Income vs Capital Growth: how to maximise your commercial property investment

Understanding income vs. capital growth in commercial property investment

The size of the commercial property market in the UK and the range of properties available at different price points makes it an attractive sector for many investors. Commercial property can also be very profitable, with returns that typically trump those you can generate from residential property. 

You can get returns from commercial property in two ways. You can generate a regular income in the form of rental payments from the business occupying the property. You can also benefit from capital growth as the property’s value increases over time. Most investors will prioritise income or capital growth when making their investment decisions, although ideally, they’ll look to maximise both. 

HOW DO YOU GENERATE INCOME FROM COMMERCIAL PROPERTY?

The primary return from commercial property investment is the rent paid by the tenants as set out in the lease agreement. Rental income usually represents the majority of the total return on a commercial property, with average rental yields currently hovering at around 6.5%. 

Commercial leases typically run for five or 10 years, providing landlords with reliable and long-term income through the life of the lease. The longevity of the leases provides income stability, although with rent reviews typically taking place every five years, it can make it difficult to increase the rent you receive. This differs from residential properties, where leases usually last between one and three years. That gives landlords more scope to increase rents in line with the market rate for their properties. 

Investors who wish to maximise their rental income from commercial properties can choose the level at which they enter the market. Prime property (property in dense and sought-after locations) commands the highest purchase price but also generates the greatest rental income. Secondary and tertiary property (within walking distance of the high street or in out-of-town locations) costs less but rents are also lower and top-quality tenants are more difficult to find.

However, according to some estimates, the rental yields (rental income as a proportion of the purchase price) from secondary and tertiary commercial property are outperforming prime commercial property in some areas. For example, average rental yields for offices in London’s West End currently sit at around 4%, while provincial offices and offices in the South East generate yields of 5.75% and 6.25% respectively. 

Tips for maximising rental income from your commercial property investment

BUY IN UP-AND-COMING AREAS

Astute investors who want to maximise their income should be on the lookout for properties in locations that are up-and-coming and subject to possible regeneration. If you look at council websites in the areas you want to buy, you’ll be able to see all the regeneration plans and determine where to invest for maximum future benefit.

BALANCE LEASE LENGTHS AND VOID PERIODS

Commercial tenant voids – that’s the time between the end of a tenancy and the start of a new one – tend to be longer than void periods for residential properties. To maximise your rental income, you should balance the benefits of a long-term tenant paying an average rent against a shorter lease that allows for more rent increases but exposes you to a greater risk of voids. 

THINK CAREFULLY ABOUT RENEWALS

If your goal is to maximise rental income, it could have an impact when it comes to lease renewals. When a tenant wants to renew but not at an increased rent, you’ll have to weigh up the difference between the rent you could achieve with a new tenant and the potential cost of a void period. 

HOW DO YOU GENERATE CAPITAL GROWTH ON COMMERCIAL PROPERTY?

If you prefer the idea of long-term gains rather than income, you can look to increase the value of your property over time, leading to capital growth. This could be the case if rental yields for your type of property are low or there’s a lack of quality tenants in the area.

Unlike rental income, which can be stable and predictable, capital growth tends to be far more uncertain. The health of the wider economy, as shown by the Covid-19 pandemic, has a big impact on commercial property values, but so can changes locally. And as you can see from these figures, the capital value of commercial properties can rise and fall, although values are forecast to increase over the next few years.  

DO PLENTY OF RESEARCH

Before making an investment decision, you should research the area thoroughly to determine whether it’s on the way up, stable or in decline. Long-term planning can also benefit you enormously by helping you decide when to sell to maximise your return on investment.

TAKE A PROACTIVE APPROACH TO ASSET MANAGEMENT

It may be possible to add value over and above market increases by taking a proactive approach to the management and maintenance of your property. Undertaking regular refurbishments and redevelopments, fixing issues before they become a problem and changing the building’s use in line with demand can help you increase commercial property values. However, it’s also a balancing act between how much you spend and the likely return. 

INCREASE THE RENT

Probably the simplest and most cost-effective way to increase the value of your commercial property is to have regular uplifts in rent. Including mainstream provisions such as turnover-related rents for retail space, fixed uplifts and index-related uplifts can keep your rents moving in the right direction. When selling the property, the higher rent will reflect positively on your property’s value. 

GET EXPERT HELP WITH VALUATIONS

Commercial property valuations can be complex and rely on a broad range of factors, including the location, demand, wider economic factors and the rent it can generate. At Eddisons, we value commercial property of all classifications and sectors and conduct valuations in line with professional standards. That gives you the best understanding of what your property is worth and how much rent it can generate.