It's a common misconception that you need a lot of capital to invest in commercial premises and that it's only for large-scale and institutional investors. Of course, the bigger the building, the more it's going to cost, but there are plenty of smaller retail and office premises that can cost no more to acquire than residential property.
The commercial market experiences ups and downs, just as every market does, but with the potential to negotiate a lease of ten years or more, once you've got the right tenant and right management team in place it can be a relatively straightforward and long-term, mutually beneficial relationship.
As with investing in residential buy to let, the 'right' location depends on the type of tenant you want to attract. Remember that what you buy and where you buy it can make or break the success of the investment, so make sure you carry out lots of research before moving ahead with a purchase.
Traditionally, most commercial landlords choose premises in locations where there's high footfall and if you want tenants that operate shops, cafes, bars, etc. then a city centre or busy high street are obviously ideal.
However, bear in mind that there are lots of commercial tenants these days whose businesses are largely conducted online and they often prefer to be outside cities and even in rural locations. That's because they tend to get more space for their money, which is particularly useful if their business requires storage, e.g. events companies.
Commercial investment has a different legal and financial framework to residential property, so it's important to take advice from professional mortgage lenders, solicitors and agents that specialise in this market. You'll also need specialist insurance to make sure you and your building are properly covered for the cost of damage and protected against liability claims.
Commercial property is an attractive option for anyone looking for a long-term investment and is particularly popular with those who already have an investment portfolio and want to spread their risk. If all your money is in one place and that market experiences a downturn, you could quickly find yourself in financial difficulty. But if you invest in a diverse range of assets - e.g. commercial premises, shares, annuities and residential property - it can put you in a much more secure overall position.
This is probably the main reason people choose commercial property. For most landlords, the ideal tenant is one who looks after a property well and stays there as long as possible, paying a good market rent. However, as a residential landlord letting property on an Assured Shorthold Tenancy agreement (AST), the tenant only has to commit to a minimum of 6 months. While most do stay for longer than that - with an average residential tenancy length in England, according to the 2017-2018 English Housing Survey, of around 4 years - commercial leases are generally for at least 3 years and commonly 10 or 15.
And, given that termination of the lease is more-or-less up to the tenant after the fixed term expires, as long as the tenant is happy with the premises, a commercial investment could deliver a steady stream of income for decades.
The yield on commercial rentals tends to be higher than for residential tenancies and has been relatively stable since 2015, at around 5%. And, compared to other assets classes, overall returns are high. Between 2000 and 2018, commercial property returned 308%, compared to 209% for the FTSE 100, according to research from the CEBR.
Also, unlike residential tenancies, commercial leases usually specify that rent can only be adjusted upwards. That means even if market prices are falling, you don't need to reduce the amount of rent you charge.
Probably the biggest risk to residential landlords is having void periods, where a property stands empty with no rental income. With an average commercial lease length of around seven years, void periods are not something to worry about day-to-day. If it's possible to let a building to two or more tenants, that reduces the risk further, as you're far less likely to have a completely vacant building at any point.
Returns are also more secure than with shares, for example, as rental income is guaranteed at a set level for an extended period of time. And the risk of the tenant defaulting is much lower than with residential properties.
In terms of downsides, there are the same ones that apply to all property investment:
But most of these are things you can overcome by taking expert advice and planning, buying and managing the let in the right way.
One big thing to bear in mind is that, once you've agreed a tenancy and signed a lease, you cannot evict the tenant and end the tenancy without a very good reason. (See What rights does a commercial tenant have? and How to evict a commercial tenant.) So you need to be very certain that you are happy with the incoming tenant before you make a legal commitment.
When you let a commercial property, you have certain obligations and responsibilities with respect to both the property and your tenant. Some are statutory (set in law), while others will be stipulated in the lease. As with all tenancy agreements, amendments or additional clauses inserted by either party cannot breach any rights or responsibilities stated in law. So, before you sign a commercial lease or tenancy agreement, you should consult a specialist legal representative to make sure the terms are (a) reasonable and (b) legally valid.
The lease will lay out:
Fundamentally, the lease is there to protect both parties and should help in potential disputes by clarifying what was agreed at the outset.
The exact responsibilities of each party are likely to vary from one lease to another, so it's vital you thoroughly check the terms and make sure you understand what you're committing to before signing.
As a general rule, the landlord is responsible for the external and common parts of the property, as defined in the lease, including any fixtures and fittings:
Commercial landlords must also take reasonable steps to make sure their tenant complies with their own health and safety responsibilities.
In terms of health and safety, the tenant is generally responsible for the interior of the specific premises they are renting. Their specific responsibilities should be detailed in the lease.
Tenants must carry out a risk assessment and take any action required to remove hazards. In the workplace, they must also provide:
If the tenant fails to comply, they can be prosecuted under the Health and Safety at Work etc. Act 1974.
One of the main functions of the LTA is to protect commercial tenants and ensure that successful businesses can carry on trading from the premises with confidence, without the worry that they might be evicted. So it gives tenants significant rights to continue to occupy the premises and tightly regulates how a commercial lease can be terminated.
Under the LTA, tenants have two important rights:
In short, once a lease has been granted, the tenant has the right to continue to occupy the premises unless they breach the terms, such as by defaulting on the rent, or the landlord has a valid legal reason to evict them.
If a landlord wants to terminate a commercial lease, essentially evicting the tenant, they must have very good reason.
Letting commercial premises has specific risks, so it's important you take out an appropriate specialist insurance policy.
Direct Line's Commercial Landlord Insurance provides a range of options, so can be tailored to each landlord's requirements, including: