The risks of commercial property investment

  • Identify the risks attached to investing in commercial property
  • Describe the ways in which an investor should seek legal advice
  • Identify the risks when it comes to buying an off-plan property
The risks of commercial property investment

A combination of the growing appetite of private individual investors to seek higher returns on their investments and savings and the increased potential to offer property for sale in a global market, via the internet (and increasingly via social media) has created a new community of potential investors in property. 

Whereas, traditionally, private investors have confined their involvement in the property investment market to 'buy to let' property in the residential sector, higher returns from investing in commercial property are tempting private investors. 

However, investment in commercial property has a very different, and generally higher risk profile than investment in residential property.  

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Q Studios story

The recent failure of a student housing investment scheme in a North Midlands university city illustrates the pitfalls which can be encountered when investing in commercial property development schemes, particularly those involving the purchase 'off plan' of leaseholds. 

According to the Land Registry, 196 tenants now seem to hold leases in the Q Studios housing accommodation development in Stoke-on-Trent. 

This largely completed development now has an uncertain future following the management company, which had a pivotal role in the proposed management of the scheme, having been put into administration. 

A similar number of buyers also find themselves with uncompleted contracts to buy leases in the scheme.

The scheme seems to have involved the developer selling 250-year leases of individual rooms in blocks of student accommodation for relatively low capital sums (which seem to have been around £70,000).

But they came with relatively high ground rents (£750 per room) subject to RPI indexation at five-yearly intervals throughout the term of the lease. 

On the grant of the room lease, the investor then granted a sub-lease of his or her room to the management company (which appears to have been connected to the developer). 

Under that sub-lease the management company agreed to pay the investor an “additional rent”, being a share of the rent received from letting the room to a student, which would achieve ''effortless'' annual returns of between 8-12 per cent. 

In addition, the management company agreed to pay the ground rent and service charge payable under the investor’s head lease.

What the investors may not have realised, was that, in completing the grant of nearly 200 leases at individual ground rents of £750, the developer not only generated capital receipts of several millions of pounds for itself, but richly endowed its freehold reversion with an annual ground rent income stream of nearly £150,000 (which would have probably doubled on the completion of the grant of the uncompleted leases). 

According to the Land Registry, that allowed the developer to sell the freehold for over £2.8m to a specialist ground rents owner.

To the investors who held completed leases with sub-leases in place with the sub-tenant company, all would have appeared well until 1 October 2018 when quarterly payments due from the sub-tenant company of the “additional rent”, were not paid. 

Following a further missed payment of that return in January 2019, the sub-tenant company was put into administration. 

Troubled scheme

In addition to the failure of the management company, investors were made aware by the administrator of three further unpalatable facts concerning the scheme: