Helping clients with the leap from residential buy-to-let to commercial

Mortgage Introducer

April 17, 2019

Darrell Walker (pictured), head of sales at InterBay Commercial

Residential buy-to-let landlords over the past couple of years have had the proverbial kitchen sink thrown at them. The scene is all change with the introduction of a stamp duty surcharge on second homes, changes to mortgage underwriting standards, and the ever-reducing mortgage interest tax relief. The wider global economic slowdown, and the uncertainty caused by Brexit have conspired to help dampen buy-to-let purchase activity.

Against such a backdrop, we’re seeing investors diversifying beyond ‘vanilla’ buy-to-let to maximise profits and spread risk, and many are turning to commercial as an alternative.

The reasons for this are understandable. The major attraction of commercial property comes in its exemption from the major tax changes that have hit residential buy-to-let including the mortgage tax relief changes. Commercial property stamp duty rates are capped at 5% over £250,000, while residential stamp duty land tax (SDLT) rates can reach 12% on properties over £1,500,000.

While the commercial market has by no means been immune from the current economic climate, rents on office space and other commercial lets can also compare favourably, providing a strong yield for landlords when pressure mounts on their costs.

Estate agents Knight Frank’s Investment Yield report found that the yield on some commercial properties can reach up to 10%. By comparison, Kent Reliance’s research found the buy-to-let residential market is averaging a yield of 4.4%.

Even so, investing in commercial property is not risk-free and potential investors should do their homework. The commercial property market is all about valuing the income stream, its certainty, regularity and security.

The checklist for anyone looking to invest

Estimating the value of a commercial property is far harder than in buy-to-let because of the greater range of factors that can affect it. A valuation is therefore a little more complicated than a residential property, which should affect both the investor’s decision-making, and that of a lender. The following three considerations will help decide whether a property is a sensible investment.

Firstly, physical aspects such as location, size, condition, how the property is configured and whether it has car parking, or if close to good transport links. The further from the prime parts of the high street, the faster rents fall. Make sure that you have a reputable, independent surveyor to call upon to ensure that the necessary checks have been done. Equally, do your due diligence – spend time in the area, ask questions and read up as much as you can.

Secondly, there are legal concerns such as the nature of the lease, its length, break clauses, opportunity for rent reviews and business rates liability.

Finally, there are the economic factors to consider such as occupancy rates elsewhere along the street. This includes anything from how long other places are staying on the market to whether it is an affluent area. This also applies to the tenants you accept – it’s better to have a stronger covenant that is more likely to remain in place even after a difficult phase of business.

What do prospective investors and brokers need to know?

For those thinking about making the move over to commercial buy-to-let from residential, there are a number of differences between the leases that landlords should be aware of.

In general, business tenants tend to sign up for longer leases – some of which can be decades long. However, break clauses are common, with tenants often needing to adapt to rapid expansion or decline.

The process of evicting a tenant is also different – for those unfortunate enough to have to go through this process. Unlike with residential properties, the landlord need only wait until the rent is overdue by more than the time period specified in the lease for forfeiture, after which the process of repossessing the property can start.

There are additional responsibilities for health and safety that would not apply to a residential property. Fire, electricity, gas, fixtures and fittings, and asbestos all have different regulations that a commercial landlord should consider. The Code for Leasing Business Premises in England and Wales was published in 2007 outlining the responsibilities of commercial landlords and tenants. While not a legal requirement, it’s worth finding out what tenants may expect of their landlord, and what competitors might be offering.

In short, there are a range of hoops that face a client looking to take a leap into commercial buy-to-let, but there are good reasons to do so. These decisions are only made more complex by the current economic environment. But, this emphasises the valuable role of the broker in these circumstances, helping inform clients, and navigate through the myriad of decisions they have to make.  For brokers looking to diversify into commercial, not only will this additional expertise be a value add for current clients, but as more landlords look into this route it could also be an alternative source for new business going forward.

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