The Property Speculator

Developing a Mixed-Use Property

[wp_campaign_3]

A very common way of getting started in property development and investment is converting or renovating a mixed use development.

‘Mixed-Use’ can mean a combination of Residential, Office or Retail within a single development (it’s highly unlikely Industrial type properties would be included in this, for example I can’t imagine a residential flat being situated above an industrial unit). So an example of this could be a shop with a flat/flats above it, or offices with residential above. Incidentally the residential portion is situated towards the top of the property because it’s not likely to require a street-level frontage, like a shop or an office might. The residential area of the property also tends to be quieter and the commercial occupants are less likely to have cause to go upstairs into this area of the property.

© Copyright John Lord and licensed for reuse under this Creative Commons Licence

It is certainly possible to convert only part of a property to a use that’s different to the original one. Be aware though that (currently) Planning Consent is required to change the use of a property (or part of a property) from Commercial to Residential and between sub-groups within Commercial. Building Regulations also need to be fully complied with.

The different ways of occupying a property are:

Freehold. This is the closest to owning the property outright (It’s only a Government body which can carry out compulsory purchase though). The Freeholder theoretically owns the plot, the land beneath the plot and the area above it (although this isn’t really enforceable in reality). Being a Freeholder offers the luxury of selling a leasehold interest in the property if he/she wishes.
Leasehold. This is usually for a period of time (term) of 99 years or more (sometimes 999 years). The freeholder effectively sells the right to use the property for the term stated in the contract. Along with this, the Leaseholder sometimes receives the right to allow Tenants to occupy the property and collect the rent. In order to reduce the chances of confusion, this is often called the Long-Leasehold interest. It is bought in a similar way to the Freehold Interest (i.e. a large amount of capital is paid for it, rather than a monthly or quarterly rent).
Tenancy. This is really just a different way of occupying the property under a leasehold interest, however for the purpose of avoiding confusion over these occupancies, I refer to it as a Tenancy (even though the occupational contract is still called a Lease…). This is paid for in the form of rent, usually paid monthly or quarterly (depending on it being Residential or Commercial). A tenancy is always shorter than the long-leasehold interest (even if it’s only 1 day shorter) but is usually much shorter, between 3 and 25 years is usual. A tenancy does not really have much value in itself other than to the landlord. This is because it’s not really possible to sell a tenancy by itself; you can however purchase the leasehold interest with a tenant already in place.

Commercial and Residential tenancies are usually quite different. The main issue is that all Commercial tenancies are awarded Security of Tenure unless specifically contracted out of it. This means that a Commercial landlord can only make the tenant leave the premise at the end of the term in certain circumstances (for example if the landlord wants to redevelop the property and has plans in place to prove this). To contract out of this, the lease agreement must specifically state that both parties wish to contract out of the Security of Tenure provisions of Part 2 of The Landlord and Tenant Act 1954, s 24-28 (or words to the same effect). Contracting out of the act should benefit both parties (such as when a lower rent is agreed upon to reflect a lower ‘risk’ to the landlord).

In contrast, Residential tenancies tend to be more heavily weighted in favour of the Landlord. A tenant does not really have any Security of Tenure at the end of the term. Many Residential tenancies are only for an initial period of 6 months. If the tenant stays in the property with the permission of the landlord at the end of the term, a Periodic Tenancy is formed. If the tenant pays rent on a monthly or weekly basis, this period becomes the notice period for either party to bring the tenancy to an end. A periodic tenancy continues until the landlord or the tenant brings it to an end.

It’s important to have an understanding of how the different types of occupation work. When developers of mixed use properties consider their projects, they intend it to work in a slightly different way to the usual private residential developer. Where a private developer buys a property at a reduced price, spends the bare minimum but produces a good finish then sells on to a new owner, a mixed use development often requires a different approach. Of course it is possible to buy and sell a mixed use development in the same way as a small residential (i.e. the freehold), but because of the combination of property types within the development it usually makes more sense to keep the freehold of the property and sell the long-leasehold interest as and when an occupier or investor is found.

If the freehold is retained, tenants can be found to occupy the office or retail portion. The residential areas of the building can be let the same way as the commercial but this involves a lot of management of tenants taking 6 or 12 month tenancies and of course, the developer will not receive capital in return in a lump sum. It’s far better to sell the long-leasehold interest in the residential units to either investors or leasehold-occupiers. This way, a profit can be made (the value of a long-leasehold interest is more-or-less the same as the freehold price) on individual units of the property. Investors or leasehold-occupiers can buy individual long-leaseholds interests one-by-one if necessary. If the residential units are above the ground floor, it is not possible to sell any of the freehold interests in these. A freehold must always be on the ground floor or associated with a property on a ground floor. If an investor purchases any of the long-leasehold interests, they will be obliged to honour any tenancies that might have been agreed prior to their completion.

It’s also important to understand how service charges apply to a property of mixed uses. A service charge is essentially a further charge to the tenant(s) to contribute to the upkeep of common areas such as grounds maintenance or cleaning and decorating of hallways and stairwells. Service charges should be ‘fair and reasonable’ and not produce a profit or a loss for the landlord. For Commercial tenants, The Royal Institute of Chartered Surveyors publish a Code of Practice guide on service charges. The method of dealing with dispute resolution will be stated in the lease. Residential tenancy service charges however, are very strictly regulated. A landlord who doesn’t follow the statutory procedures might find himself limited under law as to how much can be recovered from the tenant at the end of the occupancy.

Tenants should be supplied with a schedule of the previous year’s service costs and justification of the current level of charge. In a mixed use property however, tenants will occupy different sized areas and even use different facilities in the property. For example a Commercial tenant on the ground floor would not be expected to pay for the upkeep of a lift to service the residential units on the floors above. The principle way of deciding who should pay for what, is to consider which property a particular service will benefit. A Commercial tenant should have the opportunity of negotiating the service charge. It is sometimes possible to opt out of the charge for services that are available but will not be used.

Sep 4th, 2011

Using the Comparable Method of Valuation for Commercial Properties

Of all the 5 methods of Real Estate valuation, the Comparable method (also known as the Comparison Method) is king. It underpins all other forms of valuation to some degree.

I like to be able to work with a definition of a term so that I can truly understand it. So I will attempt to define the term ‘Comparable Valuation’:

‘The establishment of a Property’s Capital or Rental value using recent, similar transactions as a guide’.

The first thing to mention about this valuation method is that it is not rocket science. It is essentially the method that not only residential Estate Agents (Realtors) use to establish an initial property asking price, but also potential buyers. That means that if you have ever got a particular ‘feel’ for the market in an area and felt that a house or flat is over or undervalued, you have used this method too. This is because all it is is comparing one property value to another. This might be oversimplifying slightly, because there are certain considerations to look into:

The difference between the asking price and the eventual sale price (or asking rent compared to eventual agreed rent) is quite likely to be significant. This is down to the negotiation between vendor and purchaser (or landlord and potential tenant). An example of this is when residential Estate Agents are very optimistic when placing an initial asking price on a property. It’s very important when researching recent transactions that actual sale or ‘let at’ values are used. Asking prices and rents can be ignored.
The recent transactions should be as recent as possible. It’s far easier to use the comparable method when the commercial property market is active and stable. This is because information is far easier to gather. Sometimes it’s just not possible to find sale or let figures that have been produced in the preceding weeks or even months; however you must understand that the older the information on other transactions, the less accurate it is. Property is hugely influenced by changes in demand and supply; this means that if (for example) an office building was sold 3 years ago for £1.35m (Approximately $2.025m) it does not necessarily follow that it would sell for more than that now.
Transactional information should ideally be based upon properties that are located very closely together. In Central London and (presumably) other similar large cities, buildings should be on the same side of a particular street and preferably within a few hundred yards of each other before they can be considered closely comparable. However, that leads us on to the final consideration:
All properties are different in some way. This could be different Use (offices, industrial or retail plus sub-uses such as financial and professional services, general business or light industrial etc), Grade (the high profile, well-equipped and modern offices are known as Grade ‘A’, grades then go to B & C depending upon condition, level of amenities and pleasantness of the building in general), Size (the difference in sizes of buildings is addressed by dividing the rent or sale price of a property achieved by the area. This produces a value per square foot or square metre) and Location (this might be the difference between (for example) a building in Central London and a building in Warrington; or even different areas in the same city, such as a building in Streatham, London and a building in St James’ Square, London). These will all have an influence on value to some degree. If rent is being negotiated, 2 apparently identical buildings side-by-side could have different rates negotiated. This could simply be because a particular business tenant presents a lower risk to the landlord and was therefore able to negotiate a slightly lower rent than the neighbouring tenant.
Economic conditions can affect the demand for property, and subsequently the agreed rent or price. The cost of borrowing is a big factor in property sales; likewise the general level of confidence in the macro-economy will affect investor’s appetite to acquire what amounts to a highly illiquid asset. In economic downturns, businesses are much less likely to expand or move premises and this increases an investor’s exposure to risk.

It’s often said that Real Estate valuation is an art, not a science. In relation to the considerations above, establishing a property value is not difficult. However, establishing an accurate figure is where the skill comes in. Determining an approximate rate per square foot or metre is not difficult; however it’s knowing where to adjust a figure and how to account for differences between apparently similar property transactions that sometimes produces unexpected results.

© Copyright Julian Osley and licensed for reuse under this Creative Commons Licence

In the case of commercial tenancies, lease terms will have a substantial affect on the agreed rent:

The lease Term (length of tenancy). A long term is normally of benefit to the landlord, except (for example) if he plans to redevelop the site in the mid to long-term.
Break Clause. This allows one or either party to bring the lease agreement to a premature end. In the UK, it is often placed into the lease terms in 3 or 5 year intervals. It will be subject to around 6 months notice usually and might involve some reward if it isn’t exercised (such as a rent-free period).
If the tenant has some Security of Tenure. In the UK this means that the landlord can only insist the tenant leaves the premises under certain circumstances. All commercial leases in the UK are automatically subject to this unless both parties agree to exclude it at the beginning of the Term and this is specifically mentioned in the lease contract.
The financial standing of the tenant. 3 years of company accounts are normally required for the landlord to consider. This is because if the company has an excellent credit rating and has been established for quite some time, it will present far less of a risk to the landlord than a company that is in its infancy or has defaulted on some payments to creditors.
Ease of use of the premises. If for example, a tenant is unable to access premises outside normal working hours, this can have an effect on agreed rent as it might be a significant inconvenience. Likewise if an out-of-town office building does not have sufficient car-parking spaces for the staff, this is also likely to reflect in the agreed rent.
Obligations regarding repairing and maintaining the building. If a tenant is obliged to take on responsibility for all building maintenance and repair, the rent is likely to be lower as the terms of the agreement are simply less favourable for him. The same can be applied to insurance. If the tenant is obliged to pay for insurance, it represents a burden for him. Insurance payments are collected from the tenant by the landlord. The landlord usually takes responsibility for arrangement and ensuring that insurance payments are made, as this way he knows that cover is in place. The payments are recharged to the tenant under a separate arrangement.
The frequency of rent reviews. These are often timed to occur every 3 or 5 years. A new rent can either be negotiated between the parties or be determined by an external influence such as the Retail Price Index. ‘Upwards only’ rent reviews are common, this doesn’t necessarily mean (as the expression suggests) that the rent is guaranteed to increase. It does mean however that it won’t decrease, even in the event of an economic downturn. These various ways of structuring a lease can benefit either party, subsequently it will have some effect on the rent that the tenant is prepared to pay and what the landlord is prepared to accept.

An example of the Commercial use of the comparable valuation method is as follows:

To establish the rental value of Building A, three further buildings (B, C and D) can be considered for comparable evidence.

Building A is 3,000 Sq M office building. It is established that rents in the area have increased by 7% in the last 12 months.

Building B is 2,000 sq M and is of poorer grade than Building A. It was let around 2 months ago at £400,000 per annum (around $600,000). This works out to £200 per sq M but this value would be below that expected for Building A as the grade is poorer.

Building C is also 2,000 sq M and is similar grade to building A. It was let 12 months ago at £600,000 per annum (around $900,000). This works out to be £300 per sq M for a similar quality of office but rents have increased since this was completed.

Building D is 1,000 sq M and is also a similar grade to building A. It was let 1 month ago for £350,000 per annum (around $525,000). This works out to be £350 per sq M and the information is quite recent.

It could be determined that Building A could be worth around £300 per sq M. The justification for this is that it is a larger unit than C & D and although rents have increased since Building C was let, Building C would command a higher rent because smaller units are in higher demand. If Building C was being valued now, it could be justified to value it at a slightly higher rate than Building A.

Clearly this example is very simplified. However it demonstrates the technique, additional factors such as location and lease terms would have to be considered.

Aug 7th, 2011

Valuing a Commercial Property based on Profits

In the case of most types of commercial property such as retail, office and industrial, it will be a reasonably straight forward job to establish a rent or a capital value (for when being sold on the open market). The rent or capital values will likely be set by close comparison with similar property transactions in the immediate area.

Sometimes however, it’s just not possible to compare similar properties, because the information might simply not be available. This might be because the property is very unique or because similar transactions have not occurred recently enough to be of any use. This is often the case for leisure properties such as pubs, restaurants and hotels. These are often sold on the open market but because they’re a specialised investment field, you probably haven’t seen them unless you’ve been looking out for them. In fact, it’s not just professional investors who would have an interest in how these properties are valued, prospective tenants planning on running the business themselves should also know how the valuation process works. If you understand how the property is valued, you will have far more leverage when it comes to negotiation on the eventual rent figure.

If no comparable information is available, the only alternative is profits. Obviously this means that the property has to have an operational business currently running from within.

I personally feel that the profits method is a far better way to place a rental value on this type of property, even if accurate and relevant information on comparables is available. This is because these types of properties can be a similar size and closely situated but make extremely different levels of profit. The business that’s been more shrewdly run might appear to be worth more. It should be mentioned however that the business itself is not being valued, rather the ‘facility’ to run a business from the property.

© Copyright Peter Trimming and licensed for reuse under this Creative Commons Licence

To begin to establish the profits, the past 3 years accounts must be looked at. It’s very important that these are accurate enough to be relied upon; a good indication is if a reputable accountancy firm have prepared them. A very basic way of estimating the net profit figure is by the following summation:

Gross Earnings

Less Purchases

Equals Gross Profit

Less Working Expenses

Equals Net Profit

Gross Earnings is the total annual revenue that the business earns, before anything is subtracted.

Purchases are the ‘raw material’ that must be purchased in order that the business can operate. In the case of a restaurant for example, this would be food, beverages and equipment.

Gross Profit is the resulting figure that is produced from subtracting the business purchases from the gross earnings.

Working Expenses are the everyday costs involved in running a business such as electricity, staff wages and insurance.

Net Profit is the final figure left after all expenses and purchases have been deducted from the Gross Earnings.

The valuer who establishes the rental value based on profits is obliged to use his judgement in deciding if the net profit figure is accurate enough. Company accounts can only show what has been recorded. However if the business has been underperforming for some time, the valuer might consider the net profit figure too low compared to what might be achievable. Likewise if the business has been run exceptionally well, the net profit figure might be reduced for the purposes of the calculation to give a more realistic figure. In practice, the Property Professional who values a property based on profits will be a specialist in this particular field of commercial property.

It is common practice to divide the net profit figure in half (or thereabouts) to produce an annual rental value. One half is known as the ‘Tenant’s Share’ and is intended to account for the Tenant’s work and enterprise in running the business. The other half would be regarded as the annual rental value.

So for example:

Gross earnings – £100,000

Less Purchases – £35,000

Equals Gross Profit – £65,000

Less Expenses – £25,000

Equals net profit – £40,000

Tenant’s share of 50% - £20,000

Annual rental value – £20,000

When calculating the net profit figure, the Tenant’s wages should not be included as an expense. This is because the Tenant’s share is included at the later stage and must not be considered twice.

Jul 26th, 2011

A Quick Guide to Planning Conditions

Receiving the appropriate planning permission to carry out the work you want to, is one of the most important aspects of property development. However the grant of full or outline planning consent will be subject to some conditions that may or may not represent a problem to you.

Whenever full Planning permission is applied for and the developer (i.e. you) is notified of the positive decision, certain rules must be complied with in order to stay within the law. This ensures (from the Local Planning Authority perspective) that the developer does not apply his/her own ‘angle’ on the decision. These conditions will be stated on the decision notice itself or attached on a separate schedule.

To use an example of a ‘sticky’ planning condition that I came up against personally, a group of small-medium sized industrial units were offered to be let. These units were high quality as they were newly built, and a sub-division of a very large worldwide company (our client) was very keen to take on a lease to one of the units. The company required occasional access during unsociable hours in order to supply European factory production line components in the event of a breakdown at short notice. As I was progressing in negotiating favourable terms, it came to my attention that one of the planning conditions was a restriction on the hours that my client’s employees would be able to access the unit. Because of its very close proximity to some houses, the Local Planning Authority had applied a condition that ensured that occupants of the industrial units could not subject nearby residents to excessive noise during the weekend or outside normal working hours. There was not really any way round this, and as a result I had to find alternative premises for my client. The point of this is that although you might be celebrating the grant of planning permission on a plot or a property, the conditions that accompany it are equally important.

Planning Conditions can be related to almost anything affecting the property or land. If a newbuild property is planned, then it’s likely that some conditions will be connected to required materials, dimensions, access to the property and landscaping. Clearly you must be familiar with these before you start to build. If you intend to renovate and/or convert an existing property that has listed status, expect much more in the way of conditions. Sometimes the conditions involve something to be agreed to with the local council, in this case a fee is payable to have the conditions ‘discharged’.

Materials are an important aspect of how the finished property will look and how it blends with neighbouring properties and landscape. It’s likely that bricks and roofing tiles will have to be agreed to, prior to construction commencing on a new-build property. The local authority is also certain to take an interest in how the surface and foul water drainage system is planned. Landscaping is also important to the local planning authority; imposed conditions often request that schemes are provided and implemented within a certain period of time.

Both full and outline planning permission are subject to a maximum limit of 3 years. This means that from the date of consent, if works have not begun on the planned development, the permission is considered to have lapsed and will be void. For works to begin, planning permission must again be applied for and obtained before the works can actually begin. So if you already have planning permission for proposed works that is slowly running out, you should definitely get started to avoid a lot of inconvenience later. You should note that land or property that has existing planning consent that is approaching the end of its effective life is worth less than if the consent is fairly ‘fresh’. This is because of the increased risk of not being able to start work immediately before planning permission expires.

Access to the property is also a large consideration for the planners. If the development is substantial, questions will be asked in relation to increased traffic levels. Even if the development is a single dwelling, access to the carriageway will still be important as (for example) it might be on a blind bend in the road. Parking is also considered at some length.

In urban or built-up areas, the local planners might well impose conditions attached to the permitted hours of build. This is usually normal working hours, and there will be a restriction on working weekends and bank holidays. Sometimes if you are extending an existing property as part of the development, the local planning authority might remove some permitted development rights. This is because permitted development allows a certain degree of extension to a property. If the property is extended as part of your development, this in effect ‘uses up’ the degree of extension that is allowed. It doesn’t mean that the property can never be extended at any point in the future; it does mean however that consent must be applied for and granted.

It is common on listed properties to have at least some sign of the presence of bats. A dead bat, signs of droppings or visual signs of their presence is enough to warrant a bat survey. Building work cannot begin if there are grounds to believe that bats inhabit some area of a property. To ignore this is a criminal offence because of the protected nature of bats. A condition might well be attached to consent stipulating that a bat survey must be carried out and work cannot begin until the bats have ceased to occupy.

A very common condition attached to planning consent on rural properties (especially farms) is an Agricultural Restriction (or ‘tie’). This places a control over occupancy that only allows for residents to be involved in farming and must use the property and associated land to produce their main source of income (or words to that effect). This is very strictly enforced by councils, so be very wary of it because a property with an agricultural tie is offered at a hefty discount to one that does not have one in place. There is not really any way round this condition, so keep an eye out for it unless the property will ultimately be getting marketed as an agricultural one.

© Copyright Nigel Davies and licensed for reuse under this Creative Commons Licence

As I’ve already mentioned, having an understanding of the importance of planning conditions is very important to a property developer. However what is just as relevant is the understanding that conditions can be appealed against. Obviously there is no guarantee whatsoever that taking this route will provide you with the perfect scenario of having the planning permission that you planned in place, with minimal conditions attached. Professional developers often carry out what is known as ‘twin tracking’. This means that planning permission is applied for and while they await the ruling, identical permission is re-applied for. This is so that if one application is granted but is not what they wish for (i.e. the conditions are not considered viable) when the second permission is granted, the first can be appealed against. Unfortunately if planning consent is re-considered by the local authority, they have the power to decline the consent, meaning that permission to build anything is lost. If the developer holds a second separate certificate, then they have not lost everything and can still build, albeit with less than ideal planning conditions.

Jun 19th, 2011

Understanding Residential Tenancies

It is important to know exactly how residential tenancies work when you are a property investor. It is unfortunately not simply a case of finding a tenant, verbally agreeing a few simple terms and collecting the rent each month. There are 2 different types of private residential tenancies and they have slightly different rules that you, as a Landlord must adhere to.

Legislation was originally introduced back in 1915 to protect Tenants against unscrupulous Landlords. Since then, all subsequent Rent and Housing Acts have evolved the system into what we have today. Most recent acts have over the years, created more and more favourable conditions for the Landlords in an attempt to re-invigorate the sector. This in turn, has given the Tenant progressively less security of tenure.

2 types of tenancies are still in use:

The Assured Tenancy was introduced by the Housing Act 1980 and replaced ‘Rent Act’ tenancies. They offer some degree of security of tenure to the tenant. A resident under this system cannot be evicted from a property unless the Landlord has sufficient grounds to do it:

The Landlord once occupied the property as his home and now wishes to re-occupy.
The mortgagee (mortgage company) wishes to gain possession
The Landlord wants to substantially redevelop or demolish the property.
The Tenancy has devolved under testacy or intestacy of a previous assured tenant.
More than 8 weeks of rent are owed.

Assured tenancies can be put in place for a fixed term (this is often just for an initial period of 6 months) or they can be periodic (meaning that they just continue from week-to-week or month-to-month indefinitely).

During the fixed term, they can only be brought to an end if the Tenant agrees to leave, or by a court order. If the tenant remains in occupation after the fixed term has expired (and the landlord is happy with the arrangement) then a Statutory Tenancy is created by default. This continues until a new tenancy agreement is introduced or a court awards possession to the Landlord. During this time, the terms of the original agreement must be followed, a Landlord cannot suddenly introduce new terms without the agreement of the Tenant.

If the Tenant pays rent on a monthly basis, then any increase in rent must be subject to a months notice. If the tenancy is less than 1 year old however, the Landlord has to wait for those 12 months to expire before initiating any changes to the terms.

2 Assured Shorthold Tenancies (ASTs) were introduced to give Landlords greater control over their properties. The end of the tenancy term gave them almost certain possession. For a lease to qualify as an AST, certain conditions must be in place:

The lease must be for at least 6 months.
The Tenant must be aware that the lease is an AST prior to signing the agreement.
If the AST term expires and both parties wish to bring another agreement into effect, the new one must also be an AST and on the same terms as the original agreement.
If any grounds for the tenancy to end (identical to the Assured Shorthold grounds for repossession above) occur, provided the Landlord serves 2 months written notice, the tenancy is automatically terminated (see below).

Under the Housing Act 1988, s.21 allows the Landlord to serve a notice to the Tenant of a minimum period of 2 months for the Tenant to vacate the property; although this can’t be served within the first 6 months of the term.

All tenancies from 28^th February 1997 onwards are automatically Assured Shorthold Tenancies unless specifically stated in the agreement. There are also conditions that prevent a tenancy agreement from being an AST (and subsequently will become an Assured Tenancy):

The Landlord is resident in some way.
The rent is greater than £25 000 per annum (this level is increased to £100,000.00 from 1st October 2010).
None of the tenants occupying the property do so as a principal home.
The tenant is a limited company, not an individual.
The landlord is a local council

Apart from the 2 types of tenancy agreement, Tenants do have other forms of protection against unscrupulous Landlords:

Rent Books. All tenants who pay on a weekly basis must be given a rent book. This contains information such as the actual weekly rental sum due, details of any security of tenure and agencies who can help in the event of a dispute.
Harassment Laws. It is a criminal act to harass or unlawfully evict a Tenant, regardless of circumstances.
Notice to Quit period. This must be the same period as the frequency as the rent payments (except in the case of annual payments – where 6 months is permitted)
Court Order. This rules that all occupiers can only be evicted after the due court process.

In summary, you cannot simply evict a tenant without the full compliance of the law. Even if you are certain you are acting within the law, it is very important to have a property Solicitor serve any notice for you. This is because the notice wording is extremely important, and he/she will also check you are acting within the law.

May 7th, 2011

Investing in Retail Properties

When considering Property Investment, many speculators are concerned about risk. Risk is something that must be addressed and managed. However risk is the trade-off for an investment return. If risk is something you feel uneasy about, it’s easier to leave your money in the bank or purchase Bonds or Gilts.

Part of managing the risk of investing in property is diversifying a portfolio. It’s not just residential properties that can be purchased by the inexperienced property investor. Diversifying a portfolio is important, because the different types of property often behave in different ways:

Residential tends to be low yield because of a higher capital value. These properties usually have an easier life than commercial properties and so represent a better investment over the long term.
Office properties have a harder life than residential, but they are still looked after quite well (generally). This means they have a slightly higher yield than residential.
Industrial properties tend not to be treated particularly well. This means that a higher level of maintenance will be required. These properties are slightly higher yield than the 2 above.
Retail properties can be very high yield indeed. This is usually because the retail sector is about the most sensitive to economic peaks and troughs. In the present financial climate, there is a great deal of vacant shops. This is probably the riskiest of all property investments.

That said, retail properties can still provide an interesting investment opportunity.

© Copyright Alan Cooper and licensed for reuse under this Creative Commons Licence

Managing risk is very important in any investment, and knowledge is vital in this. If a retail property has a reliable tenant on a lease with plenty of the term remaining, then the level of risk decreases. It’s sometimes quite straight forward to assess how sensitive a particular tenant’s business is to economic downturns. For example, a jewellery shop that is not in a popular retail area is highly likely to be affected by a recession. Similarly, a tenant such as a high street bank or a well established chain store in a popular area is far less likely to default on rent. This is admittedly an obvious example, but this shows that retail properties can represent quite differing levels of risk.

The risk level will be reflected in the purchase price of the investment property. In the example above, the risky property will be a fraction of the price of the other.

The price to purchase a retail property can vary by a huge amount. A quick browse on either The Estates Gazette website (link here) or Showcase (link here) will provide some representative values in a particular area (registration will be required on these sites to get access). These sites however are more tenancy orientated than purchase. This is because commercial property as a whole is based around the occupants leasing them instead of buying them. It generally makes better financial sense for the tenant to do this. Subsequently, finding a suitable retail investment property might take some time at the moment due to the relative shortage currently on the market.

If investment in retail property does interest you, there are plenty of opportunities for you to begin with a small unit. A browse through the past auction results of any of the commercial property auctioneers (such as Cushman & Wakefield or Allsops) will show you that you do not need to invest many hundreds of thousands to begin in retail property. Likewise, commercial property search sites like Estates Gazette and Showcase sites have contact details of the Commercial Agents dealing with any particular properties that interest you.

Be aware though, that an excellent understanding of tenancy agreements is important if you intend to follow this route. It is reasonably common for nasty things to surprise people who have spent a lot of money on something they don’t fully understand. If in any doubt whatsoever about a lease, ask a good property Solicitor for help.

Apr 13th, 2011

All about Stamp Duty Land Tax

Stamp Duty Land Tax (SDLT) was introduced in 2003; and although it is often still known as ‘Stamp Duty’, it is now different from it.

The original Stamp Duty was first introduced in 1694, and was a tax on documents (i.e. documents used in transactions). Several years ago, Stamp Duty was referred to as a ‘voluntary tax’. This is because there wasn’t much control over registration for it (it was meant to be compulsory). Now however, there is no escaping it.

Stamp Duty (as opposed to SDLT) is payable at the point of purchase, on transactions that are evidenced in writing. When the duty has been paid (this should be within 30 days to avoid penalties), the Stock Transfer Form (in the case of shares) is stamped. HMRC delegates the determination of the Head Charge to the Stamp Office who states the amount of stamp duty that must be paid. Stamp Duty Reserve Tax is payable on electronic transactions (such as some company share purchases).

The property equivalent to Stamp Duty is SDLT. It is paid in the following circumstances:

At the point of purchase (on qualifying properties)
At the commencement of a long-leasehold occupation
At the commencement of commercial tenancy agreements, where the total rent payable before the tenant’s first opportunity to ‘break’ amounts to a sum that qualifies for SDLT.

Current SDLT rates are:

For properties up to £125,000, the rate is zero. No SDLT is payable.
For properties from £125,000 to £250,000; the standard rate is 1% of the property value , and for first-time buyers, it is zero.
For properties from £250,000 to £500,000; the rates for standard and first-time buyers is 3% of the property value.
For properties from £500,000 to £1m, the rates are 4%.
For properties over £1m, the rate is 5%.

SDLT is not tapered, like income tax. This means that if the value is over any of the thresholds, the whole value is taxed, not just the amount that is over the threshold.

So, if a property is bought for £126,000; the amount of SDLT (at current rates) payable is £1,260.00 (1% of £126,000). Likewise, if the property is bought for £124,000, then no SDLT is payable.

This situation results in an accumulation of property values at just below the threshold values. For example, there are many properties for sale at around £249,950. There really aren’t many at £255,000 (assuming these values are the sale prices).

It must be stressed, that SDLT is paid by the purchaser (although the Coalition Government is understood to be considering plans to transfer the SDLT liability to the vendor). It must also be paid in a way that is completely separate from the mortgage. I have heard of first time buyers enquiring whether they can include the SDLT charge in their borrowing from the mortgage company. This is not permitted!

If a new leasehold property is occupied by a tenant, the rates are:

For tenancies that total less than £125,000 for the life of the lease, no SDLT is payable.
For tenancies that total more than £125,000 over the life of the lease, 1% of the value that exceeds £125,000 is payable (so if a tenancy will total £130,000 over the total lease term, £50 is payable (1% of £5,000)).

Clearly, the lease term and rent would have to be quite substantial to qualify for this.

On commercial property, slightly different rates apply.

For properties that are not newly built:

For purchase values up to £150,000; or annual rent is below £1,000, the rate is zero.
On purchase values up to £150,000; or annual rents above £1,000, the rate is 1%.
For purchase values between £150,000 and £250,000, the rate is 1%.
For purchase values between £250,000 and £500,000, the rate is 3%.
For purchase values above £500,000, the rate is 4%.

For commercial properties that are newly built:

For tenancies with a term-value of up to £150,000, the rate of SDLT is zero.
For tenancies with a term-value of more than £150,000, then 1% of the value that exceeds £150,000 is payable.

For further information on SDLT, a visit to the HMRC website is recommended – http://www.hmrc.gov.uk/sdlt/intro/rates-thresholds.htm

Apr 6th, 2011

Property Security of Tenure

If considering investing in commercial property, an important consideration is a factor that, in practice changes the basis of a business tenancy by quite some degree. This is known as Security of Tenure.

This was introduced by Part 2 of the Landlord & Tenant Act 1954 (LTA) (Part 1 deals with residential property and Part 2 deals with commercial), this is often shortened to simply ‘the Act’ as it is well known among Property Professionals. It was brought in for the purpose of preventing unscrupulous landlords exploiting tenants by evicting them with little or no notice; or allowing them to stay in occupation but increasing the rent to unrealistic levels.

The LTA gave the tenant (both residential and commercial) protection by listing the circumstances in which the landlord could evict them. A minimum notice period was also introduced which gave the tenant an opportunity to challenge the landlord’s decision. Likewise, a tenant was allowed to apply for a new lease upon expiry of the old one, and the landlord was not able to deny this, except on justifiable grounds. The new lease must be on ‘similar terms’ to the original one.

All commercial leases are automatically covered by the LTA 1954 Part 2. Therefore, the act will not be expressly mentioned within the lease because the assumption should be made that it is an ‘inclusive’ (meaning it’s within the act) lease. Parties can however, opt to contract themselves out of the protection of the act, for reasons that are mutually beneficial to the particular circumstances of the occupation. To be ‘exclusive’ of the act, the tenancy agreement must expressly state that both parties wish to ‘opt out of the Security of Tenure provisions of the act’ (or words to that effect).

Under Part 2, s.30 of the act, there are grounds of opposition that can be used by the landlord to justify requesting the tenant to vacate premises upon lease expiry:

Not complying with covenants to repair and maintain the property.
A constant delay in rent payments.
Any other breach of covenant that is ‘substantial’.
The landlord has offered the tenant suitable alternative accommodation.
The current letting is based on an area less than the entire premises, and due to the current letting being uneconomical, the landlord wishes to let the entire premises.
The landlord wishes to demolish or reconstruct the building, or carry out substantial work (this must be provable).
The landlord wishes to occupy the building for his own use.

Because the Act gives the tenant considerable legal power, this sometimes changes the investment value of a lease. Many commercial landlords regard the act as a burden, and a lease that is ‘inside’ the act as being somewhat less valuable than one that is ‘outside’. Likewise a tenant sometimes feels that without the protection of the act, he wishes to pay a lower rent to reflect his greater ‘risk’. This is an issue for negotiation. A landlord will push for an exclusive lease; a tenant will push for an inclusive one. The negotiated rent will normally settle at a rate that suits the eventual decision to include the act or not.

When under the protection of the act, a landlord must serve a ‘section 25 notice’ to request the tenant vacates the property at the end of the term (this refers to s.25 of Pt 2 of the 1954 act). This is in practice, compiled by a Solicitor and delivered to the tenant between a maximum of 12 months and a minimum of 6 months before the landlord would like the tenant to vacate. In order to challenge this, the tenant must respond within 2 months of the serving of the notice.

The tenant can make an application to remain in the property after lease expiry, by the submittal of a ‘section 26 notice’ (again, this refers to s.26 of Pt 2 of the 1954 act). In common with the above, it must be completed by a Solicitor and served to the landlord between 6 and 12 months before the end of the term.

If a tenant remains in occupation of premises at the end of a lease term, the tenancy automatically becomes a Tenancy at Will. If the original agreement was under the protection of the 1954 act, then even though the original term has ended, the tenant still has Security of Tenure. This means that for the tenancy to be terminated by the landlord or extended by the tenant, a s.25 or s.26 notice must still be served under the same conditions as above.

Part 1 of the 1954 act concerns residential property. Although it doesn’t really apply much these days, it refers to protection being granted to:

1. Long leases; that is, more than 21 years long.

2. ‘Low Rent’ agreements (This is at a rent of below £1,000 per annum in London, or £250 elsewhere).

3. The property must be a ‘dwellinghouse’. Not a mixed-use property.

So the chances are, an aspiring residential property investor is unlikely to come into contact with the 1954 act. However, in the 1980’s, the Assured Tenancy and the Assured Shorthold Tenancy were introduced. These are protected tenancies types and the landlord can only take possession if:

The landlord occupied the property at some time, and wishes to return.
The mortgagee of the property (the lender) wishes to exercise a power of sale and sell with vacant possession.
The landlord wishes to demolish and/or reconstruct the property and there is no way of accommodating the tenant during these works.
The tenant dies.
The tenant is more than 2 months in arrears.

The most common form of residential tenancy now, is the Assured Shorthold. This is the default tenancy, as an Assured Shorthold Tenancy can only be created if expressly mentioned in the lease. Assured Shortholds provide the tenant with some protection but still allow the landlord to regain possession when required:

The tenant can request the detailed terms of the lease if not already supplied.
The landlord cannot request occupation until after the first 6 months have passed.
The Rent Assessment Committee has jurisdiction over the rent level, but on only one occasion which must be after more than 6 months after the start of the tenancy.

Apr 3rd, 2011

Commercial Property Business Rates

Business Rates are essentially, Council Tax for commercial properties. It is a very large consideration for companies seeking to establish themselves in new or moved premises. This is because it represents quite a large expenditure that must be accounted for.

The Government agency responsible for establishing exactly how much should be paid by companies, is the Valuation Office Agency (VOA). This is a large agency that has many employees many of whom are Surveyors. There job is to measure up almost all commercial properties in the UK and make a realistic assessment of the current rental value. As you can imagine, this is not a small task.

As a property investor or developer, it is very likely that once you have carried out a few residential projects and made a success of them, you will be drawn to the commercial side. In some respects, the commercial side of property is just like the residential one, and in other ways it can be very different. Knowledge (at least a basic understanding) of Business Rates is important if you intend to choose the commercial route. This is because when allowing for rent voids (periods when the property has no paying tenant) unless the property is below a certain value, you will need to cover them (if a tenant is in occupation, they should cover the payment of Business Rates for the property). This can prove to be a substantial change to the financial side of your plan.

A commercial building is valued using the following procedure:

The building will be measured up, and a usable area will be determined. These measurements and the area will stay on record on a very large database held by the VOA (records are viewable on-line). If these areas have changed in any way since assessment, it is up to the occupant to notify the VOA as they might receive a business rates reduction.

The property area will have a particular rate applied to it (in Sq Metres) this area will be multiplied by an appropriate value to produce a value for the building (so for example if an office property has an area of 200 Sq Metres, and a rate of £40 per Sq Metre is applied, then the value will be £8,000 (£40 x 200). If the property has rooms and areas that are incidental to the main area, those smaller areas will be assessed on a different rate.

The VOA re-assesses each property every 5 years. This means that although it doesn’t have to be re-measured, a new rate per Sq M is used to establish a value. This value is known as the Rateable Value. This means that the VOA believes a certain property is worth a certain amount, on a certain date. It does not have to reflect a current market rate.

A quick referral to the website of the VOA (link here), will provide you with a multiplier. This is then used to calculate the property business rates that the occupier must pay each year. For example:

Using the methods above, a property rateable value is established to be £20,000. This figure is essentially what the VOA believe would have been an appropriate annual rent in the year the property was last assessed by them.

The current ratings multiplier for 2010/2011 is 41.4. This multiplier changes every fiscal year, so regular checks are important. The multiplier means that for every £1 of property rateable value, the occupant must pay 41.4 pence to the Local Authority for Business Rates.

So, if a property has a rateable value of £20,000, the Business Rates will come to £8,280 ((20,000 ÷100) x 41.4) per year.

A Small Business Rate relief scheme is in place, which allows qualifying companies to use a slightly lower multiplier figure. For 2010/2011, it is 40.7. Obviously this doesn’t make a huge difference, but for qualification of the status of ‘Small Business’, the company must occupy premises with a rateable value of less than £6,000, in which case it will receive a 50% discount from Business Rates (note that a full relief from business rates has been temporarily introduced until Sept 2011 if premises have a rateable value of less than £6,000). Tapered relief is the applied if properties have rateable values of between £6,001 and £12,000.

Please note that the above paragraph is also liable to change on a fairly frequent basis, so check regularly with local authorities and the VOA.

There is currently certain business rate relief for empty properties:

Shops and office properties are exempt from paying business rates for the first 3 months of being empty. After this period, full rates are payable.

Industrial properties are exempt for the first 6 months of being vacant. After this (in common with the above) full rates will apply.

Some properties are exempt from business rates for the full duration of their vacancy:

Properties with a rateable value of less than £18,000

Empty properties of companies that are in liquidation or administration.

Listed buildings

To find the details of a particular property on the website of the VOA, follow this link. To find a property, you can search by postcode. You are likely to be presented with a list of properties, which are listed by property number or name. Some patience is likely to be needed for this, as some properties are listed under postcodes and addresses that you might not expect them to be. Quite detailed results will be available (around 90% of all commercial properties are available on the database) and it is usually possible to obtain area calculations of included properties too.

A list of publications is available on the VOA website (link here) for properties that seem to be neither fully residential nor commercial, such as stables or guest houses.

Mar 27th, 2011

Increasing the Value of a Property

To be a successful property developer and/or investor, you must learn to see your business or property through other people’s eyes. That is to say that if you intend to have a tenant occupy the property for example, you must think about how a prospective tenant will see your property when they view it. It is far too easy to make the assumption that your property (the ‘product’ of your business) is the perfect one for them because they have identical taste to you. Likewise, if a prospective purchaser arrives to view the property they are unlikely to be particularly impressed by a hot-tub installation or a state of the art media system as in almost all cases, a new property owner enjoys the process of changing the property to suit his or her own taste.

Have you ever noticed how builders change properties when they purchase them? This is yet another ‘pair of eyes’ that you should learn to view a property through. Builders know better than almost anyone how to add value to a property and fully maximise all features and benefits. This is one of the very reasons why they are probably about the most successful group of people at developing property. The other reason they are so successful is because they know how to carry out the development in the most cost-effective way possible. All materials and labour will be sourced shrewdly. Extensions, loft conversions and conservatories will be added to the property wherever possible. Rooms will be knocked through to make open-plan areas, en-suites and downstairs loos will be added and cellars (where present) will be used, all for the purpose of fully increasing the value of the property. They are very successful at it too. Be aware though, that in the majority of cases, planning permission must be sought to ensure legal compliance.

The way in which the extensions and loft conversions etc increase the property value is simply by increasing the internal property area. That’s it; the most certain way of increasing the value of a property is to increase the internal dimensions. There are some other ways to increase the value but they are not as reliable as ‘square footage’. They will be discussed later.

Property valuation is described by property professionals as ‘an art, not a science’. This means that there are no difficult calculations to carry out and no secret information that only estate agents are privy to. The majority of property valuations are based upon ‘comparables’. Comparables (in the context of property valuation) are similar transactions completed recently, that provide a guide to the likely sale price of a particular property. So to use a very basic example, if a 2 bedroom flat sold 3 months ago for £220,000; and another 2 bedroom flat sold 4 months before that for £215,000, then it would be fair to say that any similar 2 bedroom flat is likely to sell for a similar amount now. This is the technique that estate agents and valuers use, and it’s also the technique that anyone who knows the property market in a particular area uses. It really does not take long to get the feel for an area and whether properties are over or underpriced.

Property features such as garages, swimming pools, a quality kitchen and bathroom will also add value. However, there is a danger that you might not recover the initial cost of these things in the eventual sale price of the house. A double garage can cost around £10,000 to have built, but it is not guaranteed that it will make £10,000 worth of difference in the value.

So what happens if you have a property that cannot be extended or substantially altered such as a terraced house or a flat? There are still many ways that the value can be increased, it’s just a little trickier. This is because it depends so much on the property itself and the prospective owner or tenant you are hoping to ‘sell’ to. If the property is Grade II listed for example, period features must be kept and probably even emphasised. A high quality finish to the kitchen and bathroom is probably the most reliable way of adding value in this case. Materials such as slate and oak are instantly noticeable and will give that impression of quality.

In more modern and unlisted properties, the alteration of various internal walls to allow more natural light into the property will help a great deal as this will give the impression of extra space. This can also be done by adding velux type windows where possible or a ‘Sky Tunnel’. In these types of properties, it’s easier to alter things to maximise the feeling of space because you aren’t limited by the traditional layout and features of listed properties.

The modern practice of adding en-suite bathrooms wherever possible should be discussed here. A master bedroom (in a property with multiple bedrooms) with an en-suite is a clever move. If the property has more than 3 bedrooms, an en-suite to the 1^st and 2^nd bedrooms is a good move too. However, an en-suite to every single bedroom is too much. Once the bedrooms begin to get smaller, en-suites simply rob the room of valuable space. If you are hoping to sell or let the property to a family with young children, an en-suite will be useless in a baby or infant’s room. A single bedroomed property is not really suitable for an en-suite either. One bathroom/toilet is plenty.

Jan 25th, 2011

1 2 Next »