Purchasing a commercial buy to let property isn’t like buying a sandwich or even a new suit; there are enormous considerations to be made before committing. To make serious money through buy to let property by converting residential units, you need to be have knowledge of both the theory and the hurdles you may encounter along the way.
What kinds of properties should you target?
Bigger deals generally mean bigger profits, and while a building ten times the size will not take ten times as long to complete, it should generate ten times as much profit. And that’s great time leverage.
On the surface, such a process isn’t too different from buying a single residential buy to let property: you search for your property, do your due diligence, put in an offer and then go through the usual conveyancing procedures before exchanging and then completing.
The notable difference when purchasing a larger property is sourcing it.
When you are searching for a suitable commercial unit, you are more likely to approach commercial property agents who will use specialist investment surveyors to carry out the task on your behalf. This is generally money well spent if it is your first time acquiring commercial property.
Small investors will often bypass national selling agents because they don’t sit on the estate agents’ row and are generally off-radar for them. This means that small investors often miss all kinds of opportunities that are traded through small pocket listings of national agents, who are likely to give more upfront advice than standard conveyancing solicitors.
While national agents are an important consideration, most of these units are sold through private treaties and a smaller number through auctions. Auctions allow for more upfront information than if you were buying a residential single family house, and since the units will be sold in an open public arena the market will be more transparent.
Property types to consider
During your search, you will find many kinds of properties to consider, including:
• A variety of offices, from single floor to a suite in a larger building, to entire buildings
• Farms and ranches
• Light industrial units, warehouses and showrooms, measuring from a few square metres to 3,000+
• Mixed use
• Special purpose
• Development projects, including major residential or retirement complexes and tourism enterprises
• Retail premises that are usually small and sole-operator premises (although occasionally entire shopping centres come onto the market)
Most large estate agents that deal with residential properties offer commercial property listing and usually have specialist staff to handle these types of units. Many specialist commercial property agents also provide listings for larger units too.
Routes to finding your perfect commercial property
• Knight Frank’s global HQ is based in London, and there is an additional London office and 10 regional offices across the UK. They also have a worldwide network of 300+ offices.
• Savills have 99 offices across the UK and 500 offices plus associates around the world.
• Carter Jonas has a head office and five further offices in London, with 20 additional offices found across England and Wales.
• Strutt & Parker has several offices across the UK, 7 of which specialise in commercial property.
• Jones Lang LaSalle has 18 offices across the UK and 200 worldwide.
• Lambert Smith Hampton has 26 offices across the UK.
• Colliers International has 482 offices in 62 countries, 11 of which are spread across the UK and Ireland.
Online property portals
• Rightmove advertises commercial properties across the UK, and filters searches by location, type, size and price.
• Primelocation allows users to search by location (UK-wide) and filter by price.
• Propex allows location searches (UK-wide) by type, price, yield and size.
• Movehut allows location searches (UK-wide) by type, price and size.
There are definite benefits to buying commercial property at auction, but make sure that you are aware of the time scale for supplying the initial deposit on the day, as well as the limited window for completing sales, which is normally four weeks.
• Auction House has offices across the UK (excluding Northern Ireland) with auction details available online.
• Eddisons enable you to search specifically through their commercial property/land, and again serve England, Scotland and Wales.
• Allsop has offices in London and Leeds, but auction commercial properties across the UK.
• CBRE has offices across the UK (excluding Wales), and you can view their catalogue online when it becomes available.
What you should know before moving to commercial property/converting buildings
Making any decision as large as making money through commercial property requires you to consider a huge range of factors. When you move up the chain to commercial property or converting commercial buildings for residential use, it’s best to research the subject widely and talk to people with more experience to avoid tripping up unnecessarily.
Some considerations include:
This varies around the country but in broad terms, you do not currently need planning permission if you want to convert an office building into buy to let flats in most areas; it can be done under permitted development.
Despite not requiring planning permission, you do still need to apply to the council, who will consider basics such as environmental impact, traffic safety, flood risk, etc. Most offices will tick these boxes anyway, because they already had the initial planning permission for construction or conversion to office use.
Section 106 contribution
Developers may be asked to provide contributions to local infrastructure, which could come in the form of the Community Infrastructure Levy and planning obligations in the form of section 106 agreements. Learn more here: http://planningguidance.communities.gov.uk
At the very least, before exchange, it is a good idea to get a response from the council in the form of a pre-planning approval or pre-application advice, to ensure that they will be receptive to what you want to do.
Converting a pub to residential property – an example
One of my favourite models for commercial buy to let property deals is to convert a pub.
In our area in Peterborough, pubs tend to be of a size that works as an HMO unit. For example, a 3,500-square foot pub is similar in size to a big 5-bedroom detached house, meaning that I could probably get 15+ en-suite rooms out of it. Planning permission will be required for change of use, but if there is no pub protection policy, in many areas you can get permission to convert them into residential units because of housing need.
task like this can be complicated, so for your first deal(s) I would recommend hiring a planning consultant to guide you through the process. Talk with the local council about your commercial buy to let project plans, as they will generally steer you on what they are likely to grant planning permission to and what they won’t. This is also usually dealt with via a confidential pre-application process.
One of the great things about gaining consent for creating 2- or 3-bedroom flats from an office or pub is that you can then create up to a further six letting rooms without additional permission. This would take a buy to let property up to C4 use, which is effectively an HMO that doesn’t require additional permission.
Buildings such as residential institutions, care homes and shops will also require planning.
A rough guide to the commercial buy to let process
You should start by deciding, in very simple terms, what your buy to let flats/HMO rooms will be worth after you have finished the project. For example, in my area of Peterborough I know that converted flats within three miles of the city centre are probably worth about £200 per square foot. Using the example of a 10,000-square foot building, let’s break this down.
Discounting the common areas such as corridors, lift shafts, stairwells, boiler room, etc, a building such as this generally loses 10% of the area, bringing it down to around 9,000 square feet of saleable space. Multiply that saleable space by £200 per square feet, and you will find that very roughly your building will be worth around £1.8m. We will take this as the gross development value (GDV) and work backwards from there.
Conversion cost will vary depending on location, but for a basic specification like a Persimmon, Barratt or Taylor-Wimpey new build, I would estimate around £80+ per square foot. For this example of a 10,000-square foot building:
10,000 (square feet) x 80 (conversion cost) = £800,000 (roughly)
Conversion costs usually include the warranty, services and so on, but you will need to add legal costs, finance fees (which depend on your loan), any Section 106 contributions (where applicable), professional fees, health and safety, stamp duty, etc. For a buy to let project of this scale, I would add on £40,000-£50,000 for professional fees, dependent on what needs doing. The basic cost in this example would be in the region of £900,000.
The objective would be to get £1.8m from the entire building. Now that you have an idea of the cost base, you should establish the profit you want to make before working out the price you can pay. A buy to let project of this scale will take a significant amount of time, so I would probably want to be making at least £300,000 profit. You also need a good buffer for things that might go wrong.
An end value of £1.8m, minus costs of around £900,000, leaves around £900,000. If you are hoping to make at least £500,000 profit, the building purchase must cost less than £500,000 to meet that level of profit. Tracking this back, £500,000 spread over 10,000 square feet equates to around £50 per square foot.
Most office buildings I look at in the Peterborough area with a view to buy to let residential conversion are £60+ per square foot. During the credit crunch, I paid £29 per square foot for a large buy to let property, but many have doubled since then.
It’s important to get to the point where you have a checklist, formula or similar way of assessing whether a deal works for you. In my case, as in the example, for this type of project I have worked it back to £50 per square foot, so if something is then advertised or comes out at £80 per square foot, I know that it is not going to work. This demonstrates the importance of having clear performance indicators that you can use when you are out viewing.
I should also mention that while £80 per square foot may seem high compared to a basic refurbishment on a house, this type of conversion is likely to need an upgrade to most of the insulation, new windows, upgrades to improve acoustic testing, and so on. The costs are significantly different, and basic non-structural refurbishments will almost always be cheaper than commercial conversions.
Get your builder to cost out your early conversion projects.
How I learned about commercial conversions
You gain knowledge over a period of time, partly from others and partly through trial and error. I know a couple of people who develop new builds and work on bigger projects, so I talk to them. I also make sure I surround myself with people who have the right experience.
Every area is different, so it is important to find the right model for you. I uncovered my own needs by buying early buildings as cheaply as I could, which took my bidding on excess of ten buildings to land that first one.
One of my early large commercial buy to let projects was an office that had been rented by an accountancy firm and originally sold for £1.6m in 2006. The owners couldn’t re-let it and needed to sell quickly because of empty property rates (these can help you when looking at this type of building because they drag down the value of the property). It took me a year to get it though. They brought the price down to £650,000, but I kept bidding very low and they finally let me have it for £350,000. From the value of £1.6m a few years before, I knew that was a good price; even if I messed everything up, I would still make a bit of money.
When I try something new, I try to screw everything down so that I protect myself. Once I have proven the model, it’s about volume. At that point, I probably don’t negotiate quite so hard, as I would rather do more deals and spend less time on each one – and maybe not upset the vendors as much!
How to finance commercial buy to let conversions
Company might lend on an empty building based on the purchase price and any refurbishment works you plan to do to it. At around 1%-1.5% per month, bridging finance is costly. The lender might want to get involved and will certainly want to understand the project, the development costs and the end value.
Development finance from a major bank or lender tends to be cheaper, at around 4-7% or so per annum. They will also probably want to check the deal, send out their quantity surveyors and get involved.
Development finance lenders may lend in the region of 50%-60% of the whole project, which is around half the purchase and half the development cost.
Bridging companies might lend more. We have recently been working on a project where the bridging lender provided 60% of the purchase price and offered all the development costs; however, the discretion is down to each individual bridging company and how they work.
Experience and track record are important, so I have created the equivalent of a CV outlining my experience that I send out to the lenders. When I started though, I didn’t have any conversion experience, so instead I referred to single lets and other property projects I had done, which helped to get me through the door for smaller conversions.
Don’t worry that they won’t give you development or bridging finance just because you haven’t done any conversions – many will, as long as you have experience perhaps one or two rungs below full-blown conversion projects. That’s another reason to start with single lets: to build up experience that you can reference.
You can also use private finance. I borrow from a couple of people who are generally less bothered about the project and more concerned with security. I pay interest on the loan and usually put a charge on other properties that we own elsewhere, so that their money is secured.
When buying, I may get finance or buy with cash using investors’ funds, which is easier, and blend it with some of my own money for the refurbishment. Finally, I refinance with a major lender at the end using commercial long-term investment loans over 20 or 25 years.
Mistakes and learning opportunities
When you start taking on larger projects, there is always going to be a learning curve and times when plans don’t go exactly as you’d hoped. Here are a few things to look out for.
Commercial conversion costs
Estimating conversion costs accurately before you start is important. I get my builder out to each project.
Empty property rates
Contact the Valuation Office Agency (VOA) to get the property taken out of the list (where relevant), so that you do not have to pay commercial rates during conversions. As soon as you strip them out internally, the VOA will inspect the building and remove the rating.
On our 13,000-square foot bought to let building, for example, the rates are a significant £45,000 pa, so it is worth getting them removed as soon as possible.
Commercial Conversion VAT rate
Consider the amount of VAT that you pay on conversions. When I started, I used to pay 20% VAT even to convert an HMO. The correct level of VAT a contractor should charge for converting a house to an HMO is a mere 5%, as outlined in VAT Notice 708: buildings and construction (https://www.gov.uk/government/publications/vat-notice-708-buildings-and-construction). Give this information to your builder and ask him to pass it to his accountant, who will confirm the 5% rate. The same is true for commercial to residential conversions.
If you subsequently sell the unit, you can usually claim the remaining VAT back, but please note that if you intend to do that you will need to register for VAT before you purchase.
On commercial buildings, the seller often charges VAT on the sale. Serving the vendor with a VAT1614D form allows VAT to be removed from the sale price, as it confirms that you will be doing a residential conversion. Also, if there is VAT on the purchase, you pay stamp duty on it as well.
As an example, we bought an office building that we planned to rent out to our company for use as a training suite. The purchase price was £500,000 and because VAT was added on, the price amounted to £600,000, taking it from 3% stamp duty to 4%. By taking the advice described above, you can save a lot of money on that.
Refinance Commercial Conversions early
I like to start the refinance process early, contacting the bank six months before the project is ready so that they can go through all the due diligence, ask all the questions, get the surveyor out and so on, getting everything done way up front so that it can be refinanced quicker. It is important to refinance as fast as you can once it is finished, because bridging and development finance are expensive.
What I love about these larger HMOs is the income, and the fact that I can get a commercial revaluation on them afterwards, and because it’s based on income, that can be much higher. This means that I can release more money to use in the next buy to let project – I can keep going, and keep buying.