Commercial property: unleashing the full potential
Housing associations will inevitably hold some commercial property (which for the purpose of this article is anything that is not residential property and which can generate income).
This may be just a few small rows of shops, right up to an entire office building or industrial estate. It could have been acquired through stock transfers, developed as part of a mixed use development, or acquired during site assembly. Regardless of the type of asset or how it was acquired, there is usually a common issue, namely that the income generated can be enhanced. Commercial property has often been viewed as a non-core activity (or even worse as a distraction) by many housing associations, but in an ever-increasingly competitive environment, is now taken more seriously. It is also playing a bigger role in new developments.
This article looks at ways of doing this ranging from the straight forward, such as implementing rent reviews, to the more complex, like restructuring ownership. We appreciate that housing associations have an additional consideration that other property investors will not, being the need to ensure that appropriate services are available to their residents, and perhaps attracting (or preventing) use of commercial assets for particular purposes (as Guy Willetts explained in our Autumn 2018 edition.) These broader considerations will always need to be balanced alongside maximising income. Finally we look at what housing associations are doing with commercial property in new development.
Identification of existing assets
In the first place, it is a good idea to identify what commercial property is held. This may not be that straight forward, particularly for larger housing associations. Stock may have been acquired on a piecemeal basis with no detailed due diligence. However, a combination of a good commercial agent and working with your lawyers can get through this. Agents can physically inspect property to establish what units exist and who is in occupation. Lawyers can review deeds and undertake Land Registry searches to locate what leases are in place. Your agents should be able to use this data to provide you with a full portfolio and recommendations of returns can be enhanced.
Sweating the asset
An easy win can often be simply ensuring that rent, service charge and other amount due under the lease are all collected from commercial tenants. These can sometimes be overlooked, particularly amounts which are not rent. Over time and across a large portfolio, such oversights can add up to considerable sums.
“In addition, rent reviews may not have been implemented and could entitle you to an uplift in rent if the open market rental for the property has increased.”
It is not uncommon to find tenants staying quiet about paying rents that have not changed for 15 or 20 years.
Some tenants may be prepared to “regear” their lease, which in short means entering into mutually beneficial arrangements with the landlord. This is what commercial property investors term “sweating the asset”. This could be as simple as removing a tenant break right in exchange for a rent holiday, or substantially varying existing terms and granting a lease extension to commit the tenant to the property for a longer period. These arrangements could enhance the reversionary value of the asset and the yield, as well as improve the tenant’s terms.
Vacant units and other space
Unlet units can also be identified, which may well be vacant units within estates that have gone unnoticed. You could be paying rates and other property costs on these when there may well be willing tenants, even if these are ‘meanwhile tenants’ or let as ‘pop up shops’ (or even converted to residential use). There could also be less obvious potential. There may be demand for open spaces year round, for example for sporting events or open air cinema in the summer and Christmas markets in the winter. These uses also benefit residents, and the leases can be structured on a ‘turnover rent’ basis so the more successful they are, the more the housing association will benefit.
You may consider restructuring your ownership of your commercial property. One method of doing this would be to transfer it all to a subsidiary special purpose vehicle. Many of the properties involved are likely to be parts of residential blocks and therefore, a lot of the transfers would be achieved by way of long leases (which can still be done on a cost efficient basis). Standalone commercial premises can be transferred by a simple freehold transfer. The special purpose vehicle could be incorporated as a limited company, not subject to regulatory or charitable restrictions and able to dispose of property freely. Profits made by the company can be gift-aided to a charitable group member. The company could enter into agreements with managing agents and sales/lettings agents to manage the portfolio. These fees will be far more cost effective spread across an entire portfolio. Additionally, the company would be free to raise debt secured on the portfolio for acquisition or development of further commercial property. Ultimately, you would also have the option to sell the company itself to a third party investor, with the added attraction to them that such a sale would avoid the 5% SDLT rate on commercial property and instead only be subject to stamp duty on purchase of company shares of 0.5%.
Taking this idea a step further, the benefits and economies of scale could be significantly enhanced if two or more housing associations pooled their commercial property together. Again, a special purpose vehicle could be incorporated to hold the property, with each registered provider involved holding a share in the company. A joint venture agreement can be prepared setting out the obligations and profit shares of each party depending on the value of stock each has contributed.
Developing new commercial property
Housing associations are becoming more savvy in how commercial property forms part of new residential led developments, both in its specification and the intended tenants.
“Higher quality spec for some commercial units is being built into the development with a view to achieving better tenants and higher rents.”
Ever more flexible spec is also often used in the planning applications and designs, to ensure a wider market of tenants. Flexible user is also being applied for. Instead of simply applying for A1 and D1 use, a planning application will ask for commercial units to allow all class A uses, D1, D2 and B1. Housing associations are also not afraid of new covenants, which other landlords might shun for more established (but less innovative, useful and frankly interesting) tenants. In choosing to let to new covenants, a rent deposit or guarantee can be taken to mitigate the risk involved. There is also the consideration of a good tenant mix. Housing associations can, and are, taking this to new levels, even setting up their own collaborative “WeWork” style offices, giving opportunities outside city cores for new businesses that otherwise might struggle for accommodation and which can contribute to genuinely mixed and sustainable new communities.