2023 turned out to be a tumultuous year for the commercial property market, with interest rates soaring and high inflation driving commercial real estate investments down to the lowest they’ve been all decade. However, as we venture further into 2024, there’s a distinct positive shift.

The downward trend in inflation is set to continue, according to key indicators. Lower borrowing costs and interest rates will push up yields, improving the appeal of commercial real estate as an investment.

If unemployment is falling, and the economy is growing, then that would suggest a likely increase in demand for commercial property.

If you are looking, therefore, to invest in commercial real estate and you are weighing up the pros and cons, read on as we share our experts’ insights, explore commercial property investment options, and look at what’s currently out there primed for investment.

What are the current trends in commercial real estate?

Commercial real estate could be anything from office buildings to retail spaces, industrial units, leisure outlets or healthcare facilities.

Within the commercial property market, there has long been historical conflict between investment performance across property types. There is no reason why this should be any different in the coming months.

The current economic trajectory would suggest a likely increase in demand for industrial units, whilst older retail and office space may start to see a decline as commercial tenants increasingly demand modern facilities and energy efficient, sustainable buildings.

Having said that, there will always be divergence in demand across different regions, and between the cities and towns within them. This makes it essential to take localised advice before pursuing any decision to invest in commercial real estate.

What are the advantages of investing in commercial real estate?

Compared to residential property, there are various advantages for those looking to invest in commercial real estate.

Higher income potential

Commercial properties may carry higher rental yields compared to residential properties. This is usually due to the nature of commercial leases, which are typically longer and include provisions for periodic rent increases.

For example, prime office space in central London can command significant rent, translating to higher income for the investor.

What’s more, commercial tenants are usually businesses that rely on the property for their day to day operations, which often means they are willing to pay more for a suitable location that meets their needs.

Longer lease terms

One of the most appealing benefits of taking the decision to invest in commercial real estate is the typically longer lease terms.

Commercial leases can range from five to ten years, sometimes longer, providing investors with a stable and predictable income stream. This stability allows for better financial planning, and can reduce the risk connected with frequent tenant turnover.

For example, a retail tenant might sign a 10-year lease with a five-year renewal option, offering long-term security for the landlord.

Value Appreciation

Commercial properties have the potential to appreciate significantly over time. This appreciation can be driven by various factors, including economic growth, infrastructure developments, and improvements and investment within the local area.

For example, a commercial property located close to a newly developed business district or transportation hub in London could see its value increase considerably. Furthermore, investors can also enhance the value of their properties through renovations and technology investment, better tenant management, and by enhancing the property's appeal to high-quality tenants.

Diversification

When you invest in commercial real estate, it is easier to diversify your investment portfolio.

Real estate often behaves differently from other asset classes such as stocks and bonds, providing a hedge against market volatility. By including commercial properties in their portfolio, investors can spread risk and potentially enhance returns.

For example, during periods of stock market downturns, commercial real estate can continue to provide a steady income stream, balancing the portfolio’s overall performance.

Potential tax benefits

The UK offers a variety of tax incentives and benefits for commercial property investors. For example, commercial property owners may be able to claim capital allowances, which allow them to deduct certain expenditures from their taxable income. This may include costs related to the purchase of equipment, or improvements to the property.

Understanding and taking advantage of current tax benefits can significantly enhance the overall returns on commercial real estate investments. Always take tailored advice from a commercial property tax specialist, however, to ensure you are being given the right guidance for your particular situation and objectives.

What are the risks and challenges of investing in commercial real estate?

If you are looking to invest in commercial real estate, it is important to consider the risks and challenges involved.

Market Volatility

Commercial property values can be impacted by economic downturns. During times of economic instability, businesses may cut costs by downsizing or even closing altogether, leading to longer void periods and decreased demand for commercial space.

For example, the economic impact of events such as the COVID-19 pandemic resulted in a temporary downturn in commercial property values, as many businesses shifted to remote work.

As a commercial property investor, you need to be ready for fluctuations like these, and be prepared when making long-term investment decisions.

High Initial Costs

When you invest in commercial real estate, you need a substantial upfront investment. The costs include not just the purchase price, but also additional expenses such as legal fees, stamp duty, and renovation or refurbishment costs. All of this combined could make the investment unsuitable for smaller investors.

Additionally, securing finance for commercial properties can sometimes be more of a challenge, and may come with higher interest rates compared to residential properties, further increasing the initial investment burden.

Void Risks

Prolonged vacancies and tenant turnover pose considerable risks to commercial real estate investors.

Unlike residential properties, sourcing new tenants for commercial spaces can take longer, and may call for the need to offer incentives.

For example, if a large retail tenant vacates a property, it could take several months to find a suitable replacement, during which time the property generates no income. This risk is particularly acute in locations with fluctuating demand, or during economic downturns when businesses are less likely to expand or relocate.

Regulatory Challenges

The commercial real estate market is prone to a range of regulatory hurdles and potential changes that can affect investments. Regulations can impact the feasibility and profitability of commercial properties.

For example, changes in local zoning laws might restrict the type of businesses that can operate in a certain area, affecting rental income potential.

What’s more, new regulations related to energy efficiency and sustainability could require upgrades to existing properties. Keeping on top of regulatory changes and ensuring compliance is vital, but it is important to realise that this can be challenging and resource-intensive.

Factors to consider before investing in commercial real estate

There are various things to consider before you make the decision to invest in commercial real estate.

Location – the location and its amenities and transport links will impact the value of the property and tenant demand.

Industry trends – certain trends will influence the viability of an investment, for example hybrid or co-working models, demand for sustainable and energy efficient buildings, and the need for technologically advanced property.

The right advice - thorough market research and due diligence and a detailed financial analysis with cash flow projections and ROI calculations are vital. Seeking advice from a commercial property investment specialist in your chosen investment location is highly advisable, as they will be well placed to guide you on all of the above.

What’s on offer in the London commercial property market?

1 Hobart Place, Belgravia, London SW1W 0HU
A long leasehold investment property set in a self-contained, attractive Grade II listed former townhouse. This property is situated within a prominent locality, surrounded by hotels, restaurants and renowned retailers. This extensively refurbished building offers high quality office accommodation, set around beautiful period features.

43 Upper Grosvenor Street, London W1K 2NJ
This prime Mayfair office building is suitable for investors and owner occupiers. It features a passenger lift, showers, excellent natural light, a 1,200 square foot private terrace, and a 90-seat lecture theatre.

Looking to invest in commercial real estate? Talk to Mellersh & Harding, the London commercial property specialists.

At Mellersh & Harding, we have an extensive portfolio of commercial real estate to meet an array of investment goals and budgets. Why not contact us today to discuss your individual requirements? You can reach our dedicated team on 020 7522 8500.