In the current long-term low interest rate environment and with changes in BTL tax regulation, an increasing number of investors are looking to add commercial property to their portfolio.
What is Commercial Property?
Commercial property refers to buildings or land, intended to generate a profit, either from capital gain or rental income, that is used for business activities.
Types of Commercial Property
Commercial property is commonly divided into the following asset classes offering the opportunity for diversification:
- Office Buildings (Office building and services offices)
- Industrial (industrial, business parks, warehouses, self-storage, logistic & distribution centres)
- Retail (shops and shopping centres)
- Leisure (restaurants, public houses, hotels, cafés and sports facilities)
- Healthcare (medical centres, hospitals & care homes)
- Residential blocks [student accommodation & PRS)
- Land (to be developed into any of the above)
Why Investors buy commercial property
The primary element of a commercial property investment is regular, predictable and stable income from tenants. Income can be increased by rental increases, increasing occupancy levels and …..
Secondary element is capital appreciation, this can be achieved by increasing income, increasing lease lengths, improving the quality of tenants and potential change of use through planning gains.
Valuations
Commercial property is valued on a yield basis which is made up from three main considerations:
- The amount of rent being paid
- When the rent is paid and how long is the rent is contracted for
- The quality or covenant of the business paying the rent
Leases
Commercial property leases tend to be much longer term than residential AST’s. Commercial leases usually start at 3 years and run up to 25+ years.
Businesses tend to be tied to their location for several reasons:
- They have spent a lot of money fitting out their premises and cannot afford to move regularly
- They rely on the customer footfall of their location
- They rely on local pool of suitably qualified staff
Leases, even long-term leases, will include break clauses. It offers both the tenant and the property investor the ability to terminate the lease before the end of the original lease term. On the tenant side, their business needs may change and on the investor side, they may want to change the use of the building or rent to another tenant of a greater covenant or for a higher rental.
The leases most commonly entered into between the investor and the tenant is called a FRI (Full Repairing and Insuring) Lease, what this means is that the tenant is responsible for all repairing both internally and externally and the building insurance. If there is a leaky tap or the boiler breaks, it’s the tenant who sorts it out not the investor.
When the tenant vacates the property at the end of the tenancy, they have to put everything back as they found it, or they have to pay the investors costs to rectify any damage. This is known as dilapidations.
Tenants are also responsible for business rates, but if the investor is left with an empty property at any stage then they become liable. Rates are bases on a percentage of the rentable value and vary from council to council.
Investing
Commercial properties are usually purchased with a tenant / tenants in situ, this means that an investor can understand their expected income over a specific time frame before they purchase the property and they start to earn income immediately.
Some commercial properties may be elected for VAT, which means that on top of the purchase price the investor needs to pay an additional 20%.
Commercial property investment can be a good source of regular and stable income with the opportunity to achieve increased capital gains through lease up, value add or planning gain.
