A guide to buying commercial property

Categories: commercial mortgages | guides | commercial mortgage guides

You might choose to buy a commercial property to run your business from it, or to rent it out to other business owners. This guide looks at the steps you take, whilst planning to buy a commercial property, and what you need to think about at each stage of the purchase process.

What is classified as a commercial property?

A commercial property is one that a business operates from.

Some people confuse buy to let property bought through a limited company as being a commercial property and needing a commercial mortgage, but they don’t. You would simply need a limited company buy to let mortgage.

Each commercial property in the UK is classified as a specific type of building, they are divided into 5 main categories:

  • Offices - used for professional, commercial or bureaucratic work;
  • Retail - comprises shopping centres, supermarkets and retail stores;
  • Industrial - consist of warehouses and factories;
  • Leisure – restaurants, pubs, cafes, hotels, sports facilities;
  • Healthcare – hospitals, nursing homes, or specialist clinics.

Commercial buildings are further divided into classes under the Town and Country Planning (Uses Classes) Order of 1987 which defines how the property can legally be used.

Your business plan must be in line with the planning use of the commercial property that you want to buy because otherwise you could be fined. If you want to alter the building’s use, you might need to apply to the council for planning permission. Check this in advance to avoid potentially costly errors.

The main reasons why commercial properties have different types of class in place is to make sure that a given geographic area does not include too many of the same type property, such as too many pubs, and to determine which type of business can move into a property.

The funding options

If you do not have cash available, or you don’t want to use all your capital, you will have to look into different types of financing options in order to fund your commercial property purchase. The following section summarises common methods and which scenarios they are best suited to.

Commercial mortgage

Commercial mortgages are the most common funding option for buying a commercial property.

Commercial mortgages effectively work similarly to residential mortgages, as you have to pay the deposit first and afterwards you make monthly payments. With a commercial mortgage these can be either capital and interest or interest-only.

It is possible to borrow long-term, as terms typically go up to 25 years.

Your age at the end of the term may affect how long you can take out a commercial mortgage.

There are two categories of commercial mortgage loans:

  • Owner-occupier mortgages – used to buy properties as trading premises for your business/commercial purposes. It could potentially be to purchase the property that your business is currently renting, for your first business, or for an additional property to expand your business.
  • Commercial investment mortgages – used for properties that you will be letting out to another business or businesses.

Ensuring you get the right product for your circumstances is imperative, as demonstrated by the savings on a commercial mortgage Commercial Trust achieved for a client.

Bridging loan

Bridging loans are a short term financing method that provide the possibility of purchasing a commercial property before long-term funding is arranged, or cash becomes available.

Bridging loans for property developers allows those who need to renovate a property before it can be mortgaged to bridge the financial gap between doing work on the property and exiting long-term finance, or between one property transaction and another.

Bridging is a viable option if you need to purchase a property and convert it to commercial, where work needs to be done to the property, or where completion deadlines are short (e.g. auction purchases).

Bridging loans are usually secured against the property that you purchase. However, you may be able to use your own home or other property instead of the commercial property as collateral.

Bridging loans can be paid back in monthly instalments, or at the end of the loan term. Borrowers must provide a failsafe exit strategy – for example, the sale of the property or refinancing.

The interest rate will mostly depend on the loan to value (LTV).

Auction finance

Auction finance is a type of bridging loan that enables the buyer to swiftly complete a purchase of a property at an auction. Because auction purchases must typically be completed within 28 days of the hammer falling, it is very unlikely that it would be possible to purchase a property using a mortgage, which take longer than this to arrange.

An auction house usually requires you to pay 10% of the purchase price in addition to the auction fees in cash, when you place a successful bid.

Property auction finance can be very helpful in a number of ways, and you would ideally arrange this before the day of the sale. By arranging funds before the auction occurs, you would know that you can definitely secure funding, what your exact budget is when bidding and what property specification your lender will finance.

Remember though, the loan cannot be used to pay the deposit and fees, you will need your own funds for this.

Questions you should answer before buying a commercial property

Before you apply, we strongly recommend you cover all of the bases when choosing a commercial property, for a successful mortgage application and, more importantly, for your business or investment to succeed.

What location is best suited to me or my business?

Determining the right location is imperative. The location must suit your business needs or the needs of your intended tenant(s). Factors to consider include the proximity to various resources, amenities and suppliers (if relevant).

Geographic location, access and travel routes will impact the business logistically and/or the volume of foot traffic. How appropriate the location is will depend on the type of business you plan on operating, or offering the premises to.

Other factors, such as mortgage contract type, the ability to customise the property and local amenities are very important aspects for the success of your property, and the running of your business from it, if applicable.

Is it retail space, office space, or industrial?

Retail space – depending on the nature of what you are selling, high levels of footfall will be essential, with adequate parking and transport links.

Office space – office space is no longer reserved for town or city centres, where big businesses with high volumes of staff are involved, but you do need good transport links and generally to be on the periphery of a densely populated area.

Industrial premises – industrial premises may involve heavy goods vehicles needing access, so driving routes may need to accommodate that. Out of town locations are often best suited to such properties, away from residential areas, but close to dual carriageways and motorways for the purposes of logistics.

How long the investment will be for?

Commercial property mortgages are usually between 5 and 25 years, with some lenders offering up to 30-year terms.

It is very important to note that the length of your commercial property mortgage term will have a direct impact on the overall cost of your mortgage. A longer loan period means more monthly instalments, thus more interest accrued and paid over the months.

The process of buying a commercial property

Once you have a specific commercial property that you would like to purchase, the purchase process has several steps:

  1. The Purchase price must be agreed with the seller, typically through an estate agent. The agent would then prepare a memorandum of sale, which sets out the main points of the transaction. Even though it is not legally binding, it is usually referred to for legal drafting and should be accurate.
  2. Solicitors instructed – after the Heads of Terms have been agreed by both parties, the documents will be sent to the appointed solicitors (that you must formally appoint). Your solicitor will send their terms of business and ask for your identification documents and they may ask for money on account for property searches and land registry documents.
  3. The Contract package will be sent by the seller’s solicitor to your solicitor. It usually includes a draft sale contract, title documents, Energy Performance Certificate (EPC) and replies to Commercial Property Standard Enquiries (CPSEs). CPSEs are general enquiries raised on the purchase of a commercial property.
  4. Buyer’s due diligence – after the contract package has been received, your solicitor will carry out due diligence checks on the property, in line with your requirements and the lender’s requirements.
  5. Solicitor’s review of mortgage papers – they will review the terms of the mortgage and any other security documentation that has been provided by the lender. Your solicitor will also need to respond to any lender’s requirements, if applicable.
  6. Contract agreed and reporting – once your solicitor is happy with the information gathered by due diligence, the terms of the sale contract and transfer deed will be negotiated and agreed upon with the seller’s solicitor.
  7. Contracts exchanged – after you and the seller have signed the sale documents, contracts will be exchanged and your solicitor will pay the seller’s solicitor the deposit.
  8. Completion – at completion, your solicitor will receive the funding from your lender. If it is a purchase, they will send the remaining balance to the seller’s solicitor, the transfer deed and mortgage will be completed and the legal title in the property passes on to you. On a remortgage, a charge is registered on the Land Registry.

Pros and cons of buying commercial property

As with any other type of mortgage, there are multiple pros and cons that come with commercial mortgages. Below are some considerations to take into account:

Pros

  • Commercial mortgage interest is tax-deductible.
  • If your property increases in value, your capital will also increase accordingly.
  • If you buy property as an investment: When renting out a commercial property, leases are typically over 5 years and up, compared to buy to let rental periods, which are six/twelve months. So, you are in a better position to maintain income over a longer period. If your costs increase, you can adjust the rent to help pay for them.
  • If you are an owner-occupier: You are not subject to rent increases, you can update the premises without seeking landlord permission and you have the potential to pursue changes to the property as your business evolves (albeit this may require planning permission and will incur costs). Ultimately, you have more control over the property and your use of it.

Cons

  • Given that some commercial premises can be large; costs can be higher than if you were buying a residential property.
  • Commercial premises are seen as a higher risk to lenders, so the percentage of the property value you have to raise as a deposit can be considerably more than for a residential property, from 25% but up to 40%.
  • The process of buying a commercial property is considerably longer than other types of investment.

Ready to speak to a broker? Get a call-back to discuss a commercial mortgage.

FAQ

The required standard deposit amount is between 25% and 40%. It depends on various factors as to where in that range your proposed property will sit, based on the lender’s assessment of how much risk is associated with the loan.

For owner occupiers those factors include: the amount of business experience you have in the industry the property will be used for, the profitability of the business, credit history (yours and your business).

For investment purchases those factors include: your experience as a landlord, rental income from the premises, your credit history, business and property type.

Generally, a sale or a lease of a commercial property is exempt from VAT charges. However, there are some exceptions to the rule.

The standard VAT rate is applied if the property is less than 3 years old or if the vendor/landlord has “Opted to Tax”. If a property has been refurbished or renovated or for other reasons, the vendor/landlord may opt to tax, in order to recover the VAT costs, for example those associated with refurbishment work.

You may need permission from HMRC and to notify them.

You may be able to, but you will have to request to change the property from commercial to residential, in order to live in the premises.

Unfortunately, you cannot move into a property that has commercial status. There are likely to be a few reasons for this:

  • Commercial building insurance does not cover people living in the property.
  • Freehold and leasehold contracts may have clauses that forbid it
  • It would be in breach of the buildings “Use class” as determined by the local council

If you started living in a property where any of these applied, you may be breaking the law.

Yes, you can - this method can also be highly tax-efficient. Investing in a commercial property provides you with suitable premises for your company and steady monthly payments that go into your pension.

Always seek tax advice from a qualified professional.