Why invest in commercial property?
What makes commercial property an attractive investment?
Commercial property investment is becoming more popular as investors look to move away from the overcrowded residential buy to let market in search of stronger returns.
The UK commercial property market is strong, and unlike vanilla buy to let investment, can still offer excellent, and in many cases, predictable yields.
How can I invest in commercial property?
Commercial property investment can be made either directly, or indirectly.
Direct investment refers to purchasing a commercial property of your own and letting it out. This is a great way to invest if you’re looking to retain control of your investment and would like to be ‘hands on’ in your approach.
Property funds are an investment product which allows you to pool your funds with other investors, which are then invested into commercial property. These funds can be either direct or indirect property funds. This is a strong option for those who aren’t looking to be involved in the decision making of their investment or those who don’t have enough funds to buy a whole property of their own.
How does commercial property investment work?
Buying a commercial property
When buying a commercial property, most people fund the transaction using a commercial investment mortgage – a type of commercial mortgage.
Often, commercial investment property is purchased with a tenant already in place. As the terms of the lease are already set out, it’s a good idea to get your solicitor to review the lease before committing to the purchase.
For first time commercial property investors, the market can seem a little alien, so surrounding yourself with experienced professionals can make the process far simpler.
The lease is the legal document that lays out the terms of the agreement between the landlord and tenant. Commercial leases in the UK are agreed for an average term of 8 years, so it’s important that you get them right.
Leases can be fully repairing and insuring, meaning the tenant is liable for all repairs to the property, and for insuring the property during the term of the lease. Other leases may leave the liability for repairs and insurance at the door of the landlords, which can lead to additional expenses, which will impact your profits.
Other things to look out for in commercial leases include break clauses (a set period in which the agreement can be cancelled) and rent reviews. Rent reviews can be upward only, or may give scope for the rent to go up or down. Of course, upward only rent reviews give you additional certainty around your future income.
Managing the property
In theory, fully repairing and insuring commercial property should be simpler to manage than residential property. That said, things do crop up and it may be a good idea to work through an experienced commercial letting agent – even if this is just initially.
Letting a vacant commercial property is more specialist than letting residential property, and as such working with an agent could be a good idea.
Is commercial property a good investment?
Understanding commercial property yields
Commercial property yields are higher than residential, with residential property currently offering a yield of 3.53% per annum.
Commercial property returns are usually broken down by sector, with shopping centres producing a 7.5% yield, high street retail 6.75% an offices between 5-5.5%.
To calculate your yield, divide your annual rental income by the property value and then multiply it by 100.
Why is residential buy to let investment less attractive?
Commercial investment properties can have excellent yields, multi-year and even fully repairing leases, meaning you know for sure your tenant will remain in the property and handle any required maintenance as part of his occupation of the property – something landlords of residential properties can only dream of.
Semi-commercial property for investment, such as a shop with a flat above can provide even more benefits, with a long-term tenant downstairs in the commercial element and a residential tenant above.
This gives you some protection in the event of one part of the property becoming vacant, as chances of having at least one tenant and therefore an income stream are increased. On top of this, when both units are occupied, the benefit of two rent payments received each month can produce a yield far in excess of those available on your average buy to let investment.
Residential investment properties in London are producing a yield of around 3%, with commercial offering a significant increase at 6%. This sizeable jump in potential returns, along with the savings on acquisition costs and narrowing of finance rates between residential and commercial property is seeing a surge in the commercial investment market of experienced residential landlords looking to take on their first commercial or semi-commercial property.
Stamp duty surcharge
A stamp duty surcharge of three percentage points has been introduced for all second home and residential buy to let investments. Commercial and semi-commercial property is exempt, which means that there is an immediate cost saving when investing in commercial or semi-commercial property rather than a traditional residential buy to let purchase.
If a potential landlord was planning on buying a new investment property for £150,000 and they chose a residential investment, the stamp duty bill would be £5,000 compared to £0 on a commercial investment. If the purchase price was £500,000, the stamp duty would be £30,000 for the residential property vs. £14,000 for the commercial, an additional £16,000.
Funding a new commercial property investment
When taking out this type of finance, you’re usually able to borrow a maximum of 75% of the property value, meaning you’ll be expected to put down a 25% deposit.
Lenders usually want to see a tenant in place before they will offer a commercial investment mortgage. For first time investors, they may insist on an experienced agent being in place to help with the management of the property.
When purchasing a property that doesn’t have a tenant, or a one that requires refurbishment, you may struggle to get a commercial mortgage. In this situation, a commercial bridging loan would usually be the solution.
These loans are short-term, usually for a maximum of 18 months and are used to secure the property while unacceptable to a mortgage lender.
They can be completed very quickly, making them very popular with those looking to finance a property bought at auction.