Below is a brief synopsis of another interesting panel held at the Central London Property Meet, exploring the merits of commercial property investment. Left to right in the photo below, Ranjan Bhattacharya (Property Investor), Barry Shaw (Commercial Property Lawyer) Am Kainth (Property Investor), Piragash Sivanesan (Director of Totum Finance) and Daryl Norkett (BDM for Shawbrook Bank) all contributed to the discussion.
Fairly London-centric in terms of focus, it was observed that commercial property values have not seen the rapid appreciation relative to the residential sector in recent years – potentially presenting wider and more dynamic investment angles in a “post section 24” operational environment. Some important cost savings include lower stamp duty liability and the potential for VAT to be excluded or recovered post-completion (depending on the circumstances of the transaction). FRI (Full Repairing and Insuring) leases combined with recoverable insurance costs and potential service charges also mean that net yields can be considerably healthier. Contracts terms are more easily enforceable in situations of default under “peaceable re-entry”, simplified debt recovery procedures and other legal mechanisms.
According to the most recent DCLG housebuilding statistics, in 2015/16 13,879 homes were delivered under the Permitted Development (PD) rights regime for commercial to residential conversion. The surge in demand for such sites, it was argued, has instigated a “toss-up” between the pursuit of residential schemes and maintaining sites for commercial lease. Particularly in the Capital, the intensive implementation of the Article 4 Directions by local Councils (albeit under the questionable guise of “protecting employment”) may well mean that commercial property investment will be more favoured moving forward. One interesting angle worth exploring in this scenario is to convert the upper part of a building with PD rights to residential, maintaining the lower as commercial (depending on the configuration and whether such plans would be aesthetically compatible). If executed well, the result could be lower conversion costs and stronger blended yields.
In terms of sourcing, it was highlighted that commercial property only gains its real value when the lease is signed. Prudent investors should look for buildings that will ultimately house tenants with strong businesses operating in flourishing sectors. While most retail investors prefer blue-chip tenants, intensive bidding wars and overpricing is common. SME and micro-business tenants should therefore not be dismissed at face value and may present interesting opportunities providing the correct due diligence has been executed. For example, working with several SMEs within the same building / complex may minimise risk by means of diversification. Investors are advised to focus heavily on the trading accounts whilst examining the financial credibility of the tenant with forensic detail (detailed assessment of assets and liabilities – ascertaining the assignee’s borrowings, shareholdings and other business interests). Taking a personal guarantee also automatically strengthens the covenant. The possibility of holding rent in advance, in return for a marginally reduced premium, should also be considered – thereby providing short-medium security (for both the investor and the lender). From a broader perspective, it is paramount to pay close attention and observe demand patterns, local planning legislation and precedent.
When it comes to borrowing, lenders want to remove risk and uncertainty – underwriting on the basis of strength of covenant, longer leases, low void risk, rent review regularity (in line with RPI or other appropriate index) and legislative changes (such as recently announced increases in business rates starting in April 2017, affordable workspace policy and other planning law alterations). Other macro factors such further currency fluctuations resulting from Brexit, falling consumer demand, underinvestment in local infrastructure (from transport links to 4G coverage) will also be considered. The traditional banks generally prefer blue-chip tenants and work on an interest / capital repayment loan structure with LTV ratios ranging from 50 to 60%. Challenger banks and crowdfunding platforms are generally more flexible, examining borrowers experience in the market place (ability to find good tenants, clarity in terms of long-term business planning and other factors that demonstrate genuine credibility). However, the rising demand for shorter leases as a result of ongoing changes in work patterns and behaviours (the contingent workforce consisting of the self-employed, start-ups, contractors etc.) is resulting in lenders reconsidering their underwriting models.