Out of tune with the times
As we enter the 21st century, the outlook for the UK economy and UK commercial property market is favourable. Consensus forecasts anticipate steady and sustainable economic growth with inflation being kept in check by careful manipulation of interest rates. With house price rises and unemployment at a 20-year low, consumers are feeling confident. Tight planning policies in areas of high demand have kept speculative development in check so that the boom-bust cycle of past decades should be avoided.
Investors are, once again, looking at property in the UK as a good source of value and performance. They are attracted by the relatively high income yield (compared to equities) and the security provided by the traditional ‘institutional’ lease with its upward-only rent review provision. Over time this faith in the ‘institutional’ lease may prove to be misplaced.
Reduced restrictions in cross-border trade investment and labour movement, the removal of exchange control and the launch of a single currency, coupled with the rapid growth of the internet means that businesses must now survive in a much more competitive and price transparent environment. Consumer choice and power are here to stay and businesses must respond to the challenges and opportunities that this presents.
With international barriers to entry falling and the rise and dominance of global brands, domestic economies and property markets are increasingly exposed to international influences. Highly localised property markets like the City and West End of London must compete with international centres of excellence, where the 25-year ‘institutional’ lease does not exist. Many major European and US corporates are used to leases of no longer than 10 years duration, with regular break clauses. They will not accept more onerous lease terms. To ignore such occupiers for this reason is a flawed investment strategy.
Changes in working practices and technological evolution have increased the pace of change. Time to market is a critical determinant of commercial success; obsolescence of product and process is an ever present threat. In many of the high growth sectors like technology and telecommunications, product life is measured in months rather than years. What relevance has a 25-year lease to businesses competing in this sector? In a dynamic business environment, the ‘institutional’ lease is out of tune with the times.
Change is as inevitable as it is essential but this does not undermine the investment case for property, rather it presents an opportunity for the innovative investor to participate in the growth and performance potential of the UK economy and its dynamic and growing businesses.
Businesses still need property (even internet companies) to serve their customers. Property owners need to change their culture and focus upon the needs of their customer, the business tenant. To achieve success, investors should understand what drives the success of their occupiers and, through the management of their property portfolio, meet their customers’ needs.
Flexible leasing, not necessarily short leases, are what occupiers want. A lease contract of three to 12 months is appropriate for product development or support services whilst 15–25 years may be most appropriate for HQ operations and key trading locations. Occupiers will pay significantly enhanced rental levels for properties which offer the flexibility that their business needs.
In a competitive environment, businesses need to concentrate on their core activities and not divert effort and attention to property management and maintenance. The building owner has a long-term equity interest in the value and growth in value of his building together with the expertise to manage it. Owners who make the necessary commitment to meet occupiers’ needs benefit from superior performance. Flexible leasing generates enhanced rental returns, reduced voids and fewer marketing costs.
In periods of economic downturn, economic activity does not cease but businesses are less willing to enter into long-term commitments such as 25 year leases. Good quality, well-managed property offered on flexible leases with good service provision continues to attract occupiers albeit at reduced rental levels.
The opportunity exists for UK property owners to take note of what is best in European and international leasing and property management practice and adapt to create a truly competitive property product in the UK.
Paul Taylor is a director of the property division of Mercury Asset Management in London