Why Invest in Commercial Property?
**Commercial property investment** has been a cornerstone of wealth creation in the UK for decades. From individual investors buying a shop unit to pension funds acquiring office towers, commercial property offers a combination of income, capital growth, and portfolio diversification that few other asset classes can match.
For investors looking beyond residential buy-to-let, commercial property opens up a different world of opportunity - one with higher yields, longer leases, and potentially lower management burden. However, it also involves different risks, requires different knowledge, and demands more capital.
This guide provides a comprehensive introduction for investors considering their first commercial property purchase, covering the fundamentals you need to understand before committing capital.
Types of Commercial Property
Commercial property encompasses a wide range of asset types, each with distinct characteristics:
Office
Purpose-built or converted office buildings let to businesses. The market ranges from small serviced offices to multi-storey corporate headquarters.
- Typical yields: 5-8%
- Lease lengths: 3-15 years
- Key considerations: Location, building quality, EPC rating, flexible working impact
Retail
Shops, retail warehousing, supermarkets, and shopping centres.
- Typical yields: 5-10% (varies enormously by sub-type and location)
- Lease lengths: 5-15 years
- Key considerations: Footfall, tenant covenant, online retail impact, lease terms
Industrial and Logistics
Warehouses, distribution centres, manufacturing units, and trade counters.
- Typical yields: 4.5-7%
- Lease lengths: 5-20 years
- Key considerations: Location (motorway access), eaves height, yard space, loading facilities
Leisure and Hospitality
Pubs, restaurants, hotels, gyms, and entertainment venues.
- Typical yields: 5-9%
- Lease lengths: 10-25 years
- Key considerations: Operator quality, trading performance, lease structure
Healthcare
GP surgeries, dental practices, care homes, and medical centres.
- Typical yields: 4-6%
- Lease lengths: 15-25 years
- Key considerations: Operator quality, regulatory requirements, demographic demand
Mixed-Use
Buildings combining two or more uses, most commonly retail below with residential or offices above.
- Typical yields: 5-8%
- Considerations: Different valuation methods for each element (see our mixed-use development guide)
**Key Takeaway:** Different commercial property types carry different risk profiles, yield ranges, and management requirements. Your choice should reflect your risk appetite, available capital, and desired level of involvement.
Understanding Commercial Property Yields
What Is a Yield?
**Yield** is the annual rental income expressed as a percentage of the property's purchase price (or value):
**Net Initial Yield = Annual Rent / Purchase Price x 100**
A property purchased for £500,000 producing £35,000 per annum in rent has a net initial yield of **7.0%**.
Yield vs Residential Returns
Commercial yields are typically higher than residential buy-to-let yields:
| Property Type | Typical Gross Yield |
|---|---|
| Residential buy-to-let | 4-6% |
| Commercial office | 5-8% |
| Commercial retail | 5-10% |
| Commercial industrial | 4.5-7% |
| Commercial healthcare | 4-6% |
What Drives Yield?
Lower yields (implying higher values relative to rent) reflect:
- Stronger tenant covenant - a well-known national company vs a sole trader
- Longer unexpired lease term - 15 years remaining vs 2 years
- Better location - prime high street vs secondary side road
- Modern building - new build vs dated stock
- Upward-only rent reviews - guaranteed rental growth
Higher yields reflect higher risk:
- Weaker tenants who may default or vacate
- Short leases with uncertain renewal prospects
- Secondary locations with less occupier demand
- Older buildings requiring capital expenditure
- Sector headwinds (e.g., declining retail locations)
Reversionary Yield
The **reversionary yield** reflects the yield at the market rent (rather than the passing rent). If a property is let below market rent, the reversionary yield will be lower than the initial yield, indicating potential rental uplift at the next review or lease renewal.
**Key Takeaway:** A high yield is not automatically better than a low yield. It reflects higher risk. A 10% yield on a shop let to a struggling tenant on a 2-year lease is fundamentally riskier than a 5% yield on a warehouse let to a national company on a 15-year lease.
Commercial Leases: What You Need to Know
Lease Length
Commercial leases are typically much longer than residential tenancies:
- Short lease: 1-5 years (higher risk, more management)
- Medium lease: 5-10 years (good balance of income and flexibility)
- Long lease: 10-25 years (institutional quality, lower yield)
FRI (Full Repairing and Insuring) Leases
Most commercial leases are **FRI**, meaning the tenant is responsible for:
- All internal and external repairs
- Buildings insurance premiums (reimbursed to landlord)
- Decoration and maintenance
This significantly reduces the landlord's management burden and expenditure compared to residential property.
Rent Reviews
Commercial leases typically include **rent reviews** every 3-5 years:
- Open market reviews - rent adjusted to current market level
- Upward-only reviews - rent can increase but never decrease (very favourable for landlords)
- Fixed increases - predetermined rent increases at specified intervals
- RPI/CPI linked - rent increases linked to inflation indices
Break Clauses
Some leases include **break clauses** allowing the tenant (and sometimes the landlord) to terminate the lease early. Break clauses affect property value because they introduce early vacancy risk.
Lease Assignment and Subletting
Most commercial leases allow the tenant to **assign** (transfer) the lease to another party or **sublet** part of the property, subject to landlord consent. This provides flexibility for the tenant and continuity of income for the landlord.
How to Finance Your First Commercial Property
Commercial Mortgages
A [commercial mortgage](/services/commercial-mortgages) is the standard financing tool for purchasing commercial property for investment:
- LTV: Typically 60-75%
- Term: 5-25 years
- Repayment: Interest-only or capital and interest
- Assessment: Based on rental income (ICR minimum 1.25-1.50x) and borrower covenant
Deposit Requirements
You will typically need a **25-40% deposit** for a commercial property purchase, depending on:
- Property type and quality
- Tenant strength and lease length
- Your experience as a property investor
- The lender's risk appetite
Additional Purchase Costs
Beyond the deposit, budget for:
- Stamp Duty Land Tax (SDLT): 0-5% depending on purchase price (commercial rates differ from residential)
- Legal fees: £3,000-£10,000+
- Survey/valuation: £2,000-£5,000+
- Broker fees: 0.5-1% of the loan
- Building survey: £1,000-£3,000 (strongly recommended)
Lender Options
For a first commercial property purchase, consider:
- High street banks (Lloyds, NatWest, Barclays, HSBC) - competitive rates for standard investments with strong tenants
- Specialist lenders (Shawbrook, Aldermore, Hampshire Trust) - more flexible criteria for smaller or more complex investments
- Challenger banks (Allica Bank, Investec, Paragon) - good balance of flexibility and pricing
Working with a specialist broker ensures you access the most suitable lender for your specific purchase. [Contact our team](/contact) to discuss your investment plans.
**Key Takeaway:** Commercial property requires more capital upfront than residential buy-to-let, but the higher yields, longer leases, and lower management burden can provide superior risk-adjusted returns over time.
Due Diligence: What to Check Before Buying
Property Inspection
- Building condition - commission a commercial building survey
- Roof, structure, and services - major capital expenditure items
- EPC rating - minimum E for letting; proposed increase to C for new leases
- Asbestos - common in pre-2000 commercial buildings
- Environmental contamination - particularly for industrial sites
Lease Analysis
- Remaining term - how long until the lease expires?
- Rent review mechanism - open market, upward only, fixed, or indexed?
- Break clauses - can the tenant leave early?
- Repair obligations - who is responsible for what?
- Service charge - how are shared costs apportioned?
- Alienation provisions - can the tenant assign or sublet?
Tenant Assessment
- Financial strength - credit check the tenant using Dun & Bradstreet or similar
- Business viability - is the tenant's business sustainable?
- Payment history - has the tenant paid rent on time?
- Parent company guarantee - is there corporate backing?
Market Research
- Comparable evidence - what have similar properties sold for and at what yield?
- Rental evidence - what are similar properties letting for?
- Vacancy rates - how easy would it be to re-let if the tenant leaves?
- Local market dynamics - is the area improving or declining?
Risks to Understand
Tenant Default or Vacancy
If your tenant defaults on rent or vacates, you lose income but retain the costs (mortgage, insurance, rates, maintenance). A **void period** on commercial property can be costly and prolonged.
**Mitigation:** Focus on strong tenant covenant, longer leases, and locations with good re-letting prospects.
Capital Value Decline
Property values can fall due to market conditions, rising interest rates, or tenant-specific issues.
**Mitigation:** Buy at a realistic price, avoid overpaying, and maintain adequate equity to weather value declines. See our analysis of [interest rate changes and commercial property](/knowledge-hub/interest-rate-changes-commercial-property).
Illiquidity
Commercial property is illiquid - it can take months to sell, particularly in challenging markets.
**Mitigation:** Maintain cash reserves, avoid over-leveraging, and accept that property is a medium to long-term investment.
Obsolescence
Buildings can become obsolete due to changing occupier requirements, EPC regulations, or market shifts.
**Mitigation:** Focus on modern, well-located buildings with adaptable floor plates. Budget for periodic capital expenditure.
Interest Rate Risk
Rising rates increase borrowing costs and can squeeze rental income coverage.
**Mitigation:** Stress-test at higher rates, consider fixing, maintain interest cover well above the minimum. See our guide on [choosing the right lender](/knowledge-hub/choosing-right-commercial-property-lender).
Tax Considerations
Commercial property investment involves several tax considerations:
- Income Tax or Corporation Tax on rental profits
- Capital Gains Tax on disposal profits
- SDLT on purchase
- VAT - commercial property may be subject to VAT (opted to tax). Take specialist advice.
- Capital allowances - deductions for certain fixtures and fittings within the building
- Mortgage interest relief - fully deductible against rental income for commercial property (unlike residential, which is restricted)
Mortgage interest being fully deductible is a significant advantage of commercial over residential property investment for higher-rate taxpayers.
Always take specialist tax advice before making your first commercial property investment.
Your First Commercial Property: A Checklist
- Define your strategy - what type of property, what yield, what location?
- Assess your capital - how much deposit and working capital do you have?
- Get a mortgage decision in principle - understand your borrowing capacity
- Research the market - study comparable transactions and rental evidence
- Identify properties - through agents, auctions, off-market, or online portals
- Conduct due diligence - building survey, lease analysis, tenant assessment
- Negotiate the price - based on evidence and your required yield
- Instruct your team - solicitor, surveyor, accountant, broker
- Complete the purchase - legal process typically takes 4-8 weeks
- Manage the investment - or appoint a managing agent
Use our [commercial mortgage calculator](/calculators/commercial-mortgage) to model different investment scenarios.
Summary
Commercial property investment offers attractive returns, long leases, and portfolio diversification for investors willing to commit the capital and learn the fundamentals. Success requires understanding the different property types, yield dynamics, lease structures, and risks involved.
Start with a manageable first purchase - a well-let industrial unit or retail property with a strong tenant on a good lease provides stable income while you learn the market. As your experience and capital grow, you can expand into larger and more complex investments.
Ready to discuss financing your first commercial property investment? [Contact our team](/contact) for a no-obligation conversation.
*Written by Matt Lenzie, Founder of Commercial Mortgages Broker. Ex-Lloyds Bank & Bank of Scotland.*