by Tim Bloomfield
The leasehold market for small industrial units in most of South-East England has all but disappeared, replaced by a growth in smaller companies buying their own freehold.
It is an irony that just as the Government’s push towards an enterprise culture — with an emphasis on owner-occupation in the residential market — seems to be running into difficulties, the desire by small companies to own their own industrial buildings has probably never been stronger.
There is absolutely no doubt that demand for the smaller size of unit is now running at a very high level. Most occupiers are private companies, with a significant proportion being relatively young and recently formed firms — again a reflection of the Government’s enterprise culture, coupled with taxation policies.
With bank interest rates running at 16% plus for most companies it would be logical to assume that the freehold industrial market would have been as badly hit as that for freehold “courtyard” offices — or even the residential sector.
There is abundant evidence that this is not the case, however, and the market in single-storey freehold industrial units is thriving, despite current high interest rates.
For historical reasons there had been an almost complete lack of industrial units being purpose-built for small companies until quite recently.
In the late 1970s — with 100% capital allowances available on units of under 2,500 sq ft and 50% on units above that size — the small-unit market was for a time the most popular of any. But this popularity coincided with an industrial recession and inevitably produced a multitude of schemes, often of inferior quality in poor locations. For taxation reasons they were available only on leaseholds.
This combination resulted in a huge oversupply, and it has taken many years for this surplus to be mopped up by occupiers. In the opinion of many people, the small unit had become a disaster and there was an understandable reluctance by institutional developers, and their supporting funds, to consider ever going back into the sector.
Around two years ago, however, it became clear that there was an almost total lack of supply of small units in the South East, and one or two developers with sites not suitable for larger industrial developments turned to the smaller scale.
Yet, because of the problem of identifying a potential institutional investor or establishing a quantifiable yield, the developments were aimed at the owner-occupier. What many had started to suspect for some time became apparent — that there was now an inherent demand for freehold property from small- and medium-sized private companies.
Today, small industrial freeholds have now become so established that when assessing the potential of a proposed new development, it is common practice to calculate projected sales on a straight capital value.
There are several reasons why this market has come of age and why there is every likelihood that in most parts of the South East freeholds will continue to predominate to the almost complete exclusion of leasehold transactions.
- Many private companies like to enjoy the creation of a property asset in their balance sheet. It creates something they can borrow against or perhaps realise in the future, particularly on the retirement of directors or the sale of the business.
- Many small industrialists do not understand the technicalities of property, and over the years they have found it extremely frustrating dealing with freeholders and managing agents who often, from their company’s rather biased point of view, seem to be doing their best to stop the running of the business by imposing cumbersome management procedures.
- Many small businessmen and women resent incurring capital expenditure on somebody else’s property with seemingly little benefit to themselves.
What is true, though, is that the pension funds and insurance companies are unlikely ever to want to invest again substantially in schemes that are exclusively, or mainly, small industrial units.
It is a fact of life that small private companies whose covenant strength is not sufficient, or whose balance sheet is not sound enough, do not measure up to strict institutional criteria. A higher proportion of voids occur within small-unit schemes than within larger schemes where covenant strength is higher.
The management of small-unit schemes is extremely intensive, and the occupiers do not understand the technicalities of lease covenants — with which in some cases, it has to be said, they are not prepared to comply.
Private investors may be prepared to consider this market, but they would normally look for a return well in excess of that required by either an owner-occupier or an institutional investor.
The huge increase in the number and variety of financial sources has also been instrumental in bringing about change. In the past the prospective owner-occupier was largely limited to approaching his or her own bank for mortgage facilities. Today there is a wide range of organisations, both UK-based and overseas, who compete to lend money long-term to commercial owner-occupiers.
Specialist brokers have also emerged, so that potential occupiers are offered as broad a selection of loans as the residential owner-occupier. These specialists have, for example, participated in industrial co-ownership schemes. They will often become involved in the development process from the start of any scheme and ensure that the potential purchaser and occupier is offered the full range of mortgages at the same time as the building.
Included within the finance available are fixed-rate loans, low-start commercial mortgages where all, or part, of the repayment can be rolled up, non-status commercial loans where no company accounts need be seen, unsecured loans at LIBOR plus 1% for professional partnerships, and schemes which allow for repayments from limited companies to be collected net of corporation tax.
The huge growth in the pensions market has also had enormous implications for the commercial freehold market, with many small companies recognising the mutual benefit of setting up a company, or personal pension scheme, which can be used for the purchase of property, so that tax relief is enjoyed on both the interest payments and the capital repayments.
It now seems unlikely that there will ever be a return to an oversupply of small industrial units in the South East. During the past few years there has been a massive loss of industrial land throughout the region: competing uses have included residential, retail and increasingly (since the new Use Classes Order) B1 office and business premises.
All these uses at various times have commanded land values well in excess of industrial values — and unless there is a complete collapse in all those markets, industrial values will never be able to compete successfully.
