Chris Sullivan explains why the next decade will become the ‘Asset Management Years’, and uses the UK office market as a case in point

The Asset Management Years sounds like a slightly warped version of The Wonder Years, but rather than being a cheesily-narrated television series about a fresh-faced graduate at PRUPIM or Threadneedle, it is a term I believe describes the next decade of institutional property investment.

Over the past few years there have been an endless number of lessons for those of us involved in commercial property investment. Arguably the one message that has become more prevalent than anything is that an asset does not necessarily increase in value, especially not if it is just left to its own accord.

Six years ago there was a general belief among asset managers that, on the whole, they had to do very little to a property other than maintain it for a few years before moving it on for a respectable profit.

This is clearly no longer the case, and the biggest impact for institutional investors is that their teams are going to need to work their commercial property assets harder to maximise value. In fact, rather than simply trying to increase the value, there is even an argument that you should take steps to minimise the risk of ending up with a distressed asset.

In short, asset managers are going to have to do a lot more asset management, and need to have a clear and detailed plan in place for getting the best possible value from their assets. The following pointers, in our experience, should help asset managers get more out of their investments.

• Planned preventative maintenance: With assets being held for longer than they would have been previously, there is a need for a much more thought-through approach to building maintenance. Setting out and regularly updating a planned maintenance strategy is far more cost-effective than taking a reactive approach to repairs. Preventative maintenance is indispensable to responsible asset management. Not only does it reduce the risk of encountering unforeseen, expensive problems, but it allows for works to be grouped into specific projects to make cost-effective use of contractors. This is particularly relevant in multi-let office buildings, with common areas where there are opportunities to recover this against the service charge.

• Reinstatement cost assessments: An accurate reinstatement cost assessment (RCA) will eliminate the risks associated with under-insurance and will avoid payment of excessive premiums for over-insurance, which is vital in bleeding the long-term value of an asset. While having an accurate RCA is crucial, building costs - and buildings themselves - change over time, so it is considered good practice to reassess properties every three years. This avoids the risk of compounding errors and ensures that alterations or any other factors that may affect the reinstatement cost are taken into account and insured values adjusted accordingly. According to the Environment Agency, there was insurance cover for only 75% of the damage caused by the 2007 floods. In 2010 just 20% of the cost of repair from natural catastrophe was covered by insurance.

• Dilapidations: The longer an asset is held, the more lease-ends and breaks are going to be encountered, especially if lease terms are getting shorter. At a time when tenants were easily replaceable, dilapidations were often viewed as a time-consuming complication. During the recession, the number of dilapidation claims by landlords rocketed as other sources of revenue became scarce.

Dilapidation disputes can be protracted and create real headaches for asset managers. The best way to avoid them is to have a well-drafted lease and effective communication with tenants so they are clear on their repair and maintenance obligations, and their responsibility to return the property in the state received.

It is fairly common for tenants to overlook their obligation to maintain the condition of a property throughout the term of a lease, and this generally leads to a need for increased work at lease expiry. Ongoing disputes can put potential sales of the asset at risk and result in a sale price reduction. Interim dilapidation claims should be considered a viable option in protecting the value of an asset.

• Air conditioning regulations: Air conditioning systems may not be the first thing that springs to mind when considering the long-term value of a property. However, as of January 2015, the use of refrigerant gas HCFC R22 to maintain air conditioning units will be illegal, and this will mean many existing systems will need modifying or completely replacing. In theory, the responsibility for compliance with this law lies with the end-user; however, the responsibility for the expense of making the changes will vary depending on lease terms. This is likely to lead to complex and time-consuming negotiations between landlord and tenant, so should be addressed sooner rather than later. There is also the risk that, if not addressed, assets put on the market closer to the 2015 deadline will be considerably devalued.

• Refurbishments: While regular maintenance and repair is sufficient to protect the value of an asset over the long term, to really add value and deliver a significant return on investment, improvements will need to be made. For example, with an extremely competitive office market and a lot of new space becoming available, refurbishment of public areas is one good way of making a property more appealing to potential tenants, as well as pleasing existing ones. To minimise the outlay from the landlord, asset managers should look at using the service charge as much as possible when making improvement to public areas.

• Consider change of use: If an asset is in danger of becoming less attractive to tenants in its current form, or if there are outdated assets in an existing portfolio, then considering a change of use can be a prudent way of bringing life back to a building and reinvigorating an investment. Not every office block is suitable for change of use, so it is important to carry out a thorough feasibility study, as this will help establish what practical uses a building may have other than as an office space.

For asset managers that get it right, the potential is there for well-manipulated assets to deliver strong returns, both in terms of long-term rental yields and eventual resale values. Then the Asset Management Years could well turn out to be the golden years.

Chris Sullivan is a partner at Malcolm Hollis

 

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