14 November 2019/ sale_commercial_property_guide

Investing in commercial real estate

Investing in commercial property is a popular way to make money in the long term. Today, the UK’s commercial real estate market is estimated to be worth £871 billion and most investors only part with around £500 when joining a property fund. You could even put just £50 per month towards it instead. So, the commercial real estate market provides plenty of scope to generate an impressive return on investment.

Most commercial property falls under one of three key categories; retail (which includes shops, supermarkets and retail parks), office space (including business parks) and industrial units (such as warehouses and industrial estates). But, of course, the sector stretches much further than this. It also comprises buildings linked to the leisure industry, such as hotels, cinemas and restaurants, and healthcare, with its hospitals, doctors surgeries and nursing homes.

When it comes to making money from commercial real estate, there are two main ways investors can capitalise on their cash:

  1. In the short term, you can collect rental payments from commercial tenants.
  2. In the long term, you can sell the property on for a higher price than you bought it for.

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How do you own commercial property?

You have three principal options when you want to invest in commercial real estate:

  1. Making a direct investment – This is probably the least popular way to own real estate, as it can be expensive. It involves buying all of – or a share in – a specific property.

  2. Investing in a direct real estate fund – In this scenario, you own property by putting money into a collective investment scheme that has a portfolio of different buildings. This could be a unit trust, investment trust or open-ended investment company. You then make money from rental income and any increase in value generated by the property over time. There are downsides to this; you may lose money during times when the property lies vacant, and the building value may decrease.

  3. Investing in an indirect real estate fund – In this case, you hand your money over to collective investment companies that own commercial property. You own shares in them and make a return on your investment through dividends paid by the company. If the value of your shares grows over time, you’ll also make money when you sell them on. 

What is the average return on commercial property?

As you might imagine, the amount of money generated through property investment varies depending on the type of building chosen and its location. To give you an idea, here is Savills’ most recent market analysis, showing the average yield of different types of real estate and how these figures changed between 2018 and 2019:

 

January 2018 (%)

January 2019 (%)

West End offices

3.25

3.5

City offices

4

4

Offices M25

5

5

Provincial offices

4.75

4.75

High street retail

4

4.5

Shopping centres

4.75

5.25

Retail warehouse (open A1)

5

6

Retail warehouse (restricted)

5.25

6.25

Food stores (OMR)

4.5

4.75

Industrial distribution (OMR)

4.5

4.25

Industrial multi-lets

4.25

4

Leisure parks

5

5.5

Regional hotels

4.5

4.25


You can see that seven out of 13 property subdivisions benefitted from an increase in average yield of up to 1%. In the same period, the yield from regional hotels and industrial distribution and multi-lets suffered. While property yields can never be guaranteed, investors could use these figures to get an idea of the most profitable sectors before they hand money over themselves.

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Why should you invest in commercial real estate?

There are many advantages when it comes to putting your capital into commercial real estate:

  • Commercial buildings usually generate a higher return on investment than residential ones – business-related properties can have an annual return of up to 12%, while single family homes in the residential sector produce between 1 and 4%.

  • While buying shares in UK businesses can be more lucrative, the return on investment in real estate should be more consistent, making it easier to put together financial projections and plan for the future.

  • If tenants have a triple net lease, you can avoid paying extra costs like maintenance fees, property taxes and insurance.

  • While most residential rental contracts usually last between six months and a year, commercial property leases cover a much longer period of time – on average, leases last around eight years in the UK, a figure which rises to 10-15 years in London. This means you can benefit from consistent revenue in the long term without having to regularly welcome new tenants.

  • Because income from commercial property is fairly stable, you can add this type of investment to your portfolio in order to balance out riskier ventures.

  • Choosing to get into commercial real estate rather than residential property means you’ll be dealing with businesses, so any communication with tenants should be polite and professional.

  • If you invest in retail property, it’s likely your tenants will keep it in good condition so it keeps attracting customers.

  • Your tenants will almost certainly use your premises during the day so, unless the burglar or fire alarm goes off, the risk of issues cropping up overnight is minimal – you should be able to sleep well and resolve any problems as you go about your daily business. 

Potential downsides of investing in commercial real estate

With the good comes the bad. Here’s why you might be wary about owning commercial property:

  • Income from commercial property isn’t guaranteed – if the economy suffers, it’s likely your earnings will too.

  • It can be expensive to buy property – You will have to spend money not only on the building itself, but also on any transaction costs. These add up when you buy or sell properties, as you’ll need to spend up to 5% of the purchase price on stamp duty alone.

  • Commercial properties tend to be far bigger than residential ones and it’s likely there will be a lot of people going in and out of it every day. As a result, the risk of damage to the building and injuries sustained by the people using it are higher. The scale of the work required and the amount it costs will be much greater too. If you decide to hire management or maintenance professionals, you will probably have to part with 5-10% of your rental income.

  • If you opt to resolve any issues yourself, you may end up spending a lot of your free time dealing with repairs and maintenance – especially if you’ve got multiple leases.

  • It can take a long time to access your capital once you’ve invested it – this is mainly because selling property can be a lengthy process, particularly in times of economic downturn.

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Things to consider when investing in commercial real estate

You’ve decided commercial real estate investing is for you – what next? Here are a few steps to get you started:

  1. Work out your budget – If you’re buying shares, decide how much capital you’re willing to invest in them. If you plan to buy property, establish your deposit amount and determine how much you can take out with a mortgage.

  2. Decide which sector you want to invest in – From shopping centre stores to West End offices to industrial warehouses, there’s lots of choice when it comes to investing in commercial real estate. Each type of building will have its pros and cons, but it’s up to you to decide which best suits your lifestyle, requirements, budget and ambition.

  3. Narrow down your location – This will be an easier task if you’ve already chosen the type of property you want to invest in. For example, if you’d like to spend your money on a warehouse, you’ll probably have to research industrial parks. You can maximise your income by choosing a reasonably priced investment in a practical location. Opting for an office in a more rural location could be a safe bet, as many business owners will be looking to save money by hiring commercial space outside of a city centre with car parks and nearby transport hubs.

  4. Choose your investment method – Your decision to make a direct investment or contribute to a direct or indirect real estate fund will be influenced by the specific property you’re looking at, if you’ve already chosen one. Take the time to work out which investment type suits your budget; it’s vital you can comfortably afford it, otherwise you may end up struggling financially further down the line.

Finding the right property

Search for commercial property currently on the market, including retail (which includes shops, supermarkets and retail parks), office space (including business parks) and industrial units (such as warehouses and industrial estates).