Rufus Ballaster and Chris Picardo, Partners at Carter Lemon Camerons LLP, commented on the trend after working with a number of clients who are switching from an investment portfolio of residential investment property to an investment portfolio of commercial investment property. According to Mr Ballaster: 'The markets in terms of capital values and valuations have performed very differently between the residential and the commercial property sub-sectors over the last decade or so. But the nature of investment and conveyancing is similar and an experienced investor in residential stock should easily be able to consider the alternative of building a commercial portfolio.The major driver for this change of appetite is tax. UK Governments, of various party make up, in recent times have introduced more and more taxes said to be about ‘fairness’, but largely aimed at controlling what is seen as excessive growth in residential property prices, especially in the South East, producing major affordability issues for workers in that part of the UK.'

Do the maths

He said that most of these tax rises or changes applied only to residential property, not to commercial property, adding that it is “eminently sensible” for serious investors to “do the maths” to understand what would be payable on income from, or capital growth on, commercial property investment and compare this to the liabilities arising from residential property investment. 'This exercise is worth doing to understand the different tax regimes on the two subsectors, but an investor should also look at the different nature of residential and commercial property as an investment class.' 

Residential risks

He said that with residential, normally the landlord will retain significant risk on repair costs whereas, with commercial, it is far more common to enjoy truly ‘clear rent’ with all repair, insurance and similar risk put to the tenants. 'On the other hand, if commercial demand to rent drops, there is relatively little ‘owner occupier demand’ which fills that gap. This leads to higher price volatility, which happened for commercial property in the UK immediately after the start of the global financial crisis, than occurs in the residential property subsector in the UK, ' he added. 

Challenges 

Mr Picardo warned of the potential challenges of changing sector. 'A number of factors are making the residential sector less attractive to investors, including a more onerous tax regime, Stamp Duty Land Tax increases and the cap on mortgage interest relief. Some investors who have traditionally operated in the residential arena are moving into the commercial sector, which can offer higher yields and lower overheads.' He added: 'Investors turning from residential investments to commercial property, or mixed use properties, will find that a completely different set of legal principles applies to commercial transactions, for example on issues such as buildings insurance, rent review, service charges and security of tenure for tenants. Mortgages over commercial properties work quite differently too, with the lender often engaging its own lawyers to conduct due diligence.'