Top ten tips for investing in commercial property
Investing in commercial property can produce very good returns, but it is a specialist market and there are a wide variety of issues that need to be given careful consideration before committing to a purchase. Alistair Mitchell of Fenn Wright’s Ipswich office provides his top tips on what to look out for when buying an investment property:
1. The Fundamentals
Commercial property covers a wide range of asset types; the main sectors being offices, retail and industrial/warehousing, as well as specialist classes including leisure, medical premises, etc. Each sector is subject to different influences and market trends but irrespective of which is being considered, there are two fundamental considerations which affect the long term value of any property, namely its location and quality.
Questions which need to be considered include:
• Is the property situated in an area that is likely to continue to attract tenants?
• Are there planning and redevelopment proposals, improvements to infrastructure etc. which may have a positive effect upon tenant demand, or is there a risk that business will look to move elsewhere?
• Is it a modern or traditional style property? Is it “future proof”, with scope for the accommodation it offers to be adapted to suit evolving occupier requirements or is there a risk of future obsolescence?
2. Covenant Strength
The financial status of the current tenant(s) will have a direct effect upon the investment value of the property. A property let on a long term lease to a good quality, stable tenant should offer a secure income.
However if the tenant is likely to face financial difficulties then not only could there be the risk that the rent will fail to be paid, but there may be significant costs involved in obtaining possession and putting the property back into a condition suitable for re-letting. It is important to ensure that appropriate due diligence is undertaken to establish the covenant strength of the tenant. Copies of filed accounts and financial assessments can be secured without too much difficulty but payment records should also be obtained. In the event that an Authorised Guarantee Agreement or personal sureties/guarantors are provided then the financial status of the associated parties should also be established.
3. Lease Terms
The terms of occupational leases will have a direct effect upon value. All lease agreements should be studied carefully in order to assess their influence on the value of the property and the ongoing management of the asset. Typical examples of provisions which have a direct financial impact include the frequency of rent reviews and the basis upon which they are assessed (open market/index linked), restrictions on tenant repairing obligations, limitations on service charge recovery etc.
4. Rental Value
In order to allow the passing rent to be assessed against the underlying rental value of the premises it is critical that the underlying rental value is established. This will enable the potential purchaser to form a view on whether there is scope for rental growth or conversely whether the property is perhaps over rented and if so, to what degree. Any prospects for rental growth will naturally increase the return on capital whereas if the property is over rented then this needs to be reflected in the price paid for the investment.
The title of the property should be investigated. Most commercial properties in the UK now have the benefit of registered title, which can be accessed online by solicitors and surveyors. This will define the boundaries of the property and will summarise the current ownership together with associated rights and liabilities attached to it.
It will also be important to consider the best and most tax efficient method of funding and purchasing the asset, be it personally, via a company or pension, with or without debt finance. If conditions allow for the asset to be purchased as a TOGC (transfer of a going concern) this could potentially remove the VAT liability as well as reducing the stamp duty land tax payable.
6. Condition of the building
A building survey is always important as this will establish whether there are any significant defects or issues of disrepair. It will then be necessary to consider any such issues alongside the repairing covenants in the lease. An unrestricted full repairing and insuring lease will oblige the tenant to put and keep the property in good repair, however dilapidations law is a complex subject and needs careful consideration.
It is generally assumed that the current use has planning permission but it is always worth checking! Restrictions in planning policy and planning permission relating to the property may affect its scope for future change of use or redevelopment. A Listed Building is a double edged sword. A listing imposes limitations on the ability to change the style and character of the property but at the current time does provide an exemption in relation to empty business rates when it becomes vacant.
There are a wide variety of regulations affecting commercial property. In addition to the normal fire, building and asbestos regulations, one of the most significant issues which is likely to affect the sector in the short term is the Energy Act 2011. This legislation will result in it being unlawful to let a commercial property with an EPC rating below E from April 2018. If the property has a current rating of F or G then it will be important to establish what is required to improve its energy efficiency before proceeding.
9. Multi Let Buildings
With any property occupied by two or more tenants, the landlord is likely to have more responsibility for the management of common parts, external and structural repairs etc. The prospective purchaser therefore needs to be prepared to take on this responsibility or appoint a managing agent to act upon their behalf. Copies of service charge statements and current budgets should be independently reviewed, alongside the building survey which will identify items of fabric or plant that may need to be renewed.
10. And Finally
With any investment acquisition there is always an element of risk and it is important to have a “Plan B”. Most of the associated risks should be mitigated by following the points above and obtaining professional advice in relation to the current value of the investment and how closely it fits the purchaser’s investment strategy and criteria.
However at some point during the course of its life, any property investment is likely to become at least partially vacant and it is always worth finding the answer to the important question “If I can’t find a tenant what do I do next?” As with most things, it is a case of hoping for the best but planning for the worst!
Commercial property continues to find favour with investors, providing much better returns than a large number of alternative asset classes. Over the last few months Fenn Wright has handled the sale of a variety of such investments in lot sizes from £250,000 to £1,600,000, and typically producing net initial yields of over 7%. For anyone seeking professional advice in relation to purchasing a commercial property investment Fenn Wright are always pleased to offer initial general guidance and if appropriate, a full Acquisition Report covering the issues referred to above. Similarly, a Disposal Report can also be provided for those considering the sale of an existing property.
For further advice please contact either Lewis Chambers, Roger Hayward or Alistair Mitchell.