The challenges of a commercial/semi commercial investment

Matt Taylor, national relationship manager at Shawbrook Bank, looks at the challenges and benefits of a commercial or semi commercial investment and a shift in consumer habits over the past year.

Related topics:  EPC,  Commercial finance
Matt Taylor national relationship manager at Shawbrook Bank
19th October 2022
commercial building offices

The learning objectives for this article are to:

  • Understand the challenges of a commercial/semi commercial investment.
  • Understand the benefits of a commercial/semi commercial investment.

Landlords looking for alternative investment opportunities for their property portfolio, may often consider a commercial/semi commercial investment. These types of property typically consist of a blend of commercial and residential components, such as a retail unit with an apartment above it.

Before landlords make the jump into purchasing a semi-commercial property or ‘mixed-use’ buildings as they are often called; it is important to recognise both the challenges and benefits of these types of sites.

What are the challenges of a commercial/semi commercial investment?

Escalating energy costs are affecting every part of the market, and this is no different for the property sector. While the Government has introduced the Energy Price Guarantee to help reduce the unit cost of electricity and gas, commercial properties are not protected under this scheme. This may pose a challenge for commercial tenants, as rising bills may make it difficult to maintain business. Just this summer The Association of Convenience Stores (ACS) called on then Chancellor, Nadhim Zahawi, to provide financial support for its members after rising energy bills created fears that shop owners will be driven out of business. Since then, the government has announced the details of an Energy Bill Relief Scheme for businesses, which will help anyone with a fixed contract agreed from April 2022, as well as those on variable or deemed contracts.

It is important to remember that increasing energy costs are not the only factor affecting the country. The fallout since the government's mini-budget this September, has sparked fears of a recession - which could hit landlords occupying retailers’ units the hardest. According to the British Retail Consortium, August 2022 saw footfall levels in England decline by 11.2%, as rising inflation and the cost of living crisis deterred shoppers from hitting the highstreets. These are important factors to take into consideration before committing to a commercial/semi commercial investment.

EPC challenges

Another challenge which may hinder a semi commercial investment is the EPC rating of the property and the changes which are proposed to take place in 2025. Under these changes all residential landlords may be required to have a valid EPC rating of C or above on their properties for all new tenancies. According to Shawbrook’s research, some 15% of landlords are unaware of the proposed upcoming legislative changes to the Energy Performance Certificate (EPC) regulations. A quarter of landlords surveyed said they had little to no knowledge of the forthcoming changes, with long-time landlords – those who have been renting out properties for over 10 years – found to be less aware of the changes and what impact this could have on their properties.

Moreover, nearly three-in-five (58%) of renters say they would be less likely to consider a property with an energy rating of D or below, and this fact may eventually come to concern business owners who are also looking to rent a semi- commercial property.

What are the opportunities?

While the current economic climate may deter some landlords from investing in commercial/semi commercial properties, it is important to note that there are also many lucrative opportunities. The main being that investors can diversify their portfolio, which allows them to bring in revenue from two different asset classes within the same property. Also, a landlord can secure longer leases from commercial businesses, creating a steady stream of income at reduced costs, as it will require less refurbishment (subject to the conditions of the lease), over a long period of time compared to a residential tenant.

A shift in consumer habits

The changing face of consumer habits also means that there is an opportunity to buy some commercial units at a reduced cost. This can especially be seen on retail units, which currently are at a much lower valuation than they were some years ago. Earlier this year, research by property consultant company Carter Jonas revealed that average retail rental values had been declining for over a year before the pandemic, with the pandemic spurring retail rental values to fall 17.5% below 2018 levels. However, levels have moderated recently with values of retail properties now depending on the on the type of unit and where it is located. This may create an opportunity to negotiate lower purchase price due to down valuation of the property.

Moreover, a 2020 report by Centre for Cities found that the UK is facing a “chronic housing shortage” - with the greatest areas being affected located in the South East of England such as London. For landlords looking to aid this issue, there is an opportunity to convert a commercial unit into a residential one. However, it is worth pointing out that there are costs associated with this. Planning permission and application fees can cost between £96 and around £462 for change of use. On the more positive side, in March of last year, the government introduced a relaxation of planning rules for change of use from Class E properties to Class C. Under the terms of this new legislation, full planning permission is not required for these types of conversions. Landlords looking to explore this kind of conversion, should consider a bridging loan to facilitate this.

Additionally, an ‘opco/propco’ structure, a process that separates a property asset from the trading business, can be considered during a commercial/semi commercial investment. This is completed by transferring the property to a property holding company. This can be considered for non-retail deals above £300k and where the business is trading for two years profitably. One of the benefits of this structure is that it can protect the property asset in the event of opco business failure.

Client experience

In 2019, a study by Fibre broadband specialist, Glide, revealed that the UK had 172,217 vacant commercial buildings across the UK and more than 216,000 vacant homes. This high number of vacant units can create an opportunity for regeneration – particularly in areas where there is a great number of vacant proprieties. At Shawbrook we have recognised the opportunity that vacant units present, and therefore will consider lending against them, where the client is experienced. Our criteria allows clients that can demonstrate sufficient experience and track record of letting commercial units, to buy vacant properties with the view to getting them tenanted. We approach these cases with a human touch to underwriting and take the time to understand the client’s expertise. Generally this type of funding would be limited within the marketplace or require leases to be in place at completion, however for a strong client, we can assist from the outset.

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To recap, this article has helped you...

  • Understand the challenges of a commercial/semi commercial investment.
  • Understand the benefits of a commercial/semi commercial investment.