Inducements kept secret for competitive advantage

Valuations/Enough Clarity Exists:For most property professionals, the presence of incentives or a perceived lack of transparency in the market does not cause any difficulty, writes James Nugent.

Am I being asked to defend the indefensible? Is the Irish commercial property market so opaque that few really know what's going on? Surely it can't be all that bad?

To comment on the issue of transparency it is necessary to set out exactly how the market operates. Property development, by its nature, is hugely speculative with numerous risks but, if called correctly, the rewards can be substantial. Nowhere is the mantra of "the higher the risk, the higher the reward" more appropriate.

When a developer makes the decision to purchase a site, it is with a view to adding value and creating profit. In the main, this can be done during the lifetime of a development by obtaining an appropriate planning permission, completing the development and leasing the development, consequently creating an investment product.

In reality the investment is the income stream that comes out of the property and the generally accepted view is that a property with a good quality tenant on a long lease paying market rent is worth more than the same property vacant. If you accept this, then it is clear that the presence of an occupier has an impact on the value of the investment.

It is for this reason that some occupiers get incentives. However, the incentives can vary and with justified cause.

For example, the value of a lease to Heinz plc (to stick with the beans analogy) with a 20-year commitment must be worth more than one where they were only taking a lease for five years. But what happens if the company taking the lease isn't so good - should the incentive given to a new company with no track record and management with little experience be the same as that to Heinz plc? Clearly not. Hopefully this demonstrates that an incentive is given in order to secure a good quality covenant on a long term lease and create a sought-after investment vehicle, as this is what adds to the value of the investment.

In practice when a developer sells an investment property, any inducement given to an occupier is underwritten by the developer. As such, the purchaser is not concerned with incentives and makes an offer utilising a yield that is reflective of the purchaser's perception of the covenant quality. In addition, the yield utilised will also take into account the purchaser's views on the location of the property, the specification of the property, whether the rent is in line with (or below/above) market rents and the length of lease taken. Therefore, the yield used is not affected by incentives and the market is entirely transparent.

However, for those from the outside looking in, it may be hard to understand why yields can vary so much. The simple answer is because the views taken by an investor in relation to covenant quality, location, specification, rent and lease length are entirely subjective. One person's meat is another's poison.

So why is the presence of inducements kept secret? As far as I'm concerned it's obvious - competitive advantage. Let's face facts: as mentioned, development is highly risky and the end game for a developer is to make a profit. Therefore, if a developer can get away without having to grant an incentive, then why wouldn't they? Wouldn't the retailer selling beans not be happier to sell one can of beans without giving the second one away free?

So it understandable that confidentiality agreements exist and, in such circumstances, the agreement is signed by both developer and occupier. Clearly an occupier would not sign such an agreement unless there was a real benefit.

This is the free market at its best, where both occupier and developer benefit and there is no benefit to either party to tell everyone the full details of the transaction.

Where the market is not transparent relates to the effect of incentives on the true rental values of property. It is true that, in certain circumstances, incentives are granted to obtain an inflated rent and possibly an inflated end value. However, the canny investor should spot an inflated rent and adjust their yield appropriately. It could be argued that the presence of incentives can cause difficulty to valuers using a comparison of a deal where incentives were given when trying to assess the true rental value of a property, particularly if the incentives are not disclosed.

In such circumstances real property professionals have a nose for what's right and what's wrong and would not accept the transaction at face value. That is why it is said that valuation is a mixture of art and science.

The current system works. As someone working in the commercial property market I have no problems with giving out comparable information on transactions but there are instances where we are precluded as a result of confidentiality clauses. The property community in Ireland is small, most chartered surveyors are known to each other and information flows freely.

To suggest that many agents are landlord-orientated is untrue. We are, however, client-orientated. It may come as a surprise but, in the office sector, agents represented occupiers in the vast majority of all transactions in excess of 500sq m (5,382sq ft) during 2006. When acting for an occupier we try and get the best deal possible for the occupier and, likewise, the opposing agent acting for the developer is trying to do the same for their client.

It is clear that clients seeking advice can tap into this knowledge and, for most property professionals, the presence of incentives or perceived lack of transparency in the market does not cause any difficulty. We can and do accurately value property on a daily basis.

James Nugent is a chartered surveyor and director of Lisney