Property Developers, Property Investors

Is commercial property a good investment?

Simon Misiewicz

Simon Misiewicz

Expat & Property Tax Specialist

20th April 2021

What are the basics of commercial property investment?

As property accountants serving thousands of UK landlords that purchase buy to let properties, we know that risk reduction and profit maximisation are of prime concern.

Many of our UK landlords and property investor clients are looking for ways to spread any potential risk.

Diversifying a property investment portfolio can be a good way to do this, with a mix of residential and commercial properties.

Commercial property accounts for 13% of the value of all UK buildings according to industry sources and is worth over £900 billion.

The commercial property sector contains a diverse mix of property types, including office space and retail units.

Commercial property investment includes high street shops to large out-of-town shopping areas. It also includes factories, industrial units, warehouses, restaurants, pubs, hotels, gyms and even car parks.

Commercial property investment can be direct or indirect.

Direct investment involves the purchase of buildings, the ‘bricks and mortar’, while indirect investment can include investment in stocks, bonds and shares of companies that specialise in property investing.

For our clients who are familiar with buy to let property investment, the idea is straightforward.

Residential property is purchased and then let out in return for a rental income to the property landlord.

With commercial property investment, the rental income might be generated each month, quarter, or on any basis agreed between the landlord and tenant.

Most commercial property lease agreements are bespoke, rather than the Assured Shorthold Tenancy (AST) agreements used with residential property investments.

Commercial property leases are usually agreed over much longer terms than UK residential buy to let, with lease lengths for commercial properties in the UK, usually signed for between three and 20 years.

Commercial property investment has been seen as stable in the UK for some time.

Although it involves a large and costly commitment, it is possible to invest through funds such as unit trusts and investment trusts.

These trusts may own shares in property companies or own commercial properties directly.

Commercial property investment can be funded using a commercial mortgage. These are the commercial equivalent of a buy to let loan.

A commercial property investment mortgage will have some key differences to bear in mind.

Mortgages for commercial property investors tend to be offered at higher interest rates, particularly for first-time commercial property owners.

The load to values tend to also be lower, with 65% being common.

Finally, commercial mortgage lenders in the UK can often expect borrowing to be taken on a capital repayment basis. Some lenders accept interest only, but it’s not standard across the country.

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Is commercial property a good investment?

Commercial property offers a good investment opportunity in the UK to earn a regular income, as they deliver higher rental rates compared to residential properties.

There are two main ways to earn money from commercial property investment.

Income from renting to a tenant and capital growth from an increase in the value of the property.

The commercial property investment market in the UK benefits from a longer lease structure than in Europe and the US.

The average lease length in a London office is between 10-15 years, with the average lease length across the UK being approximately eight years.

This is much longer than a residential property, which typically sees a tenant lease of six months to a year.

Commercial property investment potentially offers more security relative to the returns offered by shares, as income is guaranteed for a commercial property investor at a set level over an extended period of time.

As commercial property leases are much longer, these properties usually have an investment value higher than their bricks and mortar valuations.

This means a commercial property investor can acquire a vacant property, and if let on a strong lease to a good tenant, an instant increase in value will be seen.

Most commercial property leases are also fully repairing and insuring.

This means that the tenant is fully liable for repairs and insurance of the commercial property. These leases remove much of the maintenance costs associated with the properties.

Assured Tenancy Shorthold agreements for residential buy to let property investments usually require repairs, maintenance and buildings insurance to be included at the landlords’ expense.

Industry commentators have seen many commercial property investors diversifying their portfolios as a result of the Covid-19 pandemic.

Many have shifted away from traditional city-centre office blocks towards smaller, premium office spaces.

Other types of commercial property have become more popular during 2020, such as student accommodation, pop-up commercial units and specific areas such as logistics and healthcare.

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Do commercial properties increase in value?

The value of a commercial property can be increased by simply increasing the rent.

It is worth reviewing the tenant agreements to see if they are paying market rent or if their current rent can be increased.

Some types of commercial property will become a more popular investment choice, as Covid-19 restrictions ease across the UK and consumer confidence returns.

What is a good return on commercial property?

Yields for commercial property investors are typically much higher than for residential properties.

Commercial property investments can yield up to 10%. Residential property usually delivers 1-3%.

The reason for this difference in yield returns can often be attributed to the different lease agreements.

Commercial properties that are capable of delivering the highest return are those with the highest number of tenants.

These properties include apartment complexes, office buildings, student housing and storage facilities.

Which is a better investment, commercial or residential property?

Residential properties can be purchased for far less money, with commercial properties requiring much more money upfront and with stricter lending requirements to obtain financing.

Buy to let investment has become less attractive in the UK in recent years.

Property prices have been increasing, while the average UK rental yield is now just 3.53%.

Tax rules have also become less favourable for residential property investors who own the property in their own name rather than through a limited company.

The 3% stamp duty surcharge introduced in 2016 has further squeezed potential buy to let returns.

Commercial property investment may have higher initial costs, such as building purchase price and refurbishment costs, but the overall returns will be much higher than a residential buy to let property.

Commercial property investors usually deal with companies rather than individual tenants, which means that many common issues associated with renting out residential properties do not apply.

Commercial leases are contractual, giving them more protection under the law in comparison to residential tenancy agreements.

In most cases, the stamp duty is higher on residential properties than on commercial properties.

A buy to let landlord will also pay an additional 3% levy on top of the normal charge.

Commercial property tenants are responsible for property maintenance and repair, saving time and money for commercial property investors.

This makes commercial property investment a good option to deliver a stable investment with minimal input.

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We continue to develop brand new U.S and UK tax calculators for you to use. We focus on tax calculators such as: Income Tax, Capital Gains Tax, Stamp Duty Land Tax, Inheritance/Estate Tax

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How much do I need to know before buying commercial property?

Before buying commercial property, it is worth considering the following key factors:

– Decide why you want to invest in commercial property
– Establish financing options early on
– Talk through the process and get professional advice
– Research location and review the UK hot spots
– Do relevant industry analysis
– Book in time to speak to a property tax expert

How is commercial property taxed?

Profit on commercial property is taxed at the same rate as income tax or corporation tax.

This is dependent on how you structure your property investments.

Some commercial property landlords invest in their own name and will be taxed at 0%, 20% (basic taxpayers), 40% (high rate taxpayers) and 45% (additional rate taxpayers), depending on their income levels.

If a commercial property investor holds a property inside a limited company, the corporation tax is currently 17%.

The impact of Stamp Duty Land Tax (SDLT) needs to be factored in when considering taxation of profits made from commercial property investment.

There are legitimate ways to avoid Capital Gains Tax on UK property but speak to a property tax expert.

The HMRC has laid out clear guidelines on different stamp duty rates in place for non-residential and mixed-use.

There are also some deductions and relief available from the HMRC for commercial property investors.

Is now a good time to buy commercial property?

During the first Covid-19 lockdown in the UK, many retail businesses were forced to close. This represented a likely fall in rental income for many commercial property investors at the time.

At the same time, essential retailers such as convenience stores saw sharp increases in sales. This made them a popular choice for commercial property investors in the UK, as they were seen as ‘pandemic proof’.

Industry sources have estimated that retail pop-up now represents a £1 billion industry in the UK, while there has been a rise in demand during 2020 for logistics and warehousing commercial units nationwide.

The boom in demand for warehousing space from the rise and rise of E-commerce has led to estimates of demand increasing to 92 million square feet of commercial warehousing space being required by 2024.

Some high street retailers such as John Lewis have responded in resilient ways to Covid-19 and the negative impact on footfall in UK shopping centres.

They are currently looking to turn surplus stores into affordable housing and renting unused storage facilities into gyms and housing projects. This mixed-use change bodes well for commercial property.

Industrial properties are experiencing higher demand.

Properties that had before Covid-19 been mainly for industrial use with low rents have become important in the development of the online retail sector since 2020.

They offer well-located warehouse space to store, arrange and dispatch products across the country.

Commercial property investment remains a good opportunity and now is a good time depending on the type of commercial property being invested in.

Retail units are slowing down, good quality warehousing is hugely popular, and offices will require prudent selection during 2021 to ensure a reasonable return for UK commercial property investors.

Free Online Tax Courses

Want to save tax in the future?

We have now created free online tac courses to help you build wealth whilst paying less tax. Learn today and save tax tomorrow. We have covered the basics of tax filing with HMRC and IRS. We have created courses on advanced planning strategies that will save you tax in the future.

We have training programmes for UK tax and US tax. Learn today and save tax tomorrow

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Stamp Duty Land Tax savings when buying a commercial building to convert it into residential

We see that Local Authorities are giving permitted development rights to convert offices into residential dwellings (homes). This means that you do not have to go through the whole planning process. Commercial property prices are not too dissimilar to residential prices to make this worthwhile.

Residential properties – Stamp Duty Land Tax rates

Up to £125,000 Zero
Over £125,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 to £1 million 4%
Over £1 million to £2 million 5%
Over £2 million from 22 March 2012 7%
Over £2 million (purchased by certain persons, including corporate bodies) from 21 March 2012 15%

Per HMRC’s website, a 3% Stamp Duty Land Tax surcharge that must be paid by property developers when buying a residential property. This means that the starting Stamp Duty Land Tax charge on a property costing more than £40,000 will be 3%. The top rate of Stamp Duty Land Tax to be paid by a property developer on a residential property is 18%.

Stamp Duty Land Tax (SDLT) is charged at 15% on residential properties costing more than £500,000 bought by certain corporate bodies – or ‘non-natural persons’. These include:

– companies
– partnerships including companies
– collective investment schemes

Non-residential properties – Stamp Duty Land Tax rates

Up to £150,000 Zero
Over £150,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 4%

The cost of Stamp Duty Land Tax of a commercial building is far less than that of residential property. If you purchased a commercial building, which you intend to convert into residential at the cost of £400,00o the SDLT would be £9,500. If you purchased a residential property for £400,000 the SDLT would be £22,000. This is a tidy saving of £12,500.

Value Added Tax (VAT) saving when converting commercial buildings into residential. 

As we wrote in another article that there is a VAT saving to be made when converting a commercial building into residential. All the VAT on the direct labour and material costs to do with the conversion will be reduced from 20% to 5%.

Professional fees such as planning, architecture, project management will remain at the standard rate of VAT being 20%. As we outlined in our previous article that the tradesperson has to buy and fit the materials.

Normally, you would have a VAT cost of £20,000 if the direct labour/materials cost of the refurbishment is £100,000, excluding VAT. If you take heed of this article, the VAT would be reduced to £5,000. This is another tidy tax saving of £15,000.

The above SDLT saving of £12,500 may now be added to the VAT tax saving of £15,000. The total tax saving of converting a commercial building into a residential dwelling is now £27,500.

We discussed how property investors might reduce the Stamp Duty Land Tax in another article.

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Hidden Value Added Tax (VAT) charge when buying a commercial building

One area that you need to be careful of is the potential VAT on buying a building. If you were not careful and purchased a building for £400,000 then you could face a nasty surprise of a VAT charge of £80,000. This would easily wipe out the tax savings achieved from the above. As we can see from the other article that the VAT charge when buying a commercial building may be removed if you are converting it into residential. The form that needs to be completed by the seller is called a 1614D. This form disapplies the VAT charge and saving you the £80,000 VAT bill.

There are conditions to be met before the 1614D form may be applied, ensure you take professional advice on this point.

Avoidance of paying VAT on a commercial building if it is a Transfer Of Going Concern (TOGC)

 

As HMRC’s website shows that the purchase of a commercial building that is less than three years old would be subject to 20% VAT unless sold under a lease (not freehold).

There is another way to avoid the VAT charge when buying a commercial building. If the buyer was to buy a commercial building and utilises it in the same way that the seller did, then there is a Transfer Of Going Concern (TOGC). This is exempt from VAT and is therefore not chargeable.

Where the business being transferred does not contain any land and buildings (for which further conditions may apply as set out below).

1. the supply must be a supply of the assets of the seller’s business (or part of it) as a going concern
2. the buyer must use the assets transferred in carrying on the same kind of business as that carried on by the seller
3. if the seller is a taxable person, the purchaser must be a taxable person or as a result of the transfer become one, and
4. if only part of a business is being transferred, that part must be capable of separate operation

How is commercial property taxed? 

Profit on either residential or commercial property is taxed at the same rate as income tax or corporation tax. This is dependent on how you choose to structure your property investments. Some people may invest in property in their own name and will be taxed at 0%, 20% (basic rate taxpayers), 40% (high rate taxpayers) or 45% (additional rate taxpayers) depending on their income levels as shown by HMRC’s website. At the time of writing income tax is charged as follows:

– 0% for income up to £12,500

– 20% for income from £12,500 to £50,000

– 40% for income from £50,000 to £150,000

– 45% for income over £150,000

If you hold a property inside a limited company the corporation tax rate is currently 19%. We know from HMRC’s website that the corporation tax rates will drop to 17% from April 2020.

We are ignoring the fact that people may have mortgages on their residential property investments. As shown in our article the Section 24 mortgage interest relief cap will have a damaging effect on residential property investors’ tax status.

Free Online Tax Calculators

We continue to develop brand new U.S and UK tax calculators for you to use. We focus on tax calculators such as: Income Tax, Capital Gains Tax, Stamp Duty Land Tax, Inheritance/Estate Tax

Use our online tax calculators today to help you make money-saving decisions tomorrow

Free online tax calculators

Capital allowances on commercial buildings help reduce tax

It is also likely that commercial property investments will benefit more from Capital Allowances. These tax benefit costs are for the plant & machinery and Fixtures & fittings within a property. These items will typically be valued by surveying companies such as Six Forward. The value of items found will be used to generate a capital allowances claim.

These items will then reduce your income tax or corporation tax depending on how you purchased the property. It is possible to claim the full cost of plant & machinery and Fixtures & fittings within a property within the year of acquisition. This is because HMRC provides investors with an Annual Investment Allowance (AIA). You can offset the lower of the plant & machinery and Fixtures & fittings and the annual investment allowance as shown below.

You cannot claim capital allowances on (as shown on HMRC’s website):

– things you lease – you must have a purchase lease agreement and not an operating lease
– buildings, including doors, gates, shutters, mains water and gas systems
– land and structures (bridges, roads, docks)
– items used for business entertainment

What specific items are allowed to be used as capital allowances within commercial properties?

Integral features are:

– lifts, escalators and moving walkways
– space and water heating systems
– air-conditioning and air cooling systems
– hot and cold water systems (but not toilet and kitchen facilities)
– electrical systems, including lighting systems
– external solar shading

Fixtures
– fitted kitchens
– bathroom suites
– fire alarm and CCTV systems

At the time of writing, you were able to get a £1m tax benefit from the Annual Investment Allowance.

More details about making a capital allowance claims to save property tax may be found on our website. In addition to the potential capital allowances claims it is also possible to make an enhanced claim on the structures and buildings allowance.

Free Online Tax Courses

Want to save tax in the future?

We have now created free online tac courses to help you build wealth whilst paying less tax. Learn today and save tax tomorrow. We have covered the basics of tax filing with HMRC and IRS. We have created courses on advanced planning strategies that will save you tax in the future.

We have training programmes for UK tax and US tax. Learn today and save tax tomorrow

Free online tax course

Free – Access NOW!!

Can you buy a commercial property inside a SIPP pension?

Before we go any further, we need to stress that we are not financial advisors. You should seek out the services of a qualified wealth advisor in your local area. We recommend that you speak with two companies. Please note that we do not receive any commissions or kickbacks from our referrals. We refer you to others because we have used them in the past. They have also supported a number of clients in recent times. The first company is run and managed by James Lee of J L Wealth Consultancy and  Gay Hans who owns and manages AMG Wealth

You cannot buy a residential property within a pension. However, you can buy a commercial building inside a pension. Please remember that there are a number of tax benefits of investing in your personal pension. You can invest up to £40,000 into your pension per year. This is dependent on your earnings level. We wrote more about the tax benefits of investing in your pension in another article.

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