Why Invest In Commercial Property
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- 07-02-2022
What Is A Commercial Investment?
Commercial investment is an investment in a for-profit enterprise, which is involved in the selling or buying of services and foods, with an expectation of generating cash flow. A group, an institution, or an individual can assume this type of investment. Usually, the commercial investment will be made up of a group of investors who will combine their assets to fund a commercial venture.
A commercial investment occurs when investors commit capital or money to purchase a for-profit business or property. This enterprise may just be a partial investment as a part of a group, or can just be purchased by a sole investor. There are several varieties of commercial investment examples; these include real estate properties, such as industrial complexes, hotels, apartment complexes, office buildings, and more.
Franchises are one of the most common types of commercial investment. Many low-cost franchises will require spending of around £8000 or less. This can be an excellent way to gain experience in the commercial investment field with a comparatively small amount of initial capital.
Smart investors who have a good eye for spotting up-and-coming locations on the cusp of rapid growth can get relatively strong bargains before the local market begins to soar. Your profit potential will depend largely on the location and how the rental markets in that area are performing. For many markets, commercial properties will increase in value much quicker than residential properties.
Why invest in commercial property?
Purchasing a property will not only just put a roof over your head and provide financial security over a long term period of time, but if you play your cards right, it can also be a great way to invest your money.
But of course, it is not completely safe, it is of the highest importance to keep this in mind.
For example, the 2007 financial crisis saw hundreds of property investors getting their fingers burnt by bad choices.
This time perfectly illustrates that investing in property is never without risk, no matter how much of a sure bet it may seem.
Commercial property is an important asset class to think about as a method of diversifying or spreading risk in your investment portfolio. Usually, property isn't highly correlated to other asset classes such as stocks, bonds, and cash. This means that property values move completely independently of other assets. They aren't typically affected by the goings-on within the stock market.
Types of property investing?
There are several completely different ways to get exposure to property as an investment.
Direct Investment
For private investors, the direct investment in a property means purchasing all of, or simply a share in, a property. For the majority of people, this is not at all a practical way of gaining exposure to the commercial property market.
Indirect Property Funds
Indirect property funds are collective investment schemes that invest in the shares of a property company that are listed on the current stock market. They do not have the same level of benefits of diversification as direct investment in properties. This is because property shares can move up and down with the stock markets.
It is vital to remember that there are only two main ways that you can earn money through commercial property investment. Firstly, income from renting the property to a tenant. Secondly, overall capital growth through an increase in the value of the property.
Direct Commercial Property Funds
These are also referred to as brick and mortar funds. They are a much more common way for people to invest in commercial properties through a collective investment scheme such as a unit trust, investment trust, or an open-ended investment company.
These invest directly into a selection of commercial properties such as warehouses, offices, and supermarkets, which would otherwise be completely inaccessible to smaller investors.
Is Commercial Property Profitable?
Of course, any budding commercial real estate investor will have to weigh up the revenue potential of a commercial property against any asset classes which are available on the market. Even if we were just to make a very quick comparison between the yields from commercial properties and residential properties, then the average rental taking in the UK is around 3.53%. The stats show that the vast majority of UK commercial property yields much outperform this average figure. Some locations, such as shopping centres, are more than double the average UK rental yield.
When it comes to the profitability of the indirect real estate stocks and shares investment, commercial property funds have recorded a 3% average growth every year since 2000.
Successful funds have managed to achieve and reach much higher growth rates. The AXA UK Long Lease Fund recorded a 6.6% five-year growth.
The Standard Life Investments Long Lease Property Fund achieved even more with a 7% five-year growth.
No matter whether you are considering indirect or direct commercial property investment, commercial real estate is shown to be clearly very profitable.
Keep in mind, of course, that the world of investments is constantly shifting.
In the investment field, there are many trends to be taken into account, especially in current times, the reduction in office space use due to COVID-19 and the rise of people working from home with their business set-ups. But just like everything with investments, when one door closes, another opens. The decline in office demand has led to an increase in office conversions into houses and flats. We highly recommend keeping this in mind.
This is one of the most unique quirks and caveats when speaking about commercial properties. There is a huge scope for redevelopment and renovation. This is partly because of the slowly relaxing planning laws and the Permitted Development Rights.
Direct Commercial Property Investment Types
Direct property investment is the process of directly purchasing a share in a property or a whole property. There are three main avenues to earn money on a direct commercial property investment.
Method 1
Use a buy-to-let model. Purchase the property and lease it to tenants.
Method 2
Make some kind of change to the property and then lease the property or sell it on.
Method 3
Flip the property in the short term without making any major changes.
Below is a more detailed analysis of the three methods.
Method 1 is a buy-to-let model, it is by far the most common and conventional approach. This model allows the investor to act purpose-designed buy-to-let financing, which creates a straightforward deal.
Though interest rates will be higher than average, and you will require a much higher deposit. The deposit will probably be somewhere between 20% and 40% of the property's total value.
Method 2 will most likely require the investor to pay in cash, or they will have to provide an incredibly large sum of cash upfront. This is done because there will be no tenants during the redevelopment process, meaning the investor will have to cover the mortgage using other cash flows.
Bridging finance is another option, and there are particular specialist mortgages designed for this type of investment. The method is similar to fix-and-flip investments in residential properties. Upgrades can hugely enhance the value and profitability of a building and will also enable the investor to locate higher-value tenants.
Method 3 is by far the most conventional and common in residential property fields. This method is where seasoned property flippers will locate new buyers for a house before the flipper have been completed the transaction.
You may wonder why on Earth they would do this. This allows the flipper to complete the transaction and then immediately sell the property to the new buyer, earning the flipper a very nice quick property. An example of this would be locating a specialist building that is being advertised at a price that would be considered underpriced.
Next, you find a buyer who has been in the market for this type of building for a while.
The final steps are to actually purchase the underpriced property and then sell it on to the new buyer at a great profit. Now, of course, this doesn't work for every property.
Margins need to be big enough that you can afford to pay stamp duty and other fees.
The method also needs to be compared against the total profitability of simply leasing the property instead. In many cases, leasing the property will work out to be more of a worthwhile venture.
Buy-to-Let Commercial Property Investments
The buy-to-let method is by far the most conventional direct commercial property investment strategy. Just like with residential properties, the idea is incredibly simple. You can buy the property and then let it out to tenants who will pay you a rental income, either months or quarterly.
Commercial lease agreements are most commonly longer than residential shorthold tenancies or ASTs, also known as Assured Shorthold Tenancy. These agreements will also place all of the repair and maintenance responsibilities on the leaseholder. Keep in mind that this can vary, though. The biggest risk is that tenants default on their rent. This is why mortgage interest rates are higher, but this will depend on other financial factors.
Generally, lenders will typically take rental income of around 125%. So 25% in excess of the monthly mortgage repayments. It is always absolutely vital to factor vacancy rates into your net operating income calculations to adjust for the times where you have no tenants using the property.
Are you looking for advice about investing in commercial properties?
Contact us and give us a call about any information or advice about property assessments.
