With many property investors looking elsewhere as residential buy-to-let becomes less attractive, Gary Hemming of ABC Finance takes a closer look at the merits of commercial property investment.
Get a breakdown on whether it’s a good investment, what you should be looking for in a potential investment and how to fund these properties.
Why are investors turning their backs on residential buy-to-let?
There are a number of reasons why buy-to-let (BTL) investment has become less attractive in recent years. As property prices have been increasing, yields have been reducing and now average rental yield just 3.53%.
In addition, tax rules have become less favourable for those who own property in their own name rather than through a limited company.
Finally, the 3% stamp duty surcharge introduced in 2016 has further squeezed the available returns.
How does commercial property investment work?
For those familiar with BTL investment, the concept will be simple. A property is purchased and then let out in return for a rental income.
With commercial property, that rent may be monthly, quarterly or almost any other timeframe that works for both the landlord and tenant.
This will be laid out in the lease agreement. These agreements are usually bespoke, rather than the standard AST (Assured Shorthold Tenancy) agreements used with residential investments.
Leases are usually agreed over longer terms than ASTs, with lease lengths between 3-20 years being commonplace.
What are the pros?
The returns available when investing in commercial property are undoubtedly higher than those on buy-to-let property.
Retail properties average a yield of 5.7%; a £200,000 investment in a retail property would produce £11,400 on average, compared with just ?7,062 from a residential BTL.
“As the leases are much longer, these properties usually have an investment value in excess of their bricks and mortar valuation. This means that you can acquire a vacant property and, if let on a strong lease to a good tenant, you will see an instant increase in value.”
Finally, many leases are fully repairing and insuring, meaning the tenant is fully liable for the repairs and insurance of the property. These leases remove a lot of the cost of maintaining the property and a lot of the effort involved.
This can be a big benefit as residential ASTs require repairs, maintenance and buildings insurance to be handled by the landlord, at their expense.
And the drawbacks?
The commercial property market is less liquid than the residential market. This often means it can be harder to find a tenant when your property falls vacant. As such, it may mean longer void periods for the landlord.
During these void periods, business rates must still be paid, with the responsibility falling on the landlord. If you have a mortgage on the property which must also be paid, it can be a significant drain on cash flow.
Finally, commercial property prices tend to be more volatile than the residential market. Therefore, in times of difficulty in the wider economy, you may struggle to sell your property quickly without taking a more significant hit on the price you receive.
What should I be looking for in a potential investment?
Common sense is the key here. Looking deeply at the market rather than blindly investing is the way to go.
During the first lockdown, many retail businesses saw the government order them to close. In this case, the likelihood of the rent falling into arrears increases as the tenant will have no income.
At the same time, essential retailers such as convenience stores saw their sales sharply increase. This made them a very popular choice for investors as they were seen as ‘pandemic proof’.
Although you can’t always predict the future, you should always stop to assess the potential changes to markets in the future with the aim of making an informed choice.
“There’s no substitute for experience. As such, it’s important that you surround yourself with an experienced professional team who will be able to advise you on market trends.”
A surveyor, a solicitor and a good commercial mortgage broker can be valuable resources when considering a new investment.
How can I fund commercial investment properties?
These properties are funded using commercial mortgages. The commercial equivalent to a buy to let loan is a commercial investment mortgage. Although they work in much the same way, there are some key differences.
Mortgages for commercial property tend to be offered at slightly higher interest rates, especially for first-time commercial property owners.
Secondly, the loan to values tend to be a little lower, with 75% being the absolute limit, but 65% currently being more common.
Finally, commercial mortgage lenders often expect borrowing to be taken on a capital repayment basis. Some lenders will accept interest only, but this isn’t a given.