The past few years have been particularly turbulent for commercial property investors.
Changing working patterns, high inflation and interest rates, and the fallout from the Covid-19 pandemic have meant that this section of the property market has had a lot to contend with.
However, in 2024, commercial property has been on the road to recovery, and increasing numbers of investors are taking note.
Commercial applications up 100%
Indeed, Shawbrook’s internal data revealed that commercial property applications have seen a 102% increase from 2023 to 2024 and, similarly, 2024 has already seen 24% of semi-commercial applications for new purchases compared to just 13% in 2023. This comes as investors are pivoting away from solely investing in simple buy-to-let (BTL) property and diversifying into higher-yielding assets.
With this in mind, brokers need to be informed about what commercial properties offer investors, the different types of commercial properties, and funding options available for commercial properties.
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Benefits of investing in commercial property
Commercial property offers several attractive benefits for investors, including higher-income yields than traditional BTL properties, significantly longer leases that can provide stable income, and the opportunity for investors to blend their risk through diversification.
High-income yields
Commercial properties typically offer a higher rate of return in comparison to BTL due to the breadth of the property type, which ranges from office buildings to retail and industrial spaces. The market tends to pay higher rental yields for commercial property as their main value is in generating positive cash flows.
Well-positioned commercial properties can also have longer-term value-add opportunities through development to increase the size of buildings or to add residential units. These are more complex opportunities but can be highly rewarding.
Longer leases
While residential properties typically have a six-month assured shorthold tenancy, commercial properties usually offer longer-term leases, which provide investors with a stable and predictable income.
These rents can also appreciate over time, with some leases having set milestones for rental increases linked to inflation, for example. This can be a useful hedge in a portfolio that has properties with shorter leases that are more vulnerable to void periods and tenant turnover.
Most leases tend to be on a fully repairing and insuring basis. This can make commercial properties less management-intensive as most of the responsibilities for the maintenance of the property sit with the tenant, unlike BTL.
Diversification of asset classes
In order to reduce risk, property investors might want to consider a range of property types in their portfolios. BTL properties, for example, are a popular option because of high demand levels, but typically involve higher costs and more regulation. Commercial property, meanwhile, has potential for greater income but can have longer void periods if a tenant leaves. However, by investing in both, an investor is less vulnerable to market volatility.
Types of commercial property
Commercial property can be broken down into five main categories: office, retail, industrial, leisure and healthcare.
Whilst most are self-explanatory, it’s worth noting that these titles contain within them an array of properties. For example, leisure encompasses hotels, restaurants, and sports facilities such as swimming pools and gyms, while healthcare stretches from GP surgeries to hospitals.
All of these property types have individual strengths, challenges, and trends that are worth being aware of before investing, and this can vastly vary depending on location.
High tenant demand and good transport links are usually good indicators, but this can shift depending on property types.
Outer London-based offices, for example, have not been performing as well over the past few years as many companies have adapted to flexible working schedules following the pandemic. However, the wider Southeast area has proven resilient, as have offices in Bristol, highlighting the opportunities that exist beyond the capital.
In reality, though, the risk profile often varies significantly based on the specific asset and location in question, and it is therefore important investors understand their local market.
Staying abreast of sector trends is paramount to investing in commercial property. Currently, most of the attention on commercial property has been on industrial sites following the AI boom and the growth in logistics driven by e-commerce, which requires data centres to support its growth.
As such, it’s expected that this trend will continue as more and more companies rely on tech to boost productivity. In fact, over the next four years, Europe is expected to add 3,110 megawatts (MW) of data centre capacity, highlighting just how quickly the sector is growing.
That being said, there are parameters to be aware of. There have been concerns about AI surrounding governance and environmental impact, which may translate into legislation and caps on energy usage from data centres. Investors should take this into account before pursuing investment in data centres and cloud computing facilities.
Funding commercial property
Commercial property funding can be complex, as factors such as cash flow, credit history, and tenant covenant are all considered.
Some lenders have limits on how much they can lend or how many investments one customer can hold with them, which means that accessing larger loans can be challenging. It is important to understand a lender’s risk appetite, with some being more focused on the quality of the tenant and others being more focused on the strength of the underlying asset and the investor themselves.
Specialist lenders, however, have increasingly provided a range of finance options in this market, with many offering specific products and services for commercial property investors, as well as experience working with this property type.
Considering how popular this property type is becoming, brokers should use this as an opportunity to build and develop relationships with specialist lenders in order to be best able to support clients looking to branch into commercial property.
