Investing in commercial property to let out to a business can be a rewarding and wise decision. It can cover a range of building options such as: office, retail, car parks, warehouses and industrial properties. The yields are often higher and the tenant will often sign a full repairing and insuring lease. However, few investors are familiar with the process of buying commercial property and there are a few common pitfalls you should be mindful of which can trip up even the most experienced investors.
But before I do, here are some differences between commercial & residential properties:
Commercial property is valued differently:
The capital value that is attributed to a commercial property is directly related to the income, yield and the strength of the covenant. This is not the case with residential property which is valued based on how much utility it offers to a homeowner usually.
Commercial property can diversify risk: If you own a big office building which is let out to a number of businesses, or you lose one tenant, you only lose a percentage of that income for that building, whereas you lose the entire rent if you let the property to a tenant in a single let family house.
Cashflow can be greater on commercial properties.
Often the income is higher per square foot on an investment basis on a commercial property than on a residential unit. Similarly if you rent a multi-unit commercial property, you will have more tenants to generate income than you would with a single family let.
Commercial property leases are generally longer: This will may help with the bottom line and give you stable and consistent cashflow providing the business doesn't go bust.
5 Mistakes when purchasing commercial property
So What are the mistakes you may ask? Well buckle up, I’ve listed a few below.
1. The tenants don’t want it
This can be down to multiple factors such as the price being set is too high or the building itself not being a suitable shape or big enough size for the targeted demographic. If your potential business/tenant is not satisfied with the key requirements they need or want for their business your investment could be sitting empty for a long time. For example does the property meet all of the tenant’s needs, including whether they need onsite parking and or/access to public transport? As a buyer you will need to analyse the attributes of competitive commercial properties and how factors such as zoning or location and access can potentially affect the performance of an incoming tenant/business, and your ability to let or re-let to attract tenants will become very difficult.
A good tip before you invest in a commercial property is to talk to the storefront business (if occupied) & ask if they are planning on renewing their lease & what they like. Is business good? Are there any signs that more businesses are relocating or popping up in the area?
2. Getting a place with poor footfall
Although this ties in with point 1, when it comes to letting a property to a business they need as much exposure as they can, especially if it involves marketing to the general public. The best properties are usually located in a position where people will flock to but also where they usually frequent, pass by and visit regardless if they intentionally sought your premises or not. The better the foot traffic, the higher your the rent and the lost downtime of letting and reletting the premises. Location should always be at the forefront of factors when deciding whether to purchase or not any type of property, but more with commercial premises, as these units can be sitting empty for a long time with business rates being applicable too.
Think about it like this, a tourist shop near a museum or near the airport will generate higher sales than once situated in an village or a rural town. One other thing to be mindful of is not to fall for the tricks of the trade such as flashy fit-outs or impressive improvements which are all likely designed for the short term. They disguise a properties value as well as the poor capital growth prospects within substandard locations.
3. Not factoring in all the additional costs
Anyone can buy a property, but making it work for you is another thing. If the commercial premises you are buying is old and has poor services like heating and new features adding like air conditioning, you will need to have an in depth and a comprehensive checklist to factor these in before the property is occupied again. This is where getting an professional such as a surveyor to investigate the property makes ideal sense. Getting the report is one thing, but its your responsibility to make sure you understand the implications and to check the property over yourself or with a trusted builder.
Ensure you walk around with your builder from your power team and don’t ignore anything you spot; the seller won’t volunteer any information and it will be your job to raise them. You must ask your builder/building inspector to inspect every unit, the roofs, the laundry areas, the attics, the crawlspaces, etc. Top tip 3 is to find a well- qualified surveyor/trusted builder to represent you who will provide a detailed report of the physical condition of the property.
4. Wrong decisions on property choice
This is probably one of the most common mistakes made involving commercial property. You need to find a property that suits your financial goals as well as your appetite for risk.
Remember the three most common choices for buying commercial property are income, capital growth & strategic purchase. So you letting your emotions get the better of you is a costly mistake. You shouldn't buy a commercial property just because you consider it to be affordable or because ‘you like it’. When purchasing a commercial property you will need to base your decision on a property’s location, historical performance, yield & tenant type. Remember the lower the yield the higher the value.
5. Knowing your tenants & their business
It is very important for owners and property managers of any potential rental property to screen potential tenants, such as getting credit reports and financial information to screen the applicant. But commercial property landlords and property managers need to go the extra mile and research whether the commercial tenant is credit worthy and assess the likelihood of them going bust. Is their business plan viable and will it be able to continue to pay the rent throughout the length of the lease.
Would it be a good idea to rent your commercial premises to a new mini mart or local express when there are three other stores within the same few streets? Is it likely this store would be viable and the business could close costing your thousands in potential rent and costs in re-marketing and reletting the property during the vacant periods? Another thing you could do is ask the check on the VOA website to see what business rates are payable, or did any particular operating expense increase or decrease dramatically last year compared to previous years? How are current businesses doing financially, are there lots of empty space? Be sure to ask for the sellers’ cash flow statements too.
Once you have taken the time to understand the ins & outs of commercial property investing, it can be extremely rewarding both financially and personally.