2008-9 The Year in Property

The UK economy went into recession in early 2009 following the unprecedented dislocation of the financial markets around the world in Autumn 2008. The initial impact of the credit squeeze on the Property Industry was an increase in capitalisation rates as demand for investment property reduced with the drying up of bank lending. Another immediate impact was the shelving of many development projects.

The downturn in the economy has led to a reduction in demand for accommodation in all property sectors. As a consequence, vacancy rates have increased and rental values have fallen, as landlords compete for occupiers. This has also compounded the reduction in property valuations triggered by the credit squeeze. The pressure on landlords to make sure property does not remain empty has been increased by the extension of business rates for empty units, to cover industrial space, after six months void, and the increase of empty rates from 50% to 100% on office and retail properties after three months. In some cases, this has led business rate payers to demolish properties to avoid the rates burden.

As anticipated last year, occupiers have been looking for, and able to secure, improved flexibility in terms of the availability of shorter lease lengths and more frequent options to break. This has allowed them to secure leases that enable their businesses to respond more quickly to changing business requirements, and to secure better value for money.

Occupiers have also taken steps to reduce their commercial property costs by shedding surplus space where possible, renegotiating leases, seeking to pay rent on monthly terms and, in a few cases, by entering into Company Voluntary Arrangements.

Initiatives launched in 2007/ 8, including the updating of the latest editions of the Lease Code and the Service Charge Code, the formation of the Owner and Occupiers Forum and the Commercial Landlords Accreditation Scheme (CLAS), have each begun to have an impact on the way the property industry operates.

A significant event in the past 12 months has been the initiative championed by a group of leading retailers and property owners to target reductions in service charges of up to 20%. This has led to some significant reductions being achieved and passed on to retailers at centres such as Meadowhall, Sheffield. A set of service charge guidelines has been agreed by the two groups with the aim of setting out a framework for reducing service charges in 2009/10.

Sustainability continues to be an important issue for government and business attention. The introduction of energy performance certificates on all commercial properties sold or let after October 2008 has helped to drive forward energy awareness.

Despite all this activity, the government retains a watching brief on the progress made by the UK commercial property industry to respond positively to the demands of its customers and will be conducting a review of the impact of the Lease Code in 2010.

The Value of Higher Satisfaction

The financial case for higher levels of satisfaction

• Loss of rental income
• Letting costs
• Lower rent from incoming tenant
• Service charge costs and empty rates
• Costs of their own management time to deal with the issue.

1. Business: growth, contraction, restructuring, other business reason
2. Premises: inappropriate location, wrong size, inadequately specified, etc.
3. Service: service levels, service charges, speed of response, degree of support

• Landlords derive extra rent from improved reputation/brand
• Landlords tend to derive higher rent from tenants who renew their leases

The importance of income return

Put another way and using quarterly data, in December 2005 income return only accounted for 20% of the total return. This percentage steadily rose until September 2007, when capital growth turned negative. Since then, income return has been the only positive aspect of the UK property investment market. It is therefore imperative to maximise tenant retention, if at all possible.

What do voids cost now?

The IPD Quarterly Index numbers indicates a further 1% worsening in these rates over the first quarter of 2009 alone. Given the outlook for unemployment, this position is only going to deteriorate further in 2009.

The diagram below shows the distribution of void rates amongst IPD quarterly-measured funds at the end of Quarter 1 2009. The bottom quartile figure for all property was 11.6%. These differences in performance between funds is further evidence of the value of higher retention rates to property investors: void rates explain a high proportion of differences in investment performance.

Lease expiry

Shorter leases and lease breaks

• The proportion of ERV in new leases of less than 10 years rose from 37% in 1999 to 61% in 2007/8.
• The average period to first break has declined from 8.7 to 6.2 years between 1999 and 2007/8.
• The proportion of leases now subject to break has nearly doubled between 2000 and 2007/8 from 12% to 23%.

The position was worsened by the fact that leases are also much more likely to be broken than they were at the turn of the millennium. The incidence of lease breaks rose again in 2007/8, exceeding even the decade high in 2005 with 43% of all break clause value “broken” in the period.

Summary

• In the short-term, income return is all-important.
• Current void rates are high and could rise considerably more, depending on the level of economic activity over the next few years.
• Shorter leases and higher incidences of break clauses mean that occupiers have more opportunity for choice between a “good” and a “bad” landlord.
• Demonstrable levels of service and satisfaction are potentially able to act as a key market differentiator in a difficult market.