fundamental question is whether the property has the potential to become an investment, or whether you are simply buying a property that is or could be let.
In my opinion, property funds are the ‘first-time buyers’ of the institutional property market. A property fund is a product of the financial services industry and is designed for the express purpose of generating fees for fund managers and shareholders of the parent company. When the mood of the moment (market momentum) is for commercial property, funds are launched, investors lured, and properties bought, regardless. As soon as the mood changes, and investors want out, the funds either put a stop to that or reduce the value of the investor’s holding. You might not think there is anything wrong with that, but in my opinion, it shows a lack of foresight to buy on the mood of the moment because by then prices would have risen already.
Although property fund hype is that it is better to pool relatively small sums of money so as to afford more, (an approach that ensnares private investors hook-line-and-sinker) that view is only true when what the fund buys is worth buying. Generally, as I have said, what funds buy is rarely worth buying. Few institutional investors are shrewd: most are under the impression that because they are institutional they are better equipped to appraise propositions, but that is not necessarily so. At every entry point to the market, and in every price range, there are some that know what they are doing, and some that think they do, and plenty that really have no idea but don’t want to admit it.
In 1984, in my newsletter I quoted Hugh Jenkins of the National Coal Board Pension Fund saying of chartered surveyors “(they) will be continue to be regarded with cynicism, so far as their professional capabilities are concerned, as long as they cling to gut feeling about growth prospects without being able to back them up with fundamental research.” When I suggested the modern concept of professionalism removes initiative, several advisers on motivation and corporate strategy agreed with me. Gut-feeling is an essential ingredient in the evaluation of research. You can only draw conclusions from information if you can adopt a broad view. It is not the result of research which provides a span of information, but the questions gut-feeling invite you to ask. Furthermore, since many fund managers are comparatively young, with no real experience of the market long-term, let alone much if any experience of having started a business from scratch, they can suffer from over-reliance of what they are told and their interpretation. In other words, you are not actually investing in property through anyone that actually knows what they doing, so much as being led to believe they do!
Research minimises risk in the hope that, while short term deals may be lost, the long term might bring substantial reward. But limitations of research can bring their own problems. It is a feature of professionalism that the combination of knowledge and experience clashes with logic, except in cases of absolute certainty. If you have to invest, then you are going to become increasingly frustrated if your adviser’s research tells you not to buy, when all about you, others are busy spending and getting all the kudos and excitement, That does not make the advice wrong, since investment is a waiting game (which means it’s boring), but it does nothing for the sale of lucrative financial products, which is why funds overpay.
In a downturn, property funds are very good at blaming the state of the market, but the state of the property fund is a reflection of the attitudes and policies that drove the fund to buy the investments in the first place. What one has to realise, I suggest, is that just because property funds are managed by people that one would reasonably must surely know what they are doing doesn’t mean they do.
Having said all that I am not scathing of all property funds; I think there are some that are obviously have their wits about them. The question is whether you, whose money is wanted, are able to sort the wheat from the chaff.
Stocks and Shares
Property companies whose shares are quoted on the stock market are basically companies that have floated on the stock market in order to raise money to buy the sort of property the directors have their sights on, in exchange for cheap money in the form of shares in the company.
It is cheap money because there is no obligation to pay a dividend, although many companies do and for as long as they can afford to.
Whether best to invest directly or indirectly by buying shares in a property company is an interesting question.
Investing directly requires skills that may not be available to the investor: it also requires the availability of the desired proposition. Buying shares in a property company whose property investment and/or property development strategy is often a better bet both in the short and/or long term because the company is often better placed to procure the properties in the first place, and may already own them.
Basically, when you buy shared in a quoted property company, you are paying others to buy and manage property that you might not have bought or couldn’t afford, in return for which you might get a dividend and capital growth.
Stock-picking - which companies to buy - includes an ability to read company accounts. The bottom-line is tangible net asset value (“NAV”) so it is also necessary to appraise the valuation and assess the valuer. Never be scared to think valuations may be dubious. Many valuers are more conservative or optimistic than others, the calibre of the portfolio can make a difference to saleability at any point in time. Also, watch out for the ‘collection’ value where a premium value has been attributed to the NAV for the opportunity to acquire a collection of properties in one place.
Remember NAV is the total net asset value of the portfolio as a whole. If the ‘rubbish’ outnumbers the ‘gems’ then that could depress the overall NAV.
With smaller quoted property companies, beware those where the directors have a controlling interest. If they decide to take the company private, their offer might be derisory compared with what outside shareholders would expect. Also, beware of smaller companies where the directors’ salaries, options and compensatory package is disproportionate. How much a director of a quoted property company should be paid when often the bulk of the work is done by others to whom fees and commissions might also be paid begs the question “what is the director doing for the money?”
Generally, shares in quoted property companies will stand in at a discount to NAV. Occasionally the share price is at a premium to NAV and can happen when the prospects for growth are not reflected in the NAV, maybe comparable transactions with the valuation date for the NAV was undertaken would if the valuation were carried out at a later date result in a higher NAV, or maybe there is talk of bid for the company whereby the opportunity to acquire a portfolio is the attraction. In my opinion, quoted property companies whose share prices are at a premium to the last reported NAV (assuming the date of NAV is recent) come under my heading of “high risk” because there is no telling whether the higher share price is in sync with reality or Stock Market sentiment.
Where the share price is substantially below the last reported NAV, reasons include controlling interest in the company by director(s), low-grade assets, and so on. I do not think there is a rule-of-thumb as to what would be reasonably considered a safe discount to buy at, because the attitude towards safety varies. In the prevailing market, at the last update of this information (the date can be found on the right hand side at the foot of this page on the website), I detect a shift away from expectations of capital growth towards dividend yield. The challenge is to estimate whether the share prices of many quoted property companies are too high, too low or about right. Personally, I think the only way to answer that is to ignore commentators and evaluate the NAV yourself.
Personally, for companies whose assets come under the heading of “run of the mill” and perhaps yield around 8.5-12% I should want share price about 50-60% NAV (net asset value). For companies whose assets are undoubtedly prime, important, and would surely attract considerable if interest if offered for sale in the market whether individually or as portfolio then I should want share price around 20-25% NAV. For companies whose share price exceeds the last reported NAV for no reason other than “collection value” I avoid. “Collection value” is a way of inflating share price to a level that effectively can make the company bid-proof and help safeguard the directors and managers’ careers.
Beware companies whose directors are prone to justifying holdings or recent purchases by reference to what it would cost to build the property today. That a property has been bought for less than its replacement cost does not in itself make the purchase price cheap: the point is that if it would cost less to build than its market value it would make no sense to build it! There are hundreds if not thousands of properties that have outlived their shelf-life and continue to exist for no reason other than the fact they have not been demolished or redeveloped.
Many quoted property companies are better at property than company management. Consider, for example, Land Securities plc: its portfolio is undoubtedly prime and its people adept at realising potential, but in my opinion how it manages the company for shareholders leaves a lot to be desired, such as embarking upon a share buy-back programme costing about £570 million in 2000 and more buy-back again in 2007 when the share price was around £17.20 (today it’s about £6.40, and at 30 September 2011 adjusted NAV £8.63), and converting to a REIT at the height of the market thereby paying tax on peak prices. Had that money not been wasted, Land Securities might not have needed a deep-discount rights issue (eight shares for five at £2.70) to raise £755M in 2009, and to reset the dividend.
Unlike investing on the Stock Market where investors own a share of the company, the performance of which is largely in the hands of the directors and their choice of managers and/or advisers, a property is what a company or person leases for its business purposes.
The main attraction of property is that the payer of the investor’s return on capital - the tenant - is under a legally-binding contract to pay, whether or not the tenant’s business is profitable. Furthermore, a feature of business tenancies in England and Wales is the “upward-only” rent review: although that does not mean the rent must go up at review, it does mean the rent payable cannot go down. Although upward-only review can cause problems for tenants, and there is talk of legislation, reviews are for the most part still upward-only, or on terms that compensate the landlord for the loss of certainty.
In the shop property market, each property is unique, so part of the market value will depend upon the attitude of investors for the type of investment at the time the proposition is for sale. Property transactions are one-to-one. Although interest rates play a part, for rent to have to cover interest on borrowing is not as important as the other determining factors: whether rent is likely to increase, scope for capital growth or angles to improve value.
The other part of the market value is the effect on rent of the business plan of the tenant in occupation. Although in business tenancy law, and subject to the guidelines for rent review in the actual lease, any effect on rent of the tenant’s occupation of the premises or any goodwill attaching to the premises by reason of the tenant’s occupation is usually ignored, neither of those ‘disregards’ applies to the capital value of the property. Consequently whether the tenant can afford the shop and whether that affordability is enduring so much so that on expiry of the tenancy the tenant would want to renew and for a long period of time are factors that can make an appreciable difference to the value of the investment. Where many investors go wrong is in assuming the tenant is bound to want to continue in occupation and/or renew.
Property companies whose shares are quoted on the stock market are basically companies that have floated on the stock market in order to raise money to buy the sort of property the directors have their sights on, in exchange for cheap money in the form of shares in the company.
It is cheap money because there is no obligation to pay a dividend, although many companies do and for as long as they can afford to.
Whether best to invest directly or indirectly by buying shares in a property company is an interesting question.
Investing directly requires skills that may not be available to the investor: it also requires the availability of the desired proposition. Buying shares in a property company whose property investment and/or property development strategy is often a better bet both in the short and/or long term because the company is often better placed to procure the properties in the first place, and may already own them.
Basically, when you buy shared in a quoted property company, you are paying others to buy and manage property that you might not have bought or couldn’t afford, in return for which you might get a dividend and capital growth.
Stock-picking - which companies to buy - includes an ability to read company accounts. The bottom-line is tangible net asset value (“NAV”) so it is also necessary to appraise the valuation and assess the valuer. Never be scared to think valuations may be dubious. Many valuers are more conservative or optimistic than others, the calibre of the portfolio can make a difference to saleability at any point in time. Also, watch out for the ‘collection’ value where a premium value has been attributed to the NAV for the opportunity to acquire a collection of properties in one place.
Remember NAV is the total net asset value of the portfolio as a whole. If the ‘rubbish’ outnumbers the ‘gems’ then that could depress the overall NAV.
With smaller quoted property companies, beware those where the directors have a controlling interest. If they decide to take the company private, their offer might be derisory compared with what outside shareholders would expect. Also, beware of smaller companies where the directors’ salaries, options and compensatory package is disproportionate. How much a director of a quoted property company should be paid when often the bulk of the work is done by others to whom fees and commissions might also be paid begs the question “what is the director doing for the money?”
Generally, shares in quoted property companies will stand in at a discount to NAV. Occasionally the share price is at a premium to NAV and can happen when the prospects for growth are not reflected in the NAV, maybe comparable transactions with the valuation date for the NAV was undertaken would if the valuation were carried out at a later date result in a higher NAV, or maybe there is talk of bid for the company whereby the opportunity to acquire a portfolio is the attraction. In my opinion, quoted property companies whose share prices are at a premium to the last reported NAV (assuming the date of NAV is recent) come under my heading of “high risk” because there is no telling whether the higher share price is in sync with reality or Stock Market sentiment.
Where the share price is substantially below the last reported NAV, reasons include controlling interest in the company by director(s), low-grade assets, and so on. I do not think there is a rule-of-thumb as to what would be reasonably considered a safe discount to buy at, because the attitude towards safety varies. In the prevailing market, at the last update of this information (the date can be found on the right hand side at the foot of this page on the website), I detect a shift away from expectations of capital growth towards dividend yield. The challenge is to estimate whether the share prices of many quoted property companies are too high, too low or about right. Personally, I think the only way to answer that is to ignore commentators and evaluate the NAV yourself.
Personally, for companies whose assets come under the heading of “run of the mill” and perhaps yield around 8.5-12% I should want share price about 50-60% NAV (net asset value). For companies whose assets are undoubtedly prime, important, and would surely attract considerable if interest if offered for sale in the market whether individually or as portfolio then I should want share price around 20-25% NAV. For companies whose share price exceeds the last reported NAV for no reason other than “collection value” I avoid. “Collection value” is a way of inflating share price to a level that effectively can make the company bid-proof and help safeguard the directors and managers’ careers.
Beware companies whose directors are prone to justifying holdings or recent purchases by reference to what it would cost to build the property today. That a property has been bought for less than its replacement cost does not in itself make the purchase price cheap: the point is that if it would cost less to build than its market value it would make no sense to build it! There are hundreds if not thousands of properties that have outlived their shelf-life and continue to exist for no reason other than the fact they have not been demolished or redeveloped.
Many quoted property companies are better at property than company management. Consider, for example, Land Securities plc: its portfolio is undoubtedly prime and its people adept at realising potential, but in my opinion how it manages the company for shareholders leaves a lot to be desired, such as embarking upon a share buy-back programme costing about £570 million in 2000 and more buy-back again in 2007 when the share price was around £17.20 (today it’s about £6.40, and at 30 September 2011 adjusted NAV £8.63), and converting to a REIT at the height of the market thereby paying tax on peak prices. Had that money not been wasted, Land Securities might not have needed a deep-discount rights issue (eight shares for five at £2.70) to raise £755M in 2009, and to reset the dividend.
Unlike investing on the Stock Market where investors own a share of the company, the performance of which is largely in the hands of the directors and their choice of managers and/or advisers, a property is what a company or person leases for its business purposes.
The main attraction of property is that the payer of the investor’s return on capital - the tenant - is under a legally-binding contract to pay, whether or not the tenant’s business is profitable. Furthermore, a feature of business tenancies in England and Wales is the “upward-only” rent review: although that does not mean the rent must go up at review, it does mean the rent payable cannot go down. Although upward-only review can cause problems for tenants, and there is talk of legislation, reviews are for the most part still upward-only, or on terms that compensate the landlord for the loss of certainty.
In the shop property market, each property is unique, so part of the market value will depend upon the attitude of investors for the type of investment at the time the proposition is for sale. Property transactions are one-to-one. Although interest rates play a part, for rent to have to cover interest on borrowing is not as important as the other determining factors: whether rent is likely to increase, scope for capital growth or angles to improve value.
The other part of the market value is the effect on rent of the business plan of the tenant in occupation. Although in business tenancy law, and subject to the guidelines for rent review in the actual lease, any effect on rent of the tenant’s occupation of the premises or any goodwill attaching to the premises by reason of the tenant’s occupation is usually ignored, neither of those ‘disregards’ applies to the capital value of the property. Consequently whether the tenant can afford the shop and whether that affordability is enduring so much so that on expiry of the tenancy the tenant would want to renew and for a long period of time are factors that can make an appreciable difference to the value of the investment. Where many investors go wrong is in assuming the tenant is bound to want to continue in occupation and/or renew.
REIT
Real Estate Investment Trust (“REIT”) originated in the 1880s and a time when investors could avoid ‘double tax’ or a tax at corporate and individual level. In the 1930s, the tax benefit was removed causing investors to pay ‘double tax’.
Nowadays, REIT is a tax designation for a corporate entity investing in retail estate. The purpose of the designation is to reduce or eliminate corporate income taxes. In return, REITs are required to distribute 90% of their taxable income to investors. REITs can be publicly or privately held; and public REITS may be listed on public stock exchanges.
In the UK, the rules for REITs were enacted in the Finance Act 2006 and REITS came into being in January 2007. I think the timing of the conversion date for becoming a REIT was politically motivated. There was considerable untaxed value in property assets and the Labour government was intent upon extracting potential tax. When REIT were first introduced into the UK, in my opinion the companies that converted overpaid because their assets were revalued and tax paid on the book value of the increase at that time, around the peak of the market. That the companies that rushed to convert saw no harm in destroying shareholder value struck me as curious because no one seem to mind.
Although REITs can be tax-efficient, because the property company pays no corporation or capital gains tax on the profits made from property investment, that presupposes there are profits made from the property investment activities. Where properties are held for development, the investment potential may take years to come to fruition.
I am sceptical whether REITS are run for shareholders, so much as for their directors and managers! Of course, some professional advisers enthuse about REITS - for example, there are currently 22 REITS owning approximately £40Bn of property, approximately 80% of all property held by UK companies - presumably (dare I say it) because they are on the receiving end of lucrative fees, or regards REITS as the vehicle for new types of investment (in other words, selling from the outside in). As for yield on shares, the same appraisal criteria is necessary; for example: is the prevailing share price a good value reflection of the net asset value, how reliable in the NAV, how sustainable long-term is the dividend and whether there that much scope for increase?
For more information about REIT, the British Property Federation has a website.
Real Estate Investment Trust (“REIT”) originated in the 1880s and a time when investors could avoid ‘double tax’ or a tax at corporate and individual level. In the 1930s, the tax benefit was removed causing investors to pay ‘double tax’.
Nowadays, REIT is a tax designation for a corporate entity investing in retail estate. The purpose of the designation is to reduce or eliminate corporate income taxes. In return, REITs are required to distribute 90% of their taxable income to investors. REITs can be publicly or privately held; and public REITS may be listed on public stock exchanges.
In the UK, the rules for REITs were enacted in the Finance Act 2006 and REITS came into being in January 2007. I think the timing of the conversion date for becoming a REIT was politically motivated. There was considerable untaxed value in property assets and the Labour government was intent upon extracting potential tax. When REIT were first introduced into the UK, in my opinion the companies that converted overpaid because their assets were revalued and tax paid on the book value of the increase at that time, around the peak of the market. That the companies that rushed to convert saw no harm in destroying shareholder value struck me as curious because no one seem to mind.
Although REITs can be tax-efficient, because the property company pays no corporation or capital gains tax on the profits made from property investment, that presupposes there are profits made from the property investment activities. Where properties are held for development, the investment potential may take years to come to fruition.
I am sceptical whether REITS are run for shareholders, so much as for their directors and managers! Of course, some professional advisers enthuse about REITS - for example, there are currently 22 REITS owning approximately £40Bn of property, approximately 80% of all property held by UK companies - presumably (dare I say it) because they are on the receiving end of lucrative fees, or regards REITS as the vehicle for new types of investment (in other words, selling from the outside in). As for yield on shares, the same appraisal criteria is necessary; for example: is the prevailing share price a good value reflection of the net asset value, how reliable in the NAV, how sustainable long-term is the dividend and whether there that much scope for increase?
For more information about REIT, the British Property Federation has a website.