How to let Commercial Property
This article was first published in Property Investor News, December 2022
It may seem obvious, but letting a commercial property is one of the primary ways you can add value to your investments. However, it’s not always as straightforward as it may seem. The occupier market is getting tougher as economic conditions worsen, and you will need to understand how to secure the best tenants possible in order to remain competitive.
At this point, it’s worth recapping how letting a commercial property can enhance capital value. Simplistically, you can calculate commercial value by dividing the rent by the yield. It’s therefore a simple equation – every time you add rent (income) to a property, the higher the capital value will become. The yield is the multiplier that you apply to the rental, and even this is affected by the quality of the tenant leasing the property, the lease under which they are occupying, and the rent they are paying.
Valuation is an art and not a science. When a valuer rocks up to your property they will be weighing up all the risks associated with it and will reflect that in the yield – it is no coincidence that the yield is often called the “all risks yield”. Valuers will consider the property’s location, size and configuration as well as the length of the current lease, lease terms, rent, and the tenant covenant. As a result, if a property is vacant, it is often considered as more risky.
Tenant covenant relates to the relative probability that the tenant will be around long enough to continue to pay the rent for the lease term (and beyond) in order to mitigate the chance of a vacancy in the future.
So how can you check the tenant covenants? Well, first off, I would recommend that you ask for the business’ last three years’ accounts and get your accountant to check these out. You can also use credit check agencies such as Dunn and Bradstreet and Experian, amongst others, to do a similar job. Many tenants’ filed accounts can be up to a year out of date so I would recommend that you use all means available to check out the tenants – speak to commercial agents who know them well, Google them and find out what other lease liabilities they have (through Nimbus Maps and similar). For smaller businesses it’s also useful to ask for references.
If you have any doubts at all then checks and balances should be put in place to safeguard your rent. For smaller tenants this could include requesting personal guarantees, guarantors or rent deposits. If you are being fobbed off with a poor covenant from a blue-chip tenant, then parent company guarantees may be the answer (if you are lucky enough to be able to get them!).
The best way to get a great tenant covenant, of course, is to purchase the right property in the right location. It’s a pure supply / demand equation – good tenants will want to occupy great trading locations and will be willing to stay longer and pay a higher rent for the privilege.
There are several strategies that you can employ to let your commercial investments:
1.Let / Relet to an existing tenant
This one is often the most overlooked, but can also be the easiest and quickest way to add value. I always recommend to my mentees that, if they are buying a property that is currently occupied, they have a conversation with the incumbent tenant before they purchase. The obvious benefit of this is that you can build a relationship with the tenant, ascertain how well they are trading and how likely they may be to stay longer term. If there is a short lease term in place, and the tenant wishes to stay longer-term, you may be able to open-up a conversation about restructuring the lease or offering a lease extension.
As a result of opening a conversation around restructuring a lease, tenants may be willing to surrender parts of the property they don’t use for their business – for example, unused retail upper parts that could be surrendered back to you so that you can obtain permitted development (PD) rights, or planning, to convert to a higher value use, such as residential.
If this is achievable you may be able to get a valuation uplift. Indeed, in an ideal world you would carry out this asset management before you purchase in order to achieve a valuation uplift from day one. This strategy could be used as a niched strategy – by actually targeting properties that have short leases in place and negotiating lease extension.
2. Let a vacant property
This is the most obvious letting strategy. Valuers often view vacant properties as risky, as they are not tenanted and don’t have an income stream. If you can let (or, ideally, pre-let) a vacant property then valuers will apply a better yield to facilitate a value uplift. This applies to most types of commercial property, apart from those where the alternative use value is better.
Risks around vacant property will be greater in poor letting markets, such as the one we are currently entering. One thing to be aware of is that currently many commercial finance companies will instruct their valuers to value on a ‘vacant possession’ basis to mitigate risk, so make sure you understand your finance exits well before you buy.
There are various ways you can let a commercial property – other than putting a board on the property and hope for the best. You can contact tenants direct by contacting the property teams of blue-chip tenants. For smaller tenants you can put adverts in the local press, or on local Facebook pages. However, before you purchase, I would recommend you speak to one or more commercial property agents, who know your local market and who can tell you who may be interested in the property and will also give you some indication of the lease length, lease terms and rental you may achieve. They can also market the property on your behalf.
3. Acquire properties to order
Rather than finding a property and then having to let it, a highly leveraged and niched strategy is to understand tenant demand first, build relationships with the end occupiers and acquire a property to ‘order’ that will suit their requirements. Many blue-chip tenants, in all sectors, publish their requirements online, or will have commercial agents who act on their behalf. You can look at websites such as www.therequirementlist.com to obtain an overview of retail demand in an area.
This can be a great strategy as you have the ability to build strong relationships with tenants and ‘follow them around’, although often you may need to acquire regionally or nationwide to satisfy the tenant’s requirements.
4. Reconfiguring Space to fit tenant requirements
One of the benefits of purchasing commercial property is that you often just need to do a ‘paper exercise’ to let, by putting a new lease in place or reconfiguring an old one. However, sometimes you do need to do physical works to accommodate tenant space requirements. This could include dividing up space (and letting it to multiple tenants) or making space bigger (for example, by purchasing a unit next door). This may mean that you may be able to achieve a better covenant, a higher rent, and better lease times.
Finally, there are several top tips when letting commercial property:
1. Ideally, obtain a valuation from an RICS surveyor before you buy a property, in order to assess the impact of your proposed letting on the valuation. If you want to use commercial finance at any point, make sure that you speak to your broker to understand the different basis’ on which you need to get your valuation carried out in order to comply with current or future lender requirements.
2. Use commercial agents to your advantage – choose an agent that understands your property and knows the tenant market well.
3. Try to do your asset management before you purchase – pre let or regear an existing lease. This may mean that you can obtain a valuation uplift from day 1.
4. Check tenant covenants thoroughly. Do credit checks and put in place as many checks and balances as you can to protect yourself against tenant failure in the future.
5. Ideally, let to tenants that are recession and / or ‘Amazon’ proof in the context of changing markets and economic conditions.
6. Form great relationships with tenants. Commercial property should be viewed as a partnership between landlord and tenant. When it’s inevitably time to have those tricky conversations, this could prove invaluable.
