Market Information

Commercial Property Investment versus Residential Property Investment

Investment in commercial property can produce not only capital growth but also high rent yields, since it is traditionally let on a 'full repairing lease' basis with the tenant paying all the outgoings.

However, one significant drawback of commercial property is the largely uncontrollable vacancy factor. Commercial property values and rents tend to be closely associated with the level of economic activity and are vulnerable to the effects of over-supply in a recession, which can apply on a large scale. During the economic downturn of the early 1990s many suburban shop premises were vacant for several years and in some cities the vacancy rate for offices in certain districts reached 30%. (Source "Building Wealth" by D. DeRoos).

Since almost 80% of new businesses do not survive their early years of operation, the chance of losing the tenant of a commercial premises is high. Having the right commercial tenant, therefore, can often prove to be a matter of chance. Changes in the local economy, such as a new out-of-town shopping centre, can render a once-popular high street location far less lettable and certainly less lucrative at the time of a subsequent rent review. No amount of experience and expertise employed to monitor and assess the risks will enable the investor to anticipate with any certainty where and how the next economic downturn will affect commercial property values, rent levels and occupancy rates, in a particular location.

Commercial property tends to have a high unit cost, requiring a minimum investment of several hundred thousand or more often several million pounds, in a single building. Should the premises remain or become vacant, a large amount of capital is tied up, on which there is a nil return. The cost per unit of residential investment property is substantially less - enabling a number of units to be purchased with the same amount of capital as might be required to buy a single commercial premises. When one residential unit out of a number is vacant the loss of revenue is less dramatic, and can be carried by the others. Another attraction of residential property is that it generally easier to dispose of, should this become necessary.

Many investors have ignored residential property because of its smaller unit size, and because it is therefore more costly to manage. The sector has suffered from a poor image and unhelpful legislative imposition in the past, and for many years has been considered unglamorous. However, standards have risen in recent years, not only in the physical condition of the properties themselves, but also in the calibre of tenants and in the performance of professional property managers. Void periods between tenancies of residential property are more predictable than commercial property, and a minor adjustment in asking rent, or improvement in facilities on offer, will usually enable a vacant property to be re-let quickly.

In an economic downturn, small businesses and the people they employ are often the first to be affected. Apart from causing high vacancy rates in commercial property, financial hardship for the individuals concerned can often jeopardise their ability to keep up mortgage repayments on their own homes. During such times, people still need accommodation and will often move into rented property until their fortunes improve. As a result the PRS has traditionally performed strongly in a recession, making it somewhat counter-cyclical to the residential sales market and the broader economy. This provides greater security to the residential investor in that rental yields improve at times when capital growth is more restrained. The fact that mortgage companies, in the experience of the directors, regularly lend up to 95% of the value of residential property to owner/occupiers confirms the high regard they have for the degree of security that it provides.