Buying Commercial Property for the First Time - 10 Top Tips
If you are reading this Blog chances are that you have already decided that you intend to purchase a Commercial Property whether that is for your business operations, property development or investment purposes. You are also probably beginning to realise that Commercial Property acquisition is quite different to most people's experience of buying their own home and no doubt you aren't quite sure how to start or more importantly how to avoid the pitfalls. If so, congratulations you've come to the right place! Read on for my Top 10 Tips.
Earlier this year I had the pleasure of being a keynote speaker at the #Kickstart2017 Commercial Property Insight event provided by the Royal Bank of Scotland and prepared for those entering into the commercial property market for the first time. For those who were unable to attend, don't worry my Top 10 Tips is derived from the presentations delivered which were found by attendees to be "of great interest" whilst "the content delivered was highly informative". I hope you think so too!
So with that, here are my Top 10 Tips to follow BEFORE buying your first Commercial Property:
Top Tip 1 - Finding the right property - Location
Perhaps the most important factor when searching for the right commercial property is location. Get this wrong and it's a difficult one to recover from.
A great location can often be thought of as property within a desirable or marketable area but what does this really mean? Well, in simple terms it's an area where demand is high and outstrips supply. In practical terms, the real key to understanding this in commercial property terms is to physically walk the streets and area surrounding any building being marketed that you may be interested in.
Red flags can be raised immediately on doing this and some examples may be the street being littered with "to let" and "for sale" boards affixed to commercial properties. In a high demand area typically all units would be occupied so if an area has for instance a number of empty retail units this would typically signal that the market supply is not there, a worrying aspect.
A further Red Flag is the length of time that a property has been on the market for. A property in a "good" location would typically be capable of being let or sold within a short timeframe, so if a property has been on the market for a long time then I'd suggest being extra cautious and carry out further due diligence before jumping in.
Top Tip 2 - How to find the right property
Finding a property is easy, isn't it? It's common knowledge that a quick search on the internet will reveal a number of property listing sites containing all commercial properties for sale within whatever area you desire. But wait a minute, here's an insider tip... they won't!
A considerable number of commercial properties change hands without ever hitting the open market and as such without ever being mentioned on the internet at all. Indeed, many, many properties are only put onto the open market if not snapped up prior to this from off market activities.
The truth of the matter is that most property agents and surveyors will in essence pre-release to known contacts and organisations they know are interested in the property in question i.e. a targeted approach.
So I'd suggest preparing brief requirements i.e. property sector, size (square footage), location, yield range, whether you are seeking vacant possession or a let property and then sending these to commercial property agents/surveyors. The RICS website is a good place to start to find surveying firms whilst a search on each firm's website should outline a commercial property agent to allow you to contact directly.
Don't forget if you are a new contact to the property agent to follow up every now and then to ensure you are and remain on the list whilst ensuring that they have your requirements for matching.
An alternative is to appoint a property agent yourself, furnish them with your requirements then sit back and let them do all the hard work. Some agents may even work on a fee commission basis where you only pay them a fee if you buy the property.
Top Tip 3 - Specialise in a Property Sector
Commercial property is split into various sectors including office, residential, industrial, retail, licensed trade and leisure. Each sector is unique and one of the keys to success of any commercial property investment is to fully understand the sector you intend to invest in.
So whilst most publications and certainly large property funds will talk about diversification of risk by investing across a range of property sectors, my advice to a smaller or start-up investor would be to specialise in one sector.
By doing this your market knowledge will increase, you will become familiar with what tenants are looking for with a property, what locations are best, what constitutes a good property layout, as well as understanding statutory considerations relating to the property specific to the sector. In addition, with increased experience time savings can be obtained and the property selection stage and due diligence processes streamlined considerably.
Top Tip 4 - Determining Value of the Investment
So how do we determine the value of the investment and specifically how do we compare different commercial property investments? In short, we calculate the "yield". Put simply, the yield on the property is calculated as the annual return on the capital investment and is usually expressed as a percentage of the capital value.
Many newbies often question why more emphacise is placed on property yields or returns as opposed to overall capital values... the answer to this is fairly straightforward. Capital values on property investments can only really be generated by reviewing recent, comparable transactions of similar properties in similar locations. Property yields however are easily compared across a platform of properties and because of this, it is common practice to apply a percentage yield figure as a multiplier against a property's annual rental income as this will help to build an estimate of the capital value of the property.
In general terms, we might expect to see lower yields for say modern properties in a good location with a good market demand whereas an older property in a secondary or tertiary location with a more questionable demand is likely to attract a higher yield given increased risk and possible expenditure requirements.
For example, a Grade A office building in a prime City Centre site and let out to say a well known global company on Full Repairing lease terms over a 15 year lease term will likely attract a low yield, say 5% however, in comparison an aged industrial unit within a tertiary area and let out to a small local sole proprietor on a relatively short lease could generate yield approaching 12% or more.
Top Tip 5 - Look for the Potential to add Value and Capital Growth
What differentiates great property investors from the rest is the ability and knowledge to find potential to add value and capital growth where others cant.
For example a property acquisition for investment purposes with a sitting tenant could allow an assessment of the current rental to establish if this is undervalued and whether there is an upcoming Rent Review clause (typically every 5 years in commercial leases), to allow increased rental returns to be achieved. In all situations involving a tenancy, proper Due Diligence should highlight rental levels of similar properties in order to factor conservatively future gains which can increase the yield.
Longer term strategies for the site also need to be considered including thinking "out of the box". For instance, what is the Planning Use of the building and is there an alternative use class to consider that may attract higher returns. An example may be a small retail unit on a high street that could apply for hot food consent, possibly demanding a higher rental. Another example could be a well cited industrial estate close to the city that could be demolished and turned into residential.
Top Tip 6 - Condition
Having been involved in property my entire career, I have seen countless examples of a poor acquisition where costly condition related aspects of the building such as significant and very costly repairs have remained unknown due to a lack of due diligence and unnecessary risk taking.
Of course, most readers will be thinking that a surveyor would say that wouldn't they?! It is true to say that a survey may not provide any enlightening view on condition that was not evident to yourself from viewing the property. However, it is also true to say that many surveys do reveal costly unknown issues that either result in an acquisition not progressing or alternatively a "price chip" occurring.
I have often been asked in relation to establishing the condition of a property "do I need a survey?". The truthful answer lies in the risk disposition of the purchaser and the property in question.
What I would say is that experienced surveyors are worth the additional expenditure and they will save you from making a poor acquisition and mitigate risks. A surveyor is capable of establishing costly defects utilising their skill, experience and equipment which are often not apparent or evident to others.
After 16 years undertaking Surveys, I have yet to experience one situation where the survey didn't find defects and issues that were unknown to the prospective purchaser. So my advice is to instruct a Building Survey PRIOR to progressing with any commercial property acquisition. Bet you are surprised by that Tip by a Building Surveyor!
Top Tip 7 - Dilapidation Gap Analysis
When buying a Commercial Investment property with a Tenant and Lease Agreement already in place, it is important to undertake a Dilapidation Gap Analysis. Following on from Top Tip 6 in ascertaining the condition of the building, a prudent and experienced Investor will then look to establish what repairs they are able to claim from the current Tenants.
In a typical Commercial Property Lease the Tenant will be responsible for repair and maintenance of the building although the extent of repair can often be mitigated and watered down by a well advised Tenant by way of a Schedule of Condition which has the effect of ensuring the Tenant does not have to rectify any defects that existed at lease commencement.
Where various works are unable to be claimed from the Tenant, an Investor needs to understand the cost liabilities relating to these given that for instance, they may require to expend their own monies to secure a new tenancy in future affecting the profitability of the investment. There would be little point investing in a property on the basis of the calculated yield only to then have to incur capital expenditure that could have the effect of reducing this below an acceptable level.
Another quick tip if you are acquiring a building with a Tenant in place and obvious building disrepair is to serve a Schedule of Dilapidations which is a claim against the Tenant to progress such necessary repair compliance works. This option is overlooked by Investors however, is an essential tool in a Landlord's armoury. A Schedule of Dilapidations can often be used to achieve a tactical advantage where for instance a lease re-gear is being considered.
Top Tip 8 - Service Charge & Common Works
Don't get caught out by Service Charge and Common Works!
This can apply for instance when acquiring a building with a commercial tenant in place under Full Repairing and Insuring terms. Often in such situations a Tenant is obliged to pay a stated percentage or share of any expenditure incurred in relation to Service Charge or Common Works however, often difficulties can arise with a Landlord not giving this area the attention it deserves and leaves it too late.
For instance, if Common Works or Service Charge works are not completed prior to Lease Expiry of an outgoing tenant, the Landlord can lose the right to claim for recovery of costs to be incurred. It can be a painful blow for a Landlord who would have been capable of obtaining full recovery had the works been completed a month or so before. Indeed, I have successfully defended a number of these claims for Tenants including many extending to several hundred thousand pounds due simply to a Landlord not completing such works prior to lease expiry.
A well informed Landlord should plan the exit strategy of a Tenant considerably in advance of lease expiry. Understand the condition of Common Parts, what repairs, remedial works, redecoration and improvement works are capable of being undertaken and how to ensure that the Tenant rather than Landlord pays for them.
Top Tip 9 - Statutory matters
Don't get caught out by Statute, either by assuming that the building is compliant as it stands or by assuming that you are able to for instance change it's use or alter it.
Prior to purchasing any Commercial building, a prospective purchaser should be seeking evidence of compliance of statute for instance in relation to asbestos, electrical installations, gas installations, prior alterations, use class, fire, deleterious materials, energy performance etc.
By way of an example, despite there being statutory obligations relating to all commercial properties for a dutyholder to arrange as a minimum for a Management Asbestos Survey and Asbestos Register to be obtained, I still routinely see every single week a complete disregard for this legal requirement.
By requesting evidence of compliance, this mitigates the risk of the acquisition. Why risk buying a property for instance with no Electrical Installation Condition Report where this could outline that significant sums are required or worse that the electrical installation is unsafe?
There will be some instances where the Seller simply refuses to provide the requested documentation. In such instances, this would be an immediate red flag, does the seller know something that you don't perhaps? Don't get caught out, the costs with non-compliance of statute can be significant. By way of a horror story, I know of a few instances where a party have bought a building assuming it to be compliant only to then discover they have to incur substantial sums in installing for sprinkler system. Don't get caught out!
Top Tip 10 - Due Diligence
Due Diligence is the key to every property transaction. Spend the time doing your homework on each property, this is the only way to ensure a successful acquisition by reducing risks to a manageable level. Many investors and developers fail to do this and the result is that their acquisitions are nothing more than a gamble and a play on a roulette wheel. Due Diligence covers all of the above Tips and indeed more such as finance, accountancy issues, VAT, legal matters etc.
Don't be reliant on luck or property values generically increasing, Due Diligence ensures that you won't be the person finding issues months after buying a property and wondering how to raise funds to rectify issues not factored into your financial calculations.
Many of the most successful property investors rely on a team of Surveyors, Solicitors, Accountants and other professionals to ensure that they get the best advice and best results, whilst adding value utilising their years of experience. Typically having a bank of professionals that you can rely on or even be able to ask questions of from time to time can give you the commercial advantage in any property transaction.
So there you have it, my 10 Top Tips to follow BEFORE acquiring a Commercial Property. Follow these and you can avoid some of the biggest pitfalls and gain knowledge of the most seasoned property buyers.
Greig Adams BSc (Hons) FRICS C. Build E FCABE LETAPAEWE
Greig is a Chartered Building Surveyor and Chartered Building Engineer who has attained Fellowship with both the Royal Institution of Chartered Surveyors and the Chartered Association of Chartered Engineers. Greig is a Divisional Director at Capita Real Estate & Infrastructure and leads the Edinburgh office's Building Consultancy Department. He also holds a Masters level Expert Witness qualification, has carried out in excess of 100 Expert Witness Reports for Litigation purposes and has experience of presenting oral evidence in court over a range of contractual, building pathology, dilapidations and workmanship disputes. Greig routinely provides advice to those seeking to buy Commercial Properties including Building Surveys, Dilapidation advice and more!