Commercial to residential conversion: Why you NEED TO stop creating TINY ground floor commercial units!
I understand that an element of the newly popular commercial to residential conversation strategy, part of the strategy is chopping the ground floor unit in half. The back half becomes a residential unit and the front half stays commercial.
The reason for this is seemingly because:
1.The residential unit is more valuable than commercial
2.The commercial tenants will have a small enough unit that business rates will be null
3.Planning will be difficult if part of the commercial space isn’t left as is
Here’s why investors need to be SERIOUSLY wary of this strategy.
Firstly, ground floor residential is notoriously hard to rent out. Yes, you may have fabulous interiors and state of the art technology. But, if this is located on the back of commercial, you’ll have the noise of the commercial unit, the noise of the street (assuming you’ve purchased mixed us in a prime or secondary area) and the noise of fellow residents slamming entrance doors and thudding upstairs. As a landlord you’ll quickly find that not only are tenants going to want a discount in rent, you’ll have a management headache on your hands and/or high turnover of tenant.
Higher Rents Create Higher Values – Focus on this!
Secondly, whilst a tenant may be happy with business rates relief you are shooting yourself in the foot when it comes to rental valuation. The rent is important here because it creates the value in the property. The higher the value, the more cash you could extract for your next deal.
If you have a tiny ground floor commercial then your whole floor area could fall into ‘Zone A’. Zone A rents are the most expensive and you don’t want to be paying the most expensive rents for areas you use for make shift storage or tills, it’s not profitable…. It’s far better used for money making trading i.e. seats and tables or displaying more product OR if it’s an office/agency space, another desk.
This alone means that the space would only be usable by a handful of small traders, which could take time to let. Void premises, no matter the size are a money pit! Furthermore, as a Surveyor, I know first hand that if I was asked, on behalf of a tenant, to act for them in rent review or lease renewal I’d be arguing for a hefty discount to at least account for the fact that my client can’t use all of the space as prime trading area. That would be a valid argument and I’d probably have success here.
It also seems that this viewpoint stems from the belief that commercial units aren’t profitable.
Quality not Quantity
Thirdly, (this will require further probing at a later date), by avoiding planning permission it brings up whether the work will stand the test of time. After all, planning is there for quality control… which may be lacking in buildings that use PD. The knock-on effect could be ‘the slums of the future’ (as one of my esteemed colleagues points out!) or at the very least the inability to get a mortgage on it.
Your strategy instead The solution to the potential money loss you could find yourself in because of the above is to be brave in creating commercial space that has prime Zone A and at least ancillary space. Even better, a usable basement for toilets as they have £0 value, so it’s imperative these are installed in the least valuable space. Not only will this command a higher rent (obviously, you’ve got more space!), you’ll let it quicker because more tenants will be in the market for it.
Remember, your job as a Landlord, is to get the space to shell condition. The tenants will come and fit out as they will… you could offer them a rent-free period as a sweetener. The more they spend on fitting out usually the longer the tenant will want a lease! Shell condition also helps with letting.
Using the new E use class, tenants can come and be innovative. Yes, there are still tenants looking for space they can create their business dreams in!
The Tactics You Should Use
You could also be tactical in your alienation clauses. Allow subletting of part, subject to a license to alter. The commercial tenant can split the unit, let out part, reduce the business rates themselves if they are savvy enough and at the end of the lease you can get them to reinstate. Work hard to keep costs down. Better yet put a user-friendly service charge clause in the lease, just make sure your maintenance is up to scratch and this should happen anyway. For tenants, a forecastable service charge is more reassuring than no business rates. Business rates stay pretty stable so a tenant can budget for it, wild service charge demands are harder to account for.
Whilst you’re at it, it’s worth remembering that usually commercial leases run for a lot longer than residential AST’s which means they cash flow for longer and the cash flow creates value!
The key takeaway Stop creating tiny ground floor commercial units as an excuse to bypass planning and with the idea that it’s to save commercial tenants money as a way of getting them into your unit.
This will not make you a wealthy landlord in the long run. Build a good quality unit that is laid out to benefit from a strong rental valuation. Then focus on appropriate tenant selection (yes you may have to work with other landlords in the area to get the right tenant mix shock) and the lease you’re offering. That’s how you’ll find the best commercial tenants that stick with you long term and make the highest returns.