I cut my teeth in the world of residential buy-to-let in 1990. But it wasn’t until 2003 when I discovered the joyous world of commercial property buy-to-let.
The attraction of commercial property was quite clear:
- Long term, ten year commercial leases instead of having to find a new residential tenant every 6 or 12 months;
- Commercial leases are FRI (Full Repairing & Insuring). This means that your commercial tenant is responsible for many of the obligations which would normally be yours, with residential tenancies. (ie: Your tenant will pay for buildings insurance and for repairs);
- Commercial rents are paid quarterly in advance, instead of monthly as with residential tenancies. (This is very good for the overall cash-flow of your rentals business);
- The management effort required to run a commercial property portfolio is much lower than a similar sized residential portfolio.
Today the case for investing in commercial property buy-to-let has never been more compelling:
Avoid the Section 24 tax!
The Section 24 tax being implemented from April 2017 will see buy-to-let investors pay tax on their mortgage interest payments for residential property held in their own names.
However, the Section 24 tax does NOT apply to loan interest on commercial property held by private individuals.
In a nut-shell, if you own a portfolio of commercial buy-to-let property in your own name then you will be able to continue to claim all the mortgage interest payments against your rental income.
Less regulation than residential buy-to-let
There is ever increasing regulation coming into the residential rental sector. There is a real prospect of mandatory national HMO licensing being introduced in coming years. As more voters become renters, there will be increasing political will for ever more regulation in favour of residential tenant interests.
Since commercial tenancy leases are essentially business-to-business contracts, there is much less political drive to over-regulate the commercial property rental sector.
Financing
‘In the old days’ a key disincentive to invest in commercial property was that you required a lot more cash to get started, as compared with residential property.
Back then residential buy-to-let mortgages were available at 85% to 90% Loan To Value (LTV), while commercial property Buy-to-let mortgages were offered at 55% to 60% LTV.
However, these days’ residential buy-to-let LTVs’ have fallen to 70% to 75%. Over the next few months, we will see the implementation of tougher buy-to-let lending criteria on individual borrowers, which will see residential buy to let LTVs’ fall further, probably to 65% LTV.
Going forward, there isn’t going to be that much in it between the cash deposit required to purchase a commercial property over a residential property.
Lower SDLT (Stamp Duty & Land Tax)
Earlier this year residential buy-to-let property purchases were subjected to an additional 3% SDLT surcharge. Particularly in London and the South East, this has dramatically impacted the financial viability of many projects.
The SDLT payable on commercial property purchases is different to that paid on residential property and there is no 3% surcharge.
For example, on the purchase of a £500,000 residential buy-to-let property, the SDLT payable would be £30,000. However, the SDLT payable on a commercial property purchased for £500,000 would be just £14,500; ie less than half!
An interesting angle is that SDLT on mixed use property, (eg a shop with residential upper parts), is be charged at the commercial property SDLT rate on the whole building. (Consequently demand for mixed use property has surged in higher-value areas as savvy investors buy mixed use property and benefit from much lower overall SDLT)
Retail Shops: A good way to get started with commercial property
Success in renting out any property ultimately lies with knowing your target tenant market and understanding what they are prepared to pay the maximum rent for.
When I got started with commercial property, I focused on retail shops. We all visit shops and have some idea of the rental dynamics of our local shopping parades. Most people find the rental dynamics for shops much easier to get their heads around than the rental dynamics on offices and out of town warehouses.
Getting started with ixed use property comprising a shop with residential upper parts, means that you can transfer some of your existing skills and experience of residential buy-to-let to a commercial mixed use building.
The other attraction of mixed use property is better rental yields. A flat above a shop is usually worth less than a similar flat just around the corner on a normal residential street. However, the rental income on the flat above the shop won’t be much different. That means your yield will be higher.
What makes a good retail shop investment?
The market value of residential property is driven by owner-occupiers who desire to live in certain areas which dictates the price they are willing to pay. The rental value and quality of tenant, has little impact on the bricks and mortar value of a residential property.
On the other hand, the value of a commercial property is largely determined by the quality of the tenant who occupies it and the length and terms of their lease. The bricks and mortar value of a vacant commercial unit is far less than a tenanted unit.
For example, a retail unit let to a quality blue-chip chain store as tenant, on a ten-year lease, will be far more valuable than if let to a ‘mom-and-pop’ independent store operator on a five-year lease.
Many investors who buy tenanted commercial property at auction do so on a simple yield basis. For example, at an auction over the summer, a shop in Ramsgate, let to Specsavers sold for £380,000. The shop produces a rent of £30,000 per annum which represent a gross yield of 7.89%. If you had £380,000 in the bank earning next to nothing in interest, then it is obvious why this was a good purchase.
Value Investing
My approach to residential property has always been to seek out below market value opportunities where there is potential to add value.
With commercial property, the easiest way to follow this strategy is to buy a vacant retail unit and rent it to a quality tenant.
Of course, we all know that there are plenty of vacant retail premises around, many of which have been empty for many years. So, which vacant retail units are worth buying and which units are best to steer clear of?
Here are my criteria for assessing a vacant retail unit within a parade of shops:
Is the shop situated in a ‘primary’ or ‘secondary’ retail parade?