by Gauk
Mon, Oct 12, 2020 9:31 PM

Developer’s Notebook For our purposes, commercial property is anything that isn’t residential.

Most investors will think of shops, offices, factories and warehouses and many property auctioneers regularly sell these types of lots. Another source is to look through the classified ads in The Estates Gazette, available from larger branches of WH Smith.

It would be wrong to suggest that commercial property doesn’t have its disadvantages and drawbacks, but there are also many benefits to owning this kind of investment asset. What follows are 10 ways in which you can benefit from investing in commercial property.

Number 1. Commercial property tends to be more expensive than residential property. It might sound a bit strange to call that a benefit, but in my opinion it is. What do I mean by more expensive? Well, look at it this way: there are exceptions to every rule but, by and large, commercial properties tend to come in, what we call in the trade, larger ‘lot sizes’.

Individual properties sell at relatively high prices. In any one year in the UK, the average price of a commercial property sold on the open market will be higher than the average price of a residential property sold in the same way. In other words, when a commercial property investor goes shopping, he only needs to find one property; when a residential property investor does the same, he needs to buy several.

So you’ll conduct one property search to locate one property, and you’ll only need one survey and one set of solicitor ’s fees. Granted, in absolute terms the fees might cost more than for one residential property, but compare the total cost of the single commercial property with the total cost of buying several cheaper residential properties before you jump to conclusions. It will certainly work out cheaper.

Number 2. Having invested your money, you now only have one property to manage. That cuts out a lot of heartache and hard work, but there are other management benefits which can be grouped together under a ‘lack of management hassle’ subheading. Let’s take a look at each of these.

Number 3. A well-organised landlord should find rent collection very easy with commercial property. Standard commercial leases allow for the rent to be paid quarterly in advance. 9 times out of 10 a business tenant will be prepared to pay by standing order. Sorted. No knocking on doors, no collecting ‘top-ups’ from irate tenants, no monthly collections. Plus you get it all well in advance. If the tenant is late paying the rent, standard commercial leases allow the landlord to charge interest at a reasonably punitive rate, typically 2% or 3% above base rate. But, what if they don’t pay at all?

Well, if a residential tenant on an Assured Shorthold Tenancy doesn’t pay, you’re faced with a court hearing some months in the future. If you want to fast-track possession, you have to drop your claim for rent arrears. If you pursue your claim for rent arrears, the chances are that the judge will order the tenant to pay it back at two pounds a week. Now, compare this with the procedure for a commercial property. If your business tenant doesn’t pay, you simply get your solicitor to serve a notice threatening forfeiture of the lease. At that point most tenants will pay up and the tenant’s finance director gets a kick up the backside from the board. If they still don’t pay, you can send a bailiff in to change the locks.

If the tenant can pay, but is just being bloody-minded, that’s when you get a cheque for the whole of your arrears, plus your costs, including the bailiff ’s bill, before the tenant’s finance director gets the sack.

If the tenant genuinely can’t pay, you get possession before arrears get out of hand and you can distrain: in other words, take the tenant’s chattels to do with as you like, including selling them to recoup what the tenant owes you.

Number 4: What about insurance? If you have a residential investment let on an Assured Shorthold Tenancy, the chances are that you pay the building’s insurance premium. For peace of mind, you might also take out limited contents insurance to cover your carpets and white goods, plus public liability insurance to protect yourself in case the tenant’s friend takes a tumble down the stairs and sues. This all costs you money, but you don’t have to worry about any of this with commercial investment property. Most standard commercial leases either make the tenant organise and pay for acceptable insurance (subject to your acceptance), or allow the landlord to organise it and get the tenant to reimburse for the whole of the insurance premium.

Number 5: Then there are repairs. There are two formats for dealing with repairs of commercial property in standard leases. The first makes the tenant responsible for all internal repairs; the second makes the tenant responsible for all repairs. If you look through auction catalogues or commercial property agents’ details, you’ll see commercial leases described as IRI, which means the tenant is responsible for all internal repairs and insurance, or FRI, which means the tenant is responsible for all repairs and insurance (F ull Repairing and Insuring terms).

The great thing about commercial property is that not only does the tenant pay for repairs, he also has to organise them. Therefore, no phone calls from a tenant at midnight to say the toilet is blocked. If the toilet is blocked, the tenant has to roll up his sleeve and sort it out himself. If he telephones you anyway, refer him to the lease. “Not down to me, matey!” you can say with quiet confidence. “You spend the next hour ringing through the Yellow Pages.”

Even better, if you think the tenant is not keeping the property in good condition, you can give notice to inspect, send in your surveyor, serve the appropriate notice and get the tenants to do the repairs.

Number 6: All of this means that managing a commercial property investment should really be a doddle. Indeed, many investors do the managing themselves. As a commercial lease is a private contract between a landlord and tenant, they can agree whatever terms they like. So for more complicated properties, like office buildings with more than one tenant, or small industrial estates with two or more units, or parades of shops and shopping centres, you’ll often find the lease stipulates that the tenant has to pay the landlord’s managing agent’s fees, as well as the rent and other costs.

So, if you buy the right property with the right tenant, you should hear nothing during the tenancy. Except, of course, for the sound of the postman delivering your bank statement, showing your rent is arriving quarterly in advance, on the first of the month.

Are there any other financial advantages of commercial property? Yes, let’s have a look.

Number 7: It’s your chance to beat the VATman. Whatever anybody tells you, VAT and residential investments don’t mix. Providing residential rental property is not a VAT-able service; technically, there’s no option whatsoever to elect to waive or charge VAT. If you do VAT register in an attempt to reclaim VAT on managing agents’ fees and contractors’ bills and the VAT man catches up with you, he’ll want to know why you’re not charging VAT on the rent. Well, you’re not charging VAT on the rent because, company lets aside, you’d be pricing yourself out of the market because your tenants cannot reclaim the VAT. So Mr VATman will ask for his money back … but he won’t say “please”.

Not so with commercial property. If you want to elect one way or the other, that’s up to you. If you elect not to waive the VAT, (that’s VAT speak for deciding to charge VAT), generally speaking, your VAT-registered business tenant can reclaim it. So they don’t care one way or the other if you charge VAT on the rent. The only exception is if your tenant is engaged in financial services and then they cannot reclaim VAT. If you VAT register your property business, you can reduce your costs by reclaiming VAT on things like petrol, your telephone bill, managing agent’s fees, premises, stationary and any other VAT-able costs.

Number 8: When you let a residential property, chances are you’ll let it on a six-monthly or annual Assured Shorthold Tenancy, or similar. The tenant might stay longer and you might renew the tenancy, or let them ‘hold over ’ on the old lease, but in truth, you’re never quite sure how long they’re going to be there. However, when you let a commercial property, market practice is to let it for a ‘term of years certain’. Standard commercial leases are for 3, 5 and 10 years; some of the older leases are for 15 or 20 years. As long as the tenant is able to keep trading, you will be guaranteed your rental income over that period. Longer leases also allow for you to regularly review the rent.

Are you starting to get excited by commercial property yet?

Number 9: There’s usually more scope to significantly enhance the value of a commercial property than with other types of investment. Please note that I said ‘significantly’. It’s true that you can add central heating or a new kitchen or conservatory to a residential property to enhance the value, but with commercial property, we’re talking about changing an already big number into a much bigger one!

The reason for this lies in the way commercial properties are valued. Now this is a highly technical subject and I can only give a very brief overview here, but it works something like this.

Again, let’s start by contrasting with residential property, which most of us will understand. Unless there are compelling reasons not to, a residential investment should be valued as if it’s vacant. So, for example, imagine you own two 4-bedroom detached houses and the last two or three on the estate have sold to owner-occupiers for £100,000. One of your properties is let at £100 a week on an AST, the other at £75 a week. How much is each worth? Is one worth more than the other? After all, one is making £25 a week more in rent. Well no, because if you wanted to sell, you’d ignore the rent and ask for £100,000 for each one. You certainly wouldn’t ask for £75,000 for the one let at £75 a week. That would be crazy. If you had to, you might serve notice on the tenants to leave, but in effect, you’ll still be looking to get the ‘vacant possession’ value.

Things aren’t quite so simple in the commercial world. With commercial property the cash-flow, in other words the rent received, has more impact on value, especially perceived value. In fact, it’s true to say that, in most cases, it’s the cash-flow or rental income that’s valued, rather than the bricks and mortar.

For example, when valuing a vacant commercial property, a valuer will normally assume that the property will remain vacant for a period of time, determined by his experience of current market conditions. He will assume that rent won’t be receivable until that void period is over. He will then value the potential rental income, but discount the figure because he thinks it might take, say, six months to get a tenant signed up. This will negatively impact the value.

Canny investors can use this to their advantage, especially in a slow market. Let me explain. The investor will negotiate to buy a vacant commercial property and simultaneously start looking for a tenant, preferably one who is prepared to sign up to a long lease.

The investor or trader will then be able to buy the property at a price which reflects that it’s vacant, but the moment the tenant moves in on a reasonably lengthy lease, the valuer will be valuing the property to reflect that the cash-flow has started. So there will be no ‘deferred’ period imputed into the calculation.

Another bonus of having a tenant in place is that the valuer might use a lower yield to value the property. Without going into the maths behind it, this will result in him using a higher multiplier to apply to the rent, resulting, of course, in a higher valuation figure.

So, it’s quite conceivable that the value of a vacant commercial property can jump dramatically upon letting. At that point, the investor can decide to refinance and pull out some of the extra equity as a loan, either to spend, or to reinvest on another property; a trader can decide to sell the property on at a profit.

Similarly, commercial property traders and investors are often looking for an ‘angle’, something quick and easy which will disproportionately enhance the value.

Obtaining planning consent for a change of use fits the bill. For example, suppose our investor decides to buy a secondary shop in a small parade. Now he has aspirations of obtaining consent to turn it into a restaurant, but planning consent isn’t a foregone conclusion. He’s done his research, including talking informally to the planning office and, although they aren’t thrilled with the idea, they haven’t dismissed it out of hand. He buys at a price that reflects that this is a vacant property and that it only has consent for normal retail use. As soon as he completes the purchase, he puts in an application for a change of use to ‘A3’, a use within Class A3 of the Town and Country Planning (Use Classes) Order 1987, which, to you and me, is restaurant and takeaway use. It’s a struggle, but he gets it.

He knows that its rental value as a restaurant or takeaway in that locality is much higher than for a normal retail shop, so the value of the property has increased significantly just by filling in a few forms.

He can now either let the property, at a higher rent that a retail outlet can achieve, then sell it or refinance it, or sell it on vacant at an enhanced price to a restauranteur.

This is a very simplistic example, but I know of people who do this and have made fortunes by getting a change of use on a property. I know someone who worked as a consultant for a small commercial property company who did similar deals all the time, only on a bigger scale. One of the best examples of finding angles like this, combined with increasing the value through enhancing the cash-flow, was a small package of property the company bought at auction. The property, which is in a small south-eastern market town, comprised of three shops on the ground floor, a dance studio on the first floor and a large car park to the rear. The two largest shops were vacant and had been for years; the smaller shop had a retail tenant, but the rent was due for review. The lease of the dance studio was about to expire and needed to be renegotiated.

The price paid at auction really only reflected the rent then receivable from one shop and the dance studio, even though there was a lot of potential to increase the total rent, especially by letting the empty shops. However, those units were boarded up and, to use estate agent speak, didn’t ‘present’ very well; this no doubt deterred a lot of potential bidders at the auction.

A few weeks after the purchase completed, the property company sent in the builders. They took the boards off the windows of the empty shops and tidied them up. In the meantime, following all proper legal procedures, my friend started the task of renegotiating the rent of the smaller shop and a new lease for the dance studio. It took some time (about a year) before everything was agreed.

Eventually, the empty shops were sold rather than let, at combined prices in excess of that which the company had paid for the whole lot. They obtained planning permission for a small development of sheltered retirement flats on the car park at the back and sold the land to a housing association. They also sold on the dance studio and the small shop to investors, at prices which reflected the enhanced rents negotiated.

With a little bit of vision and a year of hard work, they turned around a property which others had written off and made a substantial profit as a result.

Number 10: Last, but not least, commercial property can be held in a SIPP, a ‘self-invested pension plan’, which means that it can be extremely tax-efficient if used properly.

SIPP rules allow direct investment in commercial property, so you can source and negotiate a purchase and put it into your pension fund. What are the advantages of holding your investments in this way?

  • Firstly, you can claim tax relief on any money you put into your fund at the higher (marginal) rate of tax: in other words, the government will ‘gross it up’ for you.
  • Secondly, SIPPs are allowed to borrow in order to buy properties, subject to the condition that the pension fund must make up 25% of the purchase price. So, in essence, you can borrow up to 75% of the property value (subject to your lender ’s approval) and reap all the benefits of gearing within your pension.
  • Thirdly, any income you make from your property – rent, in other words - is tax-free.

Next, if you do ever sell, there is no capital gains tax; if you die, there is no inheritance tax.

Finally, subject to certain qualifications, if you’re already in business, you can put your business premises into your SIPP, as long as you pay your pension plan a proper rent and have a proper lease.

It would be inappropriate to go into more detail here about SIPP, as we’ve covered that subject in the past. If you’re interested, you should also talk to your accountant and/or HMRC.

So there you are: 10 benefits of owning commercial property and you don’t need to have the spending power of Harvard and Yale! Essentially, £25,000 geared up will buy you a decen t first investment to cut your teeth on.

published by Gauk

 

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