Diversifying into commercial property

Ranjan Bhattacharya

(From an article by Ranjan published in Property Investment magazine, May 2005)

Why commercial property?

Commercial property in many ways, is far more attractive than residential property, and offers the investor a much easier life!

If you buy the right property and get the right tenant, you can benefit from;

longer leases (usually atleast five years)
receiving rents quarterly in advance
having the tenant responsible for all maintenance issues
periodic upward only rent reviews

For example, one of my commercial properties is let out for 20 years, with upward only rent reviews every 5 years and with no break clause. Having a property like this in my portfolio helps provide diversity and a stream of cashflow which is from a far less risky and more reliable source than residential property.

High barriers for new investors

When I started investing in property in 1990, I had no money! Residential property is fantastic from this point of view because it is relatively easy to buy with minimum funds. However, you need a lot of upfront cash to invest in commercial property. There are a number of barriers to entry for the new property investor, including the following:

you will typically need to put down 30% deposit

the interest rate on the loan will be higher than for residential buy-to-let mortgages, typically 2% above the Bank of England base rate

lenders will usually only offer you a repayment mortgage and many will insist that the loan term is no longer than the remaining term on the current lease

finance on empty commercial properties is more difficult to obtain then on tenanted properties.

For these reasons, few people, apart from the cash rich, start off investing in commercial property.

How to raise finance to invest in commercial property

However, if you already have a small portfolio of residential property, diversifying into commercial property is relatively straight forward. Simply release the equity in your residential BTL portfolio by remortgaging. By doing this you release cash at an attractive residential BTL interest rate and you are able borrow on an interest only basis. The cost of raising capital like this will be far cheaper than the loan terms on any commercial loan.

What sort of commercial property should you buy

When I started investing in commercial property I knew nothing about factories, warehouses or offices. So, in the beginning, I stayed well clear. I focused on buildings comprising a shop with residential space above. This helps you manage your risk since the residential part of the building is known to you, and it is only the shop which is new.

How to value commercial property

Residential property has a ‘value’ which is independent of its investment potential. For example a nice suburban detached house in Surrey has a high value and would produce a low yield if rented out. In this case the value of the property has nothing to do with its rental value. Instead other ‘softer’ issues affect the valuation such as local area desirability, quality of schools and such like.

On the other hand commercial property only has a value as an investment vehicle and its value is determined by:

Rental income: The higher the annual rent, the higher the property value
Quality of tenant: A blue chip tenant such as a high street chain, is considered less risky than a small independent trader. Generally, properties let to blue chip tenants have a higher value and therefore produce less yield. Conversely properties let to small independent traders will have a lower value and produce a higher yield.
Length of lease: The more years there are remaining on the lease, the better. More than 10 years is considered good.
Break clauses: Having a lease with no break clauses enhances the properties value compared with a lease which has break clauses. If a lease has break clauses then the investor can only rely on rental income until the time of the next break clause.
Development potential: Any If the property has any development potential, in particular any potential to create more residential space, then this will add considerably to its value.
Occupancy: Vacant shops will be worth less then tenanted shops. Exactly how much less will depend on local demand for this type of property

… and finally

Property investors should always maintain a diversified portfolio. By diversified I mean not to have over reliance on any single source of income. By diversifying into commercial property, you will also benefit from investing in property which is much less hassle to manage then residential property.

The Build Your Property Empire home study course mainly focuses on residential property but Module 7 details the benifits of commercial property and how easy it is to diversify into, if you already have a residential portfolio.

Ok Ranjan, I want to know more about your Proven Property Investment System.

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