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Diversification takes centre stage

Angela Faherty

January 19, 2008

During the current downturn in the residential market, it makes sense for brokers to think about getting more involved in commercial mortgages, as the need to diversify becomes more pressing.

I would be among the first to encourage this sort of diversification, to take advantage of a market sector that is ripe for expansion.

However, commercial valuations and leases need a little more care than their residential counterparts, so here is some basic information that may help brokers to achieve a better level of understanding.

Science and subjectivity

Commercial property is traded less regularly than residential and the properties vary considerably, so traditional comparable information is harder to obtain and less relevant than it is in the residential sector.

So, the valuation of commercial property tends to be a combination of science and subjectivity – not two obvious bedfellows.

In addition, the price setters in the commercial property marketplace are the investors – believed to be around 70 per cent of the property owners – and therefore valuers need to consider carefully the likely investment return a property might generate – typically between 4-8 per cent.

The higher yields tend to reflect higher risk properties – primarily because of their location and likely level of tenant demand.

Impacting on value

In addition, valuers have to ensure they understand a variety of factors that can have a significant impact on value. These include planning permission, business use and appropriate licenses as potential considerations.

From a broking perspective, a purchase price may exceed the value because the client is happy to take a view on obtaining any missing permissions post-completion – or the client may believe speculative development or change of use may be achieved in the future.

A valuer cannot afford to be so speculative and, with a duty of care to the lender, valuers must ensure they provide a realistic opinion of the value in its current condition.

Leases

With leases, life also tends to be more complicated. In the residential rental sector, leases tend to be standard assured shorthold tenancies with little variation in detail.

Commercial tenant lease terms are longer and tend to be bespoke documents. Certain terms can affect the property value if they restrict the marketability of the property.

It is more common to see commercial property owned on long leasehold instead of freehold. Careful consideration of the terms of the leasehold title is required, specifically any clauses that may trigger forfeiture and lead to the freeholder being able to cancel the lease and leave a lender unsecured.

Clearly these clauses have the potential to break a deal and it pays for brokers to obtain copies of all lease agreements at the earliest opportunity and be mindful of such pitfalls. It is also often the case that a number of leases exist as the title has been changed through its history. This can lead to a chain of leases – all of which need to be reviewed to ensure good title exists.

Understanding the complexities of these two key areas will enable brokers to take control of the application process and deliver the fastest and most efficient completion.

An alternative, and very practical, solution for brokers new to the sector is to partner with an existing specialist. This will ensure you achieve an optimum conversion.

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