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How does commercial property leasing differ from residential leasing?

May 23, 2024

Original article from Landlord Vision - How does commercial property leasing differ from residential leasing? - Landlord insider (landlordvision.co.uk)

Most landlords opt for residential properties when they’re new to property investment. Residential property has always been a more popular investment, and it’s easy to understand why. Generally, residential properties require a lower deposit and are less complicated and lower-risk investments. However, more experienced landlords often expand into the commercial market over time, lured by the potential benefits this alternative business model offers.

While it’s true that commercial leasing can be highly profitable and provide a steady and reliable income, it isn’t without its challenges, and not every landlord who tries to expand into the commercial market succeeds.

Whether you’re new to property investment or you’re a residential landlord who wants to diversify your portfolio, it’s important to be confident that commercial leasing is right for you before taking the plunge.

In this article, we’ll explain the key differences between commercial and residential letting, allowing you to make an informed decision about whether investing in the commercial property market is right for you.

What is a commercial landlord?

Ok, let’s go back to basics here. What is a commercial landlord? A commercial landlord is simply a landlord who rents out property for business use rather than residential properties. Commercial property is defined as a building used solely for business purposes, whether that’s a huge office tower block, a tiny florist shop, or an expansive industrial warehouse. In the UK, all commercial properties fall into one of five categories: offices, retail, industrial, leisure, and healthcare.

What responsibilities do commercial landlords have?

If you’re considering becoming a commercial landlord, it’s important to know exactly what the role entails before taking the plunge.

The split of responsibilities between commercial landlords and tenants is not clean-cut. Much of it is decided on a lease-by-lease basis, and each party’s exact responsibilities should be carefully laid out in the lease agreement.

However, as a general rule of thumb, several important responsibilities usually fall to the landlord. The first is keeping the property structurally sound. That means ensuring that the building’s exterior and structure are safe and well-maintained, including major repairs to the external walls and roof. Commercial landlords are also usually responsible for any communal areas within the building. This includes managing repairs and maintenance for these areas and ensuring that they comply with the relevant health and safety regulations.

Other key responsibilities that fall to the landlord include reporting any risk of asbestos in the building and providing tenants with a valid Energy Performance Certificate (EPC).

It’s not all on the landlord, though. Commercial tenants have their own set of responsibilities under the Health and Safety and Work etc. Act 1974. In commercial properties, it is the tenant who is generally responsible for maintaining the property’s interior and all non-structural repairs, including those that relate to the heating, plumbing, and lighting. The tenant must also ensure that all non-communal areas within the building comply with the health and safety regulations relevant to their business.

To learn more about who’s responsible for what in commercial leasing, you should refer to the Landlord and Tenant Act (1954) and the RICS Code for Leasing Business Premises. It’s important to have a good grasp of the framework before you begin leasing.

What are the benefits of commercial leasing?

If you think commercial leasing sounds complicated… you’re right! It can be. So why do so many landlords take the leap from residential to commercial lets? While managing commercial lets has its challenges, there are some noteworthy benefits to this business model, too. Let’s find out what they are.

Longer leases – Commercial tenants may be harder to come by, but once they’ve signed on the dotted line, they can be there for many years. Compared to residential leases, which usually only last 6 -12 months, the leases for commercial tenants tend to be much longer, sometimes as long as ten or even 20 years! This means if you can overcome the challenges of getting into commercial leasing, it can provide a stable, long-term income.

Increased tenant security – Longer leases mean increased tenant security. After signing the lease, commercial tenants usually need to invest a significant amount of money into fitting out their new premises. This investment makes them more likely to stick around, providing you with stability and reducing the risk and hassle of managing tenant turnover.

High ROI – Because of the size of the buildings and the nature of their use, landlords usually charge more rent for commercial buildings compared to residential ones. This higher rent means that commercial leasing can offer a higher return on investment and has the potential to be a more lucrative business model than residential leasing.

Less responsibility for repairs and maintenance – While residential landlords must manage all property repairs and maintenance, commercial landlords are often only responsible for the building’s structure, with the commercial tenant taking on a significant portion of responsibility for maintaining the interior of the property. This means less hassle and fewer property maintenance expenses for the landlord.

Reliable cash flow – Longer leases, higher rents, and less responsibility for repairs mean that commercial leasing can offer a steady and reliable cash flow. This reliability makes it easier for commercial landlords to manage their finances, reinvest in their portfolio, and grow their rental business if they wish to.

What are the drawbacks of commercial leasing?

Long leases, high rent, and reliable cash flow – it sounds like you’ve found the investor’s sweet spot, right? While there are plenty of benefits to the commercial leasing business model, it can be difficult to get into and comes with its own unique set of challenges. Let’s learn more about the drawbacks of this business model.

Higher initial investment—Many landlords are discouraged from entering the commercial property market by the price of entry. Commercial properties tend to have higher purchase prices than residential properties and require a more substantial deposit. In addition, many commercial properties require repairs or maintenance to get them ready for tenants to move in.

Strict lending criteria – Lenders see commercial properties as riskier investments than residential properties. As a result, mortgages on commercial properties have stricter lending criteria and require larger deposits.

Liability for business rates – Business rates are a type of tax on the occupation of non-domestic properties. They are usually paid by the tenant or charged to the tenant by the landlord within the cost of rent. However, if the commercial property is void for an extended period, then the landlord is liable to pay the property’s business rates.

Higher interest rates – Because commercial properties are considered a higher-risk investment than residential properties, the interest rates on commercial mortgages are typically higher. According to AXA UK, interest rates on commercial property buy-to-let mortgages are around 6% higher than on a residential mortgage.

Capital is tied up – Investing in commercial property is a big commitment not only because of its high upfront costs but also because you’re committed to locking your capital up into a physical asset for an extended period. Commercial properties have longer lease terms than residential properties, and once the lease is over, you can’t just throw your tenant out as they’re running a business and have rights. This means it’s much more difficult to convert your investment back into cash quickly.

What are the key differences between commercial and residential leasing?

Exploring the role of commercial landlords and the benefits and drawbacks of commercial leasing highlights the differences between managing commercial property and residential property.

When deciding whether commercial leasing is right for you, it’s important to have a clear understanding of these differences.

Accessibility

Residential properties are usually cheaper to buy than commercial ones, making them a more widely accessible investment. In comparison, commercial properties have a higher barrier to entry and require a higher financial commitment. This can make it trickier to secure a mortgage on a commercial property.

Lease length

Residential rental properties usually have a much higher tenant turnover and shorter leases than commercial properties. Residential leases usually last between 6 months and two years, while commercial leases can range from 5 to 20 years!

Responsibility for repairs and maintenance

Landlords managing residential lets are responsible for maintaining the condition of the property, both inside and out. This includes footing the bill for any required repairs and maintenance. With a commercial property, the tenant is usually responsible for the majority of non-structural repairs and maintenance work unless otherwise stated in the tenancy agreement.

Health and safety responsibilities

In domestic rental properties, it is the landlord who is responsible for ensuring that the property complies with all relevant health and safety laws, is free from hazards, and is safe for the tenant to live in. When managing a commercial property, less of the onus for health and safety falls to the landlord. The landlord is usually responsible for ensuring that the building’s structure is safe and that any communal areas within the property comply with health and safety laws. However, it is the business operating within the building that must ensure that its premises comply with all relevant health and safety laws and standards.

Tenant Right to Remain

Another key difference when renting to commercial tenants is their right to remain in the property once the lease has ended. Providing a commercial tenant has not breached the terms of their lease agreement; they have the right to remain in the property and renew their lease. The landlord cannot evict them from the property at the end of the lease. For many commercial tenants, their business is their livelihood and being forced to move premises could jeopardise their business. In comparison, residential tenants do not have the same level of security and can be asked to leave at the end of their lease. This means successful commercial tenants could occupy a property for many years, making it more important than ever to screen potential tenants thoroughly.

Property management

Lastly, many landlords find commercial property management more time-consuming than residential property management. This does, however, largely depend on the type of commercial property you’re managing. For example, a small retail property requires significantly less management than a large office block being let to multiple tenants.

Is 2024 a good year to invest in commercial property?

When investing in property, whether residential or commercial, timing can be everything. If commercial leasing appeals to you, it’s important to take factors like the current economic climate, interest rates, and market supply and demand into consideration when deciding whether now is the right time to invest in the commercial property market.

It’s no secret that the last few years have been a rough ride for the UK’s commercial property sector. Commercial landlords have faced many challenges during this time, including decreased demand due to the Covid-19 pandemic, market supply problems, and high interest rates. As a result, the commercial property sector has experienced decreased levels of investment over recent years.

However, the RICS UK Commercial Property Monitor for Q4 2023 found that confidence in the commercial property sector’s long-term outlook is cautiously growing. It is thought that the market has now reached the bottom of its current cycle, and so the only way is up! Although the market is yet to experience significant momentum, it is making marginal improvements across the board. While demand for offices and retail spaces remains relatively low, industrial lets are still in demand.

Commercial property prices are currently low, and mortgage rates are declining. As the sector reaches a turning point, it could be an opportune moment to invest, but only in the right property. Investors should proceed with caution by thoroughly examining market values, understanding the dynamics of supply and demand, and selecting their location with the utmost care to give their investment the best chance of success.

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