Buying residential property investments has been all the talk throughout the turn of the century, providing security above and beyond riskier investments such as shares and commodities.
The 2007 global financial crisis saw an end to that thinking, with many investors left in financial tatters and highlighting the risk of residential property investment.
Investment managers always discuss diversifying your investments in many other vehicles. So as property goes – is commercial property an good investment?
The questions to ask are;
- Is commercial property riskier than residential?
- Is it a better class of investment than equities, bonds, gilts, shares and etc?
- Is it a long term or short trading option?
What are the options to Investing in Commercial Properties?
1. Buy a Commercial Property:
This is probably the ideal way of getting involved commercial property. You will, however, need a commercial mortgage if you are not buying cash. Typically you are looking at 60/40 – that is the lender will lend 60% of the value of the property.
2. Commercial Funds:
There are great number of funds that invest in larger commercial schemes ranging from large care homes, warehouses, offices, through to supermarkets. Typically these funds have a fixed return on your investment and some cases dividends on shares
3. Property Fund Managers:
These are funds that buy shares in property related companies that operate in construction of residential and commercial property, through to infrastructure such as roads, sewers, hospitals, government buildings and etc. However, the risk – as will all shares – they are exposed to the financial markets – local and global.
From a control and returns perspective – option 1 can be the most lucrative. You earn money through;
- Rental Income
- Capital Growth
Residential Buy-to-let property
Many, who own their properties, implicitly understand capital growth ‘I Bought my property 5 years ago and now it’s worth £50,000 more’. And the next stage of buying a property to let seems a little step – that is if you have a deposit and buy to let mortgage!
It goes without stating that all investments have their risks if you don’t protect yourself.
Buy-to-let mortgages
You will need a deposit. The buy-to-let mortgage market is significantly more regulated that it was in the early 2000’s. Today;
- You need a bigger deposit typically 15% to 40% depending on lender
- You will need a ‘squeaky clean’ credit history
- The ability to pay the mortgage if the tenant fails to pay their monthly rent or there is a problem in rent receipts
- Rental incomes must be 125% of the mortgage payments
- You will need to factor in pending tax changes as well
(Worth considering repayment mortgages over interest only or a mixed rate mortgage)
Buying Investment Property
When looking for a good real estate investment two equations are used to determine how successful a property investment is rental yield.
- Calculating Yield
- Your total cost of buying your investment property
- Purchase Price
- Stamp Duty
- Costs of Renovation
- Solicitors and Estate Agent Fees
- Broker Fees (if any)
- (Any other costs incurred in buying the property)
- Calculate – Annual Rent
And divide this by the total cost of the property and multiply by 100 to get gross yield percentage.
- Calculating Rental Yields
This determines whether it is a good or bad investment. Calculate total annual expenses;
- Repair Costs
- Agent Fees
- Property Taxes
- The Interest Paid on Mortgage (Remember it is tapering relief and begins in April 2017)
To determine rental yield then take the above annualised costs from total annual rental and divide by the net purchase price to give you the total net yield.
Once you have determined the rental yield, then you can look at whether your money is better deployed in a ‘Buy to Let’ property or in a bank!
Investing in commercial property
Most investors are involved in building residential property portfolios.
This mainly due to;
- They understand a two up two down
- Mortgages are ‘readily’ available
- They see their mates doing it
Commercial has some pros and cons.
The cons are quiet simple
- Bigger deposits
- Bank lending – Commercial
- Charges can be higher
- Some commercial properties attract VAT
- Cost prohibitive for larger industrial units, factories,
The pros are even simpler
- Tenancies are longer – average leases are 10 to 15 years.
- Most leases are self-repairing – that is the tenant has to look at the fabric of the building
- Rental Yields are generally better – Mixed commercials provide a great way of generating much higher rental yields (These properties have residential accommodation – Hotels, Restaurants, Salons, Public Bars, Shops and Takeaways).
There are other commercial vehicles to invest in such as OEIC’s or Investment Trusts
Open Ended Investment Companies (OEIC’s)
This type of investment allows investors to pool their monies together to buy into many types of bonds and equities without too much financial exposure. The funds are domiciled in the UK and involve themselves in different property sectors and niches – from Care Homes through to Private Hospitals.
The investor can buy and sell these equities and bonds from as little as £500, limiting themselves to market exposure.
Property Investment Trusts
These are public limited companies that issue a fixed number of shares and known as closed ended funds. Shares are traded on the stock exchange, the values of these shares is guided by the type of investment property and share demand.
Another feature of property investment trusts is that the shares can be geared to borrow money – so depending on trust it’s wise to determine their gearing.
Real Estate Investment Trusts (REITs)
The majority of property investment funds are REITs as they manage and own income producing residential of commercial properties. They tend to be tax efficient – but check that with your accountant or broker.
Many REIT’s focus on commercial development and these are subject to market conditions. So check where they are investing geographically as they could be exposed to the local market conditions.
Commercial property funds
There are essentially two types of commercial property funds.
Bricks-and-Mortar
The property investment funds own and manage the properties directly. They spread the risk across a wide number of property types – Shops, Factories, Warehouses, etc and geographic regions.
You benefit in two ways;
- Rental Income – giving an annual return
- When you sell your shares – Growth on the value of property
Pros and Cons of direct commercial property investment funds
Many of the commercial properties are on long term rentals, typically 10 to 15 years and attract upward rent reviews and are subject to annual inflation increases.
Other benefits;
- You are not managing the property
- Not looking for tenants
- Generally invest in quality property with good covenants
The downside is that in a downturn market
- Properties do not rent easily
- Tenancy voids can be for months if not years
- Shares go down in value –
During the crash of 2007/08 – shareholders could sell their shares as the funds had to liquidate the assets – in some cases it took 12 months before a shareholder could sell…and at a loss!
Indirect commercial property funds
We have discussed these earlier in OEICs Buying shares in companies that invest in companies don’t have the liquidity problems that direct commercial property funds have, allowing you to buy and sell freely.
Returns are like another share you would buy and volatility of market forces mean they go up…as well as down!
Like any other shares there are annual returns on your investment – (Or not as the case may be!) – these through the share increasing in value or dividend income, rather than the capital gain on the property directly or rental income. But while you get the benefit of the liquidity of an equity-like product, you also get the volatility of investing on the stock market.
Buying Commercial Property
The decision is one of looking at reduced risk and exposure to commercial property. Whislt property investment trusts and OEICs are reduced exposure – you have little control over the investment and still have tax liabilities.
Buying your own commercial benefits can yield good capital gain returns and typically better rental yields. Many commercial units allow for permitted development rights. This is a government scheme that allows for a change of use on a property without the need for any planning permissions.
This gives a reason for the property investor to seek out properties that have this gain. Many offices and retail units in towns have seen a mass conversion to flats – for the student market and homebuyers.
The UK housing market is short of housing – government stating that another 200,000 houses a year need to be built but that has been the case for decades. To overcome this many local councils are allowing the permitted build of residential property in commercial premises.
(Research by Santander)
Britain’s population is set to increase to 70 million within a decade. The UK’s population stands at 65 million and another 5 million residents need to be housed.
Santandar predicts that the average house price in 2030 will be £560,000 from £285,000 today. That would be the equivalent of 9.7 times average income – today it is 7.9.
So the conclusion is a simple one. Commercial properties with a residential angle can yield rich rewards to investors that are prepared to consider the advantages over residential property.
The Property Buyers specialise in buying commercial and residential property. Our recent acquisitions have included public bars, restaurants, a number of care homes – now converted to residential flats and offices. We also hold large property porfolio of quality residential properties that we occassionally sell.