With increases to stamp duty and the new mortgage tax relief regime introduced for residential buy-to-let landlords, there is speculation that some investors are looking at commercial property in addition to, or rather than, residential property as a potential investment. Since commercial investment is not subject to the recent changes in taxation, is the market experiencing a new trend? If so, what questions should potential investors consider before making the move?
What kinds of commercial properties are popular?
The RICS UK Commercial Property Market Survey showed that investor demand has risen for UK commercial property across all sectors in the first quarter of 2017. Commercial property encompasses a wide range of buildings including office blocks, warehouses, retail, and mixed-use ‘semi-commercial’ properties (shops with flats above, for example). Some investors looking to make the move from residential buy-to-let are initially looking into retail spaces and small offices. But some are also utilising their experience in the residential market to evaluate mixed-use properties, which balance residential and commercial property business models, but are taxed as commercial buildings, if the commercial space is the dominant part of the building.
How are commercial buy-to-let mortgages calculated?
Commercial mortgages are assessed differently than residential buy-to-let. They are based upon on the market value of the property, the current (or potential) rental income, but also the business that occupies the property. The robustness of any sitting tenant’s finances, as well as the duration of any current leases, are factors that affect how likely a landlord is to prove affordability and secure mortgage finance. And mortgages for semi-commercial buildings may have different rates than residential mortgages and require different terms than residential landlords are accustomed to. For those considering investing in commercial property, particularly for the first time, it will be essential to seek specialist advice.
What to consider when investing in commercial property?
Given the differences between residential and commercial buildings in areas of taxation, availability of finance, and building occupancy, there are many points for landlords to consider when evaluating an investment in a commercial or mixed-use property:
- Leases: Think about how the terms and conditions of leases you will be negotiating (or inheriting when you buy the property) differ between standard residential tenancies and commercial tenants. Commercial leases generally have longer terms but could potentially have longer vacancy periods after a tenant decides to move. How could this impact your business model?
- Occupancy: you will be purchasing a commercial building which likely will already occupied by one (or multiple) business tenants with differing lease terms. The length of existing leases and creditworthiness of your potential tenants will likely be a key factor in negotiating your finance product with the lender. Make sure you know your occupants: after choosing a building that meets your criteria, download the tenants’ accounts from Companies House, you should take in to account information such as whether your proposed tenant is a sole trader, ltd company with or without experience.
- Yields: Consider how the potential rental yields will compare with a standard tenancy agreement. Yields are generally seen as higher in commercial property but capital appreciation is less well understood in commercial buildings compared with residential property.
- Economic cycles: Consider the impact of economic cycles on commercial rents. Undertake your financial analysis by considering different levels of rent (and potential periods of vacancy) in the future as this could be impacted by economic recession, potentially more so than in the residential sector. Identify how you will hedge against these risks eg multi let offices against one lease premises.
- Property type: Identify what type of commercial premises you would want to buy. You will want to drill down your search to compare potential investments in a specific sector, for example large commercial buildings compared with smaller shops, or mixed-use.
- Business sector: Identify what business sector you want to invest in. Options include industrial, business, leisure, and retail, and tenants in certain categories may be viewed more favourably by your lender. Evidence points to stable retail and business/trade operations as more favourable, so do your research and speak with your broker first.
In addition to a strong business plan, lenders prefer when potential investors can demonstrate experience managing commercial property or at least large portfolio of residential. If this is not something that you have then it is vital to build up a strong team of specialists who can guide you. This will also demonstrate to the lender that you are taking this endeavour seriously.
Potential investors have much to consider before choosing to purchase commercial property. Determine if the benefits outweigh the costs, and speak to a specialist broker to find the best finance for you.