We take a look at UK commercial property, giving information on what it is, and how it works. We explain the benefits and limitations of this asset class from an investor’s viewpoint.
What is commercial property?
Commercial property is defined as any property which is not used for domestic dwellings. Within this broad definition, commercial property can include a range of property types. Included within this sector are shops, restaurants, offices, warehouses, hotels, medical centres, vehicle showrooms and everything else in between.
The common theme of this property type is it is leased out to corporate tenants whose primary objective is to use the property to generate income from their business activities.
What are the major commercial property types?
There are several ways of grouping these property types and there is no clear answer as to which way is best. For illustrative purposes, we have identified five primary types of commercial property. These are:
- Offices. This can be a small office above a shop to large purpose built skyscrapers in city locations.
- Retail. This includes shops, boutiques, supermarkets and shopping centres.
- Industrial. Typically this incorporates factories and warehouses.
- Leisure. Included within this list are hotels, sports facilities, restaurants and pubs.
- Healthcare. This includes private hospitals, nursing homes and medical centres.
Another area of commercial property can include multiple family rentals. We have excluded it from this review. Additionally, you can invest in commercial property via funds and equities. However, for our classification, they are also excluded. We are solely focusing on direct investments into non-residential property. For information on property funds, click here.
What are the advantages of commercial property?
- High Yielding. Commercial property is known for its higher rental yield compared to residential property. In high-quality locations where the amount of new construction is either limited by land or law, returns can be considerable, with tremendous cash flow potential. Generally speaking, Industrial buildings such as factories and warehouses generate a lower rent. However, the overhead costs are far lower compared to tower offices.
- Long term rentals. Commercial real estate tends to have longer lease contracts. It is not uncommon for leases to be 10 years plus. This differs significantly from residential property, which tends to be based on a rolling six-month contract. Having a long lease length gives the owner a high degree of cash flow stability, assuming long-term tenants occupy the building.
- Opportunity for capital growth. Commercial property can appreciate, as long as the property is well-maintained and kept up to date. Though in recent years, it has not shown the same level of growth as resident property.
- Diversification. Commercial real estate is an asset class in its own right. This means it can act as a hedge against your existing residential property investments.
- Stamp duty. Buying commercial property is taxed differently compared to buy-to-let property. There is no surcharge. This investment is tiered so you only have the higher rates for the parts above each threshold. The maximum tier is also far lower compared to residential property. You can find information directly from the government here.
|£0 – £150,000
|£150,000 – £250,000
What are the disadvantages of commercial property?
- Regulation. This is one of the main deterrents for most people would be commercial real estate investors. The purchasing and maintenance responsibilities for commercial properties are buried in layers of legalese. These rules, regulations and requirements change by county, industry, property size, zoning, and many other variables.
- Complexity. Not only is the regulation difficult to decipher. There are additional complexities in finance for securing the property, as well as understanding how the market will evolve.
- Tenant security. Whilst leases are usually long term by nature, there is no guarantee that your business tenant can or will honour the contract. In the last two years, since the onset of Covid, many businesses have not continued with their long term rental obligations.
- Refurbishment costs. Frequently commercial needs change. When a new tenant comes into the property, they may have very different needs from the previous tenant. The owner has to adapt the space to the tenant’s specialist trade. This contrasts with a residential property where tenants’ needs remain more or less the same. Even in typical office spaces, tenants’ needs have evolved. This means that the property will look dated quickly and this will impact the yield unless constantly refurbished.
- Lack of liquidity. Commercial property tends to be very illiquid by nature. So any investor is unlikely to be able to sell immediately at full market price. This lack of liquidity makes the asset class more volatile compared to residential property.
- Expensive. For investors looking at buying a commercial property directly, it is likely to be a lot more expensive. As a result, many would-be investors are priced out of the market.
Savills remain positive in their economic forecast for the UK commercial property sector for 2022. Their findings are that 2021 exceeded expectations in the sector. With many people returning to work, as low levels of unemployment have increased the uptake of commercial units. This has resulted in the price of commercial property rebounding to almost pre-Covid levels. Consequently, the yield on commercial property has lowered this is inversely related to capital values. A table taken from Savills market report illustrates this point. As you can see yields are lower now compared to the Covid peak, except for retail.
Savills reported that total UK commercial real estate investment volumes reached £57billion in 2021. This was a rise of 21% compared to 2020 figures. They forecast figures to rise by a further 10% this year despite rising energy costs, high inflation, and political uncertainty.
Investment in shopping centres has increased dramatically and this should see their yields fall at the end of the cycle when more stock becomes available.
Should I invest in commercial property?
The answer to this question is not that straightforward. Due to the regulation and complexities of this sector, the average investor may be better served by investing in commercial property via funds. However, high-net-worth and sophisticated investors could see value in this sector due to the lower taxation compared to residential buy-to-lets. They may also prefer longer-term yields.
If you are unsure about commercial property and would like to speak with a property expert then we would be happy to hear from you.