We are currently looking at a deal in a prime part of London, consisting of commercial and residential. The commercial is going to come with a fresh 5 year lease, with a blue chip company – whatever that is worth these days, the residential part is 4 flats. The yield is a respectable 5%, given the premier location the level of this yield is surprising. The location can be compared to Oxford Street.
There is also a development angle to this deal which is what makes it interesting; there is the possibility of converting the basement into residential through permitted development – please note no planning; therefore this can be achieved in 56 days. There is the further potential to gain 3 additional flats through planning, there is precedent along the road and therefore this does not look contentious.
At the end of the development you should have a rental income of £205,000, compared to the current income of £125,000. The current asking price of this deal is £2.5M.
I believe this to be a safe deal, with good upside and with very little downside.
Let’s take a very conservative position and assume you only get the permitted development flat in the basement, which I like to call lower ground, and nothing more, you will still add an expected £500,000 to the deal. It should only cost £60-70K to implement, perhaps even less, as the basement is there and is in good condition.
Luckily the borrowing rates are currently low, even with a 5 year fixed you will be a couple of percent below the 5% rental yield, this means this deal will produce a reasonable income of about £50K per annum.
There is a neat trick to increase this income by lowering the borrowing rate. The rates payable for residential are always lower than commercial. The payable rate can be reduced by splitting the commercial from the residential, this is an exercise your solicitor should be able to execute with little fuss. We are currently doing a similar exercise for a commercial building we secured for a client, we have calculated this exercise will save about £35,000 in interest costs.
A similar saving can be made in this scenario.
The optimum way to hold the commercial element is in a privately held pension scheme as the capital gains and the income generated will be tax free.
When this is done in one sense there is almost an immediate gain, as you are paying for the asset with untaxed money, not taxed money. You’re buying the asset with gross money and not net money. If you’re a high rate tax payer this would be a substantial saving.
These are a couple of tips which should always be considered when purchasing commercial and resi assets.
This is currently a live deal ready to be executed. If it perks your interest why not give the office a call.