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Residential vs. Commercial Property Investment

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Commercial vs. Residential Property

As obvious as it seems, it is vitally important to understand what types of properties and projects you wish to invest in, across both the residential and commercial markets.

Specialised commercial property portals are less common placed than their residential counterparts, but listing sites such as Commercial People can help make your first steps into commercial property investment that little bit easier.

In general, investing in commercial property is often significantly more cost-prohibitive than investing in the residential market, meaning you’ll often need significant financial backing to enter the market.

As with all investment, there is an element of risk involved; however, while investing in commercial property can offer significant financial rewards, there is also an equally significant risk with the financial barrier to entry often higher than a residential venture.

As such, commercial investing can be considered more financially risky.

Commercial properties are far more exposed to the economy than their residential counterparts with economic downturns often resulting in several businesses (especially SMEs) going bust. As a commercial landlord, this could mean your rental income could stop for an unknown period until you’re able to find a new tenant, and with the rise of CVA’s, your legal options to claim lost rent are not as clear cut as it once was.

In addition to having to fork out legal fees to challenge default tenants, you would be expected to spend more money to remove the tenant from your premises which again contributes towards the higher financial risks for commercial landlords. It should also be noted that, commercial properties typically take longer to find new tenants than residential properties due to the legal complexities and logistics involved in the deal.

There are a number of things commercial property investors can do in order to reduce the inherent risks of commercial investment such as diversification. By diversifying your investment portfolio and investing in multiple commercial assets across various markets, you can somewhat minimise the risk of a potential market crash affecting one of your other properties.

Naturally, residential properties also carry similar risks, such as problematic tenants or inability to attract renters (leading to a lack of rental income); while a significant house price crash could drastically depreciate your property’s value. However, due to the price of purchase and rent often being lower in the residential market, the impacts these incidents will have on you as a landlord will be significantly smaller than those in the commercial sector.

Return on Investment

In the residential market, returns on investments can vary hugely between the various different types of investment.

Traditional ‘Single Lets’ offer significantly lower rental returns than HMOs and student accommodations, where you’ll receive rental income on a per room basis rather than a per property basis.

While it is difficult to definitively say whether commercial property investment offers higher or lower returns than residential properties, commercial landlords enjoy higher rents and longer-term rental contracts than those in the residential property market.

Location, Location, Location

Location is certainly one of the first and most important things investors in both commercial and residential markets look at when contemplating whether to invest in properties.

While you are looking for where people live and local amenities with residential property, with commercial premises you’ll be looking at where people want to work – which can have some crossover in city centre locations, such as London, Birmingham and Manchester where demand is both high for both residential and commercial properties.

However, despite the similarities, commercial property still has unique requirements such as the proximity of the premises to road networks, the amount of floor space, the use class of the building and more.

Financing your Commercial Investment Property

How commercial and residential properties are financed can vary greatly. In commercial property, some of the common methods are direct funds and indirect funds, both of which has its own advantages and disadvantages.

Direct funding, also known as ‘bricks and mortar funds’ – refers to an organisation or individual directly funding a project, whereas indirect funds are where you buy shares in a company that invests in property.

Rental / Lease Lengths

Although the lease length for commercial properties could vary depending on a number of factors (including what type of property and which sector you are in), it is typically much longer than those of residential properties. Despite the average commercial lease lengths being reduced in recent years, they still remain considerably longer than those in the residential sector. As a landlord, this could give you a great advantage of receiving guaranteed long term income stability.

However, with a long lease, you should also remember that there is much less flexibility and greater scope for legal issues to arise in the event of selling your commercial property.

Meanwhile, in the residential market, you could be looking at anywhere between six months to two years. If you are planning on investing in serviced accommodations, you could potentially be looking at an even shorter occupation period, such as a weekly or monthly term. While this helps to reduce issues with non-paying tenants, the short tenancy agreements mean you are exposed to more frequent vacancy periods where the property has no tenants.

Finding Tenants

As mentioned earlier, finding tenants can be a more difficult task in the commercial market than residential. However typically commercial landlords and tenants have better and more professional relationships than those in the residential market, as essentially it is purely a business to business relationship.

Landlords’ Responsibilities

With residential properties, it is a landlord’s responsibility to carry out repairs and maintenance for most parts of the building.  However, this can get a bit more complicated for commercial properties as it is not always the landlord’s responsibility to do so.

For instance, in a serviced office the landlord is required to oversee the maintenance of the building, but in non-serviced offices, the leasing business is often expected to carry out any repair work. The responsibility and duty of a landlord regarding repairs and maintenance should be clearly set out when drafting the Head of Terms.

Stamp Duty Land Tax (SDLT)

One of the most commonly overlooked costs to consider when purchasing is the Stamp Duty Land Tax (SDLT), and many fail to realise how it affects the total price of the property.

Residential property has higher SDLT rates than commercial property and can go up to 15% including 3% surcharge for the portion above £1.5 million. Whereas the highest rate that commercial freehold sales can go up to is 5% (portion above £250,000) – there is no additional surcharge for non-residential properties.

For example, if you were to purchase a residential property for £600,000, the total SDLT payable would be £38,000, compared to £19,500 for a commercial property purchase of the same value.

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June 2019

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