4 - Shop Property
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Growth
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on mortgage interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on mortgage interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
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ITZA is surveyor abbreviation for 'in terms of Zone A' Often the word 'area' precedes it or is included in the abbreviation: for example Area ITZA or simply Area in terms of Zone A.
Very large shops, stores and purpose-built supermarkets, and unusual buildings, such as banks, restaurants, night-clubs, leisure uses, non-ground floor premises, and so on, may be valued on an overall basis but, with the majority of shops, the total ground floor area is normally divided into zones.
Zoning is a method of comparing shops of different layouts, configuration, shapes and sizes with one another, so as to arrive at a common denominator.
Each zone is allocated a capital letter, in chronological order starting with A, as in Zone A, Zone B, Zone C and so on. Zone A being at the front of the shop is the most valuable, and each subsequent zone is often halved-back, but the fraction is a matter of surveyor opinion. Zoning is not valuation, but simply an arithmetical calculation, so there are no hard and fast rules. For example, part of Zone A might be A/2, Zone B might not all be A/2, Zone C could be A/5 o A/6, or Zone D might be A/10, etc. Basement storage might be valued at A/10, first floor sales A/10-15 and storage A/12-A/25.
For arithmetical ease, the net area of each zone is expressed as a single figure, known as the “area in terms of Zone A”, or ITZA for short.
Usually, each zone is 20’ 0” (6.1m) deep, but depths vary in some towns and streets – for example, 15’0” (4.57m), 25’0” (7.62m), 30’0”(9.14m). Normally, shops are measured from the building line to trading or built depth, ignoring shop fittings, wall linings and non-structural partitioning, but allowing for nibs, piers, columns, and structural walls. (Where a shop-front is set back from the building line, it is a question of whether it could be set forward.) Normally, ground floor space, unusable for sales, is regarded as ancillary. Basements and upper floors and external buildings are usually measured overall and valued on actual or potential use, depending upon physical layout and the provisions of the tenancy. Subject to the terms of the tenancy, actual or potential value of structural improvements may apply. (It does not follow that tenant’s improvements have to be disregarded.)
Residential accommodation is valued on its merits, usually by reference to the number of habitable rooms, rather than the floor area.
For devaluation, rents are converted into what is known as the Zone-A rent: for example Zone-A £75. Generally, the Zone-A rent is the agreed rent net of any valuation adjustments or allowances divided by ITZA.
Very large shops, stores and purpose-built supermarkets, and unusual buildings, such as banks, restaurants, night-clubs, leisure uses, non-ground floor premises, and so on, may be valued on an overall basis but, with the majority of shops, the total ground floor area is normally divided into zones.
Zoning is a method of comparing shops of different layouts, configuration, shapes and sizes with one another, so as to arrive at a common denominator.
Each zone is allocated a capital letter, in chronological order starting with A, as in Zone A, Zone B, Zone C and so on. Zone A being at the front of the shop is the most valuable, and each subsequent zone is often halved-back, but the fraction is a matter of surveyor opinion. Zoning is not valuation, but simply an arithmetical calculation, so there are no hard and fast rules. For example, part of Zone A might be A/2, Zone B might not all be A/2, Zone C could be A/5 o A/6, or Zone D might be A/10, etc. Basement storage might be valued at A/10, first floor sales A/10-15 and storage A/12-A/25.
For arithmetical ease, the net area of each zone is expressed as a single figure, known as the “area in terms of Zone A”, or ITZA for short.
Usually, each zone is 20’ 0” (6.1m) deep, but depths vary in some towns and streets – for example, 15’0” (4.57m), 25’0” (7.62m), 30’0”(9.14m). Normally, shops are measured from the building line to trading or built depth, ignoring shop fittings, wall linings and non-structural partitioning, but allowing for nibs, piers, columns, and structural walls. (Where a shop-front is set back from the building line, it is a question of whether it could be set forward.) Normally, ground floor space, unusable for sales, is regarded as ancillary. Basements and upper floors and external buildings are usually measured overall and valued on actual or potential use, depending upon physical layout and the provisions of the tenancy. Subject to the terms of the tenancy, actual or potential value of structural improvements may apply. (It does not follow that tenant’s improvements have to be disregarded.)
Residential accommodation is valued on its merits, usually by reference to the number of habitable rooms, rather than the floor area.
For devaluation, rents are converted into what is known as the Zone-A rent: for example Zone-A £75. Generally, the Zone-A rent is the agreed rent net of any valuation adjustments or allowances divided by ITZA.
I want to dispel a widely held notion, the strong belief in which leads to investors overpaying for shop property. It is a notion that has contributed to substantial over-valuation (along with over-mortgaging by the banks and other lenders) of shop property investments for more than three decades.
When you buy a shop property for investment, you are not buying into the existing or proposed tenant's business: the only thing you own is the property itself. That is all. How the tenant chooses to run its business, the prospects for the business including the market sector the tenant's business serves, are nothing to do with you. You are buying the property and whether it is the entire building or part of a building, that is all. Therefore, the identity of the tenant makes no difference whatsoever to the value of the property. The only relevance of what is known as the 'covenant' of the tenant that makes a difference is the chances of rent on time and other requirements of the occupancy honoured throughout the term of the lease. Therefore, if you pay a higher price because the shop property is let to a well-known covenant, then that 'premium' adds to the risk and may not be recoverable when you want to sell.
To understand why even though there is no link between the value of the property and the tenant's covenant nevertheless a strong connection is made, it is necessary to go back to events in the shop property market during the mid-1970s. In 1972, all Asians were expelled from Uganda by Idi Amin, the president of Uganda at that time. Those holding British passports came to Britain. Many had been businesspeople in Africa and rebuilt up their lives in Britain. Some became retailers while others found suitable employment.
An explosive growth in demand for shops and retail businesses led to a widespread change in attitude. Before the immigration-influx, I think it fair to say many 'white' shopkeepers were living off their laurels, for example half-day closing during the week was the norm, trading times out of kilter with an increasingly cosmopolitan society. Asian shops, the ubiquitous 'Mr Patel', opened longer hours, closing at 10pm rather than 5.30pm, and extended the shopping week to include all day Sunday. Prices obtainable in the market for selling going-concern businesses also rose. In the newsagent, confectioner, tobacconist sector, ("CTN"), it was said a 'white' buyer would pay ten times turnover, but an 'Asian' buyer would pay fifteen times turnover. The difference in price was accounted for by removing staff costs and so on, because the Asian family would work in the shop. Strictly, it shouldn't make any difference to price payable that savings can be made from being more operationally efficient, but I do not think that was the agenda. It was not so much about wanting more income, so much as wanting more capital. By modernising the business, turnover could be increased and the business re-sold for a profit. It also gave the Asian family an opportunity to establish 'roots' in the wider community.
The presence of Asian shopkeepers in Britain was by no means new. The earliest origins of settlement of South Asians in Great Britain is uncertain, perhaps the Middle Ages. By the late 19th/early 20th centuries there were approximately 70,000 South Asians in Britain and following World War II and the break-up of the British Empire, immigration increased throughout the 1950s and 1960s as citizens of Commonwealth countries and former Caribbean colonies moved to Britain. Following restrictions on primary immigration, much of the subsequent growth in the British Asian community has come from the births of second and third-generation Asian Britons. As time passes, the formation and development of community can alter the demographics. Southall, in north-west Greater London, for example, is a case in point. In 1950, the first group of South Asians arrived in Southall, reputedly recruited to work in a factory owned by a former British Army officer. With the closeness of expanding employment opportunities such as Heathrow Airport, nowadays over 55% of Southall's population of 70,000 is Indian/Pakistani, Southall has one of the largest Sikh Temples outside India and Southall contains the largest Asian shopping centre in the London area.
An attraction of English property law is freehold ownership. As the ultimate owner of the property, freehold provides both physical and emotional security. Owning shop property freehold can contribute to status in community and business. As anyone that has tried to buy shop property for investment will testify, it is not an easy step. The first hurdle is convincing commercial property agencies you are serious! It's not that surveyors were impossible to deal with, simply they have regular buyers and saw no reason to give newcomers a bite of the cherry. Also, many established surveyors can't be bothered with inexperienced investors. Then there is a question of credibility. Unless you pay the asking price or your offer is very close, you risk being considered a time-waster. Similarly, if you mess about and delay exchange of contract and/or fail to complete. Moreover, there may be a language barrier. Even if you fulfil the criteria, there is no certainty of being offered anything with potential. The solution is to buy at property auctions. Property auctions lend themselves to anonymity. Property auctions have long been popular with people of all nationalities, but before the mid-1970s there was a greater tacit understanding of shop valuation methodogy. What the new wave of investors did not appreciate (or at least not give an impression) was that, in principle, a high yield suggests a shop property where little or no capital growth is expected, conversely a low-yield offers prospects for growth. In any event, because the cost of borrowing money is the same nationwide, it made no sense to be able to buy a shop property investment yielding say 12% for a lower price pro-rata than a shop property showing 7%. Hence, what began to happen and rapidly gathered steam, until the influence of the change in approach became the 'norm', was for shop properties having little or no growth prospects to go up price which in turn led to an increase in price for properties with growth prospects.\
Finance plays a pivotal role in the commercial property market. In fact, it is said that property investment is more about finance than property. When a buyer wants to mortgage an investment property, or needs a mortgage so as to buy the property in the first place, ways to repay the mortgage include the borrower's other sources of income and whether the yield on the property exceeds the instalment for payment of the mortgage. Whilst a lender will assess the credit-worthiness of the borrower, a lender is not normally interested in the prospects for the investment: all that a mortgagee cares about is whether the borrower could honour the requirements of the mortgage, or in the event of default the property could be sold to repay the loan. The fact that high-yielding investments are more risky is of no consequence to the lender, and may in fact be considered more secure simply because of a higher yield. In effect, thanks to their mortgage criteria, what the banks have imposed on buyers of shop property is the equivalent of a business plan, whereby never mind whether the shop property constitutes an investment, all that matters is that the financial side of things stack up.
What stemmed from inexperience became the 'norm' thanks to mortgage valuation surveyors. The task of a mortgage valuation surveyor, often a chartered surveyor, is to give an opinion of the market value of the property. However, the market value of a property is only the value of the property itself. It is not the value of the investment. The investment comprises the property and any existing or proposed 'tenancy' involving that property. So, since the value of the investment can vary depending upon terms of the tenancy, arguably a valuation surveyor should make that clear in the report, otherwise there is the risk the banks could be misled into thinking lending on the property is more secure than it is.
The fact that a layer of variable value can be added to the intrinsic value of a property is not something lost on sellers. The marketing of commercial property for investment involves very sophisticated and shrewd techniques. For example, one of the most obvious ways to maximise the price is to create an investment that is readily mortgageable. When selling a shop property investment, the seller is not interested in the value of the property as such, but how much the property and all that comes with it is likely to fetch in the market. It is the existence of that subtle difference for which the inexperienced investor can pay a hefty price. Selling a shop property for investment is no different to any other form of selling. Dress it up to look its best and hope the buyer doesn't spot what's wrong. Any complaints afterwards can be met by caveat emptor: the buyer alone is responsible for checking the quality and suitability of goods before making the purchase. Moreover, unlike products and services where the seller might be concerned to safeguard reputation for future custom, a seller of shop property is unlikely to care a jot about goodwill.
Although the seller of shop property is unlikely to care about goodwill, the seller's agents are mindful of their reputation in the market. To maximise the selling process whilst attempting to minimise the repercussions of overpayment, auctioneers have, for some time, highlighted the financial status of the tenant in the auction catalogue, for example the retailer's number of branches, latest turnover and profit figures.
Covenant and early review lots are guaranteed to fetch top prices. In the details, much emphasis is given to the date of review, with the estimated rental value suggested, either by having issued the rent review notice quoting a very high proposal, or by stating the vendor's opinion of rental vaiue, or by citing a brief mention of a nearby new letting.
Pre-occupation with quality of covenant has driven investment yields down to levels which, for the type of property, is more commonly expected for prime propositions, offering assured long-term growth!
Consequently, what has happened is that not only has the way shop property is valued disconnected from fundamental principles, but also the banks and vested interests have create a market that is completely divorced from the reality of property itself. The test of that claim is easy to pass, for example: imagine two shop properties, next door to each other, both shops identical size, laytout, etc, both let for 20 years at the same rent with rent reviews at five yearly intervals. One shop is let to a national multiple retailer with dozens of branches, the other to a local shopkeeper with just that one shop. Both properties are offered for sale by auction on the same date by the same auctioneer. What's the betting the shop let to the multiple retailer would fetch a higher price?
In my opinion, it is not up to valuation surveyors to insist banks lend only on the value of the property, as distinct from the market value of the investment. That decision is for the banks alone. However, I do consider valuation surveyors have a duty of care to ensure the banks understand there is a difference which might not necessarily be allowed for in the 'forced' sale valuation. A definition of 'forced sale' valuation is "the highest price which a property can reasonably be expected to bring, if offered for sale without the consent or concurrence of the owner by virtue of judicial process, in what may be a restricted market place, within a restricted time frame, to a prudent, willing and able purchaser who may have limited knowledge about the property, its uses and capability." If the forced sale valuation is a percentage of the market value of the property then in my opinion the mortgage is likely to be more secure, than if the forced sale value is the valuation of the investment.
When you buy a shop property for investment, you are not buying into the existing or proposed tenant's business: the only thing you own is the property itself. That is all. How the tenant chooses to run its business, the prospects for the business including the market sector the tenant's business serves, are nothing to do with you. You are buying the property and whether it is the entire building or part of a building, that is all. Therefore, the identity of the tenant makes no difference whatsoever to the value of the property. The only relevance of what is known as the 'covenant' of the tenant that makes a difference is the chances of rent on time and other requirements of the occupancy honoured throughout the term of the lease. Therefore, if you pay a higher price because the shop property is let to a well-known covenant, then that 'premium' adds to the risk and may not be recoverable when you want to sell.
To understand why even though there is no link between the value of the property and the tenant's covenant nevertheless a strong connection is made, it is necessary to go back to events in the shop property market during the mid-1970s. In 1972, all Asians were expelled from Uganda by Idi Amin, the president of Uganda at that time. Those holding British passports came to Britain. Many had been businesspeople in Africa and rebuilt up their lives in Britain. Some became retailers while others found suitable employment.
An explosive growth in demand for shops and retail businesses led to a widespread change in attitude. Before the immigration-influx, I think it fair to say many 'white' shopkeepers were living off their laurels, for example half-day closing during the week was the norm, trading times out of kilter with an increasingly cosmopolitan society. Asian shops, the ubiquitous 'Mr Patel', opened longer hours, closing at 10pm rather than 5.30pm, and extended the shopping week to include all day Sunday. Prices obtainable in the market for selling going-concern businesses also rose. In the newsagent, confectioner, tobacconist sector, ("CTN"), it was said a 'white' buyer would pay ten times turnover, but an 'Asian' buyer would pay fifteen times turnover. The difference in price was accounted for by removing staff costs and so on, because the Asian family would work in the shop. Strictly, it shouldn't make any difference to price payable that savings can be made from being more operationally efficient, but I do not think that was the agenda. It was not so much about wanting more income, so much as wanting more capital. By modernising the business, turnover could be increased and the business re-sold for a profit. It also gave the Asian family an opportunity to establish 'roots' in the wider community.
The presence of Asian shopkeepers in Britain was by no means new. The earliest origins of settlement of South Asians in Great Britain is uncertain, perhaps the Middle Ages. By the late 19th/early 20th centuries there were approximately 70,000 South Asians in Britain and following World War II and the break-up of the British Empire, immigration increased throughout the 1950s and 1960s as citizens of Commonwealth countries and former Caribbean colonies moved to Britain. Following restrictions on primary immigration, much of the subsequent growth in the British Asian community has come from the births of second and third-generation Asian Britons. As time passes, the formation and development of community can alter the demographics. Southall, in north-west Greater London, for example, is a case in point. In 1950, the first group of South Asians arrived in Southall, reputedly recruited to work in a factory owned by a former British Army officer. With the closeness of expanding employment opportunities such as Heathrow Airport, nowadays over 55% of Southall's population of 70,000 is Indian/Pakistani, Southall has one of the largest Sikh Temples outside India and Southall contains the largest Asian shopping centre in the London area.
An attraction of English property law is freehold ownership. As the ultimate owner of the property, freehold provides both physical and emotional security. Owning shop property freehold can contribute to status in community and business. As anyone that has tried to buy shop property for investment will testify, it is not an easy step. The first hurdle is convincing commercial property agencies you are serious! It's not that surveyors were impossible to deal with, simply they have regular buyers and saw no reason to give newcomers a bite of the cherry. Also, many established surveyors can't be bothered with inexperienced investors. Then there is a question of credibility. Unless you pay the asking price or your offer is very close, you risk being considered a time-waster. Similarly, if you mess about and delay exchange of contract and/or fail to complete. Moreover, there may be a language barrier. Even if you fulfil the criteria, there is no certainty of being offered anything with potential. The solution is to buy at property auctions. Property auctions lend themselves to anonymity. Property auctions have long been popular with people of all nationalities, but before the mid-1970s there was a greater tacit understanding of shop valuation methodogy. What the new wave of investors did not appreciate (or at least not give an impression) was that, in principle, a high yield suggests a shop property where little or no capital growth is expected, conversely a low-yield offers prospects for growth. In any event, because the cost of borrowing money is the same nationwide, it made no sense to be able to buy a shop property investment yielding say 12% for a lower price pro-rata than a shop property showing 7%. Hence, what began to happen and rapidly gathered steam, until the influence of the change in approach became the 'norm', was for shop properties having little or no growth prospects to go up price which in turn led to an increase in price for properties with growth prospects.\
Finance plays a pivotal role in the commercial property market. In fact, it is said that property investment is more about finance than property. When a buyer wants to mortgage an investment property, or needs a mortgage so as to buy the property in the first place, ways to repay the mortgage include the borrower's other sources of income and whether the yield on the property exceeds the instalment for payment of the mortgage. Whilst a lender will assess the credit-worthiness of the borrower, a lender is not normally interested in the prospects for the investment: all that a mortgagee cares about is whether the borrower could honour the requirements of the mortgage, or in the event of default the property could be sold to repay the loan. The fact that high-yielding investments are more risky is of no consequence to the lender, and may in fact be considered more secure simply because of a higher yield. In effect, thanks to their mortgage criteria, what the banks have imposed on buyers of shop property is the equivalent of a business plan, whereby never mind whether the shop property constitutes an investment, all that matters is that the financial side of things stack up.
What stemmed from inexperience became the 'norm' thanks to mortgage valuation surveyors. The task of a mortgage valuation surveyor, often a chartered surveyor, is to give an opinion of the market value of the property. However, the market value of a property is only the value of the property itself. It is not the value of the investment. The investment comprises the property and any existing or proposed 'tenancy' involving that property. So, since the value of the investment can vary depending upon terms of the tenancy, arguably a valuation surveyor should make that clear in the report, otherwise there is the risk the banks could be misled into thinking lending on the property is more secure than it is.
The fact that a layer of variable value can be added to the intrinsic value of a property is not something lost on sellers. The marketing of commercial property for investment involves very sophisticated and shrewd techniques. For example, one of the most obvious ways to maximise the price is to create an investment that is readily mortgageable. When selling a shop property investment, the seller is not interested in the value of the property as such, but how much the property and all that comes with it is likely to fetch in the market. It is the existence of that subtle difference for which the inexperienced investor can pay a hefty price. Selling a shop property for investment is no different to any other form of selling. Dress it up to look its best and hope the buyer doesn't spot what's wrong. Any complaints afterwards can be met by caveat emptor: the buyer alone is responsible for checking the quality and suitability of goods before making the purchase. Moreover, unlike products and services where the seller might be concerned to safeguard reputation for future custom, a seller of shop property is unlikely to care a jot about goodwill.
Although the seller of shop property is unlikely to care about goodwill, the seller's agents are mindful of their reputation in the market. To maximise the selling process whilst attempting to minimise the repercussions of overpayment, auctioneers have, for some time, highlighted the financial status of the tenant in the auction catalogue, for example the retailer's number of branches, latest turnover and profit figures.
Covenant and early review lots are guaranteed to fetch top prices. In the details, much emphasis is given to the date of review, with the estimated rental value suggested, either by having issued the rent review notice quoting a very high proposal, or by stating the vendor's opinion of rental vaiue, or by citing a brief mention of a nearby new letting.
Pre-occupation with quality of covenant has driven investment yields down to levels which, for the type of property, is more commonly expected for prime propositions, offering assured long-term growth!
Consequently, what has happened is that not only has the way shop property is valued disconnected from fundamental principles, but also the banks and vested interests have create a market that is completely divorced from the reality of property itself. The test of that claim is easy to pass, for example: imagine two shop properties, next door to each other, both shops identical size, laytout, etc, both let for 20 years at the same rent with rent reviews at five yearly intervals. One shop is let to a national multiple retailer with dozens of branches, the other to a local shopkeeper with just that one shop. Both properties are offered for sale by auction on the same date by the same auctioneer. What's the betting the shop let to the multiple retailer would fetch a higher price?
In my opinion, it is not up to valuation surveyors to insist banks lend only on the value of the property, as distinct from the market value of the investment. That decision is for the banks alone. However, I do consider valuation surveyors have a duty of care to ensure the banks understand there is a difference which might not necessarily be allowed for in the 'forced' sale valuation. A definition of 'forced sale' valuation is "the highest price which a property can reasonably be expected to bring, if offered for sale without the consent or concurrence of the owner by virtue of judicial process, in what may be a restricted market place, within a restricted time frame, to a prudent, willing and able purchaser who may have limited knowledge about the property, its uses and capability." If the forced sale valuation is a percentage of the market value of the property then in my opinion the mortgage is likely to be more secure, than if the forced sale value is the valuation of the investment.
The definition of "market value" has become institutionalised by the International Valuation Standards Council ("IVSC") and the Royal Institution of Chartered Surveyors ("RICS"). To the IVSC, “market value” means “the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion. "The market value shall be documented in a transparent and clear manner". The IVSC make it clear that a “willing seller” in that context is simply a seller motivated to sell at the best price obtainable on the valuation date.
In the Red Book, the RICS manual for valuers: the open market value ("OMV") is the best price obtainable in a transaction completed on the valuation date based upon the following assumptions:
(i) a willing seller (a hypothetical owner who is neither eager nor reluctant i.e. not forced but not at a price which suits only him/her).
(ii) prior to the valuation, a reasonable period to market the property and complete all the necessary legal formalities was available.
(iii) during this period, the state of the market was the same as at the date of valuation.
(iv) any bid from a special purchaser is excluded.(vi) all parties acted knowledgeably, prudently and without compulsion
In 1994, agreed with the British Bankers Association, the RICS Valuation Guidance Note introduced "Estimated Realisation Price", ("ERP") a basis of valuation to be used solely for loan valuation purposes. ERP is identical to OMV in representing an exchange price in the market place, but it differs on a number of points, two of which are fundamental. ‘Reasonably expected’ is retained in the ERP definition but the two fundamental points are:
(i) the marketing period commences on the date of valuation, with the sale completed after a reasonable marketing period to be specified by the valuer.
(ii) the market is dynamic and is not assumed to be static over the marketing period.
The opinion must be informed and given by a knowledgeable and experienced person. Valuation is not just a science, but also an art. To arrive at an opinion of value, a surveyor considers a host of factors, including intuition. In my opinion, surveyors that ignore intuition do so at their peril. The market is not always logical. Prediction may be frowned upon as esoteric, but knowing what is going to happen or at least attempting to forecast realistically is, in my opinion, just as important as basing opinion on the past or present. However, because many surveyors are focussed more on the past - for example, talking about when the market returns to 'normal' - or prejudiced by their own experience in acting for retailers whose business model depends on being able to rent shops for next to nothing - the future prospects are often ignored.
The market comprises buyers and sellers. Although surveyors do not make the market, it is the surveyor's interpretation of the behaviour and attitude of buyers and sellers that will have an often a profound influence upon the state and direction of the market. The reason surveyors have so much say is that, unlike the seller and/or buyer's opinion which is likely to be subjective and sentimental, the surveyor's opinion is objective. With 'subjective' the seller or buyer will assess the proposition in relation to the buyer's individual requirements, whereas with 'objective' the surveyor will assess the proposition in relation to the market.
detaIn theory, objectivity is neutral; in practice it may be bias. Without training, and even then it can be difficult, it is virtually impossible for a human being to be emotionally detached. The partisan of professional standards may also overshadow. For example, chartered surveyors, as members of an institution with a code of conduct, are subject to fear of a disciplinary committee or at worst expelled. It does not help that, from my observations, the RICS is prone to issuing and revising practice statements and guidance notes for its members after the event, rather than in anticipation of market trends. One difficulty I suspect is conflict of interest between valuation surveyors and their colleagues in investment departments, and quite possibly of shareholders where surveyors operate as public or private limited companies. Ultimately, the law and the view of the courts in case-law is paramount. To quote from a textbook of Professional Negligence, the authors Jackson and Powell state "a professional is not entitled slavishly to follow the provisions of a code of practice". Per PK Finans International (UK) Ltd v Andrew Downs and Co Ltd [1992], the court's reservations about the status of the RICS guidance notes are made apparent: "I suspect that they are as much for the protection of surveyors as anything else, in that they set out various recommendations which, if followed, it is hoped will protect the surveyor from the unpleasantness of being sued". In my view, where a surveyor has informed knowledge of the market there is a duty of care to anyone whom the surveyor is advising. When a surveyor has a feeling that all is not as it should be, to keep quiet and toe the party-line is not an option.
So, since there is a difference between the value of a property and as an investment, how does one go about separating the two values? The question is by no means that easy to answer. To begin with, it is a question of how far back one should go. Arguably, one should go back approximately 30 years to the time before buyer inexperience took hold and when there was a marked difference between yields in different parts of the country. If so then what has happened to the shop investment market in the after-math of the sub-prime crisis, ensuing recession and downturn generally (2008 onwards) could be said to be a return to the 'norm'. In other words, values nowadays are not on the low side because they have fallen from the peak, but have merely reverted to the rightful level. When that approach is adopted, prospects become a lot clearer.
In the Red Book, the RICS manual for valuers: the open market value ("OMV") is the best price obtainable in a transaction completed on the valuation date based upon the following assumptions:
(i) a willing seller (a hypothetical owner who is neither eager nor reluctant i.e. not forced but not at a price which suits only him/her).
(ii) prior to the valuation, a reasonable period to market the property and complete all the necessary legal formalities was available.
(iii) during this period, the state of the market was the same as at the date of valuation.
(iv) any bid from a special purchaser is excluded.(vi) all parties acted knowledgeably, prudently and without compulsion
In 1994, agreed with the British Bankers Association, the RICS Valuation Guidance Note introduced "Estimated Realisation Price", ("ERP") a basis of valuation to be used solely for loan valuation purposes. ERP is identical to OMV in representing an exchange price in the market place, but it differs on a number of points, two of which are fundamental. ‘Reasonably expected’ is retained in the ERP definition but the two fundamental points are:
(i) the marketing period commences on the date of valuation, with the sale completed after a reasonable marketing period to be specified by the valuer.
(ii) the market is dynamic and is not assumed to be static over the marketing period.
The opinion must be informed and given by a knowledgeable and experienced person. Valuation is not just a science, but also an art. To arrive at an opinion of value, a surveyor considers a host of factors, including intuition. In my opinion, surveyors that ignore intuition do so at their peril. The market is not always logical. Prediction may be frowned upon as esoteric, but knowing what is going to happen or at least attempting to forecast realistically is, in my opinion, just as important as basing opinion on the past or present. However, because many surveyors are focussed more on the past - for example, talking about when the market returns to 'normal' - or prejudiced by their own experience in acting for retailers whose business model depends on being able to rent shops for next to nothing - the future prospects are often ignored.
The market comprises buyers and sellers. Although surveyors do not make the market, it is the surveyor's interpretation of the behaviour and attitude of buyers and sellers that will have an often a profound influence upon the state and direction of the market. The reason surveyors have so much say is that, unlike the seller and/or buyer's opinion which is likely to be subjective and sentimental, the surveyor's opinion is objective. With 'subjective' the seller or buyer will assess the proposition in relation to the buyer's individual requirements, whereas with 'objective' the surveyor will assess the proposition in relation to the market.
detaIn theory, objectivity is neutral; in practice it may be bias. Without training, and even then it can be difficult, it is virtually impossible for a human being to be emotionally detached. The partisan of professional standards may also overshadow. For example, chartered surveyors, as members of an institution with a code of conduct, are subject to fear of a disciplinary committee or at worst expelled. It does not help that, from my observations, the RICS is prone to issuing and revising practice statements and guidance notes for its members after the event, rather than in anticipation of market trends. One difficulty I suspect is conflict of interest between valuation surveyors and their colleagues in investment departments, and quite possibly of shareholders where surveyors operate as public or private limited companies. Ultimately, the law and the view of the courts in case-law is paramount. To quote from a textbook of Professional Negligence, the authors Jackson and Powell state "a professional is not entitled slavishly to follow the provisions of a code of practice". Per PK Finans International (UK) Ltd v Andrew Downs and Co Ltd [1992], the court's reservations about the status of the RICS guidance notes are made apparent: "I suspect that they are as much for the protection of surveyors as anything else, in that they set out various recommendations which, if followed, it is hoped will protect the surveyor from the unpleasantness of being sued". In my view, where a surveyor has informed knowledge of the market there is a duty of care to anyone whom the surveyor is advising. When a surveyor has a feeling that all is not as it should be, to keep quiet and toe the party-line is not an option.
So, since there is a difference between the value of a property and as an investment, how does one go about separating the two values? The question is by no means that easy to answer. To begin with, it is a question of how far back one should go. Arguably, one should go back approximately 30 years to the time before buyer inexperience took hold and when there was a marked difference between yields in different parts of the country. If so then what has happened to the shop investment market in the after-math of the sub-prime crisis, ensuing recession and downturn generally (2008 onwards) could be said to be a return to the 'norm'. In other words, values nowadays are not on the low side because they have fallen from the peak, but have merely reverted to the rightful level. When that approach is adopted, prospects become a lot clearer.
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