Investing in commercial or residential property – where do I start?
At first glance, letting commercial and residential property might seem quite similar. However, there are some huge differences to be aware of if you’re thinking of investing in either property type.
Investors are still considering both residential and commercial property as practical longer-term sources of income. The Q4 2018 RICS UK Commercial Market Survey (1) found that industrial assets continued to attract a rise in investor interest. According to Direct Line for Business (2), the average rental yield from letting residential property is 3.6%, although it can be as high as 7.1% in some areas.
In either case, you’ll need to be very well-informed before investing in any kind of property. Here, we talk about the key differences to help get you started…
Types of property
Defining a residential property is fairly simple as they are let to consumers – not businesses. Broadly speaking, any property that is solely used for business purposes is classed as a commercial property. However, there are four main types of commercial property or ‘asset classes’ to bear in mind: offices, retail, industrial and leisure.
Commercial properties include anything from more standard buildings, such as banks, shops or hotels, to more specialist structures, such as petrol stations or laboratories.
There are two main ways investors can make money from property: from the income from the rent or capital growth from the property. However, if you make a profit from the sale of a residential or commercial building, it’s likely you’ll have to pay Capital Gains Tax. To find out more about this area, visit the Government’s website.
Buying any property outright is expensive, so there are a number of other options open to investors. If you’re searching for a commercial or buy-to-let mortgage, you’ll probably need a higher deposit than required for a residential property. A buy-to-let agreement is also different from a standard mortgage as you’ll need to demonstrate that your income from the rent will cover the repayments. Speak to our expert team at dot financial services for the latest buy-to-let mortgage deals.
Direct commercial property funds are the most common way to invest in commercial property. With this method, you’ll invest in a portfolio of commercial properties through a collective scheme, such as a unit trust, open-ended investment company (OEIC) or investment trust.
Another way to invest in commercial property is via an indirect property fund. These are collective schemes that invest in the shares of property companies listed on the stock market. But like any share, your investment will increase or decrease with the stock markets.
Types of agreement
Landlords letting residential property will usually issue an Assured Shorthold Tenancy (AST) agreement to a tenant that typically lasts for six months or one year. This contract outlines the responsibilities of both parties. After this time, a new contract may be agreed, or the previous agreement will continue as a periodic tenancy until either side gives notice.
If you choose to lease commercial property directly or through an agent, it’s worth knowing that these agreements are usually much longer, with the average length being around five years. However, commercial contracts can contain break clauses which allow the tenant or landlord to exit an agreement early.
With commercial property, there are two main types of lease:
1) Gross leases: a gross lease means a landlord has to pay insurance and maintenance costs, as well as property tax. With this kind of lease, the landlord will include their estimated maintenance costs.
2) Net leases: these are the most common commercial leases in the UK. Unlike gross leases, tenants are required to pay a portion or all maintenance costs (i.e. taxes or utility bills).
Net leases can be divided into three categories: single net leases, double net leases and triple net leases. With single net leases, the tenant is responsible for paying tax, but the landlord is still in charge of the rest of the expenses. A double net lease means the tenant is responsible for tax and insurance costs, while maintenance costs are still managed by the landlord. Finally, a triple net lease means the tenant is responsible for all costs, including maintenance.
Weighing up the options
As the lease lengths for commercial property are usually longer, this means that commercial property can be a viable longer-term investment as tenants tend to be less transient.
On the other hand, residential buy-to-let investors often have more control over their properties as they are usually closer to the day-to-day running. However, letting directly to tenants means that landlords will need to manage their finances carefully and calculate an expected rental yield in advance. This means working out how much income you can expect from the rent, minus expenses.
In both cases, investors need to thoroughly research their options and seek expert advice. For example, location is always a key factor when looking at commercial or residential property, so make sure you understand whether the area and its connections has the potential to provide a good rate of return.
It’s important to remember that both industries are subject to strict regulation and the penalties for non-compliance can be high. So, if you plan to let any kind of property yourself, make sure you are fully aware of your obligations as a landlord.
Seek professional advice
Whether you’re looking at investing in commercial property or becoming a residential landlord, make sure you gain professional advice before beginning your search. A good estate agency should have a detailed knowledge of the local area and the various investment options available.To speak to one of our lettings experts, contact your local branch for more information about properties for sale now.