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Is commercial property investment a savvy buy-to-let alternative?

Is commercial property investment a savvy buy-to-let alternative?

Buy-to-let has become challenging in recent years and when the going gets tough, the tough buy shops, as Christine Toner discovers.

Words by Christine Toner

Unless you’ve purposely avoided any news on buy-to-let in recent years (and if you’re a landlord you could be forgiven for wanting to do so) you’ll know the sector’s landscape has changed significantly. The amount of Stamp Duty a landlord pays on investment properties, the tax relief they can claim and the hoops they need to jump through to get a mortgage have all changed in recent years and for many landlords the challenge to adapt to these has been too great.

According to the latest figures from the National Landlords Association (NLA), one in five landlords are looking to sell at least one of their properties this year.

But while some property owners are looking to sell up, a number of others are looking to other options. For many this involves setting up as a limited company and purchasing properties via this, thereby avoiding income tax and the tax relief issue and instead paying corporation tax which is set to fall to 17% by 2020. But others are looking away from residential buy-to-let altogether and instead opting to purchase – and let out – commercial property.

“Landlords are considering other options as a result of the changes implemented by the government. A fair number are looking into commercial property as an alternative.”

“It’s certainly the case that landlords are looking at their business models and considering other options as a result of the changes implemented by the government in recent years and a fair number are looking into commercial property as an alternative to residential,” says mortgage broker Ansar Afsar, owner of Manchester-based We Know Mortgages. “Commercial mortgages tend to be slightly more expensive than residential mortgages and deposits required are usually higher, however buy-to-let landlords will be used to meeting more stringent lending requirements. Furthermore commercial buy-to-let can have better rewards for landlords with yields generally higher and most tenants opting for longer leases.”

“Investors in mixed use properties are not as badly affected by the mortgage tax relief changes which hit landlords of residential properties.”

Lisa Wilson, tax partner at Cowgill Holloway, says the tax benefits of commercial and mixed use properties are driving their appeal.

“Investors in mixed use properties are not as badly affected by the mortgage tax relief changes which hit landlords of residential properties in April 2017,” she says.

“Previously, landlords have been able to claim tax relief for finance costs on buy-to-let mortgage payments when they’ve completed their tax return, allowing them to offset mortgage interest against rental income. This has changed from April 2017 with the effect that by 2020 landlords will be subject to much higher effective rates of tax if they are already higher rate (40% / 45%) tax payers and have buy-to-let mortgages.

One in five landlords are looking to sell at least one of their properties this year – National Landlords Association

“These changes do not apply in any way to wholly commercial properties and only in part to mixed use properties that have a combination of residential and commercial units, e.g. blocks of flats with ground floor commercial units. Essentially you will still be able to claim full tax relief for loan finance costs relating to the commercial part of a mixed use property with the tax relief restrictions only applying to the residential element.”

According to real estate business Colliers International, last year saw £55 billion worth of transactions in the UK’s commercial property sector and the same is expected in 2018.

But while there are many benefits in investing in commercial premises, landlords shouldn’t make the mistake of thinking this strategy is failsafe.

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In the past, commercial property has been seen as an investment for large scale institutional investors and property funds and there’s good reason for that.

According to insurer Direct Line, commercial property can require greater investment. Shops and small office buildings involve a similar outlay to a residential property, but a typical commercial investment will involve a bigger spend.

Furthermore, says the insurer, valuing a commercial property is a highly specialised business.

And commercial landlords still have a wealth of responsibilities to their tenants including fire and gas safety, ensuring all fixtures and fittings are safe and ready to use and ensuring the structure of the building must be safe and suitable for use at the beginning of the tenancy.

That being said letting a commercial property can be easierthan letting a residential space.

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Landlords can benefit from greater security with tenants likely to rent for longer.

“There are a number of similar characteristics to residential and commercial investment,” says Neil Kirkham, director at CBRE.

“Residential, in less attractive areas, will be cheaper and in turn command a greater yield to reflect the lack of potential for capital value growth.

“The same principles apply to commercial in that offices in less desirable locations and of inferior specification will attract poorer covenants signing shorter lease terms, which again will offer a much higher yield.”

Kirkham says the key difference between commercial and residential is that the strength of the covenant that occupies the accommodation and the length of lease will drive the value of that asset.

“Residential leases tend to be standard six-month assured shorthold tenancies and, whilst one occupier will be less risk than another, that will have little effect on the capital value of the asset.”

But before landlords jump shop from residential and opt to invest in commercial property experts say familiarising oneself with the market is essential.

“Investing in commercial property can offer strong returns but some knowledge of the market is pretty essential as it is a very different beast from residential buy-to-let,” says Andrew Owen, director at Worthington Owen in Liverpool.

“Raising finance is the first challenge as high street buy-to-let lenders will not usually offer to lend for investment into shops or offices. It would be necessary to approach one of the specialist lenders and they will usually insist the investor has some experience in the sector before they will offer help.”

“The ‘buyer beware’ maxim is particularly important in commercial investment. If retail or office premises are available cheaply there will usually be a good reason for that. Does it need a lot of work or is it in an area where finding commercial tenants is difficult? Thorough due diligence is essential.”