5 things to Consider when Investing in Commercial Property

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investing in commercial property

Investing in Commercial property is attractive for investors because it can provide healthy capital growth, a consistent monthly income and better security than equities and shares. 

One of the key benefits of investing in commercial property in the UK is that the leases are longer than those of residential properties, With the typical office lease being eight years, this can provide a consistent income over a long period.

Changes in tax regulations have harmed residential buy-to-let landlords, causing the property market to shift more toward commercial property investment.

Stephen Clark, Commercial Bridging Loan broker at Finbri says “Very recently, government changes to tax and policy have meant residential, buy-to-lets (BTL) have become a less attractive investment opportunity for private landlords. However, investors have been alerted to the benefits of focusing their attention on commercial properties.” 

As property prices have witnessed significant capital growth, residential rental yields have fallen, with the average presently standing at 3.53%. Despite the challenges of the pandemic, the commercial property market is showing signs of recovering with The Q1 2022 RICS UK Commercial Property Survey reporting increasing demand. With total returns on all UK property expected to be approximately 6% this year, but office investment increasing by 20% and construct to rent investment increasing by 65%, it’s clear to see commercial property offers great potential.

So what should you consider when investing in commercial property?

1The sector you choose to invest in

The pandemic has clearly affected commercial property sectors differently and each sector has a varying level of growth. But which sector could make a worthwhile investment?

Tourism 

By 2025, it’s estimated that the demand for holiday accommodation in the UK is expected to be 30% higher than in 2019. With flexible working still remaining preferable since the pandemic, the tourism industry is projected to benefit and holiday lets could provide a healthy investment for developers.

Industrial/logistics 

Although online retailers dominated warehouse space in 2021 during the pandemic, it’s estimated that the growth of online retail will require an additional 59 million sq ft of logistics space by 2025, making warehouses a potential goldmine for investment. Though with scare stories rattling that segment, such as Amazon having potentially more than 10 million square feet of excess warehousing, this may take some heat out of the market.

Offices 

As many people continue to work from home, there has been a reduction in demand for office space. By 2022, UK office rental values will have fallen 5.3%.

However if office space continues to decline, Town and Country Planning Order 1987 classifies offices as Use Class E, which means they can be used for food merchants, financial services, gyms, healthcare, nurseries, and light industry. Notwithstanding this there’s also the relaxation of planning where commercial can be converted to semi-commercial to include residential dwellings, gyms and other similar leisure facilities. Commercial landlords seeking long-term investments could see large rewards in this area.

Retail 

During the pandemic, many retail businesses closed their doors, resulting in declining high streets across the UK. Some businesses fared well during this time and continue to do well, these include DIY, homeware, pet, and convenience retailers.

With many vacant retail outlets across the UK, the potential to profit from more socially based venues such as coffee shops, health clubs, and restaurants is increasing, especially following the recurrent lockdowns of 2020-2021.

2The location of the property

When considering an investment in a commercial property, one of the most important considerations to make is the location. For example, towards the end of 2021, the best commercial property yields were found in Scotland (20.4%), the South West (13.7%) and Yorkshire and the Humber (12.9%). Conducting thorough research on the location you intend to develop can have an impact on capital growth and the yields you can expect from a development.

3Long-term or short-term Investing in commercial property?

Carefully consider the time-frame of your investment and how quickly you want to realise a return on your investment as short-term and long-term investments both come with their advantages and disadvantages when it comes to financial predictability, risk and flexibility.

If you’re looking to make a long-term investment, adaptability is crucial. If your property can be converted to a different use class during an economic downturn or to take advantages of opportunities that present themselves from changes in planning policy, you are much more likely to maintain a healthy investment.

Short-term investments are a good choice for investors that are looking for flexibility and tangible results relatively quickly. When the time-frame is short, usually a maximum of 3 years, you forego tying up capital for extended periods of time.

Selecting a property type and location that will see good capital increases within your timeline is crucial if you want to see a quick return on your investment. What kind of property you buy, where you buy it, and how you finance the purchase will all depend on how long you have to make those decisions.

4Buy or rent?

The decision to rent or buy commercial property is not always straightforward. While your budget will mostly influence whether you can afford to acquire business premises, whether you should buy or rent will also be determined by the type and size of your firm. Consider your needs and create a business plan before making a decision.

Buying a commercial property

Purchasing commercial property is an investment that can grow in value over time. The premises can be listed as an asset and used as security to raise capital. However, property values can fall, which means it may be worth less over time.

Benefits of purchasing commercial property

  • Profit – the value of your property is likely to rise over time, which means you are more likely to make a profit from the purchase.
  • Equity release – if you want to finance another development, you have the option of using the equity in the commercial property as security.
  • Income from subletting – if you no longer need the space, you can rent it to other businesses.
  • Flexibility – purchasing property provides you more flexibility when it comes to the design of the space. You may customise the layout and decor, making it more suitable for your requirements.
  • Tax benefits – owning commercial property can result in favourable tax benefits.

The disadvantages of purchasing commercial property

  • Lowering capital – Purchasing business premises necessitates the expenditure of capital. If you don’t have the funding up front, you may need to take out a commercial mortgage of which a substantial deposit, generally up to 40% of the buying price, may be required.
  • Impact on profits – Having a commercial mortgage may have an influence on the profitability of your firm. Mortgage payments may be affected by interest rate increases, resulting in unanticipated cost increases. Other costs associated with purchasing include stamp duty, legal fees, and valuation fees, as well as recurring expenses such as business rates and building insurance.
  • Surveyancing costs – Surveys need to be completed to avoid issues such as asbestos in older buildings. If hidden issues are not discovered at the time of purchase, they might be costly to repair further down the line.
  • Issues with planning – Planning permission is required if you intend to make significant changes to the structure to accommodate your commercial demands. If you purchase the property before planning is completed, you may be left with an unsuitable commercial property and end up paying unnecessary fees.
  • Maintenance – you will be in charge of repairs and will need to budget for continuing maintenance costs.
  • Selling – selling commercial property can be time-consuming and complicated, which can be detrimental to your business if you need to relocate.

5Renting a commercial property

Renting is a fantastic alternative for start-ups that do not know what their revenue will be in the following years. It provides a safety net in that if things don’t work out, you won’t be burdened with a mortgage on expensive commercial property.

Business property leases are classified into two types: traditional and flexible. Conventional leases are often sold by the square foot and only include the space. Fitting out and upkeep, as well as fees such as insurance, will be your responsibility. Flexible leases are typically shorter in duration and more expensive, but they frequently include furniture and office maintenance.

The Benefits of Renting a Commercial Property 

  • Renting is simple: you’ll need a deposit and the ability to make monthly payments. Renting does not entail tying up your capital, and rents can be fixed. There is also more variety, with options ranging from hot desking to industrial units to suit all enterprises of all sizes.
  • Tax breaks – Rent charges can be deducted from profits, which means you’ll pay less Corporation Tax on your revenue.
  • Easy to relocate – if you outgrow your current business location, you may easily relocate at the conclusion of your lease to a more suitable location.
  • There is less work – your landlord is responsible for the upkeep, and other facilities and services may be included depending on your lease, which means less time spent organising things and more time running your business.

Disadvantages of renting commercial property

  • Decreased capital growth – if you rent the property, you will not enjoy the same benefits of long-term capital growth that you would have had if you had purchased the property.
  • Space limitations – There may be limitations on what you can do with the office space, and adjustments require landlord approval. When the lease expires, you may need to return the office to its original configuration.
  • High competition – there is huge competition, particularly in prominent locations; unless you sign a long-term contract, rents can rise, and you may be forced to relocate if faced with an unexpectedly large rental increase.
  • You’ll be committed for the long haul – you’ll be required to pay rent even if business slows or you close your firm, leaving you accountable for further costs.
  • Higher payments – rental payments might be higher than mortgage payments.

6Financing a Commercial Property

There are several options available to an investor when financing a commercial property.

Commercial mortgage

When buying a commercial property, a commercial mortgage is often the funding option of choice.

Similar to a home mortgage, commercial mortgages need a deposit followed by monthly principal and interest or interest only. A business mortgage typically has terms between one to thirty years, making it an excellent choice for a long-term loan for those businesses that can prove their creditworthiness and long-term business viability.

Bridging finance

Commercial property can be acquired before permanent financing is in place with the help of a commercial bridging loan. Bridging finance can be obtained much more quickly than a mortgage, typically within 2-4 weeks weeks, making it suitable  for fast opportunistic purchases or buying from auction.

This type of finance can also be used to purchase a semi-commercial property..

While the property you’re buying is typically used as collateral for a bridge loan, your primary residence or other investment properties can also be used in place of, or in addition, to the commercial property you’re purchasing.