When I first started to collate material for this article, I was a little bit disappointed to find that the vast majority of it was prepared in the early part of 2014 and related to anticipated rises in commercial property prices in United Kingdom for the forthcoming year. It turned out though, that the reality was different.
In addition to reviewing various written reports in connection with commercial property, I was also extremely fortunate to be able to discuss privately with a few wealthy investors who specialised in commercial property investments. Two of these suffered heavy losses as a result of the economic crash but have since recovered, albeit at a lesser level. One of these people was virtually unaffected since he was cash rich and had been investing in commercial property for a long period of time, which meant that any outstanding loans at the time of the collapse were minimal. The final person with whom I spoke had effectively “lost everything.” He had invested heavily with borrowed money and when the crash came, there was nothing in reserve to help tide him over during the worst times.
One of the above investors, who is a personal friend, suffered greatly as a result in the value of commercial property. However, he persevered and was able to dispose of his commercial assets, including a large shopping centre, thus enabling him to settle all outstanding loans with the bank. On the actual day that his final loan was settled, in a bravado step of “thumbing his nose” at the bankers, he went out and bought a brand-new Ferrari, albeit a small one! He was back in business and he was letting the banks know it!
You will recall that following the Global Economic Crash, many of the UK banks transferred their worst loans into what was known as “toxic accounts” so that these assets could be held separate from more profitable ones. However, in order for the banks to dispose of such “toxic loans” they had to find investors with sufficient available capital to not only purchase the property attached to these loans, but to turn them into viable enterprises.
The government of China, through many of its investment subsidiaries, has been investing heavily in UK commercial property over the past 12 – 18 months. This does not mean though that such investors were prepared to pay what they might consider to be inflated prices for what were once deemed to be toxic investments. In effect, they were looking for bargains but were prepared to pay, in cash, to acquire the bargains.
Furthermore, the general recession within the UK meant that more commercial properties were becoming empty as tenants went into bankruptcy. As with all property, private or commercial, if there are no tenants, that means there is no incoming rent which in turn means loans cannot be paid back from the incoming rent. It was and continues to be in the interest of banks to dispose of such properties as quickly as possible, even if this means selling at a loss when compared against the actual loans that had been granted for the properties. If the same properties could not be removed from the bank asset accounts, then they would continue to incur interest which would be reflected in the bank’s overall profitability.
Large commercial property investors divide their target into three main areas:
Everyone knows that London is the capital of the United Kingdom. Anyone who has tried to rent a flat there will know not only how congested it is but also how expensive. The same applies to commercial property. There is only so much property within the centre of London and when any of it becomes available, it is fought after like dogs around a bone. It is therefore unfair and unrealistic to base the price and potential price of commercial property purely on those values that are realised in London.
This same comparison would also apply to high street shops and in particular, large hotels. Scarcity is the secret behind high purchase values.
As I mentioned previously in this article, there is currently an abundance of international capital looking for a home in the UK – particularly in London. This is further enhanced by the low interest rate environment which was created by “quantitative easing”. Investors are searching everywhere to find new and higher yield on investments, particularly since the return on the usual equity and bonds is miserably low.
London has become a sellers’ market as a direct result of both the shortage of investable properties coupled with the large amount of investment capital that is available. More than three quarters of all commercial investments in London were financed by international buyers in the first half of 2014. For the first time since 2009, several of the U.K.’s most prolific property investors are actually shedding their assets in order to free up cash. Sales prices have broken all records, such as an Indian property company’s investment in the Canadian embassy building on Grosvenor Square at a staggering price of £300 million.
Unfortunately the experiences of London are not reflected throughout other regions in the UK.
The Republic of Ireland’s state-controlled bank had a large portfolio of property investment in Northern Ireland, particularly in the commercial property field. Its “toxic loan book” was hived off into a separate division known as Nama with assets valued in excess of £4.5 billion.
In order to end its involvement in Northern Ireland, Nama recently completed a sale of these assets to an American investment company for the sum of £1.3 billion. Unfortunately for the people of the Republic of Ireland, it is they who will have to carry and finance the burden of this loss through austerity and increased taxation. The portfolio consists of hundreds of properties and includes office blocks, hotels and even development land.
There are similar examples of this throughout the whole of the UK, particularly in the northern regions. Property values have plummeted yet there are not many buyers around, unlike in the London market.
You will recall in the introduction to this article, I mentioned that I had spoken to several acquaintances who in the past had been heavily involved in commercial property investment.
Each told me that they would no longer make international investments as these proved to be far too risky, particularly in countries where legal ethics are somewhat questionable. Interestingly, they all told me that they had now and would cease in the foreseeable future, to invest in any commercial property in Northern Ireland. Yes, there might be plenty of properties available but the economic situation is such that tenants, both for high street shops and office blocks outside of the capital Belfast, are currently hard to find. This does not bring about a business plan that would be acceptable to banks in order to finance such investments. There now must be proof of actual rent coming in from tenants of these properties both now and in the future in order that loans can be properly serviced. Without such tenants and such rent, banks just do not want to know and so property investment from cash poor investors is severely curtailed at the present.
As more and more commercial properties lie vacant due to the downturn in the economy, landlords are becoming more hard pressed. They really face two alternatives: they either effectively hand the property back to the banks or, they sell, sometimes at a considerable loss, in order that they can clear all and any outstanding loans on the property. It is questionable as to which is the lesser of these two evils.
Please forgive me if I once more refer to Northern Ireland but there have recently been a number of attempts by local authorities to try and disguise the true economic situation of the region. During recent internationally-televised events, councils have painted out the large number of empty shops with murals that portray the premises as actually being full and active. Granted it looks somewhat prettier than an empty shop but it still overclouds the dire straits in which the local economies find themselves.
I am sure that you, the reader, like many other people take dubious notice of forecasts because that is all they are – simply forecasts!
For months, we have been told by the Governor of the Bank of England that there will be an imminent rise in the Banks Base Interest rate. Yet every time we approach that “red line” the rules change and any increase is put off for a few more months. At the beginning of 2014, various experts predicted that there would be a considerable inflow of capital into the UK and the average return for UK commercial property would be within the region of 11.5%.
Certainly in London and the surrounding areas, this figure may very well be achieved. However in other areas of the UK, properties still remain empty and in order to see a substantial increase in the rate of return on commercial property, it obviously will be essential for these premises, particularly office blocks and industrial complexes to become occupied. This in turn means that jobs must be attracted to the areas so that these properties may become occupied.
Once again I look at both the North of England and Northern Ireland. Due to transport communication issues between the south to the north of England, it is difficult to such areas to attract new businesses. Similarly in Northern Ireland, when a company announces it is going to increase its workforce by 20 positions or more, the local government hails its victory in bringing more jobs to the region – hardly even a ripple in the pond!
All indications are that the rate of return on commercial property within the overall UK will remain either stagnant at best, or drop several points at worst over the next few years.
Whilst new construction is certainly starting to show signs of improvement, contractors are becoming more selective about the type of jobs they are prepared to undertake and also are far more accurate in their cost projections than in the past.
But what about the existing owners of commercial property? Well of course, the type of commercial property is an important and relevant factor. Large out-of-town industrial complexes and shopping centres are still sought after investment properties, dependent upon location. Large UK retailers and in particular, Internet fulfilment specialists have become more aware of the need to compete effectively on delivery times. The demand for such urban distribution hubs, particularly smaller urban warehouses, is starting to increase, especially since the pressure on delivery times intensifies. As a result, it is anticipated that such commercial property will show an increase in rental values over the next 12 to 18 months.
High Street commercial property is another issue. The “family business” is starting to disappear since the footfall on high streets is moving to the out-of-town shopping centres. There is still the requirement for such premises, but it is anticipated that the demand will continue to decrease within the foreseeable future. With the reduction in demand, it is inevitable that the reduction in rental revenue will follow.
Golf has become the game of now, particularly following the recent success of Rory McElroy and other UK-based golfers. Large hotels incorporating 18-hole golf courses are in the planning in a number of areas and as a direct result of the anticipated increase of participants in the game, investment in these commercial properties is much sought after.
By way of summary, it is fair to assume that if located in the right position, there is an abundance of potential investors for commercial property. Where this falls by the wayside are those areas, of which there are many, which are not deemed to be in the right location. This presents a major problem for existing owners of commercial property. Do they try to weather out the storm with low and often non-existent rents resulting in low or non-existent yields, or do they sell the property and suffer any losses? The former is often not an alternative whilst the latter relies on the existence of potential, willing investors.
It is obviously clear that outside the area of London and the south-east of England, life is not easy for the existing commercial property owner. Sales are hard to come by due to the lack of investors and even if such an investor is identified, the potential sales price is considerably less than that envisaged by the vendors. It is often far more advantageous to consider the possibilities of a cash sale of your property and we are more than happy to offer you advice in this area.