Property has long proven to be one of the best investments in the UK. But while residential properties have been popular with investors for generations, recent changes including the reduction of tax relief, fluctuating residential property market and the current political uncertainty surrounding Brexit have led many investors to turn to commercial properties for a greater yield and more stability as part of a portfolio diversification strategy. UK mortgage brokers and lenders also suggest investors are increasingly interested in commercial buy-to-let as an alternative to traditional residential lets. This is because rents on office space and other commercial lets tend to be higher, providing a better yield for landlords when pressure mounts on their costs as it has for buy-to-let residential landlords.
If done right, renting out commercial properties can reliably bring in higher annual returns than residential property investments.There are different risks associated with running a property portfolio with commercial tenants. Assessing if a commercial property is a smart investment requires proper research, homework and undertaking thorough due diligence. This article will look at the factors to consider when investing in commercial property, as well as the pros, cons and challenges associated with commercial real estate investment as opposed to residential.
Overview of Property Investment – Fundamentals & Differences Between Residential and Commercial PropertiesTraditionally, buy-to-let property investment refers to property let by private landlords to residential tenants, meaning the property is a rented accommodation specifically aimed at people who need somewhere to live. From a funding point of view, the mortgage lender will assess the value of the property and the associated rental income in relation to mortgage payments, agreed loan, interest rates and terms. Buy-to-let can also include multiple units, blocks of flats rented out to different families or even HMOs (houses in multiple occupation) which typically house students or professionals in separate lockable rooms with shared common rooms (usually kitchen and living/dining room) within a common dwelling. These particular types of investments require more complex financing and are often investments done through a limited company. The next natural step in property investment is to invest in a semi-commercial or “mixed-use” property and usually refers to a building with a shop or an office (or any other business) in one part of the building (generally on the ground floor) and a residential flat (or multiple flats) in any other part of the property (usually above the commercial premise). These types of commercial properties are typically let by private landlords (or private funds) to businesses as tenants conducting enterprise on the premises. Commercial funding and mortgages are assessed on the value of the property, the rental income produced, but also and more crucially, the business that currently sits in the property (the quality of the tenant) and the strength of the lease (length, clauses, terms, etc). All these factors will affect how likely a landlord is to secure funding for this type of investment.
Pros of Commercial Real Estate InvestmentAccording to the Q3 2017 RICS (Royal Institution of Chartered Surveyors) UK Commercial Property Market Survey, investment demand for commercial property continued to pick up, and proved the strongest in the industrial sector, with 55% of respondents seeing an increase in enquiries (up from 40% in Q2), while 41% of respondents saw a rise in investment demand for offices and 9% saw a rise in enquiries to invest in retail space. This surge in interest and demand for commercial property investment is not only coming from seasoned commercial property investors, private funds, investment trusts and corporations, but also from more traditional buy-to-let residential landlords and investors looking for alternative investments to create diverse portfolios. Semi-commercial properties in particular, are growing in popularity because they typically produce higher yields than vanilla buy-to-let properties and are not subject to the stamp duty surcharge or the tougher affordability calculations on personal buy-to-let borrowing. A recent research conducted by Mortgages for Business showed that semi-commercial properties produced an average annual gross yield of 7.6 per cent compared to 6 per cent for vanilla buy-to-let over the past 6 years. Here are some of the reasons commercial real estate is attracting an increasing number of property investors:
- Higher income potential
- Cash flow stability and predictability
- Professional relationships with business tenants
- Limited hours of operation
- Diversification strategy
Cons & Challenges of Commercial Real Estate InvestmentWhile there are many positive reasons to invest in commercial real estate over residential, there are also many challenges to consider as well.
- Commercial property investment requires a bigger initial investment.
- Specialist lenders usually required at slightly higher rates
Investors have to be prepared for unexpected expenses, and these can be large with commercial properties.Vacancies can take time to fill and void periods can be long between commercial tenants, triggering costly business rates for the landlord. Repairs to commercial properties typically need to be done by professional workers and can be on a much larger scale than repairs to a house or an apartment unit. Preparing for these expenses is a fundamental part of owning commercial property. Click here to download your FREE due diligence guide & checklist for commercial property investment now.
- Commercial property investment can be more risky.
- Demographics: changes in the composition of a population such as race, income and gender have a greater impact on the real estate value and its performance.
- Cyclicality of the economy can also have an adverse effect.
- Finally location, an important key in influencing the price values.
ConclusionCommercial property investment is a much more complex process than residential property investment. In today’s economic climate, gaining a robust understanding of the asset being purchased and the income it generates is more important than ever, with the due diligence process now a key part of any property transaction. Undertaking a thorough due diligence is consequently paramount when considering buying a commercial property. The due diligence process can initially seem rather daunting as it requires extensive research, analysis and enquiries but it is an essential first step of any investment. But we’ve simplified the process by creating a FREE due diligence guide and checklist that can walk you through the process step-by-step. Get your free copy by clicking here.
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