“May you live in interesting times,” would seem to be the most appropriate phrase at the time of writing this article. As we find ourselves ever closer to Brexit, a General Election and whatever other unbelievable thing the Houses of Parliament, Lords and the Supreme Court can throw our way, we can take comfort in the fact that one thing has remained a constant amidst all this chaos.
Investment in commercial property.
The team here at Prideview Group have been advising their clients throughout the political and economic roller coaster that the UK has faced since the referendum in 2016. Commercial property investment became the order of the day at that point, and little has changed since. Private commercial investors sought ways to avoid being taxed excessively on projects such as residential buy to let property, and to minimise their risks by moving away from a stock market that has shown no sign of being any less volatile than it was just a few years ago.
With the Bank of England base rate at a continuing all time low, commercial property investment was, and indeed still is, seen as a steady and safe way to maximise the returns on one’s investment. Naturally, property investors understand that this is a long term game – the dizzy heights of fairy tale returns are reserved for the stock market, along with all of the risks and pitfalls that accompany them.
And so, to our commercial property investor, a calm and methodical approach is key, which is why we have prepared a checklist for everything that needs to be considered before launching in to any commercial property investment.
Now this list is by no means exhaustive, and it is not meant as any form of replacement to speaking with a qualified and experienced commercial property investment consultant. Moreover, not every item on this checklist will be relevant to you, but it’s a good idea that you tick at least seven of the so called ‘boxes’ from this list to give you just a little more peace of mind that you, and of course your investment capital, are heading in the right direction.
Location, Location, Location
It almost feels like a cliché now, but location continues to be the number one priority whenever considering property, be it residential or commercial, and for obvious reasons.
If, for example, you’re considering a high street shop unit, then it’s important to take a look at the foot traffic in the high street in question. Your tenants need to be running a successful shop in order to meet all of their operating expenses – namely, your rent. If a new shopping complex or superstore is under construction within less than a mile, then that high street is under threat from major competition.
But this is not an article designed just to show you what to avoid – you want to consider those positive aspects instead – those which show you a property with the potential for a good return.
Let’s consider office buildings for example. Just how close is it to public transport links for commuters? Could they walk to work from a nearby station and, if not, can they complete their commute by bus? Is it also close enough to shops, restaurants and cafes where they could grab lunch, or pubs and bars where they could socialise with colleagues after work?
If the office building in question is on a business park, is it well served by road links, along with adequate parking?
When considering location, it’s a good idea to put yourself into the mindset of your potential tenants. A shop owner needs to feel confident that the location of his shop is going to be at the core of his or her successful business. A tenant in an office building needs to know that he or she can keep their staff happy, whilst also appearing to be an attractive proposition to new staff looking to join the firm. In addition to that, many office tenants will want to invite clients into their offices for meetings, and a remote location can prove to be a real barrier to some in that regard.
Naturally, we are acutely aware that there are an awful lot more categories of commercial property than merely shops and offices, but we hope that this brief introduction can highlight the importance of location and why it is that it is the very first item on our checklist.
Once again, as is also the case with residential, commercial property falls into a particular category – freehold or leasehold. Within this there are some sub categories to consider as well, such as virtual freehold and long leasehold.
Long leasehold does what it says on the tin. Typically, a long lease would be in the region of between 125 and 199 years. Naturally, such a length of time is unlikely to be of concern to anyone, but at the point of inspection, it’s important to enquire as to the cost of extending the lease, or if the freeholders are open to the idea of selling the freehold.
A virtual freehold is actually a leasehold property, but with a lease of 999 years. You may ask why such things exist at all – why not just offer the freehold?
Well it’s all to do with ground rent. As a lease holder, you are required to pay ground rent to the freeholder, and that freeholder is well within their rights to increase that sum on an annual basis. Now whilst it would be wonderful to think of all freeholders and honest and fair, many leaseholders have found themselves on the receiving end of a ground rent bill which is unfairly high and thus rendering their property unsaleable.
Clearly, freehold is the best option, and we are not suggesting that the others should be rules out entirely, but it’s important that you have the right checks and balances in place, which we will discuss later in this article.
A blue chip tenant, such as a well known supermarket chain or bank, typically indicate a strong tenant. Such clients will pay their rent on time, and will have a plan to be in your commercial property for at least ten years, with the earliest option to leave being set at five years.
The same, strong tenants are more likely to have their own maintenance contractors on retainer, which means that they will take care of any issues, and the responsibility to do so will be woven into your contract. It’s the ideal situation, where you can relax and let the value of your commercial property investment rise.
Conversely, smaller, high street shops could be rented to independent retailers or even brand new businesses, which naturally incurs a higher risk.
The more stringent checks your potential tenant carries out before committing to a rental agreement, the more confident you can feel that your investment is in safer hands, so make sure you’re satisfied with the nature of their business too. That being said, in these times of continued economic uncertainty, even house hold name brand businesses are closing down, and none of us has a crystal ball.
Is this property unique?
Perhaps not so relevant when looking at an office building, but when it comes to retail outlets, a building with individual character can be a serious draw for potential tenants. A unique frontage can be just what a restaurant needs to attract new diners. An interior with split levels can enable a simple shop to offer its customers separate ‘departments’ and new shopping experiences. Indeed, many more stores are offering an eclectic mix of services in order to compete with nearby superstores and shopping centres. It’s not at all unusual to be able to buy a new outfit, grab a coffee and get a haircut all under one roof!
There are also less ‘quirky’ but still important options which the property could offer, and in a busy high street, none is more popular than parking. Nearby parking is often the holy grail to new shop owners, concerned that a lack of it will directly affect foot fall. If their shop allows customers to park right outside their front door, then that prospect becomes a lot more attractive.
Sustaining the Rent
You will no doubt have run the numbers and calculated a reasonable rent to charge for your commercial property. And the keyword here is ‘reasonable’. Rows of empty shops in high streets are usually attributed to the same problem – rent rates that are simply too high to be considered sustainable. If a business can’t keep up payment of rent, it will be forced to either close or relocate, and in either instance, that’s not good for your investment.
Rent rates also tend to rise, year on year, and many landlords often hike up rents when the annual review comes around. But is that really necessary? As a commercial property investor, you will have taken on this property for a long term return. The monthly rents should be covering the mortgage on the property, plus a little more for maintenance and then profit. With the right mortgage in place, that cost is likely to remain fixed for at least three years, so there’s no reason to raise rent. Find a good commercial mortgage broker and have them get you the best fixed term deal available and then advise your tenants that rents will be fixed for a certain period. That peace of mind will make your commercial property a much more attractive proposition for would be tenants.
Break clauses and the length of the lease
It’s natural that any commercial property investor is looking to source a tenant and sign them to a long lease. Blue chip clients are the safest option here, with the majority likely to expect an initial ten year lease with a five year break out clause.
However, it’s important when putting your projections together to only look up to the point of the break out clause. The term you’re looking for here is ‘certain’ – it refers to the time up until the break out clause itself, therefore a 10 year certain term is a comfortable starting point, although many consider that a 15 year certain really is the gold standard.
To clear up a common misconception, buying a VAT property does not mean that you’ll be paying VAT on the purchase price. There are simple processes in place in order to help you avoid doing that and your accountant or commercial property manager can advise you accordingly. However, you are required by law to charge VAT on the rent, and this can be an important consideration for many potential tenants that do not or cannot charge VAT on their customer transactions, such as banks, for example.
Tenants need to be aware of the implications of VAT on their rent. For many businesses, it’s just not a concern – they are most likely to be VAT registered and therefore their own accounts people will organise their ability to reclaim it, but do make a point of discussing this with your potential tenants – it shows that you care, and that, in turn, will make tenants more comfortable doing business with you.
Are You Buying The Whole Building?
Many commercial properties, particularly retail shops, come with upper parts. In many cases, these form ancillary offices for the business of the tenant, but in other instances they may be entirely separate offices or residential flats.
Outside of London, it’s common for the sale of commercial property to be for the entire unit, and this can indeed be a lucrative proposition for our commercial property investor, as what may have started as one income stream could now be doubled, tripled or more.
Within London, the ground floors of units with flats above may be referred to as a “Lock-up”, and the unit is sold and purchased independently of the other units in the building.
In many instances, the entire building may be the advertised commercial property investment, but if that proves to be beyond one’s budget, it’s worth asking if the property can be split. It’s a lot more administration and many sellers are not keen, but it’s not beyond the realms of possibility, so it certainly does not hurt to ask.
Many commercial properties have the potential for expansion down the line. It may be sitting on a plot with space to construct a whole new unit, or may have the potential to be converted in order to open up new revenue streams.
As we’ve said before, none of us has a crystal ball, so it’s a good idea to explore any commercial property’s full potential, thus minimising your losses should your tenants either fold or simply have to move out.
It must seem strange to be bringing up finances as number ten in our list. After all, it’s important to know how much you can afford before you begin the process of sourcing your next commercial property investment.
However, when it comes to borrowing, the majority of mainstream lenders will want you to have ticked all or most of these other boxes first. Just as you are investing in commercial property, they are investing in you. If it’s clear that you have done your due diligence, then you are much more likely to be approved, and may indeed have more than one lender negotiating for your business.
Financeable properties offered for sale within a suitable timescale will be accessible to more buyers, although as a counter to that, they will be more expensive than those being marketed toward cash buyers offering very quick exchanges.
The market is cyclical. Satisfy yourself that you are not buying at the peak of that cycle – do your research and be sure that you are buying at a reasonable market rate and that your investment will yield the returns for which you’ve hoped. If the property appears under market value, be sure to find out why, as there may be a catch. If there isn’t, move quickly as other buyers will be looking to take advantage of the same, good deal.
Look for a Good Agent
Quite a lot of the items in this checklist can be bypassed, simply by finding a good agent. That’s not to say that you’re taking shortcuts, but it does mean that the majority of the research will have been done for you.
A good agent will be aware of the benefits and pitfalls of commercial property investments within a given area – and that refers to geography as well as specialised industries.
Moreover, this could well be your first venture into investing in commercial property and, as you can clearly see, there’s a lot to take on board. A good agent will take the time to get to know you and establish just what it is you expect from your commercial property investment.
The marketplace is vast, and whilst there are many commercial properties which seem very attractive at first glance, there’s every possibility that a good agent will be able to tell you why that particular investment is not right for you – not that it’s bad, just that it’s not the right fit for you.
The best agents will have the best portfolios, as more and more vendors are happy to trust them to match their properties with the best investors. Don’t think of your commercial property agent in the same way that you might regard a residential estate agent – they offer much more to their clients and are keen to offer a level of advice and service to you in order that you too will stay with them for many years to come.
Use a Good Lawyer
We did want to be thorough, but this one goes without saying. Investing in property is a minefield, and without a good lawyer in your camp, a deal could be structured which ultimately leaves you out of pocket with no avenues for recovery.
It should be clear that any property transaction, from the purchase of a single commercial unit to an entire business village, is not without complexity. It’s your lawyer’s job to protect you and your investment, and to be bold enough to tell you if and when you should pull the plug on a particular transaction. Find someone you trust implicitly and let them continue to earn that trust.
Use a Good Finance Broker
We spoke earlier about financing and how mainstream lenders view particular investments. Arranging finance is as equally complex as the legal issues that we mentioned above. A good finance broker will not only be able to advise you on all of your options, but is more than likely to have access to deals that are not made directly available to the public.
Seek a broker who is both regulated and truly independent. You want them to have access to the whole of market so that they can help structure the best option for you.
Remember, if both you as an investor and the commercial property are an attractive proposition, then it’s likely that more than one lender will want to get behind you. A good broker can act as your intermediary, negotiating even better rates than what you might have been offered at the outset, and almost certainly better than had you approached those lenders directly yourself.
Use a Good Accountant
Your commercial property investment is a business. Granted, it may well be a business in which you don’t work all that hard (your level of involvement is down to you) but it is a business, none the less. Therefore, like any business, the money will need to be managed effectively. We’re not talking about book keeping here, we’re more focussed on your tax liability, including VAT, which we touched upon earlier.
A good accountant will be able to help you minimise your tax bill and thus maximise the potential on your commercial property investment. HMRC have an exhaustive checklist when it comes to investing in commercial property, so you need someone who truly understands everything that is expected of you. Failure to comply can have some damning consequences far beyond seeing a poor return in your investment, so make sure you have that covered.
Use a Good Property Manager
By now, we’re hoping you will have seen just how much goes into making the most of any commercial property investment. At the core of all of this are the services of a good property manager, and naturally, that’s where Prideview come in.
Our team of Commercial Property Managers bring years of dedicated experience to the market. It’s our aim to match commercial property investors with their next properties, and thereafter to help them source and secure tenants, maintenance contracts, and everything else that they need.
So whether you’ve ticked everything on our checklist, or are just about to start, get in touch and let us help you make the very most of your commercial property journey.