IPD: Short leases hurt growth in the UK market (UK)

IPD lease length analysis shows that signing a new five-year lease leads to a fall in value of around -1.8%, despite the property being let.

In addition, properties with short lease tenants (under five years) have seen considerably less growth year on year than those on longer leases, as investors look for assets with secure, long-term – or 'prime' – tenants.

"The number of five-year leases has increased by 26% in the last five years, and accounts for about 44% of the entire property market," explained Andrew Gerrity, Client Manager at IPD.

"As landlords have struggled to control vacancy rates they have shortened leases and offered more flexibility in an effort to let properties. This has kept vacancy rates relatively low, at about 8.7%, but it has not stopped values falling in a market that demands safe assets and tenants.

"While the impact of vacancies on values is higher, landlords need to be aware than signing short leases is not necessarily a guarantee of value protection, and though it generates a higher yield initially, holding out for a tenant on a longer lease is more profitable in the long run."

Investors who sign a 20+ year lease can expect to see a boost in value of about 5%, and there has been a considerable increase in the number signed in the last year, as investors have attracted tenants by offering lower starting rents. The divergence in capital growth for properties with both long and short leases is at its greatest for over 10 years, a sign of the disparity in the market as investors push prime values higher while secondary values suffer.

Gerrity continued: "This may be particularly disconcerting for those investors looking at the secondary sector and the high yielding, discounted assets it contains. While there is talk of using active management to maintain, or improve income streams, one of the byproducts of this is often shorter, more flexible leases. And this means there values are going to keep declining, and there income streams will deteriorate further as rents fall."

Falling income on secondary properties is of increasing concern in the UK market, and preliminary findings from the IPD Stress Index, due to be published within the next two months, indicates that income on secondary property is often untenable. This has severe implications in a market once again experiencing capital value decline, both for financing ltv's and attracting future investors.

The retail sector
In the hard hit retail sector the number of leases under five years jumps from 26% to 32%, a sign of the continuing struggle landlords are facing to keep shops occupied.

"Short leases in the retail sector allow more flexibility, but the impact on values is severe, and we cannot forget that 50% of the commercial property sector is invested in retail. Properties on five-year leases have lost about 39% of their value in the last five years, whilst those on longer leases have only lost about 18%," concluded Gerrity.

Source: IPD

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