Castlefield Chambers, Stone Street, Manchester – offered for sale with full vacant possession at an asking price of £2 million (£288 per sq.ft.).
Increasingly, business owners are asking us whether it would be better for them to buy rather than rent. So what is the answer?
Historically low interest rates are leading many business owners to consider buying their own commercial property. But does owning really make financial as well as business sense?
After years of negative or near zero rental growth, inflation is now a feature of most commercial property sectors. This means that providing you have sufficient equity to invest it is likely to be cheaper to buy a property than to rent it over a period of say 10 years. Put simply, you could swap your monthly rent for a similar fixed rate mortgage repayment. Eventually once you have paid down the mortgage debt you will be left with an unencumbered asset that should have appreciated in value. Buying therefore seems a far more sensible proposition than renting. Or is it?
Owning a commercial property involves additional financial responsibilities compared to renting. It also comes with some significant operational constraints. But are these enough to deter you?
The biggest financial responsibility relates to the maintenance and repair of the physical structure of the property. Whereas tenants usually have limits to their repairing obligations set out in their lease, owners have none. This burden is particularly relevant to office buildings where technical obsolescence can make long term ownership extremely costly. For example, replacing lifts and air conditioning equipment can be very expensive. Similarly, the cost of refurbishing toilets and common areas can also be considerable.
These periodic injections of capital are often overlooked by owner occupiers when they undertake their first purchase. This can result in unrealistic expectations of capital appreciation when the property is eventually being sold. For example, it can come as a shock to vendors just how much money needs to be spent on refurbishment in order to achieve the value they think their property is worth.
As well as the additional financial costs, owning your own property brings with it certain operational constraints due to its relative illiquidity as an asset. For example, disposing of a vacant Freehold is usually a lot more challenging than handing the keys back to a landlord at the end of a lease. Depending on market conditions at the time, it could take you years to sell or let your Freehold premises. Compare this to having a break clause that allows your business to terminate its leasehold occupation at pre-defined points in time irrespective of local market conditions. Owning your premises can therefore make relocation a lot less flexible. There is also the cost of effecting the sale to take into consideration. In comparison, leasing is a lot more straight forward. So, if there is a possibility that your business might need to relocate within the next 5 or 10 years, owning your own premises might not be the most sensible option.
Let us assume that having considered the above you are still keen to buy rather than rent. The next challenge is finding a suitable property. For most prospective buyers this is the greatest challenge of all.
In Hong Kong there are thousands of individual office suites that are owned and regularly traded on a strata title basis. This has resulted in far greater liquidity for owner occupiers than in the UK where the vast majority of office buildings are owned by a single property investor and let out on a leasehold basis.
Even if you manage to find a suitable property the price might be too high in the current market particularly if it is in a sought after location such as Manchester City Centre. This is due to fierce competition from both owner occupiers and investors. The latter are finding it increasingly hard to acquire income producing properties at a reasonable yield. Investors are therefore being forced to consider vacant properties that would have previously appealed almost exclusively to owner occupiers.
If you are lucky enough to find a suitable property where should you pitch your offer? Much will depend on how you fund the purchase. If it is with pure cash then the sky is the limit, in theory. What is prudent becomes a personal decision. From an advisory perspective we would analyse comparable transactions in the area and arrive at a sensible view based on the property’s individual characteristics relative to its peers.
To give you a general feel, suburban offices in Greater Manchester are currently changing hands for between £150-£300 per sq.ft., depending on age, specification and location. In the city centre, the figures tend to be double these levels.
If you are looking to purchase through a SIPP or SSAS structure, the price you pay will need to broadly match the property’s current Market Value. The pension administrator (and any supporting funder) would therefore find it difficult to support a purchase price in excess of such a figure. This could make it difficult to compete with buyers that are not subject to the same constraints.
In my view, you should start the whole process by focusing on your motivations for wishing to purchase a property. Is it to create a long-term income stream for retirement? Is it to safeguard the future of the operational business? Is it to generate a short-term capital gain? Or is it something else?
In my experience, business owners that tie their operational business to their retirement income usually end up regretting their decision. The reason is that such an arrangement inevitably creates a tension between the two interests. Ultimately, this can undermine the valuation of one or more likely, both assets. For example, the future buyer or investor in the operational business is likely to view the arrangement as an additional risk factor. They often suspect that the operational business will be held hostage in some way by the former owner at major lease events (e.g.’s rent review, lease renewal). Meanwhile, the value of the property as an investment may be viewed as being riskier as the letting to the operational business was not conducted at arms length. The rent and lease contract cannot therefore have been properly tested in the open market so there will always be an element of doubt as to what the property can achieve if, and when, it falls vacant.
Brookland House, Salford – offered for sale with full vacant possession at £1 million (£120 per sq.ft.)
Far better in my opinion to maintain flexibility for the operational business through leasehold tenure. This will allow the business to realise its full potential without compromises brought about by being tied to an unnecessarily restrictive lease designed to safeguard the pension requirements of the business owner.
In some cases, of course, having an operational business can allow one to underpin a commercial property acquisition. By having a ‘Plan B’ letting strategy involving an operational business you control you can perhaps afford to be more aggressive in your bid. However, the underlying issue of operational flexibility will remain. What is more important, a flexible lease for the business or long-term income security for your pension?
If you select the right property, you might just be able to achieve both. The question you should probably start with then is how long and how much money would it take to re-let the subject property if your business was to vacate it today? Also, how long a lease would you be able to secure and at what rent? And most importantly, how financially secure is that tenant likely to be? Once you have answers to these questions you need to compare and contrast this opportunity to alternative investments. Are the risk reward profiles similar? For example, for the same price and income yield, could you buy a high street retail investment let to a national retail chain for the next 10 years. Which would you consider to be riskier as a long-term investment taking into account property management, technical obsolescence, marketing and re-letting costs?
If you would like advice on your specific circumstances please get in touch.