Ground-floor retail yields less growth than housing: the 6-8% hides a risk

Ground-floor retail has risen less than apartments, and that's why it pays more

Away from the prime shopping streets, many commercial premises are worth the same or less than ten years ago. Online shopping and the closure of small businesses have left ground-floor units empty in neighbourhoods, and the result is a gap visible in prices: while housing has held up or rebounded, retail space has been left behind. The gross yield on price gives it away: for a commercial unit it runs around 6-8% a year, for an apartment 4-5%.

That differential is not a gift. It is payment for a higher risk, and anyone who ignores it will be left holding the bricks.

Why ground-floor units have risen less than apartments

The first reason is that they are valued with different criteria. An apartment is bought by a private individual, and its price is set by the mortgage payment they can sustain over 30 years. A commercial unit is bought by someone with a calculator: price equals net income divided by the cap rate. When rates rose in 2022-24, cap rates widened and commercial property fell 15-25% in Europe, while housing corrected 2-3% and rebounded. That's half the gap right there.

The second is physical oversupply. The United States has 22-24 m² of retail space per capita; Western Europe, 4-5. It was built like crazy in the 2000s and demand moved online, with online peine stabilised at around 25-27% in the UK and Germany and 18-20% in Spain for non-food. Surplus square metres don't rise: they rot.

The empty unit eats the extra yield

Here's the detail that doesn't appear in the fund managers' brochures. An apartment is let in days or weeks; a unit in a run-down neighbourhood can go a year or more without a tenant, and that eats up several years of yield differential. If the business fails, it stops paying. And many tenants are self-employed or small businesses, with cash flow wobbling every quarter.

Add the contractual fine print: commercial leases are not governed by housing rental rules, but by the Civil Code and freedom of contract. More leeway for the landlord, yes. And more exposure when the tenant struggles or walks away.

From haberdashery to micro-apartment: converting ground-floor units

The phenomenon visible in the cities is another one: the ground-floor unit that won't let as retail becomes housing. Buildings from another era, with a ground floor where Conchi ran her haberdashery or Manolo his bar, are being converted into windowless studios selling for 200,000 euros. On one street, three units —a tutoring academy, a bakery and another closed one— became apartments; on another, a bar, a picture shop and a hairdresser's, too.

The developer's maths is simple: if the commercial unit yields no income, it's turned into whatever does. And in passing, the problem of retail oversupply is dodged. The result is a stock of micro-apartments separated by plasterboard, with three doors, three windows, three letterboxes and three meter panels where there used to be a single 90-square-metre ground floor.

Top streets and dead streets: two different markets

The trend is not uniform. In Valencia and its surroundings, units on secondary streets are worth little commercially and are converted into housing or Airbnb-style hostels. Those on the main streets are outrageously expensive and within reach only of multinationals with high margins or of those using the business for other purposes. Between those two extremes, a desert.

Some argue the prices are obscene given that, apart from a few streets in each town, most see very little footfall. Potential customers, that is. And there's no shortage of people who, in their area, see the opposite: units that have risen as much as houses or more. The average hides very different realities.

The question left unanswered

With these numbers, buying a ground-floor commercial unit away from the good streets should be examined with the same calculator used for an apartment: price, net income, months of vacancy and conversion cost. The 6-8% gross cannot be compared with the 4-5% of housing without subtracting vacancy, arrears and the risk of the business failing.

And the underlying doubt remains: if the ground floor becomes housing, are we looking at a solution to the excess of retail, or a way of flogging micro-flats at the price of a full-size apartment? The market, for now, hasn't decided. It has only decided that commercial retail is no longer what it used to be.