The commercial property market in the UK remains of huge interest to investors of all kinds. Savills found that investment volume continued to climb against its 3-year rolling average in 2018, reaching £62.1bn.
The commercial property market is extremely robust and shows some great signs of promise for the future. It is unsurprising that the amount of people looking to buy their first commercial property is continuing to grow.
Even despite the impacts of COVID-19 and the reduction in office space demand, growth in the warehousing, logistics and eCommerce sectors is spurring on the commercial property market.
There is far less guidance out there when it comes to buying commercial property compared to a residential property. Buyers and sellers are expected to carry out in-depth checks for the sake of due diligence, enlisting experts such as Chartered Surveyors and commercial property solicitors to conduct a physical and legal analysis of the target building.
Avoiding critical errors and other bumps in the road will keep your commercial property purchase experience running smooth.
Here are 8 tips for buying your first commercial property.
There are two main reasons why one would look to purchase a commercial property:
- To use for business purposes
- For investment; to resell or let
There is a growing market for buy-to-let commercial property investments as well as flipping commercial property in a similar way to residential property. Since commercial property is generally more volatile than residential property, the earning potential is higher for such short-term investment tactics. However, risk is also higher, and this puts even greater emphasis on due diligence.
Regardless of whether you’re looking to buy a commercial property to use directly for your business or as an investment, there are certain things to be aware of. Commercial property investment is not something you should do on a whim without considerable research. It’s also vital to enlist the services of experts in the field, such as Chartered Surveyors, independent financial advisors and specialist commercial property solicitors.
It’s firstly wise to consider what you’re actually buying the commercial property for and why. As mentioned, it’s possible to purchase a commercial property for use or investment purposes, or both.
Your buying motive will help narrow your search and provide a starting point for what to look for. If you’re looking to buy a commercial building for use, then it’s worth considering whether or not you’d be better off on a short term rent or lease.
Read our guide on the pros and cons of buying or leasing commercial property here. As a rule of thumb, buying the property as freehold provides you with ultimate freedom over the property, but you’ll still have to use it in accordance with its Use Class(s) (unless you change them). This also means you can sell the property when you no longer need it, or lease it to tenants.
Leasehold is cheaper and more flexible, but it also limits your control over the building. You will however benefit from active maintenance of the property and potentially also extra features like staffing and security.
The Use Class Order sets out the use classes of buildings in the UK. Each Use Class comes with its own unique set of rules and regulations that forbid uses outside the scope of the class. It is sometimes possible to change the Use Class of a building using Permitted Development Rights.
The main types of commercial buildings are listed below. It’s also possible to find mixed-use buildings or developments, e.g. shops with integrated residential units.
|Offices – Usually Class E||N/A|
|Retail – Usually Class E||Shops, supermarkets, shopping centres, retail warehouses|
|Industrial – B2, B8 or Class E||Warehouses, factories|
|Leisure – Varies, usually Class E or Sui Generis||Restaurants, pubs, cinemas, gyms, hotels|
|Alternative commercial property – D1, Sui Generis or others||Petrol stations, schools|
You should also consider whether or not you require additional services, e.g. a 24-hour reception, canteen, any specific pre-installed machinery, etc. Some of these services are only typically available to leaseholders, if you plan to freehold then you’ll often need to sort out your own staff services.
A common situation is investing in a readymade, established business premise, like a restaurant. There are many restaurants, gyms and other pre-established businesses that are looking for leasehold investors to purchase the property, usually on a reasonably short lease.
For more information on this form of commercial property investment, see our article on commercial property flipping.
Finally, you’ll need to consider the location of the property. This is crucial if you’re hoping for the building to appreciate in value so you can lease it or sell it later. Location is also important for when you’re hoping to take out Planning Permission on the property for use changes, renovations or extensions.
Consider your intended use and how the area ties into your plans:
- Shops and other commercial B2C businesses may require solid footfall in the local area.
- Offices or industrial spaces may need adequate parking nearby.
- Developing a learning establishment or school near a polluted or busy main road could be met with resistance by the local planning authority.
Chartered Surveyors can advise you on the location of the building and property checks will reveal any restrictive covenants, Article 4 planning restrictions or other issues that could affect your redevelopment plans.
Calculating property budgets and making profitability/viability checks is one of the most important yet long winded stages of commercial property investment.
We’ve covered some commercial real estate metrics that you can use to analyse and assess commercial properties:
- Net Operating Income: Calculates the net operating income of a building after operating costs.
- Debt Yield Ratio: Calculates loan divided by NOI to provide a risk indicator.
- Cash-on-Cash Return: Calculates net cash flows divided by the initial investment.
- Net Present Value: Calculates inflation-adjusted cash flows and profits throughout time.
- Cap Rate and Net Yield: Calculates rental income divided by net operating costs without mortgage payments factored in. Net yield does factor mortgage payments in.
- ROI: Calculates the overall return on investment.
Some metrics, like the cash-on-cash return and cap rate and NOI are excellent for quickly comparing different properties on the market. You’ll also need to calculate your budget, making sure that you provide for:
- The initial investment.
- Surveyor and legal fees.
- SDLT (Stamp Land Duty Tax).
- Any repair costs and upgrades.
- Operational and maintenance cost, either annual or monthly.
- Environmental compliance costs.
- Waste management.
- Mortgage payments.
Ongoing costs vary between buildings, but it’s crucial to not underestimate the role they play in your budgeting.
This is only relevant for those who intend to invest in a commercial property rather than using it for themselves or their business. It’s often necessary to find a profit making angle.
This might be simple in the case of buying a commercial property and immediately leasing it to tenants. This isn’t the only investment angle available to investors, though.
There are 3 main methods for profiting from a commercial property investment:
- Method 1: Lease the property to new tenants and profit from rent.
- Method 2: Redevelop/renovate/extend/repair the property and remarket it
- Method 3: Source a new buyer and rapidly sell for a profit.
In residential property flipping, the most popular approach is to ‘fix and flip’ the property. This involves buying a property without tenants, fixing it and upgrading it, and selling it on or filling it with new tenants. This allows the investor to add and extract value from the property.
We’ve covered flipping commercial property in detail in this guide.
Once you’re confident that the building fits your expectations, have arranged a preliminary check and are happy with financing options like loans and mortgages, it’s time to make an offer.
You’ll usually make an offer via your estate agent. Heads of Terms will be drafted by each party’s legal advisors. This will set out a timeline for conveyancing, carrying out checks, searches and surveys on the property and eventually, completion.
The HOTs is an essential document – you can read more about it on our guide to the HOTs here.
At this stage, both parties will embark on the process of due diligence, which will first involve the following searches:
- Local Authority Search
- Drainage and Water Search
- Environmental & Flood Risk Search
- Highways Search
- Chancel Search
After that, it’s essential to carry out a building survey with the assistance of a Chartered Surveyor. Never rush the process of due diligence – the onus is on the buyer to uncover all necessary and relevant details of the property prior to completion.
It’s normally advised that a full Building Survey is carried out on commercial properties. If you’re hoping to extend or redevelop the property then you’ll also need a planner to work with the surveyor.
Commercial real estate is a complex legal domain. Professional insight is an absolute must, there is simply no way that you can take on a commercial investment project without the assistance of solicitors and surveyors at least.
On the financial side, it’s certainly wise to liaise with an independent financial advisor when it comes to comparing financing options. When you delve into financing like bridging loans then there’ll be more options and risks to weigh up. It’s hard to account for investment risk without performing a rigorous economic analysis of the target asset.
Enlisting a RICS Chartered Surveyor is crucial for the due diligence process.
Your survey may alter the perception of the building, especially if major structural flaws are discovered. This could enable you to save vast quantities of money, or even save your property from catastrophic issues down the line.
There are several tax incentives and schemes that provide relief for some commercial property investments. These do vary throughout time, and it’s also possible to find localised schemes to incentivise businesses to clean up and redevelop commercial property and land to strengthen the local economy, etc. Contact your local Planning Authority and discuss your plans.
Here are some current nationwide tax relief and incentive schemes:
- Capital Allowance allows UK businesses to claim against their taxable profit under the Capital Allowances Act.
- Business Premises Renovation Allowance (BPRA) is a tax incentive for converting or renovating unused qualifying business premises in a disadvantaged area.
- Land Remediation Relief is a corporation tax relief. It provides incentives for qualifying expenditure incurred from cleaning up contaminated land.
- R&D Tax Credits may also apply to your business if you wish to carry research and development work on the commercial premises.
Note that these forms of tax relief will apply in certain circumstances. HMRC or your local council or Planning Authority should assist you if they feel that you can claim.
Once an offer has been accepted, the HOTs will help dictate how long you have to complete due diligence checks before completion. However, it’s important to bear and mind that the HOTs isn’t usually contractually binding, so you’re not absolutely obliged to finish everything before its expiry.
If there are more serious problems to sort out then don’t rush, take your time to sort them out before exchanging contracts. It’s exceptionally difficult to take a step back after completion, so ensure that every base is covered and no stone is unturned before turning the final screw!
So there we have it, our selection of 8 tips for buying your first commercial property.
Some are quite simple and intuitive, but arming yourself with some more niche key information might just be crucial. The key is to be slow and analytical at every stage of the process. Whilst decisiveness is also important, looking over crucial details can be catastrophic. It’s not worth sacrificing key steps for the mere purpose to hurry the transaction through. Do as much preparation pre-offer as you can to avoid delays after the HOTs has been drafted and handed to both parties.
The more knowledge you have in your arsenal, the smarter and more astute you can be with your property investments.
You should first question what sort of building you want and why. Will you be using it for business purposes or is it an investment? Consider the location, the local and national economy and the lending market.
Whilst some commercial buildings (offices) are falling out of demand, others (warehouses) are growing in demand. In terms of the building itself, the condition is absolutely crucial as repairs are expensive. You should also consider the future scope of the building; is it an area where development is usually permitted?
There are many different types of commercial property and supply and demand is changing all the time. Office yields did drop over the coronavirus pandemic, but a growing demand for premises for startups and SMEs ensures that demand is relatively healthy. There is also great demand for light industrial, warehouse and logistics buildings due to the rise of online delivery and eCommerce. Overall, though, there are many ways to assess the credibility of commercial property investment. It’s both an analytical, creative and considered process.
In a word, yes. Commercial property investment is generally more risky than residential, but also has much higher returns. Professional assistance is absolutely vital; commercial real estate investing is potentially lucrative but requires skill, experience and advice.