In the residential mortgage market, although it is estimated that 11 per cent of all housing stock is held by private investors, owner occupiers are the most dominant group and consequently act as the overall price setters for residential property.
The commercial property market, on the other hand, is dominated by investors, namely institutional rather than private individuals. Recently we have started to see a cross-over of these two markets as private individuals energised by residential buy-to-let ownership are beginning to add commercial property to their portfolios.
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Appealing
There are a number of key reasons why commercial property is starting to appeal to the private landlord. First, the underlying performance of the commercial property market has been extremely strong. Commercial property has averaged an annual return of 11.5 per cent over the last five years.
In contrast, government bonds have returned 6.5 per cent per annum and the FTSE all share index has shown a loss of 1 per cent per annum over the same period. Next, property yields on commercial property average between 5 per cent and 8 per cent depending upon location and tenant quality. While these have suffered recently due to increasing capital values, they still exceed levels achieved in the residential market.
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Thirdly, the income stream from residential property investment is likely to be more volatile in the short term, as assured shorthold tenancy leases provide for six-month break opportunities for the tenant. In commercial lease arrangements, lease terms are typically between five and 10 years with a break clause at year five. This break usually affords an upward-only rent review option for the landlord.
Although these terms have recently been the subject to a government review, they do provide some notable advantages to the short-term residential tenancy period. Longer lease terms mean investors will have less management and maintenance to deal with. Many tenants are also likely to upgrade the property themselves and so potentially help increase the capital value for the landlord.
Considering properties
When considering properties for commercial investment, the basics remain the same – location, location, location – but there are a number of different property types to consider. Typically investors are looking to purchase three property types: industrial, retail, and office space, each of which come with their own features for successful investment. With industrial property it’s important that investments are sited near raw materials, skilled workers, and suppliers, with good communication links.
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Retail property is an asset class that provides a wide variety of potential tenants. Here, investors need to consider whether the retail unit is in a primary or secondary location or in a market town that is growing or in decline. Structural changes to the retail industry should be considered, but good retail units in good locations have been some of the highest performing investments. The Royal Institution of Chartered Surveyors’ Q4 2006 survey highlighted that the amount of available retail property fell for the first time in 18 months.
With office space, crucially an investor must consider the amount of supply locally, together with proximity to transport links. The condition of the office space together with parking facilities can make a big difference to its attractiveness.
Residential landlords are recognising that as their numbers grow and the capital values of residential property continue to increase, the rental yields are shrinking. They have begun to understand the potential of commercial property. There are new challenges to the BTL landlord in this field, but the benefits normally combine to make the risk-reward equation work.
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