18th March 2014

Commercial Property Investment questions

What type of property should I invest in? What are the biggest commercial property investment challenges? How safe is commercial property investment? James Craven, the managing director of syndicated property investment company Rougemont Estates, answers the key questions for people looking to invest in commercial property.

What’s the biggest challenge to finding the right properties for investment?

The big issue at the minute is a lack of available investment stock to buy. The occupier market is picking up and demand is growing, but there is a significant lack of new quality space being developed.

Those who are unable to move are just renegotiating preferable lease terms with their existing landlords and seeking to reduce their overheads. This means there are very few new long term leased investment properties being created and made available outside of the supermarket or hotel sector.

There is a two tier market, long term secure income which is in demand and benefitting from premium prices and then there is the secondary short term leased market where banks will not fund purchases and landlords can’t find occupiers.

This secondary market is consequently being heavily penalised by the marketplace due to the risk involved. Transversely prices remain competitive for secure long terms income due to the flight to security.

What particular types of property are most attractive for investors and why?

Properties that are located in strong city locations, with leases to financially strong tenants, in excess of 15 years with rent reviews every five years that are linked to the Retail Price Index (or CBI) are the ingredients everyone is after.

These are attractive due to their risk-free nature, plus growth is obtained by the rents increasing in line with inflation (RPI & CBI).

We also consider assets that are in prime locations but are being undervalued purely due to the lease length remaining. For example, even nine year unexpired leases are being devalued as opposed to 12 years which is deemed acceptable.

Therefore, if we can target undervalued assets in prime locations with in excess of 8 years of income remaining, the location, rental level and nature of the property should underpin the prospects for a good long-term investment.

How safe is commercial property as an investment?

For many investors who purchased assets between 2005 and 2008, the bubble will have burst on them largely because they will have borrowed from the banks to acquire assets and the banks all wanted their money back.

On the other hand, we typically only acquire with cash funds and so, although the capital value of the property may have been affected as a result of the deflation of values, our investors’ income stream remains unchanged provided the tenant has remained in business.

Consequently, our investors were not forced to sell their properties at the worst possible time.

What happens if there is a further downturn in the commercial property sector?

It is unlikely we will see another commercial property downturn in the near future because there is very little available space at the minute. When we entered the last downturn we had a surplus of supply and that had a heavy impact on the sector.

However, that space has now pretty much gone and we are faced with a severe shortage. With occupier demand rising and limited development happening, we will see strong rental growth as developers slowly work to provide the space these businesses need.

There were also some harsh lessons learned from the last downturn where a lot of people were left sitting on empty stock with draconian rates to pay. No-one will be keen to see a repeat of that and I don’t expect to see any speculative development for some time yet.

Syndicated property is not affected in the same way during a downturn. Because syndicates are typically purchased with cash funds and sensible levels of borrowing, there are no third party pressures from a lender seeking to sell the property at the worst possible time. It is therefore a matter of time for the syndicate to hold the investment, continue to enjoy the income stream from the tenants rent and wait until values improve before then looking to sell.