Investing in Commercial Property

Why commercial property?

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Compared to residential property investments, commercial property offers some key advantages:

Long-term secure cashflow — Commercial lets normally have long lease contracts, with periods of 10 years and more not being uncommon. In addition to this, commercial property tenants are less likely to default on payments and even if the tenant goes into liquidation, the liquidator may continue paying the rent in order to stop the lease being forfeited.

Maintenance — Commercial tenants are generally liable for the maintenance and upkeep of the property, contrasting with residential leasing, where the onus tends to be on the landlord.

Income yield — Commercial property tends to deliver a relatively high income yield throughout the rental period. In comparison residential property investors rely on the capital value of the house increasing to generate a good return. This is fine during periods of rising property prices, but less beneficial during property slumps.

Commercial property investments have also performed well in terms of growth and stability, compared to equities and gilts over recent years.

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Commercial property for the personal investor

Few personal investors will have sufficient funds to invest directly in a commercial property, however there are opportunities for indirect investment.

For the small investor, only looking to invest a couple of thousand pounds, the choices are limited to a small number of unit trusts and life funds that invest in property or buying shares in property companies, such as British Land and Slough Estates (though these are often more linked to the equities market, rather than property market performance).

Larger investors have a greater range of options available, with a number of products offering a chance to invest in geared property investments through a limited partnership structure. Often these products will require a minimum investment in the region of £25,000 to £50,000, which is invested in a single property.

A few investors will be able to buy a complete property directly, however the cost of the property is likely to be 10 or 20 times the size of a residential buy-to-let, making direct investment prohibitive to most.

Commercial property risks

In line with all investments, commercial property investment comes with its own risks:

Poor liquidity — Compared to equities and bonds, property has poor liquidity, both in the time spent finding a buyer and making the transaction. This can be further emphasised in poor market conditions when the ability to find a buyer offering the right price will become very difficult.

Poor diversification — The more diverse an investment portfolio, the less susceptible it will be to tough market conditions. Investing in a single property can be a risky challenge.

Market performance — The property market is prone to cycles, as yields grow and decline depending on the level of supply and demand for commercial property. Current rental rates could decline in the future.

Sector performance — A decline in the sector that your property services could affect your investment. For example a period of poor sales performance and market withdrawal in the retail sector could lead to the demand for small store, supermarket, department store and warehouse property to decline sharply.

What to look for when buying commercial property

Location — the location of the property is very important and will be a major factor in determining the value of property and rental income. Easy access to transport networks is an obvious plus factor for most tenants, but consideration should also be given to future developments in the area. For example, the development of a new supermarket, might depreciate the value of small shops.

Type of building — The requirements of tenants can change over time, with implications on the type of building they need. For example the move to open plan office space, could make older buildings with their rigid enclosed spaces redundant. Many companies also look for facilities like air conditioning and the ability to connect computer terminals through under floor wiring.

Tenant quality — Properties whose tenants are reliable, present a low credit risk and hold a long-term lease will hold a premium value.

Market factors — Try to identify which sectors and sub-sectors of the market will perform well in the future. The same can be said for geographic regions, which might receive future government or multi-national investment.

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