08/04/2024
Residential vs. Commercial Property in the UK
Are you looking for a solid investment opportunity in the United Kingdom? With such an incredibly dynamic real estate market, it can be difficult to determine which type of property will best suit your investment goals. From attractive city center apartments offering abundant rental yields to retail units strategically placed in prime shopping areas, investing in residential and commercial properties both come with unique rewards. Residential and commercial properties both offer different levels of capital growth potential as well as ongoing income benefits – but which is the right choice for you and your specific financial goals?
In this blog post, we’ll take you on a tour of residential vs. commercial property investments across the UK, assessing risk factors, benefits, and return potentials along the way. Whatever path you choose for yourself, we aim to ensure that you make informed decisions and understand how each type of property could work for your particular portfolio.
What is Residential Property?
Perhaps the most well-known form of property to UK property investors, residential property in the UK includes houses, flats, and other land and buildings that are used as a place of residence. This can include anything that somebody would generally live in, from huge country estates, cosy cottages, and apartments to townhouses.
What is Commercial Property?
Commercial property is used primarily for business purposes. Examples of commercial property investments include:
1. Retail (shops, restaurants, bars, cafes, and other businesses that provide goods or services to customers. This type of property can range from small independent stores to large shopping centers).
2. Logistics (warehouses and hardstanding for lorries)
3. Factories/Industrial units
4. Offices
5. Leisure – hotels, pubs, restaurants, cafes, sports facilities
6. Healthcare – medical centers, hospitals, nursing homes
What are the benefits of investing in UK residential property?
Here are some potential benefits of investing in UK residential property over commercial property:
1. Residential property investment is easier to finance
Residential properties typically offer greater accessibility and simpler financing options compared to commercial properties. Securing financing for commercial properties often entails larger down payments and stricter lending criteria from commercial lenders.
2. Residential property investment has lower entry costs
Residential properties typically have lower entry costs compared to commercial properties. This means that you can start investing with less capital
3. Increased demand for residential property for rent in the UK
As a result of the UK housing crisis and a significant exodus of private landlords from the market, there has been a surge in demand for rental properties. While there is typically a higher demand for residential rentals compared to commercial properties, recent data indicates a drastic reduction in available rental properties through letting agents between 2019 and March 2022. This shortage is exacerbated by the retirement of 140,000 private landlords last year and an estimated 500,000 expected to exit the market over the next five years, particularly as 'baby boomers' retire. With high demand reported by RICS and a decline in available lets, along with negative growth in new landlord instructions, the supply-demand gap is widening. Residential landlords are likely to benefit from a larger pool of potential tenants, reducing the risk of prolonged vacancy periods and potentially leading to further rental increases. The Office for National Statistics reports a 4.9% average increase in UK rent from March 2022 to 2023, with nationwide increases anticipated over the next twelve months.
4. Long-term growth potential
The residential property market in the UK has a track record of delivering substantial capital appreciation over extended periods, making it an attractive option for buy-and-hold investors, particularly when paired with a passive income approach. In contrast, while commercial property investments can yield impressive returns, they often entail greater volatility and are more susceptible to fluctuations in the market.
What are the benefits of investing in UK Commercial Property?
1. Commercial Property Investment Provides Reliable Income
The customary longer lease durations associated with commercial properties result in more reliable cash flows, making them an attractive option for investors seeking consistent and predictable income streams. With proposed legislation aiming to introduce 'periodic tenancies' to the residential rental market, leases exceeding 2 years are expected to garner significant interest from UK property investors. Moreover, in the case of industrial units and factories, lease terms of 35 years or more are not uncommon, given the substantial investment in machinery and equipment, thus ensuring an exceptionally stable income.
2. Commercial property income is more passive
Commercial property ownership often requires less direct involvement due to the prevalence of FRI leases. In an FRI lease, which stands for Full Repairing and Insuring lease, the tenant bears responsibility for all property repair, maintenance, insurance, and related expenses. From the landlord's standpoint, an FRI lease limits liability and mitigates the risk of unforeseen maintenance expenses or property damage. With the tenant tasked with property upkeep, landlords can have greater assurance that the property will be well-maintained, ensuring continued rental income throughout the lease term.
3. You can use your pension to invest in commercial property
If you're interested in property investment but lack substantial savings, commercial property offers the advantage of being accessible through your pension funds. Two pension types facilitate investment in commercial property: a Self-Invested Personal Pension (SIPP) and a Small Self-Administered Scheme (SSAS). Both options enable borrowing of up to 50% of the net asset value for investment purposes.
Moreover, there are numerous benefits associated with investing in commercial property via a pension fund. These advantages encompass tax relief on contributions, the possibility of deferring capital gains tax, and the opportunity for additional borrowing. Recent legislative changes have eliminated the lifetime limit on pension contributions, rendering it a savvy vehicle for retaining your property earnings.
4. Tax benefits of investing in commercial property
Investing in commercial property within the UK offers various tax advantages. Notably, capital gains tax (CGT) is waived on the property's appreciation upon sale, while business rates typically remain lower compared to residential rates.
Moreover, investors may qualify for tax relief on specific expenses related to property ownership and management, including repairs and insurance premiums. Furthermore, rental income from commercial properties is subject to distinct tax regulations from residential rental income. Generally, landlords can deduct certain expenses from rental income before taxation, such as mortgage interest payments or maintenance costs, thereby reducing the taxable portion of the investment's income.
Additionally, Stamp Duty Land Tax (SDLT) is considerably lower for commercial properties. Moreover, if one acquires the limited company holding the commercial property, the SDLT is only 0.5%.
Should you invest in commercial or residential property?
Ultimately, when faced with the decision between investing in residential or commercial properties in the UK, there is no definitive answer. Each option presents its own set of advantages and considerations, depending on factors such as investment objectives, time horizon, financial circumstances, and risk tolerance.
Residential property investments generally involve lower initial costs, easier access to financing, and a growing demand for rental accommodations. This sector holds appeal, particularly given the ongoing housing crisis and the decreasing number of private landlords. Consequently, there exists significant potential for rental income and long-term appreciation.
Conversely, commercial property investments offer stable income streams, extended lease durations, and the possibility of passive management. Maintenance expenses in commercial properties typically fall upon tenants under Full Repairing and Insuring (FRI) leases, thereby ensuring steady and foreseeable cash flows for investors. Moreover, investing in commercial property through a pension fund brings tax benefits and leveraging opportunities.
