A nation of shopkeepers

Falling yields in the residential lettings market are attracting growing numbers of private investors to commercial property, lured by the generous tax breaks and the higher rents.

“Investors are increasingly letting property to businesses, such as shops, rather than residential tenants, because of signs that the traditional buy-to-let market has passed its peak,” says David Whittaker, of brokers Mortgages for Business. “As interest rates have started to rise, income from rents has been eaten up.”

Despite a slight stabilisation over the past few months, residential rents have been on a steady downward trend for the past two years in some parts of the country, particularly in London and the south-east, according to the Royal Institution of Chartered Surveyors. This has meant that residential property yields – which measure rental income as a percentage of the property value – have also started to come down and are currently around 5 per cent compared with around 8 per cent in 2001.

“Although some areas of commercial property have become overvalued there is still potential for high returns, and yields on some commercial property can be as high as 10 per cent,” says Whittaker.

In 2004 commercial property returned 18.3 per cent, according to the Investment Property Databank (IPD). Experts say s this is because, whilst that while residential investment relies on capital appreciation and the strength or weakness of the housing market, commercial property is more versatile as it is led more by the performance of different commercial sectors.

Mat Oakley, head of commercial research at the broking arm of Savills, says investors can spend anything from a few hundred thousand pounds to up to £5m for a shop with a tenant in place. At the top end of the market there are also investors are clubbing together to buy more expensive properties, such as an office building in the City of London costing for around £20m.

One of the benefits of commercial over residential property is that leases are longer so your rent should be more stable. “While most residential tenants typically sign up for a year, commercial property usually comes with tenants on much longer leases and in many cases the contract guarantees that rents will rise every year,” says Oakley.

Compared to with residential property, investors in commercial property can also benefit from lower capital gains tax on profits when they sell. “When investors sell residential property, they must pay CGT on gains of more than £8,200, but with commercial property, there is CGT taper relief,” says Anita Monteith at the Tax Faculty. “For a higher-rate taxpayer, the rate tapers from 40 per cent if he or she sells after less than three years to 24 per cent after 10 years or more.”

There are other forms of tax relief on commercial property. too. The 2001 Finance Act 2001 introduced tax relief for the costs of converting parts of business premises into flats. Monteith says: warns, there are criteria which people must watch carefully, such as ensuring that the property is not more than 4 storeys and that and flats must have four rooms or less. “If it meets certain criteria, then the relief is a 100 per cent capital allowance for the renovation costs.” .

For those that decide to go down the commercial property route, the traditional place to get a loan is from the commercial divisions of high street banks for mortgages although there are more firms coming into the market.

Commercial mortgages tend to work in a similar fashion to residential mortgages but with some differences. The maximum loan as a percentage of value tends to be around 75 per cent, as opposed to the 90-95 per cent limit for residential property. The rate of interest levied is quoted at a premium above the Bank of England base rate, usually about one and a half 1.5 per cent.

“Another difference is that with commercial loans, lenders often want to know about the tenant and the type of business they run,” says David Frohnsdorff, associate at Savills. “The amount of money people can borrow and the rate of interest they will get will depend on the type of lease the tenant in the property is on. If the tenant is Boots and they are on a 15-year lease the lender is likely to be happier about lending money than if the tenant is not well known and on a short lease.”

Despite these attractions, however, there are areas of the commercial market where prices are high. “The weight of the money going into the market has meant that prices for some properties have gone up, so yields have come down slightly. At the moment yields on prime offices in the West End are only around 4 per cent on some premises but shopping centres are hot buys at the moment,” says Oakley.

He also points out that the commercial market is muchsmaller and much less liquid so if investors need the money quickly it may be difficult to get the right price for the property.