Property Investment Guide: Part Two

By Jonathan Neale – property and business journalist

While the fundamentals of property investment are the most important aspects of any decision to invest in a building, it is worth considering a few of the general characteristics of each commercial property sector.

Surveyors tend to divide the market into office, industrial and retail/leisure, so we’ll take a look at each of these headings in turn and examine each one’s peculiarities.

Offices

Office investment is the traditional bedrock of investment property, and was, until the emergence of vast shopping centres such as the Metro Centre in Tyneside and Bluewater in Kent, the favourite of the pension funds.

The main reason for this is that many offices were let on what were known as institutional leases. In other words, they were occupied by Government departments or other institutions – the most secure tenants you could possibly have – on very long leases, usually at least 15 or 20 years.

While Government tenants – alongside major corporates – are still seen as being the strongest covenants, lease terms have generally decreased in length and such terms are no longer the norm.

The private sector is increasingly demanding greater flexibility, which attracts higher rents – and the public sector has, generally, followed suit.

Even new offices will rarely attract leases lasting more than a decade, but rents, of course, have increased to compensate for the increased risk.

The other factor that is starting to reduce the level of interest in offices is oversupply, particularly in London and the South East. The IT boom saw massive amounts of space built, much of it in the City, Docklands and the Thames Valley west of London.

A lot of this is now standing empty, allowing tenants to pick and choose – a big issue if the current tenants of a building you are inspecting have a contract break on the horizon.

Rents have dropped somewhat in the South East and it makes sense for tenants to move from their current premises, as they may be paying rates that were valid five years ago. Keeping them may mean cutting a deal that will reduce the return on your investment.

This is a big contrast to the situation in big regional centres such as Manchester or Birmingham, where demand matches, and sometimes exceeds, supply.

The fact that these cities are more secure – immune, perhaps, from the peaks and troughs that have marked the South East market – has led to foreign funds making serious purchases here for the first time ever.

Historic towns such as York, Winchester or Durham have similar situations and offer great prospects for the smaller investor. Tight planning controls have meant that supply, particularly in the centre, is limited.

A lower profile means that rents are lower and yields higher than in larger centres – meaning that entry costs are much lower – while offices are often let to relatively secure professional practices.

‘Period’ offices also tend to have a longer shelf life than new-build, although many have converted to residential use in the past few years as returns there have, until recently, seemed so much more attractive.

If smaller towns or villages are your area of interest, then geography and prediction become more important. It is worth seeing if any new transport links are on the cards, which affect property prices more than any other factor. If the council in question has a relevant local plan, this will also tell you what other developments are planned.

None of this advice, however, can affect one key fact – properties, unlike many other assets, are unique. Each one is different. Sometimes visiting the building, looking at its location and talking to its tenants is the best guide to an actual investment decision.

Industrial

Factories and warehouses are often seen as the poor relation of office premises. The general rules of investment are similar, but their dowdy image has meant that yields are usually slightly higher than their more glamorous cousin.

The much-publicised slump in British manufacturing has not had a devastating effect on this sector, as some might expect. The country consumes more now than ever, even if much of it is imported from abroad, and it has to be stored or assembled somewhere.

This, as well as the fact that the manufacturers who are left generally cannot be elsewhere, means that the income from industrial property has been seen as a ‘safe bet’ by many investors.

It is also much easier to let old industrial units than it is to let older offices, mainly because manufacturers or distributors have smaller margins than most paper-pushers and they will do anything to drive down costs – such as renting antiquated buildings.

Location is the be-all and end-all of industrial investment. Dual carriageways, motorways and easy access to a front door with a heavy truck are all indications of a good, long-term investment.

The other big factor is employment. In the South East, with its low jobless figures, finding staff to work for the low wages tenants in this sector pay can be a problem, and many firms have been forced to relocate because of shortages.

The main barrier to the smaller investor looking to buy property in this sector is the tendency of smaller operators to want to buy their own buildings.

Low interest rates over the past few years have increased this tendency and it could be hard for the potential investor to find something suitable.

Retail and leisure

Owning a shop, pub or restaurant is certainly the most glamorous end of the investment spectrum, but it is also the most risky.

We know from our own experiences that shops can appear and vanish overnight as consumers’ tastes and willingness to spend change.

High Streets are also the most vulnerable to new developments. New shopping centres such as Birmingham’s Bull Ring can reduce the popularity of other parts of the region and drive businesses to the wall.

This applies even more to restaurants and pubs, which tend to fall in and out of favour as a matter of course. Spend here is also the most vulnerable to a recession – people will always need food and clothes, and will adjust their spending on luxuries accordingly.

This level of uncertainty means that, more than ever, landlords crave a reliable covenant. Clearly, the big prizes are the High Street chains, but this stability comes at a price.

Established independent businesses used to be almost as prized, but the rise of the supermarkets has reduced their kudos.

Nevertheless, this rapid rate of change means that this sector is where the shrewd investor can make the highest returns. Rents and yields vary here like in no other area of property, but research is indispensable.

Clearly, the fundamentals still apply – rental income, capital growth and yield. The word retail investors mention a lot is ‘footfall’ – the number of people walking past your premises, and the amount of disposable cash they have in their pockets.

This will be higher in affluent and highly populated areas, but footfall is rather more specific than this. More people pass a smaller unit on a High Street than a larger unit on an adjacent side street, and buying a unit with a dowdy tenant on a busy street and replacing them with a more reputable one is a classic route to riches.

Patterns such as this could change tremendously if a new railway station, bus route or car park opens in the centre in question. It will change even more if a brand new shopping centre opens in the vicinity.

A thorough examination of the council’s plans, together with a browse through the press, will give you a rough idea of the town’s future. Together with a visit to the site and a little bit of ‘gut feel’, this will tell you whether your potential investment purchase is going to be of long-term worth.