Commercial property investment

Commercial Property Investment – Guide to Investing in UK Commercial Properties

If you are a property investor considering commercial property investment opportunities in one of the more traditional real estate asset classes of offices, retail, leisure or industrial property then our guide to investing in UK commercial property is certainly a good starting point.

The global financial crisis that started way back in autumn 2008 has left many investors still questioning just how beneficial investing in commercial property is with many still hesitant to put their money into commercial real estate assets.

What about Commercial Property Investment?

Despite this gloomy assessment taken by some investors, there are a rapidly growing number of property insiders who are looking at the situation without quite so pessimistic an eye and who see commercial property investment as an attractive medium to long-termer opportunity that is now worthy of serious consideration.

The head of global strategy at Standard Life, Andrew Milligan OBE, believes that, in the future, property will yield bigger returns than shares.

At the start of the global financial crisis UK commercial property assets suffered a significant fall in value between 2008 – 2009, with commercial property prices dropping by as much as 44 percent and yet the market has now recovered relatively quickly, sparking growing interest in the commercial property sector as investors seek steady and reliable investments.

Despite some investment pundits arguing that now is not a good time to invest in commercial property, there is growing demand for good quality UK commercial property investments from both home-grown and international investors.

Benefits of Investing in UK Commercial Property

The UK has traditionally used a longer lease structure for its commercial property than many countries throughout the world, and this can be highly beneficial to investors as it provides much more security over a longer term.

While commercial lease terms have tended to fall from the 25 year norm of yesteryear, leases in the UK now average around eight years, meaning that investors can expect an extended regular monthly income.

Due to the nature of commercial buildings, their size and potential, investors can usually expect higher rental returns than typical residential properties.

As mentioned previously, commercial property should deliver a stable income over a specified term, but there is also the additional benefit of capital growth in the value of the property itself.

Many property investment specialists speak of the reliability in “bricks and mortar” investments such as commercial property. They argue that commercial property investment provides an income that other indirect investment asset classes struggle to yield.

Direct ownership of commercial property is a tangible asset that can be modified, renovated, redeveloped and reviewed as the market changes, giving investors better control over how to respond to shifting trends and occupier needs.

In the UK property market commercial tenants are typically responsible for building maintenance and repairs, especially where a full repairing and insuring lease (FRI lease) is in place.

This is in contrast to residential property investments where the responsibility for building maintenance and repairs usually falls to the landlord.

It is also important to choose commercial tenants wisely and shrewdly and an investor should seek a tenant with a good reputation and strong, reliable finances to ensure the risk of the tenant defaulting on their financial and other obligations during the lease term are minimised.

The Risks & Other Considerations

Naturally the higher the financial stake, the larger the risk, and this holds true for commercial property investment opportunities when compared to smaller residential property investments.

Investment in this sector often requires significantly larger amounts of capital and therefore it is important that potential investors thoroughly research the market, location, investment types, anticipated returns and tenant demand before they begin investing.

  • Property Location

    Location is arguably the most important factor to consider when planning to buy commercial property.

    Location can be everything and choosing the wrong area may result in lower than anticipated yields, along with reduced rental and capital growth opportunities in the future.

  • Lease Covenant Strength

    What commercial property investors should also note is that the strength of a tenant and their lease can have a significant impact on the investment value of a commercial property.

    Lease strength of this nature is commonly referred to as “covenant strength” and is a term used in property circles to denote the strength or quality of a commercial tenant.

    A FTSE 100 company would typically be seen as a very strong tenant, much more likely to keep to its lease covenants, to pay its rent on time and not to break any of its lease obligations.

    However, if a tenant’s credit rating deteriorates during the lease term this can affect the income that an investor can expect to receive and also the future investment value of the commercial property.

    It is important to assess and research the reliability of potential tenants before any lease agreements are signed.

  • Market Performance

    It is important for investors in commercial property know their market, and this includes wider market performance issues.

    Despite the financial crisis of 2008, which had an unprecedented effect on the commercial property market, it proves that while the “sector isn’t volatile” it can still fall victim to economic downward spirals.

Investing in Commercial Property

There are many ways to invest in commercial property assets and it is essential for investors to consider all of these routes before taking the plunge.

The two primary options open to prospective investors in commercial property are either the direct or indirect investment approaches.

Direct investment involves the purchase of the physical “bricks and mortar” property assets, while the indirect approach involves investing in Real Estate Investment Trusts (REITs), stocks and shares of companies that specialise in property and real estate, property index derivatives, trust companies or bonds of corporate property organisations.

  • Direct Investment in Commercial Property

    An investor should decide firstly whether they are in a position to invest directly in property and that they are aware of the risks associated with such an approach.

    Direct investment in commercial property is not usually a viable option for the smaller private investor due to the high values associated with this type of property asset.

  • Indirect Property Investment

    The alternative to the direct approach is indirect investment which is considered by some to be the less risky option as the capital sums involved can be much smaller.

    The indirect investing approach is also considered by many to be a low cost and easy way to gain exposure to a range of commercial property investment opportunities.

  • Property Trusts

    There are different types of property trusts; the first, known as a bricks and mortar fund, invests in a property or a selection of properties directly, the manager of which owns the properties.

    Another type is a property security fund, which invests in property companies themselves by investing in shares.

    The disadvantage of this is that it is affected by the performance of the stock market whereas the bricks and mortar fund can be more stable as financial returns are generated by rental income and activities directly associated with the management of property assets.

  • Real Estate Investment Trusts (REITs)

    In 2007 the UK introduced a new form of property company that had started in the USA known as Real Estate Investment Trusts or REITs.

    REITs allow people to invest in commercial property indirectly, like the options above.

    Property companies can become a REIT and then individual investors can buy shares in these companies.

    There are special rules governing the formation and operation of REITs but their main advantage to an investor is that they are exempt from paying tax, resulting in shareholders receiving larger gains.

Commercial Property, Disposal Costs & Illiquidity

Both indirect and direct investors should be aware that commercial property investment is much more illiquid than many other investments, meaning that they can sometimes take much longer to sell than other investments.

Many investment trusts and funds will charge exit-fees if an investor finds that the returns on an investment do not meet their expectations.

Those brave and financially secure enough to invest directly in commercial property assets should be aware that due to the nature of commercial property, liquidating your assets (selling) will often take much longer than other types of investments.

Property Investment Solutions

As a leading independent property and land investment specialists Investment Property Partners offer expert advice and support to clients across our specialist areas of expertise helping them to achieve their investment objectives.

If you are a property investor searching for commercial property investment opportunities in the UK or internationally, residential or overseas property investments please contact us today to discuss how Investment Property Partners can help you.

Further reading…

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