The value of commercial property investment in the UK reached some half a trillion pounds in 2018 and continues to rise. Back in 2016, the Property Industry Alliance found that commercial property in the UK was valued at £883 billion, representing some 10% of the UK’s net wealth.
As we can see, the commercial property market in the UK is pretty colossal, but in such a deep forest of opportunity, how can you see the wood from the trees when it comes to finding commercial property investment opportunities?
What Is Commercial Property Investment?
Commercial real estate or property are properties used for commercial business purposes. Residential property, like houses and flats, are not commercial buildings and only have limited permitted legal uses as far as business activity goes. Commercial buildings have different Use Classes, as per the Use Class order, which permit more activities that are strictly related to business. The opposite is also true; commercial buildings cannot be lived in unless they’re of mixed use (e.g. a shop with a flat upstairs).
Commercial property investment involves exchanging money in the form of purchase for a commercial building. Both freeholding and leaseholding a commercial building are forms of commercial property investment, depending on the end goal.
A business might invest in a commercial building for use, whilst also profiting off a later sale or installing new tenants. Commercial buildings can also be flipped rapidly, a bit like residential ‘fix and flip’-type investments.
Is Commercial Property a Good Investment?
The closest comparison to commercial real estate investment is residential property investment. Both residential and commercial property investment is often compared to investing in the stock market. Investopedia compared the returns of real estate and the stock market and, granted it’s a very difficult comparison to strike, the returns of real estate property investment is generally better than returns from stock market investment.
It’s like comparing apples to oranges. It’s best to specify exactly what commercial property investment offers:
- Reliable cash flows that can last years with the right tenants
- Low maintenance costs depending on the lease agreed and contract
- The chance to profit from the proceeds of a sale when a building increases in value over a tenancy
- Potential for diversification and adaptation to changing demand
- Flexibility for both high-value investors, who can invest solely into a commercial building, and flexibility for lower-level investors that can invest as part of a brick-and-mortar fund or real-estate investment trust (REIT)
In a sense, the UK’s investment volume in commercial property speaks for itself. It’s a diverse but strong investment sector that grants investors a specific type of control over their investment given the fusion between bricks-and-mortar and wider industry-specific, national and international trends.
Is Commercial Property Investment Risky?
The classic characterisation of commercial property investment is one of risk and reward due to greater market volatility – people always need somewhere to live, but they might not always need a steel manufacturing plant. Conventional logic dictates that lower risk = lower potential returns. This is true to an extent, but in reality, the situation is much more nuanced.
If commercial real estate has higher returns than most investments then surely it’s very risky? It certainly can be – it really depends on the building in question, the location, Use Class, tenants and of course, the investor’s knowledge and professional advice.
In recent years, some investment schemes in off-plan commercial property have really gone off the rails, often to the deficit of investors. This is largely because investors simply didn’t know what they were getting into.
Some of the risks of commercial property investment are balanced by the length of a typical commercial lease, which is much longer (5-years+) than a residential rental agreement. But again, this depends on securing a reliable business tenant. Throughout the pandemic, many commercial (and residential landlords) were forced to take legal action against tenants defaulting on their rental payments.
Highly successful business tenants are like gold dust for commercial investors. This is when the best returns can be secured.
Commercial Property Yields
In 2021, commercial property yields are just north of 5% on average, according to Savills. The gap between poor-performing commercial property yields and high-performing commercial property yields has narrowed.
The highest yields are observed across the retail and leisure sector but market sentiment here is generally weak as questions about the post-shopping bounce back persist.
The rise of eCommerce has vastly increased demand for all manner of storage, logistical operations and warehousing services and this is probably where current demand is swelling.
Laith Khalaf of AJ Bell told This is Money that supermarkets and eCommerce-related commercial buildings thrived throughout the pandemic, and since the rise of eCommerce shows no signs of abatement, this is set to continue.
Shopping centres and supermarkets rank as very solid investments with yields generally approaching 6% on average, but warehousing and industrial market sentiments are stronger, according to a report by Knight Frank.
The Traditional Categories of Commercial Buildings
The Use Classes Order sets out the legal definitions of various buildings in the UK alongside their permitted uses. The traditional categories of commercial buildings are:
- Leisure
- Industrial/warehousing/logistics
- Retail
- Office
- Land for development
- Education
- Health care
- Mixed-use
Leisure: The UK has a lively tourist industry and demand for hotels for business travel remains high. The coronavirus pandemic knocked the tourism industry back and hotels bore the brunt of the impacts. Analysts are hopeful for the future prospects of the UK hotel industry, though, and hotels are set to remain a target for investors.
Warehousing: The warehousing and logistics sector is very strong right now, largely due to the increase of eCommerce and huge demand for warehousing and delivery services. The rise of eCommerce is not slowing and it’s difficult to foresee a drop in demand for warehouses, especially those that are all-positioned within urban areas.
Retail: Shopping centres and other retail buildings have traditionally held some of the strongest commercial property yields. Like many other industries that rely on footfall and brick-and-mortar customers, the retail sector was damaged during the coronavirus pandemic. Nevertheless, market sentiment for the future is quite high as customers relish the omnichannel retail experience that intends to reinvigorate the high-street.
Healthcare: The healthcare sector has become more accessible to investors as the private healthcare sector increases in the UK. Knight Frank’s recent focus on healthcare property investment is indicative of this. Care homes and day centres remain a popular commercial real estate investment.
Land: Land is not commercial property market per se, and does tend to fall into its own specialist investment category. Land buyers can leverage ground rents or sell up for development purposes. Land investors will attempt to predict regional demand for land with developments in commuter belts being a popular target.
Flex: The post-coronavirus era has created new space for innovation in the commercial property market. Namely, flex working spaces and collaborative working environments have really surged in popularity. Knight Frank continually name flex working spaces as some of the most exciting commercial property investments going forward.
Changes to the Commercial Property Market
The staples of the commercial property market for investors are offices, retail, leisure and warehousing/industrial, as well as mixed-use residential and commercial properties. Educational, healthcare and other sui generis property are a bit more of a niche affair.
The commercial property landscape in the UK is changing. We live in an unprecedented era where the rise in work-from-home and flexible working setups have irrevocably changed the commercial property market.
Offices are probably facing the worst decline in yields combined with the highest vacancy rates, but, for prospective investors, flexible working spaces are thoroughly in demand.
Flexible working space was already appearing in office investment portfolios pre-pandemic, but it’s now taking centre stage with numerous opportunities popping up for shrewd and agile investors that have some cash to spend on fitting out offices with flex-space technology.
The rise of emerging trends combined with a low-interest rate lending market is tantalising for investors willing to take somewhat of a punt.
How to Finance Commercial Property Investments?
Commercial property investments can be made using 3 broad methods:
- Direct investment; where the investor(s) buy the property. They can then use it for their business(s), let it out on a short-term or long lease basis, or change or redevelop the building in some way.
- Direct commercial property funds, also called brick-and-mortar funds, allow investors to invest flexible amounts into a portfolio of buildings owned by the fund.
- Indirect commercial property funds, which are collective schemes that invest in commercial real estate companies listed on the stock market
In situations 2 and 3, the investor will not need a mortgage or any sort of typical property financing. Direct investment usually requires finance, unless the business(s) are cash buyers.
Commercial mortgages vary considerably depending on the risk posed by the investment. Mortgage providers will look at how easily rent and/or the turnover of occupying businesses can service the debt. Commercial mortgage rates tend to be higher than residential mortgage rates due to the increased risk for lenders, but it’s hard to generalise.
Mezzanine or bridging finance can be used to top-up the investors’ equity. Prompt funding allows the investor to take action on the building without necessarily letting it out immediately, which is useful when building renovations, upgrades or changes in Use Class are needed. Property development loans are another option for investors that want to develop the property prior to letting it out to new tenants. This may allow the lender to project the future value of the property(s) once development has taken place.
The lending environment is exceptionally strong in the UK right now. The Bank of England continues to hold the base interest rate at 0.1%, thus encouraging lenders to ‘turn on the taps’ to encourage development and growth.
Low-interest rates are perhaps synonymous with a low-yield environment, in a general sense at least, but analysts believe the low-interest-rate environment poses an attractive situation for commercial property investors, particularly those targeting flex or other next-generation property.
Finding Commercial Property Investment Opportunities
In terms of direct property investment, it’s common to utilise a commercial property investment agency or consultancy rather than going it alone. But, for smaller commercial property investments, it is possible to invest at one’s own accord, or to team up with one or two other investors.
An example might be a small mixed-use retail and residential unit. These can be found for something like £150,000 in the north of England, Scotland and Wales to £1 million or more in Greater London. These types of small-scale commercial investment properties are perfect for those looking to buy with cash or a small mortgage, renovate and convert if necessary, and let out to both commercial and residential tenants.
We have a massive guide on how to invest in commercial property here which provides numerous tips on finding commercial property investments.
Summary: A Guide To Finding Commercial Property Investment Opportunities
Finding commercial properties requires either experience and skill as an investor, potentially moving from the residential property investment market, or the service of property experts and consultancies.
Phoenix and Partners are commercial property investment agents that specialise in both acquisitions and sales; valuations, lettings and leasings.
The commercial property market in the UK continues inform and there are tantalising opportunities for both small and large-scale investors. Whilst traditional commercial building investment opportunities such as hotels and leisure, offices and land continue to display excellent yields, warehousing and flex spaces provide a fresh angle into the world of commercial property investment.
Frequently Asked Questions (FAQs)