How to Play the Commercial Finance Market ‘Game’ in the UK’s Window of Opportunity
This article was first published in Property Investor News, July 2024
I’m delighted to have written this month’s article with Kallem Brooks from Bond Finance. Kallem is a specialist commercial finance broker who has been involved in this market for 10 years and works with my clients and myself on commercial deals.
In the commercial market in the UK, there’s currently a dichotomous tension between the state of the commercial investment market and the commercial lending market. We are in a down-cycle in the commercial property market – prices are substantially down, and many vendors are motivated to sell. It’s a fantastic Window of Opportunity in the market if you are a purchaser, but many owners of commercial property may have very expensive debt and be suffering from down valuations. Lending is expensive and loan to value ratios have reduced as commercial lenders have become more cautious in this part of the cycle.
However, this unique market presents a huge opportunity for savvy investors who understand the art of finance structuring and are prepared to adapt to lenders’ policy requirements.
1. Recognising the Opportunity
The commercial and semi-commercial property market is ripe with potential. Key to capitalising on this opportunity is grasping the nuances of financing structures and anticipating future lending policies. Investors need to be strategic, considering scenarios where assets might need to be financed and refinanced multiple times, either with the same lender or different ones. This is particularly relevant at present for properties such as commercial units with 1-4 tenants facing lease expiries, sites where owners are experiencing high stress due to current rates, or large sites with little demand from buyers.
2. Vacant Possession vs Market Value
Until recently, lenders would have been happy to finance commercial property based on ‘market value’ (MV). Market value is what a valuer thinks a property can be sold for in 12 months and with the benefit of the current tenant. This often reflects reality!
Vacant possession value is the value of a property assuming there is no tenant in place – it’s the inherent bricks and mortar value. In the current market, even if a commercial property is currently occupied by a commercial tenant, unless there is a lease over 5 years and the property is occupied by a brand, banks will often instruct their valuers to value on vacant possession value. Why? Because they recognize that we are in a down cycle, and they are trying to mitigate their risk.
However, there are ways to play the ‘game’ to increase the vacant possession value – such as by proving that the property could be let very quickly (ideally with letting evidence from the subject property, or from close comparables); hence making the vacant possession value and the market value not too dissimilar.
3. What Lenders Love at the Moment
Lenders are showing a strong preference for specific types of assets:
– Light Industrial: These are particularly favoured by lenders, given their robust performance and lower risk profile.
– Multi-Unit Offices and multi-let Industrial
– Assets with over 10 individual units, including business parks, are highly attractive due to their low default rates.
– Semi-Commercial Properties: These are also in demand, with notable consistency from at least one lender who offers ‘market value’ consistently.
As regular readers of this page will know, I highly recommend that all commercial investors niche their strategies. The commercial sector is vast and if you don’t niche you can have a tendency to scattergun invest, which can lead to mistakes and lower returns. If you can niche your investing strategies based on what finance you can achieve it can also be a highly profitable investing strategy.
4. Strategic Moves in a Down Market
Another lucrative strategy in the current market, involves purchasing commercial properties, increasing the number of tenants, and then refinancing. Here’s why this works:
Stage 1 – Purchase at Current Vacant Possession Value. Acquiring properties at their current vacant value allows investors to leverage potential future value increases. This will usually entail finding properties in the market where there are motivated sellers.
Stage 2 – Increase Tenant Numbers: By boosting the number of tenants, investors can shorten the average void period and enhance demand. An example of this could be to subdivide space and create more tenant demises. This increase in the number of tenants reduces the asset’s risk profile, as the rental risk is spread across more tenants. This in turn will increase the vacant possession value as a valuer will see there is more demand for the property and is likely to increase the value as a result.
An example of this is a recent refinance that Kallem managed, where the investor purchased a rundown unit that was part office / part industrial. The purchase price was £950,000 and the cost to refurbish the property and subdivide it further was £80,000 (commercial property is often much cheaper to subdivide than residential).
The investor increased the number of tenants in the property, which lenders liked as it spread the risk. As a result, the market value (MV) jumped to £1.5m and the vacant possession value (VP) increased to £1.25m. This strategy ticked several boxes for the bank – it was a multi-let industrial bought on vacant possession value and the investor increased the number of tenants, hence spreading the rental risk more widely.
5. Capitalising on Planning and Permitted Development Rights
The changes in Permitted Development Rights (PDR) have obviously made converting commercial to residential an attractive opportunity. With a substantial amount of vacant commercial space across the UK, this is a prime area for investment. Lenders are increasingly accommodating, offering products that allow investors to navigate the planning process with greater flexibility.
6. Lending Snapshot
Here’s a quick overview of the current lending landscape (current as of 5th July 2024):
Commercial Loans:
– Minimum Loans: £150,000
– Up to 75% of Vacant Possession value (VP)
– Rates: Debt under £300,000 starts from 7.8%; over £300,000 starts from 7.5%
Semi-Commercial Loans:
– Minimum Loans: £100,000
– 90% of lenders offer up to 75% of VP
– Consistent lender at market value
– Rates: Starting from 7.10%
Conclusions:
Navigating the commercial finance market in the UK requires a keen understanding of both current opportunities and the evolving landscape of lending policies. By focusing on properties that lenders are willing to fund, investors can position themselves to capitalise on the unique window of opportunity available today.
In my experience, using a great commercial broker to navigate this market for you pays dividends!
Suzi Carter is a chartered surveyor and commercial property expert who offers training to SME investors, based on her 30 years of experience of investing in this sector. https://www.commercialpropertyacademy.co.uk/talk-to-suzi
Kallem Brooks is a commercial property broker with over 10 years of experience in the commercial finance market. Kallem can be contacted on kb@bondfinanceltd.co.uk.
