Buying commercial property is very similar to buying a buy-to-let investment – you research which type of premises you want and in which area you want it, take out a mortgage, and collect rent from a tenant.
Arguably, it makes far more sense to invest in commercial premises because, if you already own a home, you probably don't need any more exposure to the residential housing market, particularly at a time when house prices are falling. Commercial property prices have become far less correlated with residential prices in the past five years although, importantly, both still have a low correlation with equities.
There is, however, one very important difference between commercial and residential property. Whereas you can easily pick up a flat for £150,000 outside a major city, you will need to invest at least £500,000 to secure commercial premises. And even this sum will only secure a small outlet in a regional location – for something in the south east, for example, you will need £1m-plus to secure a prime site. The rental income you receive will, of course, be considerably greater, but there are two major advantages that this substantial investment will secure.
First, commercial leases usually run for at least 10 years, and often 20 years or more – particularly in the retail sector - compared with just six to 12 months for residential leases. This means that you don't have the hassle of finding new tenants every year, and you don't have to worry about 'voids' – when your property is empty and you have no rent to cover your mortgage payments.
The second advantage is that you are leasing your property to businesses rather than individuals – Lloyds TSB, for example, is likely to be a far more reliable tenant than John Smith.
Choosing the right kind of premises and the right location is key. "If you secure a prime product in a prime location, you could be looking at yields of 8 to 9 per cent," says Mr Lang. He particularly likes offices in towns along the M4 corridor, such as Maidenhead, Reading and Slough, where there is lots of space ready to accommodate expanding IT companies that are doing well after a difficult few years. He also highlights the importance of considering the general vitality of the town from a residential point of view, as companies tend to be interested in setting up offices in areas that are attractive to prospective employees.
Taking the plunge
If you are going to take the plunge and buy commercial premises, you need to do a great deal of research – as you would for any investment that requires an initial outlay of at least £500,000. Once you have a pretty good idea of what you are after, you need to contact one of the major commercial property auctioneers such as Allsop (www.allsop.co.uk), Jones Lang LaSalle (www.joneslanglasalle.com), Nelson Bakewell (www.nelson-bakewell.com), FPD Savills (www.fpdsavills.co.uk) and Cushman & Wakefield (www.cushwake.com). They will also be able to offer advice on the best property to suit your specific requirements.
Borrowing costs
Once you have found a property, you will need to arrange finance. This is the single most important aspect of any commercial property transaction, as you need to ensure that your repayments are less than the rent you receive. As David Yeadon, director of Savills Private Finance, warns: "If you want gearing [borrowing to invest] up to the maximum, you may well find that your rent only just covers your repayments." And if you are not adequately covered, a small rise in interest rates could leave you in serious trouble.
Mortgages on commercial properties are more expensive than their residential, buy-to-let counterparts. You will generally pay 1 per cent above what the lenders call "the cost of funds", which is simply the rate they themselves borrow the money at. You will need to pay at least 20 per cent of the total value up front.
Most mortgage providers, banks and building societies have a commercial lending department. Alternatively, you could use an independent broker to find you the best deal – 80 per cent of all residential mortgages are arranged through a broker, but less than 20 per cent of commercial deals are done this way. Most brokers will charge a fee, typically between 0.25 and 1 per cent of the total value of the loan, together with an application fee. This may sound like a lot, but their specialist knowledge of the different providers on the market can save you a lot of money over the life of the mortgage.
When deciding how much to borrow, you need to factor in some hefty upfront charges. Stamp duty alone is 4 per cent (on properties worth over £500,000, and 3 per cent on those worth between £250,000 and £500,000). So, together with agents' and solicitors' fees, and VAT, you can expect to pay approximately 5.75 per cent in total, says Mr Yeadon.
Leasing arrangements
Commercial property leases are fairly standard, but there are a number of clauses that you need to insist on. To protect against any future interest rate rises, and resulting increase in mortgage repayments, you must ensure that the lease provides for upward-only rent reviews – for example, every five years. You must also ensure that your tenant has signed a full repairing and insuring lease, which means that the tenant is responsible for all upkeep and insurance costs. The ability to insert this clause into any lease is another major advantage over buy-to-let residential investments, where the landlord is responsible for all maintenance and repairs. Finally, you can insist on a privity of contract lease, which ensures that the original tenant is ultimately responsible for paying rent, even if they decide to sub-let.
There are no other major costs involved if you are happy to manage the property yourself – which involves little more than ensuring the rent is paid on time. If you are not, then you will have to appoint a managing agent, which will typically take 10 per cent of rents collected as a fee.
Group together
If you cannot afford to buy a property yourself you can join a syndicate, where your money is pooled with that of other investors to make up the necessary amount. There is nothing to stop you forming your own syndicate with friends, although you will need good advice from a lawyer and a chartered surveyor, or you could go through a local independent financial adviser, a number of which already run such schemes. Just make sure there are sufficient provisions made should you decide to exit the scheme.
