An overview of commercial property investment

The term commercial property typically relates to assets such as shops (both with and without adjoining residential accommodation), pubs, hotels, offices, warehouses and land. In theory, it is similar to the residential buy to let market, you buy an asset, rent it out with potential long-term income and capital gain benefits. However, in practice the commercial property market is different in many ways.

What types of finance are available and how easy is it to apply?

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The range of products for commercial property is similar to residential, such as variable rates and fixed rate options from 2,3 and 5 years. However, some lenders offer their commercial borrowing on a variable rate, either bank of England base rate or Libor, for the life of the loan only. Also, while interest only is as standard for residential buy to let this not always the case with commercial investments. Some lenders, while their rates are very completive, may offer their loans on a capital repayment basis only or limit the lending to a lower overall loan to value if there is an interest only element. Taking the loan on repayment while it has its benefits, will of course reduce the monthly positive cash flow from the property.

Commercial investment interest rates do come at a premium over standard residential, however due to the nature of the market it’s difficult to put an exact number on this. The lenders available to a certain client will not only depend on the type of property they are looking to finance but also other factors such as the clients experience in the sector, background assets and their overall financial position.

Commercial transactions will also incur higher upfront costs as commercial properties require specialist valuations and legal work. Depending on the size of the loan, many lenders will require both their own legal representation and the client to use their own solicitor, meaning two sets of legal fees.

What type of returns can you expect?

The mix of capital and income returns will vary depending upon the nature of the commercial asset involved. Lower value commercial properties often achieve yields of 10% or more however rental returns between 5% and 6% with a higher potential for long-term capital growth are favoured by some investors.

What are the risks of this type of investment?

There are several risks to take into consideration when looking at commercial property. These include:

  • Void periods – While residential property can usually be re-let quickly this may not be the case with some commercial units. The lenders are of course aware of this and this is one of the major points addressed by the valuation report. If you are purchasing a property where the current lease is going to expire before the end of your loan, both you as the applicant and the lender will want re-assurance from the surveyor that there would be good demand for new tenants.
  • Failure of the tenant’s business. While you may be able to obtain a long lease from your property, the payment of this lease depends on the tenant’s business being able to pay it. There is therefore any additional due diligence to be done by both the landlord and the lender regards to the occupiers.
  • Limited secondary market – The commercial property market is not as liquid as residential properties, especially niche assets like land or warehouses
  • The purchase/sale process for commercial property transactions tend to take longer than residential assets

Aside from the investment risks it is the additional cost of financing and maintaining commercial property investments which stand out from traditional owner occupier investments. However, commercial property rental arrangements tend to be more secure because of the long-term nature.

How strong is the commercial property market in the UK?

The UK commercial property market has been impacted by “Brexit” talks which have been extremely volatile. There has been a slight reduction in commercial property yields having peaked at 6% last year with many companies (and individuals) preferring to sit on the side-lines and delay any expansion plans in the short to medium term.

The London residential property market is reflective of the concerns within the financial sector amid signs that some of the larger financial institutions could be uprooting their London headquarters for pastures new, such as Dublin. At this moment in time the performance of the UK commercial property market seems to be based upon a worst-case scenario with regards to Brexit talks. As a consequence, long-term commercial property investors have been cherry picking undervalued assets with a view to creating long-term opportunities for both capital appreciation and strong rental income.

If you have any questions on commercial property, you can speak to NM Finance on their dedicated forum

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