For many years UK residential property has been regarded as a good and safe investment particularly in London and the South East. Even during times of recession and downward movement in prices, the residential sector has been attractive because investors realise that more than any other asset class residential property moves in cycles and values will always harden eventually. Over the last few years investment in residential property has grown substantially, especially in Central London, boosted by off-shore money and lower sterling values.
However, residential property is becoming a much less attractive option for today’s investor. Whilst it is true values have been adversely affected by Brexit, this has been partially offset by the lower pound for overseas investors. The inexorable increase in Stamp Duty Land Tax (SDLT) rates over the past few years has concerned investors; the government has introduced a number of reforms to the SDLT regime including banding which reduces the tax on lower value properties but introduces a top rate of 12% on those sold for more than £1.5 million. Companies have been even harder hit: unless they fall within one of the exemptions, they pay a flat rate of 15% at prices exceeding £500,000 and on top of that may have to pay an Annual Tax on Enveloped Dwellings (ATED) of up to £220,350.
The real game changer for residential property was the introduction of a 3% SDLT surcharge for second homes, effectively attacking the buy-to-let market and not just the overseas or high-net-worth investors. This produces a top-rate tax of 15% for properties worth more than £1.5million: a drop in the ocean for many parts of London where investment has traditionally been the highest. Even properties at the relatively modest value of £625,000 will pay a top rate of 8%. The latest Treasury initiative is to restrict tax relief on mortgage interest on buy-to-let properties.
The effect of this has been a shift in attention for some private investors to commercial property opportunities, where the top rate of SDLT is 5%. This trend is borne from figures released by the auction houses which show that lot sizes of up to £5 million mark are being snapped up by private investors. That rate applies to mixed-use properties such as a shop with flats above, rather than just purely commercial properties such as an office block: investors can still have their residential investment, provided there is a commercial element to the property.
There are number of other advantages for switching to commercial property including:
- Commercial properties can be bought through a Self-Invested Personal Pension (SIPP); under current rules residential properties cannot.
- Yields and therefore profits are generally higher for commercial properties.
- Tax relief (at full rate) for interest on loans to buy commercial property is widely available and the capital tax treatment can be more beneficial if certain other reliefs are available.
- Tenants are generally business users and therefore more commercial. They are less likely to ‘do a runner’ and it is easier to evict them if they don’t pay the rent .
- Tenants are usually responsible for the full repair of a commercial property. With residential tenancies the landlord is responsible and also has certain statutory maintenance obligations.
- Commercial properties are often more resilient in economic downturns.
- There are more opportunities for investment in other parts of the country outside of London.
However equally there are some potential downsides that new investors to the sector should be aware of:
- Unlike a residential property, commercial tenants can be difficult to replace and the value of the property is directly influenced by the covenant strength of the tenant.
- The property may be elected for VAT, effectively increasing the price by 20% or forcing the investor to register for VAT.
- There may be stricter regulatory considerations, such as energy ratings (properties with very low ratings won’t be able to be let after next April), fire risk assessments and asbestos management.
- If the property remains vacant for any length of time it may be something of a millstone with potential loan payments to make with no rent coming in. Business rates will be payable after six months.
- Funding may be more difficult to obtain with a lower loan-to-value (LTV) ratio applied by lenders.
- Increases in capital values may well be slower than for residential particularly in London; some properties such as warehouses have hardly increased in value for years, and much depends on the identity of the tenant.
- Professional managing agents will almost certainly be needed.
A move to commercial property is a big move for even experienced residential investors. It brings its own set of risks, but the rewards are there too. It is no coincidence that most funds and investment institutions have a substantial commercial real estate element to their portfolios. Residential property will no doubt continue to be a favoured and successful investment for many, but with the current UK tax regime the growing trend towards acquiring commercial property is unlikely to be a fad. On the contrary, the trend is likely to continue and the balance of real estate investment will be permanently altered.
Irwin Mitchell Private Wealth would advise that if you are looking to invest in commercial property, that you seek professional tax, finance and property legal advice in order to ensure that all of your investment options are considered and that you are supported by a professional team who can build a network of financial advisors as well as legal experts.
Published: 20 July 2017
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