Please note: This is Chapter 4 in the Complete Guide to Property Investment Strategies, focussing on Mixed Use property investments.
Mixed Use Property Definition
Here, I am defining Mixed Use property as a building with both commercial and residential units within it. A classic example would be a freehold terraced building with a retail unit on the ground floor and one or more flats on the floors above, with their own separate entrances.
These form distinct rental units let to different occupiers.
Such investments fall somewhere between single lets and HMO’s on the yield enhancement spectrum. Yields and hence returns are higher than single lets, but without any of the more onerous obligations of an HMO and the potential for friction between house sharers to deal with.
In my personal experience, they fall into a small niche of their own. Most residential investors shy away from any commercial element, probably due to a lack of knowledge. Similarly, most purely commercial investors shy away from the residential element and tend to go for larger commercial investments such as warehouses and so on.
Advantages of Mixed Use Property
This provides opportunity for the smart investor, although the commercial element brings greater risk, given the changing and declining nature of physical retail locations under the onslaught of e-commerce giants such as Amazon. On the flip side, there are services for which we will always need to visit in person. Examples being hairdressers and tattooists.
The advantages of this property investment type are:
- Much lower Stamp Duty Land Tax (SDLT). Mixed use properties pay SDLT according to a completely different schedule than pure residential investment purposes and it does not attract the 3% surcharge that a residential investment purchase must pay. In fact, purchases below £150,000 are exempt altogether. This makes the investment proposition much more attractive.
- Commercial Letting Agreements. Commercial elements are usually let on what is called a Fully Repair and Insurance lease (FRI). What this means in practice is that the commercial tenant is responsible for any refurbishment, upkeep and maintenance of the commercial elements as well as paying a proportion of the landlords building insurance (as set out in the lease). Typically, once let, a landlord has very few obligations to the commercial tenant, unlike in a residential investment.
- Long lease agreements. A typical commercial lease agreement will be for 5 years or more. Multinationals will let on terms in excess of 15 years. Compare that with the typical 12 months on a residential agreement! Such leases may have break clauses, but usually only every 2-5 years depending on the lease. They also contain provisions for upward-only rent reviews, meaning your yield can only increase.
- Despite having multiple tenants, each tenant in each letting unit is responsible for all utility costs, unlike an HMO or Serviced Accommodation.
- Economies of Scale. There are certain advantages of having multiple units in one building from a maintenance and management perspective.
- Adding Value. Simply getting a quality commercial tenant on a strong lease will result in immediate value uplift to the commercial element and hence the property as a whole.
Disadvantages of Mixed Use Property
As you will be understanding by now, you don’t get an enhanced return without some increase in risk. The disadvantage of mixed use investments largely related to the commercial element:
- Voids. A commercial unit takes much longer to let than a typical residential investment and could be vacant for months. Note that any applicable business rates could become the responsibility of the landlord is empty for a prolonged period.
- Bad Debt. Small retailers can struggle with cash flow and hence get into rent arrears. Whilst a tenant may prioritise paying their rent on their home in order to ensure a roof over their head, they may be much more pragmatic in their approach to paying rent on a shop unit.
- Initial terms can be favourable to a commercial tenant. Depending on demand, a commercial tenant can typically negotiate a rent-free period up front or a period of part-rent during the first 12 months whilst they get the business established. This is relatively common.
- Funding. You will need a specialist commercial mortgage to buy a mixed use property. The terms will likely be more onerous. For example, interest rates will be higher and covenants may be more risky. A commercial mortgage will often have a covenant that a certain Loan to Value (LTV) percentage must be maintained and the lender reserves the right to request extra funds if required. This can leave you in a precarious place should property values drop significantly.
On balance, this is a more advanced strategy due to the higher risk of the commercial element, but it is an often overlooked niche of property investment.
My Golden Rule
If you do consider such investments, then a golden rule I think is worth adhering to is to ensure the rental value of the residential units covers the outgoings on the property if the commercial element is empty. This means that should you suffer a protracted void on the commercial element, then the property as whole washes its face. It means the profit element is in the commercial opportunity.
TKM Triangle: Mixed Use
- Time. It takes no more time to manage the units contained within a Mixed Use property than in a comparable number of Single Lets. In fact, I would argue it can take less time as the commercial unit will be let on an FRI lease with less management overheads as a result. There is also the benefit of certain economies of scale by having multiple units in one building.
- Knowledge. Clearly, the knowledge on the residential elements are no different to Single Lets or HMOs (depending on the use), or, indeed, Serviced Accommodation if the residential units lend themselves to this. It does require a little more specialist knowledge to understand the commercial element.
- Money. Mixed Use properties can be bought for similar money as a correspondingly sized residential house. In some cases, they can be cheaper, especially if the commercial units are empty.
On balance, a Mixed Use investment would be a good next step once you have some Single Let experience under your belt.