Are repossessions the future?
With home repossessions at an all time high, David Aitken, managing director of Executive Financial Solutions questions whether the situation is reflected in the commercial arena
The record numbers of homes being repossessed seems to be headline news on a practically daily basis in these testing economic times. But should commercial landlords and commercial property investors be alarmed?
All signs point to a bleak outlook for the UK’s £600bn commercial property market. In 2007, one quarter of high street lenders reported a rise in commercial repossessions, compared to the previous year, with warehouses, the industrial sector and retail spaces seen as particularly vulnerable. And with the credit crunch pressing from every angle, repossessions are set to rise throughout 2008.
So, with pessimistic predictions, what’s really driving this trend, and can landlords protect themselves?
Commercial investments can generally be categorised as either ‘semi commercial’, such as residential flats above shops, or ‘true commercial’, including factories and warehouses. Whilst the same principal applies to both when assessing viability, amateur landlords are particularly at risk. People without a portfolio of properties to fall back on run a bigger risk of being unable to service their repayments – and so must be doubly aware of the risks.
Rental void periods, short commercial leases, securing reliable tenants, refurbishment scenarios, access to sound professional advice, and interest rate volatility all play their part in the rise in commercial repossessions.
Despite recent Bank of England interest rate cuts, savings are not being passed on by lenders. Landlords due to refinance are finding it an increasing struggle, with only the strongest prospects easily securing mortgages. If they do manage to re-mortgage, the steady rise in interest rates from over the past year will sharply affect them: each 0.25 percent hike in interest rates means an extra £1,250 annually on a £500,000 interest only mortgage.
Interest only mortgages can lull landlords into a false sense of security, as the investment is then purely based on capital appreciation: however, in the current economic climate – where the capital value of warehouses has decreased by an estimated 34 percent, this is a risky strategy.
In the current economic climate where capital devaluation on property is rife, commercial property is especially vulnerable. True commercial property, such as warehouses, is sensitive to devaluation as they age and require more attention.
Landlords are actually being laid open to risk thanks to a trend for shorter leases on true commercial properties. Landlords generally have to secure two year leases and rental income that’s 100 – 150 percent of the annual mortgage repayments. The lower the cover the more the landlord is at risk.
Long leases offer continuity of income, clear definition of rent required and the timing of rent reviews – plus the landlord can monitor and enforce the tenant’s own maintenance and insuring obligations more easily.
It’s vital that landlords credit and quality check their potential tenants, as it’s too easy to be stung by poor payers once the tenancy agreement is signed and sealed. In these situations, unfortunately, the tenants have stronger rights and the landlord is left to shoulder legal costs associated with non-payment and evicting the tenant.
It’s not unusual for landlords to experience long delays in securing tenants, when issues of the building’s use rear their ugly heads. Naturally, long void rental periods are very landlord’s nightmare – so it’s crucial that landlords don’t simply assume that change of use applications – say from shop to restaurant – will automatically be granted.
To ensure the investment doesn’t fail before the tenants even move in, landlords must be clear on renovations costs and planning consent.
Selecting the wrong professional advice can be devastating to landlords, as not all solicitors firms, mortgage advisors and debt management consultancies are made equal. Smaller firms that don’t specialise in commercial property often quite simply aren’t armed for speedy resolution of contractual issues, or tenants that aren’t paying.
Sound advice and a clear understanding of the risks and rewards involved, can mean the difference between being repossessed and a healthy investment – even in the current, testing economic climate.
