For the commercial property investor – particularly one just starting to build their portfolio, one of the most common issues lies in acquiring tenants. Until such time as the commercial unit is occupied and tenants’ rent is being paid, the property is just one big cost centre.
For the smart commercial property investor, this need not be a lengthy or daunting process. Commercial agents have databases of potential tenants and, in fact, many of them will have clients who have expressed an interest in a particular commercial property at the point at which it entered the market. Those people are not in a financial position to acquire the property outright themselves, but would be keen to rent.
Should no tenants be immediately known to the commercial agent, then the property will need to be advertised – a process which will take time and money. Ordinarily, anyone investing in commercial property will have factored this into the equation. Much like investing in residential real estate, owners need to be in a position to meet their mortgage payments until such time as a tenant can take those over, and most will have budgeted for a reasonable period of time in which they can expect the property to be vacant.
The good news is that there is an increasing trend in the commercial property market to purchase a commercial unit with tenants already in place – often referred to as being ‘in situ’. In this article, we’re going to look at the positives and negatives of buying a commercial property like this, as well as the rights of both the landlord and the tenant.
It’s important to consider the risks
Ordinarily, we like to open with the pros before we talk about the cons, but in this instance, we’re going to start with a warning.
A commercial property with tenants already in place really can seem too good to be true. Sadly, some things that do seem to be too good to be true often aren’t, so let’s consider why that might be in this case.
Whenever a property comes onto the market, be it residential or commercial, buyers often approach that property with a certain question in mind – why is it for sale? In the case of commercial property investment, if an owner is meeting his or her financial commitments, perhaps even making a profit, and all whilst seeing the property appreciate in value, then why sell?
It’s important that the motivation behind the sale is clearly established, and perhaps even further investigated. Regrettably, there are plenty of commercial landlords who are letting out their properties illegally. Such breaches of the law may include not maintaining the property to appropriate health and safety requirements or accepting rental income from tenants without the necessary documentation to work or operate a business within the UK.
A commercial property being rented out illegally will also be known to the local council at some point, and this presents a problem. Even if the new owners correct any breaches in the law upon completion, they could be accused of knowingly purchasing a property that should not have even been placed on the market and, as such, could be held responsible for paying a fine.
Naturally, any shrewd commercial property investor will have aligned themselves with a first-class solicitor and expert in commercial conveyancing. Problems like these will be picked up early on in the conveyancing process, at which point the investor can choose to withdraw his or her offer and look for an alternative property. All well and good, but it does mean that they will have had to have spent money on land searches and provisional enquiries from their solicitor at the very least, and this is money that cannot be recovered simply because the purchase is not going to go through to exchange or completion.
This may seem scary, but it needn’t be. A reputable commercial agent will be familiar with the problems that can come with buying a commercial property with tenants already in place, and they are more than likely to have done their homework. In many cases, if they are not 100% confident that there are no issues, they will often simply refuse to list a particular commercial property investment opportunity. Whilst their first duty is still to their vendor, they also are motivated to help new investors build their portfolios, and simply cannot afford to risk having their reputation damaged in any way.
The most obvious benefit to purchasing a commercial property with tenants in is that the income from the investment starts coming in from day one. Many commercial agents and solicitors advise that the completion of any commercial property with tenants in situ takes place on the day that rent is due.
This makes things easier for both parties, especially the tenants. Assuming that they are solid and reliable tenants, their business will have budgeted for paying the rent on a set date each month, and their entire accounting procedure will have factored this date into the equation. As such, it’s beneficial from their perspective to maintain the status quo.
However, if this is not possible, then the seller will pay the buyer the remainder of the month’s rent in what’s known as an apportionment. Whilst none of this will cost anything extra, it does mean additional administration for both buyer and seller once the purchase of the commercial property in question has been completed, and often, sellers are keen to consider the matter closed and move on.
Health and Safety
If a commercial property already has a business operating on the premises, then it is a fairly safe bet that the building in question already meets the health and safety standards.
Upkeep of building maintenance to these standards will fall to either landlord or tenant, depending upon the nature of the original lease agreement. Either way, this gives assurances to the commercial property investor.
If the landlord is responsible, then there is a strong likelihood that the building will be in an acceptable state of repair and in compliance with health and safety legislation. After all, if there were any problems at all, then the tenants will have brought them to the attention of the landlord with a request – possibly even demand – that they be addressed immediately.
Should the responsibility lie with the tenant, then it is incumbent upon the new investor to carry out their due diligence and have the property thoroughly inspected, bring any issues immediately to the attention of the tenants and agree upon the best course of action to ensure that the property is quickly brought back into line with all laws regarding health and safety.
We did, of course, list this under the ‘positives’ section of this article, and this is because it is extremely rare to find a case where a commercial property with tenants in situ comes to market with health and safety violations. Much like the risks we mentioned earlier, commercial agents will not want to list such properties in the first place, giving the investor assurances that they are looking at a viable investment, rather than a money pit.
This is another area which is not unlike the situation mentioned above concerning health and safety. If a commercial property is home to an operating business, particularly a retail unit, then it’s likely to be well presented in a decorative sense.
When talking about retail property, rather than office space, décor is almost always the responsibility of the tenant. Nobody wants to invite their customers into a tired looking shop, so it’s likely to that as well as regular decorative maintenance, that the store might go through a rebranding or refurbishment every few years as well.
As a commercial property investor, this presents a number of benefits. First and foremost, there is no additional outlay for decoration. Many commercial properties that have been vacant for some time require a high degree of modernising before being presented to potential tenants, clearly none of that is necessary here.
Second, any commercial investor enters into a project with an exit strategy. Granted, like all real estate investment, plans do need to be long term, but knowing that maintenance is already in hand at the point of completion can be a relief.
When buying a commercial property with tenants in situ, it’s important to note that their original tenancy agreement supersedes any new agreement drawn up by the new landlord. Ultimately, a new agreement will need to be drawn up between the existing tenants and the new landlords, but the tenant will have the right to not sign any agreement containing clauses with which they do not agree.
The advice to the commercial property investor here is to have their solicitors thoroughly peruse the existing lease agreement as part and parcel of the conveyancing process.
Regrettably, it may be necessary to have the existing tenants removed, but this can be a slow and complicated process. If we take the example of an assured shorthold tenancy agreement, landlords are required to give sufficient notice to their tenants, and this is especially true if they are still within their initial six-month agreement. If that’s the case, notice cannot be served until month four.
Moreover, if the previous landlord had agreed to make repairs and had failed to complete that work, those same tenants would be legally allowed to remain within the property. This is also true if they had not been provided with all of the appropriate and required documentation at the outset of the tenancy, such as the How to Rent Guide.
Once again, it is our intention to provide a balanced view of purchasing a commercial property with tenants in situ. With the right advice and high levels of due diligence, the benefits can outweigh the risks, but it would be remiss of us not to point them out to you here.
Some other considerations - Utilities
There are some considerations which may seem minor but are important for the commercial property investor, especially as, when buying a property with tenants in situ, it’s important to consider the needs of the tenants and their business.
Many commercial property buyers have long standing relationships with particular service providers for utilities such as gas, electricity and telecommunications. When purchasing a new property, they may well want the existing service providers’ contracts to be terminated in order for them to switch over their contracts.
Such a process takes time and whilst many commercial utility providers would love to claim that switching to them is a seamless process, several things need to be in place in order for that to be the case. Most important is how much notice is required.
A period of four weeks is usually more than sufficient for the switch to take place, and as most completion dates are set for four weeks after contracts are exchanged, this doesn’t present a problem.
However, some completion dates can be brought forward and some utilities transfers can take longer, and if the transfer of utilities is not handled correctly, tenants could find themselves without power, heat or communications. This would have an adverse effect on their ability to operate, and the commercial landlord would be required to cover any losses incurred as a result.
Rent Deposit Deeds
A deposit deed is drawn up by the commercial landlord’s solicitors to secure their tenant’s deposit. What the deed essentially does is outline that the deposit remains the property of the tenant. However, should that tenant default on the lease, then the funds from that deposit become available to the landlord. This deed also protects the landlord from unexpected losses and expenses as a result of the commercial tenant forfeiting on their lease.
Working with Managing Agents
This article, we hope, will have highlighted both the highs and pitfalls of buying a commercial property with tenants in situ. One of the easiest ways to mitigate many, if perhaps all of these issues, is to purchase a commercial property which is already under the management of a commercial property managing agent. As well as taking care of the administration of the property itself, they will usually handle all communication with the tenants, and this can be particularly useful if the investor in question is looking at a completely hands off and remote approach to his or her investment.
At Prideview Group, we like to provide as balanced a view as possible to anyone considering investing in commercial property. Our team of advisors are on hand to help people maximise the return on their investments. Get in touch with us today and let us know how we can help.