Most auction advice directs information towards the residential side of buying at auction, and while the mechanics are similar when you are buying commercial property at auction, the risks are not.
The VAT question that can add twenty per cent to your winning bid
Not considering VAT is one of the easiest ways to miscalculate the real cost of a commercial auction purchase, but why? In short, commercial property can be subject to VAT where the property owner has opted to tax the property.
In a bidding scenario, you could win a commercial property for £500,000, only to find that VAT is also payable; therefore, if VAT applies at 20%, that creates another £100,000 that needs to be accounted for.
It is no secret that this creates a significant difference when you are arranging finance.
VAT being a player in such a huge sale is something you should put to your accountant before committing to the purchase, particularly where VAT recovery is part of your plans. VAT positions vary, which is why your funding requirement should be considering this before you think about buying commercial property at auction.
The bottom line is, the figure you see in the auction catalogue is not necessarily the final amount you will need to fund.
How buying a property is different to buying the lease
A huge consideration is whether your property comes with a tenant or not, as this is very different from buying an empty building.
You are buying the property together with the existing tenancy arrangements, and those arrangements can have a significant effect on what the property is worth. First things first, you must find out information about the lease. This includes important matters such as:
- The unexpired term
- Rent
- Break clauses
- Various obligations affecting the landlord and tenant.
You also need to understand whether there are rent arrears, service charge disputes or other issues that could affect the income you are expecting to receive.
Considering your exit strategy if you use a bridging loan for auction
If your plan is to refinance the auction purchase onto a commercial mortgage once the bridging loan has been repaid, the future lender is going to look at the property and its income.
Thus, a short unexpired term or an upcoming break option can therefore change the refinancing picture considerably; all the while, vacant possession has the opposite trade-off.
An empty commercial property gives you more flexibility to refurbish or find a new tenant, but it also means there may be no rental income while you carry out that work.
The bottom line is, do not look at the rent figure in isolation, look at the lease attached to it.
Why commercial valuations behave differently to residential ones
During a residential valuation, valuation evidence is often heavily based on comparable sales.
Simply put, similar properties in the same area are used as indication of what another property may be worth.
However, commercial property on the other hand is often assessed on the basis of investment, with the likes of rental income playing a hugely important role.
That means two commercial buildings on the same street can have very different values.
The tenant, lease length, rent, covenant strength and investment demand can all affect the valuation.
For example, a property producing a sustainable rental income on a long lease may attract a different yield from a similar building with a short lease and subsequently uncertainty around the income.
The energy compliance issue that creates unlettable property
Energy performance is an issue commercial auction buyers need to understand before bidding; commercial buildings generally require an Energy Performance Certificate when they are sold or rented, and the rating can impact on the property’s investment potential.
Minimum Energy Efficiency Standards also apply to relevant privately rented commercial properties in England and Wales, with the current minimum standard is generally EPC E, subject to the relevant exemptions.
So when you’re looking at what could seem like a cheap commercial lot, if the property has a poor EPC and needs improvement before it can be let, that cost needs to be part of your acquisition budget.
For an investor, that makes the EPC more than a box to tick, it is a crucial part of understanding the future cost and usability of the asset.
The real constraint: Reviewing the legal pack before commitment
The biggest mistake we see around auction purchases is treating the legal pack as something to read after winning.
Commercial legal packs can involve more complicated title arrangements, leases, licences, planning history, searches and documents that need to be reviewed before you commit to the purchase.
That is why your solicitor needs to be involved before you bid, and the same applies to your lender.
A commercial auction purchase is much easier to fund and justify when the lender has had an opportunity to understand the asset, the purchase price, the proposed exit and any unusual features of the lot prior to the auction taking place.
What a lender is actually assessing on a commercial auction lot
From the lending side, we are looking at the whole transaction.
That includes numerous factors, such as:
- The type of commercial property
- Location and marketability
- Condition of the asset
- Tenancy position
- Purchase price
- How the loan will be repaid
The exit strategy always remains central, so before planning a bid, plan your exit. This might mean refinancing onto a commercial mortgage, selling the property, completing works before refinancing or another suitable repayment route.
Commercial auction finance is more than finding money quickly after you have won a bid, it is about having the right funding structure in place before you bid.
The commercial auction buyer who prepares wins before the auction
Commercial property auctions can create opportunities, but the buyers who benefit are the ones who understand what they are actually buying.
VAT, leases, valuations, compliance and funding can all change the economics of the deal.
If you are considering buying commercial property at auction, explore our auction property finance or speak to our team at MS Lending Group about your funding requirements before you bid. We can also help you consider commercial bridging finance and the appropriate refinance route for your exit.
Frequently Asked Questions
Do I have to pay VAT when buying commercial property at auction?
Not necessarily, it depends on the VAT position of the property and whether the property has been opted to tax. Check the legal pack before bidding and discuss the position with your accountant.
Can I get finance for a commercial auction lot with a sitting tenant?
Yes, commercial auction finance can be available for tenanted properties. The lender will need to understand the tenant, lease terms, rental income and how those factors support the property’s value and your proposed exit.
What happens if the commercial property values below my winning bid?
A lower valuation can reduce the amount a lender is prepared to advance, leaving you needing to provide more capital yourself. This is why understanding the likely valuation before bidding is important.
How soon before the auction should I arrange commercial auction finance?
As early as possible, ideally, the lender should have reviewed the property, auction pack, valuation position and exit strategy before you bid. Preparation gives everyone more room to deal with issues before the auction.
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