UK: SME - The guide to good property hunting.

UK: SME - The guide to good property hunting. - Property represents such a high percentage of a firm's overheads that it's vital to shop around before buying or committing yourself to a lease.

by Clayton Hirst and Andrea Carpenter.
Last Updated: 31 Aug 2010

Property represents such a high percentage of a firm's overheads that it's vital to shop around before buying or committing yourself to a lease.

If you don't give property prime consideration when running your business, you could be in for a shock. It represents a high proportion of the overheads of SMEs, so it is vital that you weigh up the options carefully before buying an office, shop or plant or committing to a lease. You must choose the type and amount of space appropriate to your operation, while maintaining flexibility without locking up too much money.

How much space do you want?

Michael Pearce, partner at chartered surveyors King Sturge, believes the first thing to think about is your business culture. 'The density of space allocated to individuals must depend on the way in which the business operates,' he states. 'Firms tend to look at 100-200 sq.ft per person with offices of 200 sq.ft tending to be fairly cellular. If your business operates on a more open-plan basis, you can cope with a higher density.'

Independent financial adviser Hill Martin has relocated from offices above a retail unit in Bristol to 4,100 sq.ft of offices more centrally located in the newer Spectrum building. 'Our office - on two floors and a mezzanine level - was very cellular, making communication very difficult.

Since our business aims to serve clients across a range of products, we wanted to be able to communicate actively,' says financial director Brian Thorn. A space planner assessed its requirements at around 130-140 sq.ft per person.

You need to think not only of existing space requirements but also future needs. Look at your business plan in terms of how many extra employees you will be employing and then try to build that into the space. Many firms rely on chartered surveyors to give this sort of advice.

What sort of space do you want?

Then think about what the space is for. Offices, for example, are more expensive than storage or light industrial/production. As Pearce explains: 'Businesses tend not to use office space for dead filing. With rents much lower for storage space, firms can consider renting this elsewhere. But it depends on how you archive your documents - microfiche files obviously require less space.'

Certainly, decent space is hard to find. 'There is little good space around but there is lots that is pretty poor and secondary,' confirms Pearce. 'The cheaper space tends not to take IT and sometimes it doesn't have air conditioning.' Hill Martin's choice of the Spectrum offices was driven in part by IT yet, adds Thorn, 'the building is not state-of-the-art but, at 10 years old, it is sufficiently modern to save us a considerable amount of money'.

Where do you want to locate?

Surveyors will tell you the three most important things when considering a property are 'location, location and location'. While the agent uses the adage as a hackneyed marketing ploy, there is some truth in the words.

The location of a business will affect how much the property costs to rent or buy. National disparities between property prices are well-documented but vast differences also occur at local level. In the City of London, for example, many finance giants have offices around Liverpool Street station, where rents are among the highest in the country. Take a stroll half a mile east, however, and rents are barely a quarter of that. The differential may seem extreme but it is caused by a clique of similar companies wanting to be located together, hoping to promote a flow of business information and attract a strong skills base.

Access to transport is important in attracting staff. Traditionally, this has translated into a good road network but government policy is now seeking to restrict car use and to promote public transport. As part of the Government's initiative, out-of-town developments are being discouraged, which means that planning permission for schemes away from towns will be harder to get, says Erica Mortimer, director of planning consultancy CGMS. If space in these areas becomes scarce but demand remains strong, rents could go up.

Do you lease or buy outright?

You've worked out how much space you need and where you want it to be located, but now you need to think about whether to take a lease or buy the freehold and own the building outright. The problem with owning the freehold is that it ties up capital in an investment that is not part of your core business.

'You do have more control over your property but you have to question the logic of putting money into property when it's your own business,' says Pearce. Small businesses, he adds, often expect to put up to 30% of their returns back into the business and having to spend it on property costs would be a waste.

Once you take the lease option, it is time to go property hunting. Your first and possibly the most important decision is whether to use an agent to do the work for you. The initial cost may be off-putting but an agent will sniff out potential properties and can offer you independent advice on bargaining with the landlord.

How much can you expect to pay?

Before considering any property, you must decide how much you are prepared to pay. Rents on offices and industrial space are quoted as pounds per square foot. Hill Martin, for example, paid £11 per sq.ft on a 10-year lease.

In addition to today's rent, potential rises must also be worked into the equation. When rents come up for review, normally every five years, a landlord will use any upturn in the property market as an excuse to rack up the rent. Today, the market is booming and it should keep growing for another two years. When the market dips, however, don't expect rents to fall at the next review as most contracts have what is termed an 'upwards only' clause.

Rents are not the be all and end all, when it comes to cost. The landlord - or his agent - will also entice tenants with a series of inducements.

These can include rent-free periods and cash payments to refurbish the building. Rent and inducements must therefore be taken together when assessing the cost of the building.

What to look for when negotiating a lease

You have found a building in the right location and negotiated the rent and inducements, now all that's left to do is sign the lease. Wrong. It is at this stage that some of the most important aspects of the lease are thrashed out. Some of the key points to note are listed above. Remember that the landlord is in business too, so expect to negotiate. But if the decisions that you make about your property needs are informed, you have costed it out properly and taken account of any future requirements, you should be able to avoid unpleasant surprises.

KEY CHARGES AND CLAUSES TO THRASH OUT BEFORE SIGNING THE LEASE

Lease length: Landlords want long leases to secure their income stream, tenants want short leases for flexibility. Short leases often mean proportionately higher rent.

Service charges: These apply if a building is multi-let to a number of companies. They cover things such as heating of common parts, lighting, shared receptionists, maintenance and security. Expect to add around £5 per sq.ft on top of the rent for basics. Letting agent Archie Cowan of surveying firm Frank Knight warns against open service charge clauses in contracts: 'This allows the landlord to do what he pleases to the building and the cost is then passed on to the tenant.' Ask for a clause in the lease that refers any dispute on service charges to a specified independent body.

Building upkeep: If you are the only occupier, you are likely to be bound by a full repairing and insuring lease (FRI lease), which makes you responsible for the condition of the building. The level and frequency of works are open to negotiation but check what the lease actually says.

Alienation clause: This restricts sub-letting or assigning leases (selling the contract to another tenant).

The landlord is just trying to protect his income and property. On a longer lease, however, this gives you flexibility. Typically, you will have to get the landlord's approval, which cannot be unreasonably withheld.

Covenant strength: Landlords will undertake credit checks and examine bankers' statements on potential tenants to assess their financial strength and ability to the pay the rent. If a landlord is nervous about a company's covenant strength, he may ask for a deposit of up to two years' rent or a personal guarantee before letting a building. To provide themselves with a safety net, landlords look for a tenants profits to be around three to five times the rental figure.

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