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Making sense of commercial property investment

by | Jan 16, 2023

Investing in commercial property can seem like a daunting task, but with the right knowledge and understanding, it can be a highly rewarding endeavour. 

From retail centres to office buildings, the commercial real estate market offers a wide range of opportunities for investors. 

However, before diving in, it’s important to have a solid grasp on the intricacies of commercial property investment. From understanding the different types of commercial properties to evaluating potential returns, there is a lot to consider. 

In this article, we’ll guide you through the process of understanding commercial property investment. We’ll delve into the key concepts, provide tips and strategies, and help you navigate the often-complex world of commercial real estate investing. 

Whether you’re a seasoned investor or just starting out, this article will arm you with the knowledge you need to make informed decisions and potentially reap significant financial rewards.

invest in commercial properties

What do you need to know before investing in property commercially?

There are a good few factors involved in a commercial property investment including whether you want to be investing in propane for the long or short term. 

On top of this, you should consider the type of commercial space that you’re interested in investing in, whether that be because of your investment strategy or having particular knowledge in one area.

These factors, along with some other should all be considered when beginning a commercial property investment journey.

How long you want to be investing for to see a return

Whether you want to be in the investment for the short term or long term is perhaps the biggest thing you should consider. This often comes down to the tolerance for risk you have as an investor. 

Those who want to be able to add to 

What type of commercial space you prefer

Often, investors choose to go for money rather than the safest investment. As a result, they may go for a niche of commercial real estate investing that they don’t know much about or take additional risk on a different type of property for more money.

In general, there are three categories for commercial property investment including office space, industrial space and retail space and there are generally good deals to be found all around. It is just a matter of preference.

Office

In recent years, investing in office space as a commercial investment must be done with caution as fewer companies are turning to office space as they settle into hybrid ways of working with some companies being completely remote.

Either way, office space can still be a target investment if investing in areas where there is high rental demand such as where there are major cities and industry that is already established.

In addition, if an investor has a large database of renters or access to them who are in the rental market for office space, buying an investment property in this way can be a great way to make money

Industrial

Industrial real estate relates to spaces where there is a larger amount of land such as building sites. For example, an investor who owns a plot of land next to a railway may be able to rent the land to a  construction company.

This form of investing is often considered some of the most passive types of investment as there is very little maintenance necessary in order to keep the client happy.

In office space and retail space, there is a requirement for staffing and cleaning that should be provided by the landlord. However, industrial space that just involves land will not need this input.

However, because of this convenience, it is unlikely the investor will be able to charge a high rental income to get a higher rental yield due to the passive nature of the investment.

industrial commercial property investment

Retail

Companies that operate as businesses who have customers in and out of them qualify as retail property. For example, grocery stores can rent property from landlords with the aim to set up their store.

The advantage of large retail stores like this is they are often set up for long periods of time so a landlord can guarantee income from  retail space for multiple years and sometimes decades depending on the commercial lease in place.

Do you want to lease it or buy it?

In order to make a return on investment in commercial property, it is not necessary to always buy the property and there are also additional ways of owning the property too.

For example, a landlord may choose to own the freehold for the property which will give them the right to rent out the rest of the commercial space to leaseholders.

Or, they could purchase the leasehold for a set number of years in which time a n investor can sublet the property.

Also, there is also the option to not buy anything at all and participate in the business model of rent to rent. This is where an investor guarantees rent to a landlord and promises to manage the property on their behalf.

In turn, they are able to increase the rent of the property in order so they can keep some profit in between. Nonetheless, this method does require the investor to take on additional risk.

Where in the UK are you comfortable investing?

As an investor, it is vital you ask yourself this question. It could be the case that the landlord is able to make the investment work in an area where they have someone to manage the property.

However, most investors would like to be near their investment so they can conduct regular inspections. Especially early on in their investment career where they are less qualified to pass this responsibility on.

As well as the need to be near the property for convenience reasons, an investor may also choose to invest in a particular area for its particular attributes like having high rental demand or lower property prices.

For instance, a property that has fallen in demand for purchase but has increased in demand for rent could be ideal as a commercial investment. The investor would need to buy and rent and make a profit in this case.

What financing options are available for you 

If you cannot find the funds to pay for a direct deposit for a commercial mortgage, there are some different ways of investing in property. These include using direct investment, commercial property funds and indirect property funds.

Direct investment

In a direct investment, the investor will partner in a deal by buying a share of a property or buy the property outright without a mortgage. This is not practical for most investors and even those who are experienced will still use some form of financing.

Sometimes, direct investments can refer to sharing a deal with a mortgage where each party puts in a different share of a deposit and hence takes the same relative amount of rent from the income of the deal.

Commercial property funds

Brick and mortar funds are useful for those looking to buy a property in a collective scheme. For example, if there is a company or a trust that wants to secure their financial future.

These large organisations can invest in commercial property development which would require millions of pounds. This could result in them purposefully removing competition from smaller investors.

The pooling of income in this way can allow for better opportunities , rates with lenders and return on investment.

commercial property investment in the UK

Indirect property funds

If you plan on investing in commercial property indirectly, it is useful to note that this is not an accurate representation of how an individual deal or property is doing. This is because you’ll be investing in a share in the stock market.

These investment opportunities are sometimes called Real Estate Investment Trusts (REITS) where any member of the public can invest a small or large amount in a publicly traded company whose stock rises and falls based on the demand of the investors rather than the actual performance of the property portfolio.

These investments are generally considered safe. However, there have been instances where the stock prie did not reflect the reality of the health of the investment portfolio.

For example, read the article here to find out how this world is in the real world.

What goes into finding a good commercial property investment?

 The correct steps to follow are similar to finding a good investment in a residential property or any investment in general in property. They include making sure you understand the client (tenants) and the demand of renters.

As well as this, it is definitely worth trying to predict the return on investment in the future and having an exit strategy. Whether this is based on capital appreciation or rental yield, this does not matter.

Working out whether to rent or buy a commercial property

Considering to rent rather than buy or buy rather than rent can potentially turn a good deal in commercial property investing into a great one. This is because there are pros and cons to each that can alter the return you make.

This means if a n estate agent or seller is encouraging either one, considering if they’d be open to a different type of set up for their property could be worthwhile.

Because commercial property investments are often larger investments, there are usually less potential buyers. This means the deal is more likely to be successfully renegotiated. So, be sure to ask questions and barter.

Pros of renting commercially

  • Low maintenance cost for the commercial property
  • You remain liquid without having to pay significant deposit
  • There are deductible, allowable expenses 
  • Relocation and exiting a deal is far easier
  • You won’t have to pay a mortgage that can be costly

Cons of renting commercially

  • You may be charged service charge on top of rent
  • You have to pay rent for the entire term of the agreement you have signed for
  • There is not option to benefit from commercial property capital appreciation

You also should consider the additional tax you have to pay in the eve that you buy a commercial property like stamp duty. Check out our stamp duty calculator to find out what his figure is for you.

Understand how strong the tenant is

Understanding the tenant is crucial to gain an understanding of whether a commercial property investment is the right thing for you. 

A stronger tenant is seen as a commercial client who has a business that is more reliable. Look for previous bank statements, whether the company is in debt and new propositions for the business.

You can check all of this out and do your own due diligence on companies’ houses using the government website here

Know how the market is likely to perform

If the market performs well, there can be a large difference in the outcome of a commercial property investment. Especially when there is a mortgage interest rates are considered or there is a variable rate mortgage like in a buy to let mortgage.

For example, if you’re buying a commercial property with a longer mortgage over decades and the interest rate is high at the moet, you may want to hold off until the interest rates climb back down.

This can result in a huge saving over years to come. However, sometimes it is feasible to buy a property commercially despite the higher mortgage interest rate as you can refinance or remortgage the property later on.

This all comes down to the investor, how confident they are in the market, what kind of return they are looking for, what their tolerance is for risk and the predicted rental demand in the future. 

All in all, it is definitely worth considering and weighing up these options.

What the return is likely to be 

Typically, if you are a large scale commercial property investor, you would already have potentially bought a second home or looked at other ways of investing in property as commercial investing is viewed as fairly complicated.

This means you’d expect an investment of around 5% – 12% depending on the deal where the more maintenance a commercial investment needs, the larger the lower the rental yield as a general rule.

What is a good return on a commercial property?

A good return on a commercial property would be around 10%. However this largely depends on the type of client there is and what the economic climate is like.

This can all be understood better by reading more about rental yield using our article.

Commercial property investment vs residential property investment

Residential properties have tenants who are living in a property so the use for the property is completely different. On top of this, the type of mortgage that is used in this case is different with a different application and approval process.

There are a bunch of other factors that you should be aware of to inform you as you invest below.

Capital appreciation

Capital appreciation for those looking at a residential investment will typically be less on average. Therefore commercial property appreciation is superior if an investor is looking to make money through selling rather than renting.

Capital value growth of commercial property in the UK

As you can see below, the sectors of commercial property investment shown by data by Statista shows there is a wild predicted variation in where the most appreciation will come from.

Industrial sites will remain the most profitable whereas it is likely shopping centres will face a loss for the next few years.

commercial property capital value

Rental value growth of commercial property in the UK

When looking at capital appreciation, it is also useful to look at the rental appreciation. For instance investing in standard retail could seem like a good idea by just looking at the capital appreciation.

On the other hand, when looking at the graph below to compare it there is a predicted dop in rental demand in this sector in the future making it less appealing for investors.

commercial property rent value

Hidden VAT charge

If you buy a commercial property that is worth over £400,000, you may have to pay a surcharge on the amount of VAT you pay. This should be looked at on a case by case basis as there are a few factors that determine this you can find here.

However, this is one of the reasons why it may be better to get involved with a residential property investment rather than a commercial one.

Purchase price

In terms of the purchase price, commercial properties are often a lot more expensive and those who are able to afford to invest in a commercial deal are therefore often wealthier.

As a result, a lot of commercial deals are done as joint ventures where multiple people try to get involved with the same deal by pooling their money and taking a percentage of the profits relative to their deposit.

Wrapping things up

In conclusion, commercial property investment can be a profitable and stable option for those looking to diversify their portfolio and earn a steady stream of income. 

However, not unless they take the right steps to make sure their investment is suitable. On top of this, it is crucial for inventors to make sure they are in the right position financially to ensure they have enough capital to make it through a commercial deal.

A lot more is typically required when comparing commercial investments to residential ones so it is important to do your research and understand the risks and rewards associated with this type of investment in this way.

Finally, looking at the investment strategy that suits the investor will also aid their ability to manage and maintain the property effectively. You don’t want to be out of your depth and lose money on deals.

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donnell-bailey

Donnell Bailey

Property expert

Donnell is a property expert focusing on the property market, he looks at a combination of legislation, information from property managers, letting agents and market trends to produce information to help landlords.