Property - Profit from property?

Premises are key to business, even in today's technology-driven market where deals are increasingly done over the phone or online. Whether to impress clients or attract and motivate the best staff members, where you operate is crucial to success.

More than 80% of businesses lease their properties. This is the most flexible approach with the lowest initial investment, but there is a potential loss of autonomy when it comes to refurbishing or expanding a business property owned by a third party and, over the long term, buying can prove more financially rewarding. Building from scratch is an alternative that enables a business to provide its staff and clients with a custom-designed working space, though at a cost.

In an environment that has to cope with regulatory costs in addition to the creep of competition from online aggregators, the question of whether or not you can afford to invest in 'bells and whistles' premises is highly pertinent. Throw in the problems currently facing commercial property and the decision to buy becomes a hard one. With property prices already on the slide, now could be a good time for opportunists to either pick up a bargain or find a quick route into negative equity.

Business or corporate banking advisers will play an integral part in providing advice on premises that are based on your overall plans for the company. Jonathan Bush, insurance director at Barclays Commercial Bank, says: "Each business strategy will drive the right outcome for that particular business." In addition, commercial estate agents, solicitors, accountants and surveyors can all help work out the pros and cons.

Premises management is an essential part of operations; having the right place in the right location can have a direct effect on your business' future success.

There are obvious advantages to leasing; for example, less capital is tied up and the money saved can be reinvested into your business. Bush adds that leasing offers "tax efficiencies that can help improve your profit and loss position".

Adaptable

Leasing can be more flexible than buying, depending on the particular contract and length of lease. Terms are usually between three and 25 years and it is important to ensure break clauses are included on long leases that could otherwise prove inescapable. Most agreements include rental reviews every five years with either fixed increases or indexed movements that see rent levels move in line with inflation. An agreement should always be tailored to the specific needs of your business.

In addition to rent, other costs include stamp duty maintenance costs, utility bills, insurance and service charges, the latter of which varies hugely and can be extremely expensive. It is best to find out precisely what it covers and question the charge if it seems unreasonable.

Maintenance is an area of leasing that often causes disputes and it is important to be clear about who is responsible for what. Every lease is different and the responsibilities depend on your agreement but, as a rule of thumb, tenants are accountable for internal repairs and health and safety, including:

- Ventilation and lighting

- Temperature

- Sanitation and drinking water

- Maintaining equipment

- Keeping the building clean and free of waste

- Carrying out risk assessments

Landlords can be responsible for external repairs and shared areas like:

- Stairwells

- Toilet facilities

- Lifts

- Entrances

Shared responsibilities often include:

- Gas, fire and electrical safety, as decided by the lease

- Security and crime prevention

Small businesses or start-ups may want to commit to a short-term lease only. Anything under three years is usually referred to as licensing, which requires little money upfront and can have notice periods of as little as a month, although there is no right to renew a license at the end of a term.

Another option to consider is a serviced office, in which desk space is rented along with telecoms and IT infrastructure and reception services. Some serviced offices provide refreshment areas, meeting rooms, and message handling facilities. John Spencer, chief executive of serviced office provider MWB Business Exchange, comments: "More companies are using serviced office space as an integral part of their property strategies because they can flex in and out of the space according to the needs of their businesses. Unlike long-term leases, serviced offices are not a liability on a firm's balance sheet and this allows them to make and implement strategic decisions quickly."

"There are also significant cost advantages," he adds. "Leasing requires huge initial capital expenditure on furniture, an IT and telecoms infrastructure and legal fees. All of these elements can delay a company's ability to do business. With serviced offices you can move in on the same day you expressed your interest."

Whether leasing, licensing or renting, the three approaches share certain benefits. They avoid the problems of negative equity, capital gains tax liability and interest rate rises and also bear less responsibility for the building, leaving more free cash to invest into your business.

According to HSBC, 70% of managers of SMEs that do not own their business premises feel that owning them would help them to grow. Buying clearly offers advantages to those with enough capital for a deposit.

Mortgage payments can work out less than rental payments and the business owns the property at the end of the term, which then allows for sale, rental or continued operations to take place in it. Colin Bell, managing director at mortgage lender InterBay Commercial, says: "Many people view the cost of leasing as 'dead money' that isn't working for them in the long term. The only way to hold the asset is to own it. In recent years owning a commercial property has given considerable returns in terms of asset value."

Bradley Baker, partner at property consultancy Knight Frank, agrees: "Buying can be a very good investment. You have freedom to alter the building and no exposure to varying rental levels."

A property can be used for any purpose and if alterations to the building are required then there is more freedom available than a renting tenant would enjoy. However, it is still vital to look at planning permission, buildings regulations, health and safety, waste management, changes to energy efficiency and utility costs.

Adaptability

Buying premises offers flexibility over repairs and maintenance, as there is no necessity to have to pay a service charge and furthermore there is no tie to a long-term lease. With flexibility, however, comes responsibility: an owner is fully accountable for health and safety and for any alterations or repair work internally and externally such as making the building accessible for disabled staff and visitors, all of which could cost time and money.

When buying, consideration must be given to the all-round suitability of the premises for your business. Think about space, facilities, staff comfort, the impression it will give clients and the cost. Location is key and so thought must be given to whether or not it suits the needs of the business and its staff, suppliers and clients. Take professional advice from a chartered surveyor about the property.

In order to raise the money for purchasing premises it is likely that external funding will be required. The first stop in attaining this should be a commercial or business banking manager that will assess your firm's financial position and recommend a good option for your needs. The chances are that it will be a commercial mortgage but, as there are now a handful of standalone commercial mortgage lenders in the UK, it could be worth shopping around.

Average commercial mortgages run at around 70% to 75% loan-to-value, meaning that you will be expected to put down 25% as a deposit. Some lenders allow down payments of as little as 15%, provided that your credit record is clean, though this will tie up money that could be used to better effect in your business.

Costs in addition to a mortgage include buying fees, VAT, stamp duty, searches, business rates, local authority charges such as waste collection and parking, insurance, repairs and maintenance and running costs like cleaning, heating and lighting. Remember, though, that buying can leave a business open to the possibility of negative equity or possession if repayments are missed.

Buying offers businesses clear long-term advantages, according to Bush: "The core benefits are the inherent security in property ownership, control over your overheads and on your lease terms. Property can be good for investment, although it's important to consider the investment timeline and other key factors in the commercial property market."

While this market has boomed over the last few years a slowdown is now taking place. Prices dropped by 4% in December and 2% in January, according to the IPD Index, and 4.3% in 2007 according to real estate adviser CBRE.

Confidence in commercial property is dwindling to the extent that some of the country's largest property investment fund providers, including Scottish Widows, Friends Provident and Scottish Equitable, have had to impose restrictions on customers that want to get their money out. This is in response to the hundreds of millions of pounds that have been withdrawn over the last six months (£235m in November, according to the Investment Management Association), leaving the life companies with a liquidity crisis. Delays of six to 12 months have been introduced to investors requesting withdrawals to allow the funds time to increase their cash holdings without having to accept below market value for their assets in forced sales.

The problems began as early as last summer. The Royal Institution of Chartered Surveyors noted in its third quarterly survey of 2007 that the credit crunch had already begun to have an impact on business. Investor demand for commercial property declined as did capital values, which fell fastest in the 'previously rampant' office sector.

Property consultancy Kings Sturge predicts that commercial prices could continue dropping until the middle of 2008. According to partner and head of research Angus McIntosh: "There is a 50:50 chance that capital values will drop by 20% from their high point in mid-2007 to mid-2008, although the faster they fall the quicker the market will return back to normal."

Market eye

So, is a falling market a bad time to buy, or a good time to pick up a bargain? The divergent types of business property will perform differently and the region that a business is based in will also have an effect.

Bush says: "Property values or rents are dipping in some areas, however, in the right locations they are likely to be more robust in the long term. For example, London is continuing to hold well in terms of rents and valuations."

The size of a business and its premises can also have a pronounced impact. According to Bell, smaller commercial properties will fare better over the year: "The types of properties owned by SMEs behave differently from large commercials. Small commercial property is more muted in times of volatility. Although we will see a slight softening in prices, we expect values for this property type to grow again in the longer term."

The key to investing in commercial property is to take a long-term approach - it could be that a faltering market is the best time to get a good deal. Australian property company Valad has just launched a £500m opportunity fund to buy into the distressed UK property market, the plan being to take advantage of troubled sellers with liquidity issues. If it suits your business strategy and purse strings then the time could be right to invest in commercial property.

What is certain is that premises, leased or owned, are key to a successful business whether by being in the right location, presenting the right image to clients or by providing a better working environment for your staff. As Simon Clayton, development director at LFC Insurance Group, surmises: "Your premises should say something about your priorities and culture as a business."

TIME FOR A CHANGE?

Offices reveal a great deal about a business, whether or not it is client-facing. Staff members are more motivated if they work in well-located and comfortable offices. John Spencer, chief executive at MWB Business Exchange, says: "Even businesses that don't entertain visitors face-to-face need to think about first impressions; how the telephone is answered or whether the postal address presents the right image."

If you do meet with clients in your office then it is even more important to give the right impression. "The more professional the office then the more confident those individuals will be in the ability, competence and professionalism of the broker," claims Jonathan Bush, insurance director at Barclays Commercial Bank.

If you need to make changes or improvements to a property then check the provisions of any available planning permissions first. Permission is not required for minor alterations inside and some changes to the outside of a building, however it is needed if you want to add to, convert or change the external nature of the premises.

If leasing, permission may also be required from the landlord and tenants may be required to undo any alterations when they move out, reinstating the building to its original condition. Bush advises: "If you don't, you may need to pay dilapidation to the landlord. Seek agreement with your landlord before undertaking any work." Also bear in mind that the ultimate benefit of any refurbishment will lie with the landlord or long leaseholder of the property.

When considering costs, look at how long a refurbishment will take and how long it may require you to be out of the building; this is essential in assessing how this will affect the business. In terms of funding, commercial banking providers will be able to suggest a number of options such as asset finance or remortgaging. Bush adds that "there may be tax advantages by utilising write-downs for refurbishments".

CASE STUDY - LEASING

Name: Clive Galbraith, director Company: Green Campbell Fisk Based: Hastings, Bexhill, Crowborough, Eastbourne Sectors: Commercial and personal. Also has a separate IFA office Number of staff: 60+ Turnover: Around £17m GWP with commissions of £3m Established: 1973 Premises: All the premises are leased, the Hastings branch from one of the original partners. Bexhill, Bexhill Life Office, Eastbourne, and Crowborough are all leased from the proprietors of the brokerages purchased.

Galbraith comments: "Having acquired brokerages, leasing from the former owners gives them some extra income and there is minimal disruption to clients. We have bought 14 companies and they have tended to be in areas where we have an office close by. On a couple of occasions we have relocated our office to the one being purchased.

Buying would be a favoured option but I am not unhappy at the amounts we pay for leasing. There is the usual 'conflict' between dead money and investment but we are happy with the current situation.

We no longer view ourselves as high street brokers; the amount of business that walks through the door is very small compared to a decade ago. The business is split between client visits, post, phone and email. Local service remains of great value but we would happily relocate to a business park, however, they are not abundant in our areas."

CASE STUDY - BUILDING FROM SCRATCH

Name: Simon Clayton, development director

Company: LFC Insurance Group

Based: Eastbourne, South Woodham Ferrers, Westcliff

Sectors: All classes of commercial business

Number of staff: Over 80

Turnover: £29m GWP estimated for 2008

Established: 1988

Premises: One brand new and purpose-built business park out of town office in Eastbourne (Sussex) and two older office buildings in South Woodham Ferrers and Westcliff (Essex). The firm is also building an office in Latchingdon on a two-and-a-half acre site.

Clayton says: "We needed to build the new premises because the existing HQ office had no more room and this was restricting our activities. We also wanted to merge our two Essex operations into one site.

We couldn't find anywhere locally that was big enough for our needs but the opportunity to acquire land came up: building seemed to be the ideal solution.

The final costs are still being assessed but it will work out beneficial in the long run. It is not seen as a financial investment but as a necessary investment in our business and people to allow us to reach ambitious growth targets.

The new premises will provide more space in which to house our latest and any future acquisitions. Although nearly all our client contact is done at their premises, it is good practice to provide professional staff with good facilities and the space to work effectively. A good place to work gives a sense of being valued to our people. We want to be more efficient and it is good to centralise teams."