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A guide to investing in commercial property

Purchasing commercial property is a very popular way of developing a property portfolio for investors. It adds volume and diversity to the portfolio, providing new opportunities to the investor whilst helping them to spread their income through a variety of assets.

There are different ways in which a property investor can get involved with the commercial property market including Direct Investment, Direct Property Funds and Indirect Property Funds:

Direct Investment

This type of investment is where private investors buy the property, or at least a share in the property. However this type of investment is widely considered to not be a practical way of getting experience in the commercial property market.

Direct Property Funds

This is one of the most common types of commercial property investments and it is often referred to as bricks-and-mortar funds. It is usually done via a collective investment scheme, where they invest into a commercial property portfolio, including offices, warehouses and other properties, which would often be inaccessible to smaller investors.

Indirect Property Funds

This involves a collective investment scheme investing in shares of properties that are within the stock market. This type of investment doesn’t possess the same benefits of a direct investment because of the nature of the stock market, as property shares can fluctuate either way.

When you buy a commercial property, there are two key ways in which you can earn money when you invest in this type of asset. The first is through rental income by renting the property out to a tenant, and the second is through capital growth as the value of the property increases.

Buy-to-let property

Investors looking to build a property portfolio often already own their own home, and so the process of buying a property is familiar to them. Many mortgage companies now have much stricter lending criteria for first time buyers, so with more people renting properties and rents rising across the country, buy-to-let investments provide investors with a high yielding investment that has less risk than other commercial investments like property funds.

Buy-to-let mortgages

Most people that are looking to invest in residential property will have to borrow money in order to complete the purchase of the property. The lenders for a buy-to-let mortgage take many things into consideration for this specific type of mortgage, including the size of the deposit and also the rental income that the property will generate. If you are looking to get a buy-to-let mortgage, there are a few things that you may need to consider:

  • Interest rates on buy-to-let mortgages are often higher than a normal mortgage because there is more of a risk to the lender, due to the fact that there could be periods where you have no tenants or even that the tenants don’t pay their rent, meaning that there is no rental income.
  • Mortgage charges will be higher as there are often different fees associated with this type of mortgage.
  • A buy-to-let mortgage requires a much higher deposit, often around 20% to 40% of the value of the property.

Buy-to-let property and rental yield

It is important to have an idea of the rental yield that your potential property will produce, before you invest in it. Calculating the rental yield allows you to see how beneficial it is going to be for you to invest in the property, taking a look at what it is going to mean for you financially.

Before you invest in property, you also need to know of any costs that you may incur once you become a landlord. Despite the payments of your mortgage, there are also other costs that you will face, including buildings insurance, maintenance and repair costs, ground rent and charges and finally letting agency fees.

The rental yield can be calculated by dividing the net rental income (the rent minus outgoing costs) by the value of the property. You will then need to multiple the answer by 100 in order to turn it into a percentage.

Investing in commercial property

Although many investors are more familiar with residential property investment, and would typically prefer to invest in this kind of property, commercial property investment can often be a simple alternative at a lower cost compared to residential properties.

As commercial properties are often a much bigger development, costing millions of pounds, taking much longer to build and in turn generating much larger rental incomes, it can be difficult for investors with smaller portfolios or smaller budgets to try their hand at commercial property. An option to help with this is to invest via investment funds, where you can be part of a bigger plan and can start with as little as £500.

Within commercial property, there are three categories:

Industrial property – Including industrial estates or warehouses.

Retail property – This would include shopping centres, high street shops, supermarkets and retail warehouses.

Office property – These are specifically designed for businesses, with the need for features that businesses will require, such as high speed internet.

Why is Commercial Property a good investment?

The UK market has a beneficial longer lease structure compared to that of the US and the rest of Europe. The approximate average lease length in the UK is eight years; however it is between 10 and 15 years in London. A residential property often has a lease that lasts between 6 months and a year, meaning that having a guaranteed set level of income over a longer period of time via a commercial property will be heavily beneficial.

Commercial property funds

The way that investing through investment funds works is that you pay your investment money to them. If they own properties that you are investing in, they will pay you returns dependant on their growth and the rental income of the property. Another way that they work is that they buy shares into a property-related company, with you receiving returns based on the value of the shares and payment of dividends.

There are two types of commercial property funds that you can invest in, including direct commercial property funds and indirect commercial property funds.

Direct Commercial Property Funds

This type of commercial property fund is often referred to as a bricks-and-mortar commercial property fund, whereby the fund for the investment, directly purchases the properties that are being invested in. The way that it works is that a number of properties are bought, and if one property has no tenants, it means that other properties that are within the fund can generate the income. The investor receives returns based on rental income and also any increases in the value of the properties within the fund.

Indirect Commercial Property Funds

This type of commercial property fund is where you buy shares in companies that invest in property. The way to access the shares is to monitor the stock exchange and trade daily, moving in and out of the fund as you like. You gain money through share price appreciation and the income of dividends, as opposed to prices being directly reflective of the rental income and property prices.

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Glossary of Terms

Our glossary of terms contains a comprehensive guide to various property investment related terms to give you a better understanding of the language and terminology used when talking about investing in property.

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