With the changes to the buy to let property market over the last 2-3 years, more and more landlords are turning their attention to commercial property. In this guide, I will break down why this is happening, how commercial mortgages work and the key points to consider before investing.
Why commercial property is such a popular investment
Commercial property can be an excellent investment as they tend to provide much stronger yields than residential buy to lets. In addition to the strong yields, they tend to be backed by long-term leases, often between 5-20 years, which in theory provides watertight income for a defined period.
These factors combined, plus the fact that there are often provisions in leases for rents to increase in line with inflation each year can make them an appealing option.
Some leases are ‘fully repairing and insuring’. This means that the tenant takes on the legal responsibility for both insuring the property and undertaking any repairs, including general wear and tear. This means that you’ll be receiving the property back in the same condition as when the lease was signed. This is a major benefit compared to residential investments, where you are responsible for both repairs and insurance of the property.
Picking up a bargain property
Vacant commercial properties are often much cheaper than those with solid leases in place. This means you can pick up vacant properties and increase the value quickly by finding a strong tenant who is happy to sign a long lease.
Where this approach is employed successfully, you can often refinance to release some of the uplift, allowing you to invest in further property. This strategy works especially well when you can fund the initial purchase in cash or using a bridging loan.
There does need to be an element of caution employed, however, as while the property sits vacant, you are liable for the business rates. Should it take longer than expected to find a tenant, this can add up to a significant amount.
How has pandemic has affected the commercial property market
The impact has certainly been felt throughout the market; however, some sectors have been affected far more heavily than others. For example, essential retail properties, such as local shops are a very strong investment and many retailers have had a strong 2020.
The flipside to this is pubs and other leisure properties. These businesses have often been forced to close at very short notice, which ultimately creates a threat of loss of rent, or even completely losing your tenant. This has created a lot of uncertainty in certain sectors and you may even struggle to secure finance if your tenant is in an industry which is considered high risk.
When looking at potential investments, you must consider how the pandemic has affected that industry, as this could have a significant short-term impact. In addition, you should also consider the long-term viability of that type of business, plus the other types of businesses who may wish to let the property if your tenant were to leave.
The finance options available
These property investments are usually funded using commercial investment mortgages. Commercial mortgages allow you to borrow up to 75% of the purchase price of the property, or the value for remortgages.
They work in much the same way as residential mortgages, with a lump sum being released upfront and monthly payments made to repay the loan. Some lenders will allow you to borrow on an interest-only basis, this is a popular way of improving cash flow by reducing your monthly costs.
The drawbacks of commercial property investment
Although the market can be a great one to invest in, as with every investment, there are some drawbacks. The main ones are the following:
- The commercial property market is less liquid than the residential market. This means that it can be tricky to secure the right price should you wish to dispose of the asset quickly. This means that commercial property investment is generally a longer-term strategy.
- The difficulties facing business owners due to the pandemic are ultimately the problem of their landlords. If your tenant falls into financial difficulty, the issue is likely to affect your rental income.
- Should you lose your tenants, or if the lease expires you will be liable for business rates of the property. This can be a strain on cash flow if you have a mortgage outstanding on the property, which will still need to be paid.
- It can take longer to find tenants for vacant properties, depending on the property and its location.
The main considerations before moving forward
The key to success is to fully understand the market before progressing. When looking to invest in commercial property for the first time, it’s wise to surround yourself with experts. You’ll need a good agent with local knowledge, an experienced commercial mortgage broker and a solicitor who is well versed in commercial property.
By working closely with experts, you’ll be able to avoid a lot of the common mistakes, while also learn a lot from them in a short space of time.
