Commercial Property refers to buildings or land intended to generate a profit, either from capital gain or rental income. In the past, such opportunities were often only availlable to large investors; these days, however, there is a new wave of investment opportunities open to individual investors with modest budgets. Such investments encompass a range of sectors, from student to self-storage, car park to apart-hotel, and a wide variety of investment levels and objectives.
Such investments take advantage of niche sectors to achieve the healthy yields and robust security that comes with high demand. This is also impacted further by economies of scale, which enables investors to buy in prime locations whilst reducing the cost of property management.
This type of investment has become increasingly popular, as it often enables investors to benefit from a completely hassle-free income. With double digit yields also achievable under the right circumstances, the returns can far outperform the vast majority of traditional buy-to-lets.
The key to a quality commercial property investment is its ability to achieve the highly sought after combination of high yields and investor security. Although this is possible, it does require thorough due diligence and a keen understanding of how investments of this type work. Below, we will introduce you to some of the key factors in achieving a balance between protection and profit.
How Are High Yields Achievable?
It is important before sourcing an investment to understand how and why high yields are possible. Anyone can tell you that they can provide guaranteed returns, but you need to conduct the due diligence required to ensure the figures make sense. Below, we will take a look at just why commercial property can return such high yields.
High Demand in Niche Sectors
The first factor, which I touched upon briefly above, is the fact that commercial property investments take advantage of high demand in niche sectors. The due diligence you conduct with regards to location is crucial in ensuring that you are able to benefit from this.
By focusing on a niche sector, you are able to select a location where a certain type of property is undersupplied. For example, a city with a large student population but undersupplied with suitable student accomodation, or an international airport with a high demand for parking but only a limited number of parking spaces. This undersupply increases demand and ensures high occupancy, enabling favourable income yields and the potential for improving rental returns, if a similar supply and demand ratio persists .
The impact of such a profit-conducive location/sector combination is also enhanced further by the fact that initial purchase prices can often be much lower in such areas. The cost of property in large cities, such as London, Liverpool and Manchester, is, for example, much higher than that of Sunderland. With regards to the student sector, however, the environment in the latter example is far more conducive to sustainably high yields than the others.
Economies of Scale
When it comes to micro aspects of location, a second factor enabling high yields is economies of scale. By investing in a unit within a wider development, you are able to benefit from reduced costs across a number of areas – from the overall freehold to property maintenance.
This enables investors to purchase property in key central areas, which otherwise would have been outside of their budget. This is another crucial element of securing high demand, occupancy and yields.
Such economies of scale also impacts the cost of property management and maintenance. With a number of units within one property, developers often establish their own property management company to look after all aspects of the investment – occupancy, repairs and maintenance, rent collection etc. This is much more cost effective than managing an individual house. The quality of management also often improves due to an increased level of attention, with permanent staff often employed. This improves the long term attractiveness of a property.
Below Market Value Purchase
One of the other factors that enables investors to achieve high yields in commercial property is if the purchase price to rental return ratio is attractive. Developers often sell individual units to investors off plan in order to finance the construction. Once constructed these properties then immediately jump up in value meaning the rental return ratio is more attractive. This enables the investor to benefit both from high yields and the potential for almost instant capital growth.
Protecting Your Investment
High yields are one piece of the investment puzzle; the other is security. High yields tend to come at the cost of liquidity or security and it is finding opportunities with the correct balance between those three things that is the key to good commercial property investments.
Some of the factors mentioned above do, of course, also influence the security of an investment. For example, ensuring that you source a prime sector/combination is key. This is especially true with long term guaranteed income periods, as they are only viable when there is a critical undersupply of a specific property type. There are some other aspects of security, however, which help to ensure that your investment performs as expected.
Know Your Objectives
Before anything else, when it comes to security it is crucial that you understand your own investment objectives. Ideally, your investment will be flexible to suit your ever evolving situation and fits with your own needs and ambitions.
By understanding your objectives, you are able to map out your investment journey in advance, enabling you to further understand the entire process. Creating ‘potential investment scenarios’ – say for a year 1, year 3 or year 5 exit – is also a great way of planning your investment to ensure that it works for you.
Experienced, NHBC Registered Developer
Within the commercial property sector especially, it is crucial that you research the developer. With student property and a variety of other asset classes performing so well, a number of inexperienced and under-qualified developers have been attracted to the sector. As with all property investments, income projections will only ever be achieved with a timely and quality build.
One of the biggest indicators of a developer’s commitment to quality is NHBC registration. Having an NHBC-registered developer ensures exceptional build quality and insures the property against structural defects for 10 years. NHBC Buildmark Warranties now cover over 80 percent of new UK houses, but many new commercial developers are still not registered. NHBC developments also benefit from independent RICS surveys during key parts of the build and protection during construction.
By investing in a non-NHBC developer, you are taking a huge risk over the quality of the build and thus the security of your money.
Experience within a specific asset class is also important. If a developer has only ever done residential projects, they may not have the required knowledge to successfully complete a student property, for example.
Robust, Asset-Backed Contracts
Another important factor of security linked to the developer is the presence of robust, asset-backed contracts. First, it is crucial to understand how a development is being financed. Ideally, there will be zero debt. If the developer has few assets, or is in debt, then the investor sacrifices a significant amount of security.
It’s not enough simply to see that a developer has assets or is cash rich; it is also important that you ensure that all of your guarantees are underwritten by this asset base. It is common in commercial property for developers to sign contracts with third party management companies. In such a situation, regardless of how asset rich a developer may be, the investor has no benefit from this.
Commercial property commonly comes with a set of investment conditions. These include guaranteed income periods, buy-back etc. There are occasionally commercial investments that have all of the details – from purchase to exit – completely written into the contracts.
Investment conditions can have a huge impact on the security of an investment. In particular, they have a role to play in the creation of a flexible exit strategy. When it comes to selling your commercial property, it is likely that you will also be forwarding on a set of investment conditions and this can be as big a part of attracting buyers, or putting them off, as the property itself. A long and attractive guaranteed income period, for example, enables an investor to pass on guaranteed income on a fully operational development – something that is highly sought after.
As important as investment conditions are, however, it is also crucial to investigate their viability. Request information on how a certain income yield can be achieved. This is also crucial when it comes to guaranteed buy-backs. These are not always guaranteed at all, but rather based on speculation. It is vital that you deem any buy-back to be based on an established business model, as well as ascertaining that it is contractually secure.
Commercial property can indeed provide you with that highly sought after balance of profit and protection – high yields, flexible or assured exit, capital growth and investor security. There does, however, need to be an extensive degree of due diligence conducted to ensure that you can achieve this.
You must understand an investment – why it works, how the projected yields have been calculated and why it will remain attractive. It is vital that you map out the investment journey and consider your own objectives.
If you do all of this, you can be assured that your investment will provide you with the secure and reliable income stream you are looking for.