On the face of it, investing in commercial or residential property might seem quite similar. However, there are some huge differences to understand if you’re thinking of investing in either property type.
Investors are still open to both residential and commercial property as viable longer-term sources of income. The Q4 2018 RICS UK Commercial Market Survey (1) found that industrial assets continued to attract a rise in investor interest. According to Direct Line (2) the average rental yield from letting residential property is 3.6%, although it can be as high as 7.1% in some areas.
In either case, you’ll need to be well clued-up before investing in any kind of property. Here, we talk about the key differences to help get you started.
Types of property
Defining a residential property is fairly straight forward as they are let to consumers – not businesses. Broadly speaking, any property that is solely used for business purposes is classed as a commercial property. There are four main types of commercial property or ‘asset classes’ to bear in mind:
Commercial properties include buildings, such as banks, shops or hotels, to more specialist structures, such as petrol stations or laboratories.
There are two main ways investors can make money from property. From the income from the rent or capital growth from the property. If you make a profit from the sale of a residential or commercial building, you may have to pay Capital Gains Tax. To find out more about this area, check out the Government’s website.
Buying any property outright is expensive, so there are a number of other options open to investors. If you’re searching for a commercial or buy-to-let mortgage, it’s likely you’ll need a higher deposit than needed for a residential property. A buy-to-let agreement is also different from a standard mortgage as you’ll need to show that your income from the rent will cover the repayments. Speak to our expert team at dot financial services for the latest buy-to-let mortgage deals.
Direct commercial property funds are the most common way to invest in this kind of property. With this method, you’ll invest in a portfolio of commercial properties through a collective scheme. These include a unit trust, open-ended investment company (OEIC) or investment trust.
Another way to invest in commercial property is via an indirect property fund. These are collective schemes that invest in the shares of property companies listed on the stock market. But like any share, your investment will increase or decrease with the stock markets.
Types of agreement
Landlords letting residential property will usually issue an Assured Shorthold Tenancy (AST) agreement to a tenant. Typically this lasts for six months or one year. This contract outlines the responsibilities of both the landlord and tenant. After this time, a new contract can be agreed, or the previous agreement will continue as a periodic tenancy until either party gives notice.
If you choose to lease commercial property directly or through an estate agent, it’s worth knowing that these lease agreements are usually much longer, with the average length being around five years. However, commercial contracts can contain break clauses which allow the tenant or landlord to exit an agreement early.
With commercial property, there are two main types of lease:
- Gross leases: a gross lease means a landlord has to pay insurance and maintenance costs, as well as property tax. With this kind of lease, the landlord will include their estimated maintenance costs.
- Net leases: these are the most common commercial leases in the UK. Unlike gross leases, tenants are required to pay a portion or all maintenance costs (i.e. taxes or utility bills).
Net leases can be divided into three categories: single net leases, double net leases and triple net leases. With single net leases, the tenant is responsible for paying tax, but the landlord is still in charge of the rest of the expenses. A double net lease means the tenant is responsible for tax and insurance costs, while maintenance costs are still managed by the landlord. Finally, a triple net lease means the tenant is responsible for all costs, including maintenance.
Weighing up the options
As the lease lengths for commercial property are usually much longer, it can present a good longer-term investment as tenants are less transient.
On the other hand, residential buy-to-let investors often have more control over their properties as they are usually closer to the day-to-day running. However, being more hands on also means that landlords will need to manage their finances carefully and calculate an expected rental yield in advance. This means working out how much income you can expect from the rent, minus expenses.
In both cases, investors need look at all options and seek expert advice. For example, location is always a key factor when choosing a property. Make sure you understand whether the area and its connections would allow your investment to thrive.
It’s important to remember that the commercial and residential property industries subject to strict regulation. The penalties for non-compliance can be high, so if you plan to let any kind of property make sure you are aware of your responsibilities.
Seek professional advice
Whether you’re looking at investing in commercial property or becoming a residential landlord, make sure you gain professional advice before you begin. A good estate agency should have a detailed knowledge of the local area and the various properties available.
Speak to one of our lettings or commercial experts about investing in property today. Contact your local Stirling Ackroyd branch for more information about properties for sale now.
If you are interested in commercial property you may like our blog on How to Find Commercial Property.