Commercial Property Investment (A Guide!)

commercial property investment


Investing in commercial property represents a strategic approach to investment portfolio diversification, effectively mitigating risk.

The potential for financial returns from commercial real estate investments arises both through rental income, provided by leasing space to tenants, and through capital appreciation, as the market value of the property increases over time.

Unlike other investment assets like cash, bonds, and stocks, commercial real estate often exhibits low correlation with these markets. This means that the performance of commercial properties tends to be independent of the fluctuations in stock market trends, offering an additional layer of financial security amidst market volatility.


Section A: How to invest in commercial property


1. Commercial Property Investment Sectors


Commercial property investment in the UK encompasses three main sectors. Retail property includes shopping centres, supermarkets, retail parks, and high-street stores, offering a diverse range of consumer-focused spaces. Office property is designed specifically for business use, often necessitating the installation of high-speed internet and other vital business services, while industrial property covers industrial estates and warehouses, which serve a crucial role in manufacturing, logistics, and storage operations.

Investors looking to engage with these commercial property sectors have several avenues to consider.

Direct investment is one approach, where an investor purchases an entire property or a stake in one. However, this method may not be feasible for the majority of individuals due to the substantial financial commitment required.

Alternatively, investors can explore property funds, which can be either direct or indirect. These funds allow individuals to invest in commercial properties with a lower barrier to entry, broadening access to the commercial real estate market.


2. Investing in commercial property funds


While many investors gravitate towards the familiarity of residential real estate, commercial property presents a compelling, often more straightforward, and potentially cost-effective option.

The financial outlay for acquiring or developing commercial properties can reach into the millions, yielding significant rental revenues. However, such investments typically fall beyond the reach of smaller investors due to their substantial cost.

Consequently, the prevalent route to commercial property investment for most is through investment funds, such as unit trusts, Open-Ended Investment Companies (Oeics), or investment trusts. Our guide on different investment types offers further insight into these financial products.

These investment vehicles may directly hold commercial properties, providing investors with returns derived from both the appreciation of the property’s value and the rental income it generates. Alternatively, they might invest in stocks of companies associated with real estate, with returns coming from both share value growth and dividend payouts.

Entry into a property fund often requires a minimum investment of about £500 for a lump sum or £50 per month for those preferring to save regularly.


3. Investing in Direct Commercial Property Funds


Bricks-and-mortar funds are synonymous with direct investment in commercial property, where the fund itself acquires tangible real estate assets.

This approach diversifies risk by spreading investments across multiple properties. Thus, if a particular property is vacant and not generating rental income, others within the fund can still contribute earnings. Investors see returns through both the appreciation in property values and the income derived from rentals.

The rental component offers an annual yield, and upon liquidating your investment, the aim is to reclaim your initial outlay along with any appreciation in the fund’s property values, although it’s possible for the property value to decline below the initial investment.

a. Advantages of direct funds
Commercial leases often extend for five years or more, offering stability and a reduced risk of default compared to residential properties. Furthermore, leases typically include provisions for upward-only rent reviews, ensuring rental income keeps pace with inflation at a minimum.

The fund manager handles the complexities of property selection, negotiation, and management, freeing investors from these burdens.

b. Disadvantages of direct funds
Vacant properties still incur management and maintenance expenses.

Also, the property market’s liquidity is significantly lower than that of most financial markets, making the process of buying or selling real estate lengthy. This illiquidity can also hinder the quick sale of fund holdings, presenting a challenge for investors seeking prompt access to their funds.


4. Long-term asset funds (LTAFs)


Long-Term Asset Funds (LTAFs) represent a newly approved type of open-ended investment fund designed to encourage individual investors to explore less liquid private markets, such as commercial real estate.
During the Autumn Statement of 2023, Chancellor Jeremy Hunt revealed the integration of LTAFs into Innovative Finance Individual Savings Accounts (IFISAs), signalling a significant move to broaden access to these investment opportunities.


5. Indirect Commercial Property Funds


These investment vehicles, typically structured as unit trusts or Open-Ended Investment Companies (Oeics), focus on purchasing shares in firms that engage in property investment.

The shares involved are publicly traded on the stock exchange and can be bought or sold daily. This feature eliminates the liquidity issues often encountered with direct investments in commercial real estate, allowing investors the flexibility to enter or exit the fund as they wish.

Returns on these investments are generated in a manner akin to other stock investments, through the appreciation of share prices and dividends, rather than from direct increases in property values and rental income.

However, while this model offers the liquidity advantages of an equity-like instrument, it also exposes investors to the inherent volatility of the stock market.


6. Real estate investment trusts


A significant portion (more than 80%) of these property-centric firms are classified as Real Estate Investment Trusts (REITs), offering enhanced tax advantages compared to other publicly listed property entities.

REITs are exempt from paying corporation tax on their property assets, under the stipulation that they distribute at least 90% of their taxable income to shareholders in the form of dividends. This condition often results in higher dividend payouts for investors. For tax purposes, the dividends received by REIT investors are treated as property-letting income, with tax rates applicable at either 20% or 40%, depending on the investor’s tax bracket.


7. Property investment trusts


As an alternative, investing in property investment trusts allows you to collectively invest in real estate and shares of property companies.
Unlike Real Estate Investment Trusts (REITs), these trusts are treated as conventional companies, meaning the dividends they distribute are subject to tax.

For the 2023-24 tax year, basic-rate taxpayers are taxed at 8.75% on dividend incomes exceeding £1,000, while higher and additional rate taxpayers face tax rates of 33.75% and 39.35% on dividends, respectively.

Property investment trusts possess unique capabilities not found in unit trusts and OEICs. Notably, many engage in gearing, which involves borrowing funds to invest a greater amount in property than the sum of the investors’ contributions. This strategy has the potential to amplify profits in a buoyant market but also increases the risk of exacerbated losses should the market decline.


Legal disclaimer


The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.



Commercial Property Investment (A Guide!) 1

Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.

Gill is a Multiple Business Owner and the Managing Director of Prof Services - a Marketing Agency for the Professional Services Sector.

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