It has been a punishing couple of years for the buy-to-let market with tax changes and tougher lending criteria weighing heavily on profits. But experienced brokers have a unique opportunity to support their clients as they explore new investment options beyond the traditional residential space. Experts report that a growing number of BTL landlords are venturing into new territory to try their hand in the commercial and semi-commercial space.
It is easy to see the appeal of leasing property to businesses rather than residential tenants, with higher potential yields and a more favourable tax treatment. Yet there are plenty of risks to consider and landlords who are new to this part of the market will value the guidance and professional contacts that brokers can offer.
A recent study by OneSavings Bank found that half (51 per cent) of brokers had been approached by landlords looking to diversify their portfolios; and, in 56 per cent of those enquiries, investors were considering HMOs (houses of multiple occupation). Of those looking to diversify, 14 per cent were considering commercial property and 9 per cent looking at semi-commercial or mixed use.
OneSavings Bank plays in both the residential BTL lending sphere under the Kent Reliance brand and the specialist commercial arena through Interbay.
Interbay’s head of sales for second charge and commercial lending, Darrell Walker, says: “We are seeing a snowball effect at the moment as both brokers and landlords become more savvy about these opportunities and the market builds some real momentum. But it is not something to go into lightly and landlords need the right support and professional assistance. This is where specialist brokers can be worth their weight in gold.”
Given the tax treatment of commercial and semi-commercial properties, it is easy to determine what underpins this trend.
First, there is the difference in stamp duty. Cowgill Holloway tax partner Lisa Wilson says: “Both commercial and mixed-use properties are exempt from the 3 per cent surcharge. Therefore, flats above shops, for example, avoid the extra stamp duty. This has caused many buy-to-let landlords who wish to remain in the residential market to look at mixed-use property as an alternative to conventional buy-to-let.”
Wilson adds that some landlords are even buying commercial property in a bid to avoid paying the 3 per cent surcharge, with a view to later obtaining planning permission for a change of use and converting the premises into flats.
But she cautions: “While this has the potential to prove a cost-effective way of ultimately obtaining
a residential property, the investor needs to be comfortable with the fact that they could end up with a commercial investment if planning permission is not granted.”
For landlords who are used to the residential sector it is a whole new ball game
The second big tax advantage behind the trend towards commercial property investment is the continued ability to offset mortgage interest against profits. With residential BTL, of course, the gradual erosion of tax relief on mortgage costs is already under way and by 2020 this perk will have disappeared altogether.
Wilson says: “These changes do not apply to commercial properties and, for mixed-use properties, the commercial part of the property will be exempt from the changes. Essentially, you will still be able to claim tax relief for loan finance costs relating to the commercial part of the property.”
However, she warns: “Care should be taken in apportioning loan finance costs between commercial and residential parts of a development because the legislation governing this is somewhat opaque. We recommend that you seek professional advice on this given that the legislation is untested in this area.”
Vantage Finance managing director Lucy Barrett agrees that landlords new to the commercial market should ensure they have expert help on tax and legal matters. She says: “For landlords who are used to the residential sector it is a whole new ball game. They need to make sure they have got an appropriate solicitor to advise on the lease, especially if they are looking to buy a vacant property and find a tenant.
“If the tenant is in situ then it is slightly more simple. They should look for a solicitor who specialises in commercial.”
One of the biggest challenges for landlords will be identifying the right properties and tenants for their new commercial or semi-commercial investment venture. Here they will need to carefully balance risk against yield.
Buy to Let Club managing director Ying Tan says: “If you’re buying a kebab shop you might get a better yield – of, say, 12 or 13 per cent – than with other types of property, such as a supermarket chain, which might be closer to 6 per cent. But a kebab shop is not going to be as reliable and could go bust, so the downside is your void periods could be longer.
“Don’t forget that with commercial premises when they are empty you still have to pay the business rates, which are horrible.”
Yet Tan points out that many ordinary landlords are unlikely to be able to afford large offices on business parks, or spaces suitable for big retailers in shopping complexes. Furthermore, just an occasional cursory look at the business pages tells one how many well-known house-hold names are going under from week to week, so a high-profile tenant is no guarantee of success.
Barrett adds: “You also need to be aware that many well-known chains are actually franchises, which means, even though they carry a brand name, they don’t have the financial backing of a strong parent company.”
Trying to gauge the financial health of a business may seem daunting but this is where a prudent approach to lending can be a safety net for the landlord as well as for the bank itself.
Tan says: “The lender is looking at the tenant as much as the borrower. I see cases where banks are not willing to lend on properties with certain big-name chains as tenants because, when they looked behind the covenant, they found that they had cashflow problems.
“They will look at how long the business has been trading, what its track record is like, and so on. Ultimately, the tenants pay the mortgage, not the landlord.”
You need to do your research and create a business plan
At Interbay the underwriting process draws upon the expertise contained within the wider OneSavings Bank group, explains Walker.
“When we look at the property itself we have our own in-house real estate department made up of qualified surveyors who act for the bank, so we can get a view before the stage where people are putting their hand in their pocket to get an official valuation from one of our panel valuers,” he says.
“Brokers love the fact they can come to us and we can help them to shape the deal and get a feel for whether a case is a goer. On top of this we have a twice-weekly transactional credit committee, where we can take deals of a large nature that are a little bit quirky. We can go to this committee to present opportunities.”
While no landlord should enter the commercial space with a view to making easy money, there is clearly great potential for those willing to take the time to learn the ropes.
Tan says: “You need to do your research and create a business plan. I wouldn’t suggest it’s right for the part-time dinner party landlord but, for someone who understands property and has been doing it for a number of years with a reasonably large portfolio, commercial is the natural progression.”
For brokers who have previously worked only with BTL clients, the commercial and semi-commercial market may be just as daunting as it is for landlords who are looking to diversify for the first time. But help is out there. Even brokers who prefer to stick to what they know should not be blinkered to new earning opportunities.
“Our industry offers great support for brokers who are looking to take advantage of the growing opportunities that exist in the commercial arena,” says Walker.
“We have a nationwide team of experienced business development managers, as well as a phone-based broker liaison team on hand to help and support from initial enquiry stage right through to completion.
“And for brokers who are perhaps a little nervous of making the initial jump into the commercial world, we also work with a wide range of experienced master brokers that have the specialised knowledge and understanding of the wider market.”
With Britain’s bricks-and-mortar retailers facing an ongoing struggle to keep their place among the new online giants, our high streets are in for a bumpy ride. In these turbulent times, landlords increasingly may come to value the insight of clued-up brokers in helping them to pick business tenants with staying power.