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There’s a big difference between commercial and residential property investment. Most of us are familiar with domestic property and we can anticipate the requirements of a residential tenant. But that’s not necessarily the case with a commercial tenant.
Commercial property, or a non-domestic property, is a property which is not primarily a residence, though many mixed use (commercial and residential) buildings do exist: shops, offices, workshops, warehouses, factories, leisure centres and hotels are all examples of commercial property that could be considered to have investment potential. Interestingly, licensed houses in multiple occupation (HMOs) are considered commercial property investments for financing purposes.
Both residential or domestic property and commercial rentals have their own legal regimes, though there are some broad similarities. Governed by a whole raft of landlord and tenant rules and regulations, anyone contemplating becoming a self-managing residential or commercial landlord should be prepared to familiarise themselves with their legal responsibilities for each branch of the law.
There are pros and cons to both being a residential or a commercial landlord, and perhaps the best way to illustrate them is in the form of a comparison chart:
It is crucial to do thorough research to establish your target tenant type and the demand in a particular location. This is particularly important for commercial as many high streets have been decimated with home shopping, and office demand has been reduced through working from home. There is potential for converting offices and shops into residential through the relaxation of permitted development rights, and there are some tax concessions for this.
You should use a risk reduction strategy. This might involve finding run-down properties that can be bought below market value and transformed through refurbishment and splitting into multiple units, or made into mixed-use such as flats above shops – there are the special permitted development rights planning rules in some situations. You need to decide whether you would be better off developing properties – as a property developer - or if you simply want to be a landlord owning and renting them out long-term. There are different tax implications for both – seek professional advice.
Commercial properties have a particular tax benefit in that they can be owned in a pension, a SIPP or a SASS. These trusts give you freedom to invest your own pension money however you want, including buying commercial property, and they have major inheritance tax (IHT) benefits. Get professional advice before you invest, form a limited company or pension vehicle.
Selecting tenants is a very important part of being a successful landlord and successful business tenants are the most important aspect of letting commercial properties. A “blue chip” business tenant, known as covenant strength, on a long lease gives you a secure long-term income – a guaranteed income-return for the x number of years on the lease.
Not every tenant is a blue chip, especially if you are letting small units, and you are at the mercy of the market if demand is low. But remember, as a landlord you are better off with a vacant unit than one with a bad tenant in place. Always do thorough background checks. This is important with businesses as many are limited companies with limited trading records. Take director guarantors having done background checks on them.
Have generally shortened in the modern era. In years gone by nothing much changed in the business environment and companies would take on very long leases. This has become much less common in an era when things can change rapidly. Therefore, even the biggest blue chips are looking for shorter leases, down from 15 or 20 years to perhaps three, five, 10 or 15 years if you are lucky.
Unlike residential, which has its highest sale value when vacant, commercial property has its value multiplied when occupied by a strong covenant business tenant. So, a successful conversion / refurbishment and a good letting adds tremendous value to your investment, especially if you wish to sell and move on.
Commercial ‘tenancy agreements’ are usually referred to as a lease, with a typical term of three to 25 years, but more commonly, with the modern trend to shorter leases, between three and five years, though some may be longer with break clauses. Landlords are expected to follow the RICS Code for leasing business premises.
Shorter leases and lower rent amounts may not be FRI. These make the tenant responsible for the interior of the premises only. Often an off-the-shelf lease will suffice here, for example the Law Society commercial lease – which will considerably reduce legal costs.
However, for any substantial commercial letting, lease terms are usually negotiated between the parties, necessitating a custom drafted document. It is crucial to get this right from the outset as commercial tenancies are primarily contractual – in other words the courts will interpret them at face value, on their exact wording.
The statutory rules come into play at the end of the lease term, giving business tenants security of tenure: an automatic right to renew the lease on similar terms. This is subject to several exceptions, for example when the landlord intends to redevelop – see “Grounds for resumption of possession by landlord” Part 1-12 in the Act. If the lease is ‘excluded’ from Part II provisions of the Landlord and Tenant Act 1954, tenants will have no automatic right to stay in the premises at the end of the lease.
It’s important for both landlord and tenant to establish the condition of the premises prior to the letting, especially with an FRI lease. Otherwise, there’s no evidence available to identify maintenance and repair issues, and the repairing obligations at the end of the term, when a schedule of dilapidations is drawn up. Usually, a chartered surveyor would prepare these reports.
It has been customary for the ingoing tenant to pay all legal costs – both sets of solicitors’ costs – but this tradition is perhaps a little outdated for smaller transactions and many lets are now completed with both parties paying their own legal costs.
This is the area where most of the commercial landlord’s responsibilities lie. Under the Health and Safety Act 1974 landlords have a duty to make sure the premises are safe for occupation. In multi-occupation buildings their responsibilities go much further, with a responsibility for maintaining common areas and providing adequate fire safety measures. This will include signage, fire alarms, emergency lighting and fire extinguishers, maintenance and periodic testing, making sure that escape passageways are kept clear and carrying out periodic fire drills and risk assessments.
The lease plays a big part in defining who is to be responsible for what and should make health and safety responsibilities very clear, but the contract cannot override statutory rules and obligations – the landlord cannot pass on his or her own statutory duties to the tenant.
The Health and Safety Executive’s guidance is designed to make sure that everybody in a building is protected and many of these health and safety responsibilities will naturally fall on the business tenant. However, some of these responsibilities may be shared between landlord and tenant, depending on who can be identified as the statutory “responsible person”, particularly in multi-occupied commercial premises. The periodic risk assessments must be carried out by this person or persons.
It’s in the landlord’s own interests to make sure tenants carry out their own workplace health and safety responsibilities as an individual unit’s safety could affect the whole building. Landlords should enforce this where the terms of the lease are being breached. Tenants are responsible for making sure their workplace is safe by complying with the Health and Safety at Work Act 1974 and with fire safety regulations.
Depending on the type of agreement (FRI or not) the landlord has repairing obligations responsibilities under Section 11 of the Landlord and Tenant Act 1985 (as amended), and this Act outlines the landlord's statutory obligations for repairs to the structure and exterior of the property in the absence of agreement in the lease.
In the case of a FRI lease, tenants will be responsible for maintenance of repairs not specified in the lease, even if not properly maintained or repaired prior to the commencement of the tenancy. This comes as a shock to many tenants when a dilapidations report is produced.
The Regulatory Reform (Fire Safety) Order 2005 sets out the main obligations of the ‘responsible person’, that is anyone who has control over fire safety in a commercial building. The responsible person will usually be the employer (tenant) of the building in a workplace. The landlord may be responsible for providing and maintaining equipment, depending on what the lease says, but will always be responsible for fire safety in communal areas. Therefore, there is a shared responsibility in many cases.
Prior to letting, the landlord must obtain an Energy Performance Certificate (EPC) with a minimum rating of E or above. After April 2023 it became illegal to lease or renew a lease on a property that does not meet the minimum standard and it is very likely this minimum standard will be tightened in future, so landlords should be thinking now about how they can future proof the sustainability of their commercial premises.
Landlords should make sure that the building is free from harmful asbestos prior to letting by having an asbestos survey carried out and arranging removal if necessary. Otherwise, the lease should specify whether asbestos is the landlord or the tenant’s responsibility during the lease term. There are serious penalties for failing to manage asbestos correctly.
Duty holders, including employers, landlords, managing agents, those in control of premises and those with health and safety responsibilities for others, need to comply with their legal duties in relation to legionnaires disease. These include identifying and assessing sources of risk, preparing a scheme to prevent or control risk, implementing, managing and monitoring precautions, keeping records of precautions and appointing a manager to be responsible for others.
The landlord is responsible for providing equipment that is safe and legally compliant in the first instance, for example gas central heating boilers, but the lease will usually specify that the tenant is responsible for ongoing maintenance, including annual gas boiler servicing and safety checks.
Responsibility for gas safety may be the landlord’s or the tenant’s responsibility, or both, depending on the situation and the terms in the lease. Most likely the tenant will be made responsible for maintaining gas equipment and making sure that occupants are safe from fire and CO and other risks through regular risk assessments of dangerous substances. Maintenance must be carried out according to the equipment manufacturer’s instructions and annual gas checks by a registered gas safe engineer.
A commercial landlord has a legal responsibility to make sure that the building’s electrical system is safe. The Landlord and Tenants Act 1985 specifies that the building’s electrical installation must be ‘Safe at the beginning of the tenancy’ and ‘Maintained in a safe condition for the entire duration of the tenancy’. The Occupiers’ Liability Act 1957 and the same Act of 1984 apply and make it clear that a landlord’s duty of care extends beyond the tenant to occupants and anyone who visits their property, including workers and customers – for instance, office workers or shop customers.
Prior to letting commercial premises, landlords should have an Electrical Condition Report (EICR) prepared by a registered electrician. This test should be repeated every five years. In the meantime, the safety and maintenance of any electrical appliances they own is the tenant’s responsibility and, depending on the terms, of the lease they may be responsible for maintaining the whole electrical installation is a safe condition. Landlords are responsible for the safety of all electrical and gas installations in communal areas.
The code for leasing business premises in England and Wales 2023 sets out the recommended responsibilities of commercial landlords and tenants. This is a joint voluntary Code prepared by industry regulatory bodies: RICS, The British Council for Offices, the British Retail Consortium and the Confederation of British Industry.
The code includes guidance on commercial tenancies, including:
The Code, although voluntary, sets out best practice and helps at the negotiation stage of lease drafting.
A good commercial insurance policy is crucial to protect the landlord’s property and their risks from other sources. Most policies will cover the following risks and the premiums would usually be paid by the tenant through service charges. What does commercial landlord insurance cover? You might have a block policy with multiple properties covering the following:
There is little difference between commercial and residential landlord insurance, as far as the landlord is concerned - both require a specific landlord policy and both cover similar risks. However, residential landlords always pay for their insurance whereas commercial landlords usually pass on the cost to their tenants via service charges.
Service charges are usually annual charges sent to commercial tenants by landlords for the various services they provide, and they are in addition to the rent. Service charges are more likely to be significant for multi-occupied buildings where external maintenance and repairs are apportioned between the tenants. Examples of annual service charges include:
Service charges may be apportioned by floor area, rent payable or other metrics as agreed in the lease.
Dilapidations is a term used to describe the extent of deterioration in the state of repair of a building and there is a process used to measure and value this. Commercial leases usually contain repairing obligations and with FRI leases often quite extensive ones. Tenant liabilities can even extend to defects present before they signed a lease, unless these are noted at the time. Clauses in the lease usually use terms like “keep in a good tenantable repair”. At the end of the term or sometimes before this if there are issues, a survey will be asked to draw up a schedule of dilapidations for which the tenant will be held responsible.
Every property in the UK is assigned a “Use Class” category which defines what activities a residential or commercial property may be used for by its lawful occupants. First introduced in the Town and Country Planning (Use Classes) Act 1987, this was updated in September 2020 making it easier to change 'Use Class’ allowing business more flexibility to adapt to swiftly changing environments.
Every commercial lease will contain a ‘user clause’ which defines what the tenant can use the building for providing it is assigned the same use. The more restrictive the user clause, the more the rental value of a commercial building is restricted. Changing the use of a building would usually need full planning permission, or make use of permitted development rights, e.g. from a shop into a restaurant, or a restaurant into an office or office to residential.
Commercial bailiffs can be used to encourage tenants to pay their rent on time. The Commercial Rent Arrears Recovery (CRAR) process allows landlords to seize a tenant’s goods from the demised premises in order to recover unpaid rent. It replaced the old common law right to levy distress, but is now more strictly regulated than the old regime - it requires the use of enforcement agents and tenants must be given notice in advance.
There are several reasons why a landlord would need to evict a commercial tenant, most commonly for rent arrears but other reasons might be breaches of contract, for example failing to carry out repairs, failing to observe safety obligations, subletting without permission etc.
The process will be determined by the terms of the lease and the law of forfeiture. This is the legal process through which a landlord can terminate a commercial lease due to the tenant's breach of contractual terms. The process typically involves serving a notice of forfeiture to the tenant. The notice must clearly state the breach and provide a reasonable period for the tenant to remedy the breach, if indeed this is possible.
If the tenant fails to remedy the breach within the given time frame, the landlord can proceed with the forfeiture. Professional advice is required here but ‘peaceable re-entry’ of the premises could be used in some circumstances – secure the premises by changing the locks and a notice affixed to the premises confirming the forfeiture. Great care is required when using this method, and a court eviction order is probably a safer route to take.
There are three ways of buying commercial property: personally, in your own name, or using a limited company. A limited partnership is another option but they are taxed in the same way as personal investments. You may also consider investing through a SIPP or a SASS. There are pros and cons of each method depending on your circumstances, the size of your investment portfolio and how big you intend it to grow. Tax rules are complex, so it’s advisable to seek professional advice before investing as long-term financial planning always pays off.
