Can retail be the new buy-to-let?

Easy money gains in buy-to-let property look increasingly difficult. Interest rate rises are eating up more of the monthly rent, capital values of property in many areas have hit a ceiling or are falling and potential tenants have a greater than ever choice - witness the forest of rental agents' signs in some towns.

This week the Nationwide warned of the "first signs" of a cooling off among would-be landlords - a modest enough statement compared with a calculation from a senior member of the Bank of England's interest rate setting committee that house prices could fall by as much as 30%.

But if investors think they've missed the buy-to-let boat, they may not need to worry. According to the promoters of a property investment exhibition being held at London's ExCeL venue this weekend, buying commercial property - shops, factories and office blocks - could be the way to make a faster buck.

Nick Clark, whose firm runs the Property Investor Show, says: "Narrowing yields in the residential lettings markets have led shrewd buy-to-let investors to look at commercial property as the next investment hot spot."

One Yorkshire agent recently sold half of a new development of workshop units to "amateur" landlords - the remaining units went to owner occupiers.

But Clark's views are controversial. Others in the property business warn that investing in commercial property is strictly for experts with deep pockets and long investment horizons. And they add that current purchase prices are high.

Clark bases his view on a new survey from broker Mortgages for Business which shows "89% of investors who currently do not invest in commercial property have plans to widen their portfolio to include commercial properties."

But Mortgages for Business managing director David Whittaker believes citing "commercial property as the next investment hotspot" is "stretching the statement".

He says: "The survey was among clients and potential clients who realise that the quick buck profits of residential buy-to-let have gone. The only way forward is to accept a more modest, if safer, return. Some have bought flats above shops. Now they want the shops as well."

Whittaker arranges loans for both residential and commercial landlords with an average £120,000 borrowing on houses and flats and a typical £300,000 on a shop or small workshop/office unit.

He hopes to see his commercial property loans business grow as banks and building societies start to offer "off-the-shelf" mortgages similar to buy-to-let packages.

But John Heron at Paragon Mortgages, one of the first and biggest in the residential buy-to-let market, is not impressed by the "hotspot" claim. He says: "We have looked at this area and decided there was very little cross-over between residential and commercial so we will not offer a commercial mortgage. Assessing the risk is just too difficult - it has to be on a costly case by case basis."

Heron believes commercial property is a series of specialist areas which are not homogenised.

"Residential letting is driven by demographics. People need a roof over their head and will be prepared to pay. But commercial property is driven by economics both locally and nationally," he adds.

The Property Investor Show team also commissioned a survey which showed "76% of property experts felt that commercial property had been the best performing asset class over recent years."

Simon Cooke, of Hotbed, which organises investment into commercial property and unquoted companies for investors with at least £25,000, accepts the historical truth of that statement.

But the former property fund manager at Deutsche Asset Management is sceptical. "Yes, prices have gone up but so much that commercial property is expensive relative to four years ago. Returns are falling - we'll need positive economic growth to sustain recovery," he says.

"The maths are simple. Rental yields have dropped to below 6%. But financing costs have risen to 7% or more. So, even if you can afford a 20% or 25% deposit, your interest costs are equal to your rental income. You are totally reliant on rents and capital values rising. If they don't, or if you are unhappy and a tenant goes bust, you are a loser," he adds.

Cooke believes it would be "totally sinister if the private investor was lured into commercial property. This is not the next investment hotspot."

Jonathan Paul, the property analyst at investment bank ABN Amro, says the small investor's options are "incredibly limited".

"Only major investing institutions can afford top developments such as out-of- town retail parks.

"Tenants want to upgrade to prime property. This is not the right time in the economic cycle for quick buck investing. You have to ask how you will grow the rent - without that, your capital values are likely to remain static."

What to expect in the commercial sector

Commercial property mortgages work on much the same basis as the buy-to-let ones. Lenders want to see a deposit of at least 20% to 25% and a rent that more than covers the monthly interest outlay -typically the rent should be at least 130% of the loan cost.

But most commercial property loans go a step further. Lenders will want to know about the tenant and the type of business they run.

Most residential landlords work on six-month contracts with tenants. However, commercial property users need the security of long periods - top retailers want a 25-year lease,accepting upward rent reviews every five years in return.

At the smaller property end, leases often run for five to 10 years. Lenders may want to credit-check occupiers as rents stop if tenants go bust.

Besides losing rent, the problem is then finding another tenant. Buildings are zoned - you cannot usually replace a car parts retailer with a fast food outlet.

On the plus side, the rent you get from a commercial tenant is money in the bank. The tenant is generally responsible for repairs, business rates, most insurances and other running costs.

Figures from Business Moneyfacts show commercial property mortgages range from 1% to 5% over the Bank of England base rate (now 4.75%) with most loans currently costing from 6.5% to 7.5%.

Most of the big mortgage firms will lend. But landlords taking the plunge into commercial do need expert broker help - this is not a DIY loan market.