What Is Commercial Property? (A Complete Guide!)

In the UK, commercial property refers to real estate used for business activities. This broad category encompasses not only buildings housing businesses but also land intended to generate profit and large residential rental properties. Examples of commercial properties include shopping centres, supermarkets, and office spaces. This broad category is vital for businesses of all types, facilitating their growth and operations across various sectors .

 

Section A: Understanding Commercial Property in the UK

 

1. Classification of Commercial Property in the UK

 

The classification of commercial properties in the UK underwent a significant reform as of September 2020. Previously categorised under the Town and County Planning Use Classes Order 1987, commercial property use classes were updated to reflect modern business needs. These classes dictate the legal definitions for utilising spaces, impacting various business activities from retail to industrial operations.

Understanding these classifications is essential for businesses and investors in the UK commercial property market. They affect where and how a property can be used, potentially impacting investment decisions and operational strategies.

This is because each class is tailored to specific types of business operations, indicating the permitted uses of a property and any restrictions that might apply. Changing the use of commercial space within the same class may not require planning permission, but verifying this before making any alterations is crucial.

Key classes include:

a. Class E (Commercial, Business, and Service)
This is a broad category encompassing retail, services, offices, research and development, health services, and more. It reflects a more flexible approach to commercial space use, allowing for a mix of services and commercial activities.

b. Class F.1 (Learning and Non-residential Institutions)
Covers buildings and land for non-residential education, museums, public libraries, public halls, religious instruction, and law courts.

c. Class F.2 (Local Community)
Includes local shops selling essential goods, community halls, outdoor sports areas, and swimming pools or skating rinks.

d. Sui Generis
A term for unique uses that do not fit into other specified categories, including theatres, nightclubs, pubs, and hot food takeaways.

 

2. Types of Commercial Properties

 

In the UK, commercial properties are classified into various categories, reflecting the diversity of business activities they accommodate.

The classification system, updated in 2020, helps in planning and development by ensuring properties are used to match their designated purpose .

These categories include:

a. Offices
Spaces designed for businesses’ operational and administrative functions, including financial and professional services. These spaces often prioritise location for easy commute and include necessary facilities like meeting rooms and reliable internet connectivity .

b. Retail Spaces
These properties are designated for retail activities, ranging from small shops selling essential goods to larger outlets like cafes and restaurants. A retail space’s classification and attractiveness can depend on its ability to attract public footfall .

c. Industrial Estates
Industrial properties, which include warehouses and factories, are categorised based on the type of industrial process they accommodate. These properties are essential for manufacturing, storage, and distribution, with classifications distinguishing between general industrial activities and storage/distribution centres.

d. Leisure Facilities
This category encompasses many properties, including hotels, pubs, restaurants, gyms, and other sports facilities. Leisure properties are classified based on their specific use, such as non-residential institutions for educational and cultural activities or spaces for local community use.

 

3. Future Trends in UK Commercial Property

Several key trends, particularly sustainability, green buildings, and technological advancements, are shaping the future of UK commercial property.

 

a. Sustainability and Green Buildings
Sustainability has become a central focus in the commercial property sector, driven by the broader goal of achieving a net-zero economy by 2050. Significant investment is anticipated in the green building sector, with an estimated £90 billion expected to be invested by the decade’s end. This shift is partly due to growing environmental consciousness among consumers and businesses, who now demand more eco-friendly materials, renewable energy integration, and efficient waste management systems. Green certifications, like NABERS and EPCs, are becoming increasingly crucial for buildings as they help demonstrate a property’s sustainability credentials. Moreover, the industry is seeing a rise in modular building, which moves critical stages of the construction process off-site, reducing waste and emissions, thus contributing to a more sustainable construction future .

For example, investing in London’s commercial property shows how market dynamics, such as changing work patterns and the push for environmentally friendly office spaces, can influence investment decisions. High-quality, flexible office spaces that prioritise environmental credentials are increasingly in demand. Despite changes in working patterns, there is significant investment interest in London offices, especially those catering to the new workplace requirements .

 

b. Technological Advancements
The commercial property market is also witnessing the impact of technological advancements, which enhance building sustainability and operational efficiency. Real-time energy consumption monitoring allows for fine-tuning building management systems, ensuring energy efficiency and transparent reporting. The concept of ‘hotelisation’ of workspaces, transforming traditional office setups into multifunctional spaces with coworking areas, lounges, and amenities like cafes and gyms, reflects the changing dynamics of workplace requirements. This trend underscores the importance of integrating technology to cater to the evolving needs of employees and businesses .

Moreover, these trends are underpinned by an increasing emphasis on sustainable construction practices. For instance, the use of ground-source heat pumps and geothermal energy for heating systems is gaining popularity, especially with the upcoming ban on new gas boiler installations in 2025. Adopting living materials in construction capable of self-replication and carbon absorption showcases the industry’s move towards innovative, environmentally friendly solutions.

 

Section B: Investing in UK Commercial Property

 

1. Benefits of Investing in Commercial Property

 

Investing in commercial property in the UK offers several compelling benefits, notably the potential for high returns and the diversification of an investment portfolio. These advantages are increasingly attracting investors to the commercial real estate sector.

Anyone considering entering the commercial property market must conduct thorough research and consult with professionals to navigate this complex but potentially rewarding investment landscape.

 

a. Potential for High Returns
Commercial property investments can yield significantly higher returns than residential real estate. The average yield for commercial properties in the UK was reported at 5.23% in October 2022, with a good yield generally considered to be around 5%. Certain classes of commercial properties can achieve yields above 8%, which is considered exceptional. Long-term leases and the ability to charge premium rents in prime locations drive this potential for high returns.

 

b. Diversification of Investment Portfolio
Investing in commercial property can significantly diversify an investor’s portfolio. By spreading investments across different types of assets, investors can reduce risk. Commercial real estate often behaves differently from other investment assets like stocks and bonds, providing a buffer against market volatility. This diversification is further enhanced by the variety within the commercial property sector, including offices, retail spaces, industrial properties, and leisure facilities, each responding differently to economic cycles.

 

c. Potential for Regular Income
Commercial property can offer a steady and secure cash flow, often through long-term leases, providing a reliable income stream that can remain robust even during economic downturns .

 

d. Potential for Appreciation
Appreciation in commercial property value over time, especially in high-demand locations, enhances the potential for capital gains upon sale .

 

e. Tax Benefits
Commercial property landlords should fully utilise any available tax advantages, such as potentially lower stamp duty than residential property and eligibility for certain tax reliefs .

 

f. More Formal Tenant Relationship
Commercial leases are business-to-business, so a more professional relationship with tenants can result in fewer maintenance issues and late-night callouts than residential tenancies .

 

2. How to Invest in UK Commercial Property

 

Investing in UK commercial property involves several critical steps and a blend of strategic planning, financial acumen and legal knowledge. The process can seem daunting, but the right advice and due diligence can lead to a prosperous investment journey.

The critical steps to investing in UK commercial property include:

 

a. Market Research
Before entering the commercial property market, it’s essential to conduct thorough market research to understand your business’s needs both currently and in the future. This involves analysing various properties’ usability, price, transport links, employee accessibility, and proximity to clients/customers. Identifying a shortlist based on these criteria will help pinpoint the best investment opportunities .

 

b. Financial Considerations
Financing the purchase of a commercial property is another vital step. Engaging a broker early on can provide insights into the best ways to finance the purchase, including understanding different financing options and obtaining an offer in principle from a lender. Discussing the most tax-efficient and investment-savvy ways to finance the deal with an accountant is also advisable .

 

c. Legal Aspects of Commercial Real Estate
The legal process of purchasing commercial property includes several vital stages: negotiation, due diligence (including property surveys, environmental searches, and checking the property’s title), addressing CPSEs (Commercial Property Standard Enquiries), and finalising financing and legal considerations.

 

It’s crucial to engage commercial property solicitors early to guide you through negotiating the purchase price, conducting due diligence, and ensuring the property has the necessary rights for its intended use without third-party restrictions.

The final steps involve exchanging contracts, where a completion date is set, and post-exchange preparations leading to the final completion and post-purchase formalities .

 

3. Challenges Facing Commercial Property Investors

 

Investing in UK commercial property offers potentially high returns and diversification for an investment portfolio, but it also comes with its challenges. To navigate these, investors must adapt their strategies to align with the evolving market environment.

 

a. Economic Fluctuations
Rising interest rates significantly impact commercial property investments. For over a decade, investors enjoyed a period of cheap money, but as interest rates rise, refinancing loans taken out when rates were near zero becomes challenging. This situation is further complicated by the relationship between property companies and banks, where rising rates can lead to a vicious cycle affecting property values and banks’ willingness to lend . The COVID-19 pandemic has also changed working patterns and increased the demand for high-quality commercial properties and sustainable and tech-enabled buildings, thus impacting the traditional demand for office spaces .

 

b. Working from home movement
The shift towards remote working, significantly accelerated by the COVID-19 pandemic, has presented notable challenges for commercial property investors. This change in working patterns has decreased demand for traditional office spaces, impacting the commercial property market.

One of the main challenges is the decline in occupancy rates, as more employees work from home either full-time or on a hybrid basis. Nearly half of UK workers now work remotely for at least some time, reshaping workplace expectations and leading to a demand for more flexible and technologically equipped office environments. Despite this, there’s still a demand for office space, albeit with a preference for models that allow remote and in-office work. Investors are encouraged to reconsider their asset strategies to adapt to these new demands, focusing on properties catering to modern working styles, such as those offering flexible, collaborative spaces .

Financial pressures compound the situation, with rising interest rates making it harder for investors to refinance loans taken out during periods of lower interest rates. This challenge is particularly acute for the commercial real estate sector, which has historically relied on stable rental income and valuations to secure financing. The relationship between property companies and smaller regional banks, which are at risk due to rising bond yields and unstable deposits, further complicates the refinancing landscape, creating a cycle that can impact property values and the availability of finance .

Moreover, the working-from-home movement has explicitly impacted the market for office spaces. The demand for large, centralised office spaces has diminished, leading to declining property values in many locations. This shift has prompted commercial landlords to invest in modernising and reconfiguring spaces to meet the new demands of a workforce that values flexibility and collaborative environments. These changes require substantial investment and pose a significant challenge in an environment of rising costs and stricter environmental regulations .

 

c. Regulatory Changes
Staying informed and adaptable to economic and regulatory shifts is crucial for commercial property investors. Flexibility and understanding the market’s changing dynamics will be vital to navigating these challenges and seizing opportunities in the commercial property market.

 

Commercial Property FAQs

 

Q: What defines commercial property in the UK? 

A: Commercial property, also known as commercial real estate, business property, or commercial premises, refers to buildings or land intended to generate a profit, either from capital gain or rental income. It includes office buildings, retail spaces, industrial estates, and leisure facilities .

 

Q: What are the main types of commercial properties? 

A: The main types include retail spaces (e.g., shops and supermarkets), office buildings, industrial estates (warehouses and factories), and leisure facilities (hotels, pubs, restaurants, gyms) .

 

Q: What are current trends in the UK commercial property market? 

A: Key trends include a focus on sustainability and green buildings, technological advancements in property management, increased demand for flexible and hybrid working spaces, and the growing importance of amenities for employee well-being .

 

Q: How does sustainability influence commercial property investments? 

A: Sustainability is becoming a top priority, with investors seeking environmentally friendly and energy-efficient buildings that align with their ESG (Environmental, Social, and Governance) goals. This includes interest in green certifications, renewable energy integration, and sustainable construction methods .

 

Q: Are there any specific regulations affecting commercial property in the UK?

A: Yes, commercial properties are subject to various UK regulations, including planning permissions, building regulations, and energy efficiency standards like the Minimum Energy Efficiency Standards (MEES). These regulations are part of the government’s effort to reduce carbon emissions and promote sustainability in the built environment .

 

Q: What are the financial implications of investing in commercial property? 

A: Commercial property can offer high returns through rental income and capital appreciation. However, it also involves risks such as market fluctuations, changes in occupancy rates, and the impact of economic downturns. Potential investors should consider these factors and conduct thorough market research .

 

Q: How has the shift to remote working affected commercial property investments? 

A: The shift to remote and hybrid working models has led to changes in demand for office spaces, with a growing preference for flexible office layouts, enhanced connectivity, and health and wellness amenities. This trend is prompting investors and developers to adapt their strategies to meet the evolving needs of businesses and employees .

 

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.