London serves as a hotspot for commercial property and is known to have one of the most competitive real estate markets in the world, with a wide variety of providers and prospective occupants interacting daily to ensure that businesses conduct their work in an ideal environment. Due to this competitiveness, it is vital that businesses understand pricing dynamics before signing a lease for an office space, retail shop, or industrial premises in the British capital. In this post we will examine how commercial property in London is valued and how these valuations impact rental rates.
What is a Commercial Valuation?
Valuation is a process that aims to determine the value of a commercial building. This process often occurs when a property changes hands (either by being sold or leased), or for tax and insurance purposes. As a prospective tenant, understanding the valuation process can help you determine if the price of the property you’re interested in is fair and competitive.
Commercial valuations are conducted by a professional appraiser at the request of the potential investor, buyer, or tenant. If you can’t find a licensed appraiser, your real estate agent may be able to help. Appraisers consider a variety of factors, including:
- Land value.
- Construction costs.
- Market conditions, comparing the property in question to others with similar characteristics in the same area.
- Property location, since some areas are more desirable than others due to their proximity to major roads, public transport, or business clusters.
- Property size, including the number of rooms and the total square footage.
- Property condition, including everything from structural issues to heating, ventilation, plumbing systems, etc.
- The building specifications or classification (Class A, B, C).
After valuation is complete, the appraiser will produce a written report. The details included can vary, with self-contained reports often providing a fully comprehensive outline and restricted use reports serving to online outline major findings. Valuation and reports are paid services, and the costs vary based on the property’s value. Fees are levied on a sliding scale that starts with properties valued at £200,000 and under.
How is Rent Determined?
The outcome of a commercial valuation is used as a guideline to set rental rates. Commercial rents are calculated using several different formulas, with the most common being:
Total square footage x Price per square foot / 12 = Monthly rent. This is usually applied to office space.
Open market rental value
Which considers property class and condition to determine a realistic figure that the property could be let for in the open market.
Base rent + additions
Base rent (determined by local market conditions and average going rates), plus insurance or service charges.
Percentage or turnover-based
Base rent plus a percentage of gross income or gross receipts. This is common in retail leases.
Rent Control and Rent Reviews
The UK government does not enforce rent control, although in times of crisis it has been known to pass legislation to prohibit eviction if a tenant is in arrears. Commercial landlords are given the option to negotiate prices and lease terms with their tenants, during both the initial rental contract and during renewals, which usually entail a rent review.
Rent reviews are a common feature of long-term commercial leases and can result in rent increases every three to five years depending on the market and several other factors. These reviews usually follow a new valuation that provides an up-to-date estimate of the premises value. Rent increases can also be calculated by considering:
- The current Retail Price Index, although this model may be challenged in the near future.
- Business turnover.
Factors That Increase & Decrease Rental Rates
Properties that are centrally located or in up-and-coming areas command higher rates.
Tight supply or space shortages drive rental rates up.
Shorter leases carry a higher premium.
Current vacancy rates
If vacancy rates are low, tenants have less room for negotiation.
The state of the economy
During an economic downturn, landlords may be more inclined to lower rents or to increase rent-free periods.