The "Buy to Let Mortgage "concept has become exceptionally popular during the past 5 years as people have realised the fantastic growth opportunities that are unique to property. The poor returns of the UK Stock Market coinciding with the total fall out of the Pensions Market, has strengthened further peoples perception that Property remains the best medium - long term retirement planning vehicle.
In the past the Property Investment Market was predominantly led by wealthy individuals and families with established property backgrounds. However, with the significant rise in property prices, home owners have also been able to enter this market, by releasing equity gained in their homes. Lending organisations have also caught on to this concept, realising what a huge lending market was at their disposal. Therefore, there has never been more choice, with a staggering number of Buy to let products now available to property investors. Lenders have significantly reduced their levels of underwriting to appeal to the mass market.
Many individuals have expressed concerns over this huge increase in people purchasing property for investment, many of whom have no property investment knowledge whatsoever. It is therefore very important to always seek sound professional advice before considering a property purchase for investment purposes. The main reason behind this statement is that some of the best and most desirable of locations to live in, often rural, are not the best properties for finding prospective tenants who will pay enough rent to cover ones monthly mortgage payment. Many investors forget this extremely important concept, with many suffering as a direct consequence.
Similarly Property investors need to have a purchasing strategy, in the types of property they buy. At the core of any decision is whether the property investor is seeking good rental returns i.e. they will receive a profit from the rents they receive over and above their mortgage payment, helping with their monthly cash flow. These investors tend to purchase cheaper often ex-council properties, and tend to be new property investors. More experienced, often also wealthier from an income perspective, tend to prefer not to adopt this strategy but instead target properties with strong capital growth. Here their strategy will be to buy better quality properties, typically period conversion flats in London which over time have increased at a far higher rate than that of the ex-council properties. The downside is that these properties have now become very expensive to finance, meaning that many investors have to supplement the rent they receive from their monthly incomes to cover the mortgage payments.
When considering a property purchase for investment purposes, the number one criteria is Location, Location, and Location. Tenants will require not only decent public transport such as Train, tube and bus stations nearby, but also excellent Eating, drinking and shopping facilities in close proximity. It is important for people be it owners or tenants to feel safe in their homes, therefore for investors to achieve good rents, tenants must want to live in their property and surrounding areas.
Indeed in order for property investors to be successful they need to consider any given property purchase from a tenants perspective. What factors are important in any flat or house finding a suitable tenant? As already mentioned location is key, as tenants are effectively renting a lifestyle from you the property owner as well as a property.
Infact for most property investors the level of rent achievable on their investment is at the very core of defining their property purchasing strategy. Clearly approximately 5 % of property investors are independently wealthy and therefore do not require a mortgage to fund a property purchase. However, with interest rates despite their recent rise still being so low, many of these are still borrowing funds so as they are able to purchase more properties and earn better levels of profit.
The minimum level of deposit required by lending institutions when granting a borrowing facility on a "Buy To Let " mortgage is 15 %. Property investors also need to factor in on top of the deposit, other associated property costs. These include Stamp Duty which a property purchasing tax paid to the Government. There are 4 different bands at time of writing. For properties purchased for less than £60,000 there is No stamp duty charged. However, a 1 % charge is levied on properties purchased between £60,000 and £250,000. For Properties purchased between £250,000 and £500,000 a 3 % charge is levied and for all properties purchased over and above £500,000 a 4 % charge is levied. Purchasers will also have additional fees to pay Solicitors and mortgage brokerage fees. Therefore investors should budget for having 20 % of a properties purchase price when considering another property purchase.
For most property investors the total mortgage required constitutes a LTV (Loan to Value) of 85 %. Therefore for a property purchase of say £200,000 the borrower will need the lending organisation to grant them a mortgage offer of £170,000, with the investor funding the remaining £30,000. In order for this to happen, it is imperative that the level of monthly rent received is enough for the lending organisation to grant £170,000. Not surprisingly, every lending organisation has their own unique method of calculating the amount of monies they will release.
Lending organisations typically have their standard variable mortgage rate at approximately 2 % above bank of England base rates, currently 4.5 %, thus a SVR of 6.5 %. Lenders will apply then apply their SVR against the level of Borrowing required, in order to work out the annual cost of borrowing. A loading of 130 % is then typically applied by the lender as their assessment of the additional lending risk of a Buy to Let Mortgage over a main residence mortgage. Clearly there is a higher risk as if the Borrower loses their Tenant and thus their monthly rental payment, how are they able to continue paying their monthly mortgage payment. One can then divide this annual payment by 12 to establish the monthly payment.
A worked example being if we apply a SVR of 6.5 % on a borrowing of £170,000, it equates to £11,050. We then apply the 130 % rule, which will increase payment to £14,365. Then we need to divide by 12 which equates to £1197. Therefore, this means that when the Lending organisation sends their Valuer around in his report in order for the lender to offer the borrower their required £170,000, there has to be a monthly rent achievable of at least £1197 say £1200. If this is the case, there is no problem. However, if the valuation report comes back saying that only £1100 is achievable, then the lender will not lend the required amount of £170,000. Instead the lender will offer £157,000 based upon the same rental. This would mean that in order for an investor to purchase the property for £200,000 they would need to put in an addition £13,000 on top of the £30,000 being 15 %, which in total means a total deposit of 22 %. Therefore it's important to assess accurately the realistic rental expected on any given property purchase.
Another important consideration when purchasing an investment property on a Buy to let basis is that the Property will be valued for rental purposes in its present condition. Therefore often investors attempt to buy properties in poor condition with the aim of spending an amount of money refurbishing it in order to increase the properties value. Remember firstly the property has to be habitable, i.e. be able to be rented out for a valuer to put a rental amount which can be capitalised for lending purposes. Where properties are not deemed habitable investors are wasting their valuation cheque as the Valuer will not put a rental amount down, which will result in the lender refusing to lend any money and thus the investor having to look elsewhere to be able to fund the property.
Often investors have to move into the property, whilst renovating, as it's the only way of achieving a mortgage to cover the majority of the finance required to fund the property purchase.
When investors have purchased their properties, they then have to find a suitable tenant who hopefully will remain in the property for some time and who will pay a market level rent, which will hopefully enable the investor's mortgage payment to be covered. Investors can manage their properties themselves or employ a managing agent usually through an Estate Agent.
Finally when the investor decides to sell their investment they have to take certain taxation issues into account, in the form of CGT (Capital Gains Tax). This is levied over 10 years reducing initially from 40 to 20 %on a sliding scale of profits made. Investors are liable to pay CGT on any gains / profits made from any of their investment properties which are not their main residence in the past 3 years up to the sale date.
COMMERCIAL FINANCE
The Commercial finance market has developed into a £10 Billion market in the UK alone. Traditionally 80 % of all commercial finance was dealt with by the individual or companies Personal Bank. This trend is changing however as more Commercial lending organisations have come in to the market. Underwriting has in many cases been relaxed with flexibility seen as a key ingredient in an investor's choice of commercial finance.
Firstly it is important to establish exactly what we mean by commercial finance. Property is ultimately seen as commercial if it enjoys a commercial use under the 1987 use classes order. The other main factor is determined by a properties usage. Clearly where a property is ones main residence, it will come under residential use category and loans and mortgages will be under residential lending criteria. The Buy to let market is essentially commercial property as people invest in property for commercial gain. However despite this sector not being protected by the MCCB (Mortgage Code Compliance Board), lending has far more similarities with residential than it does with commercial finance. Most people would accept that where individuals own 3 or more properties under a Buy to let basis, they are effectively corporate investors and lenders will assess their portfolios under commercial finance underwriting. In this regard, many Buy to let lenders will only lend on a certain number of flats within a building if they are to treat it as residential and not commercial.
Semi Commercial finance, an example being where you have a high street shop with 2 residential flats above is largely dealt with under the same rules as that of commercial, more so than residential. Indeed as with the 1993 Leasehold Reform Act when giving individuals the rights to extend their leases there is a requirement that the building has a 10 % or less commercial content. Clearly with most semi-commercials this is not the case which is why it is treated as commercial.
There are many areas within commercial finance including the following; Offices, Shops, Warehouses, Public Houses, Restaurants, café's, Night Clubs, Hotels and guest Houses, Care Homes, Garages, Buy to let, and Semi Commercial. Each of these areas are very specialised with differ rent criteria and as with the residential lending market, different banks preferring to lend on certain sectors.
Generally speaking Banks prefer lending the cleaner more established uses where the companies who they are lending to are operating in more stable industries and environments and who are unlikely to go in to liquidation and loose the financial institution a large amount of money. Conversely unless companies or indeed in dividable can show a proven track record of success over a sustained period banks will be very nervous when lending funds in Night clubs or fast food outlets.
When seeking to borrow commercial finance, banks will assess cases almost exclusively on a status basis. Normally a minimum deposit on a purchase of 25 % will be expected, with the bank assessing the merits of a loan of the remaining 75 %. When assessing, banks will look very closely at the companies last 3 years set of formal accounts, carefully monitoring the companies Assets and Liabilities and their Profit and Loss. Different sectors of the commercial market will generate higher or lower levels of gross profit on turnover. A bank will look closely at how much if agreed the new funding agreement will cost the company to see if with all its other associated costs it will be able to cope and retain sufficient levels of profits.
That said there a few commercial lenders who have recently taken the residential self certified market and applied a similar principal for commercial. As with residential the banks are taking a higher risk and will therefore load the interest rate. This will result in rates typically 4-5 % above Libor / base rates as appose to conventional commercial finance which at its best is only 2 % above base rates.
Unlike residential mortgages, almost without exception loans have to be taken out on Repayment only basis, often over periods no longer than 15 years. This will clearly impact on the monthly finance payment required to be paid by the company. Banks will only lend additional monies on properties where, evidence via accounts and sometimes projections is made available to confirm that the company or individual can sustain the additional payments.
Banks will also lend finance to companies or individuals who are purchasing properties with the sole intention of letting their property often under a business tenancy or long term lease for purely investment purposes. Here once again the bank will often charge a higher interest rate as investment finance is more risky than that of Owner Occupier schemes. In addition the bank will want to see that the rent received from the incoming tenant at least covers the mortgage payment and in some cases as with Buy to Let Mortgages banks will want to see a profit rent being achieved.
Within the realm of commercial finance is development finance, which again has become increasingly popular with property investors. Banks have also become far more developer friendly over the past 5 years due to the huge levels of increase in property values. This was not the case at the end of the 1980's where most of the banks lost millions of pounds with many developers going bust due largely to the wide scale recession.
Banks will lend developers usually up to 70 % of the purchase price of the property and a similar percentage of the development building costs. Other banks will lend finance as a percentage of the realistic sale prices of the development or indeed as a percentage of the perceived levels of profit in any development. This flexibility has enabled many first time developers to enter in to the market by virtue of using their equity generated in their homes.
Similarly with certain sectors of the UK housing market likely to see a more cautious growth curve in the next few years, more and more property investors are seeking opportunities with angles where property value uplifts can be achieved, without having to worry about the property market increasing which it has over the past 7 years.
Indeed many property investors / developers are becoming more and more sophisticated with many not just concentrating on London and The South East, but the whole of the UK and for some mainland Europe and The United States of America. With many of the UK commercial lending organisations having global presence bait with partners in other countries, UK investors are now better than ever before able to take advantage of this.
Bridging Finance has also seen a huge resurgence over the past 7 years. There are several reasons behind this. The main reason concerns the way property is bought and sold in the UK. Unlike Scotland and most of Europe, in the UK an offer on a property has no legal grounds. In fact it is not until one exchanges on a property, where typically an amount of 10 % is put down by the purchaser into the Vendors Solicitor's client account. At this stage the property transaction becomes legally binding. The problem occurs in that it often takes 2 - 3 months in order for people to exchange contracts as they require a mortgage to be arranged along with pre-longed conveyancing carried out by their solicitor. During this period, under the Estate Agents Act all Estate Agents remain duty bound to continue to disclose any offers for the property they are selling on behalf of the Vendor, their client. During the past 5 years or so, property values have been increasing often at a rate of 3 % a month. This means that a typical 3 bedroom semi-detached family house being sold for £300,000 may have gone up in value by a further £30,000 by the time exchange of contracts can occur. This is how and why gazumping often occurs in the UK, the result being that the poor purchaser has lost out on his purchase, having incurred much expense and become emotionally attached. Hence many purchasers in attempt to prevent this happening arrange a Bridging Loan for an amount large enough to be able to exchange contracts. There is a risk here as if the purchaser subsequently has a problem arranging a mortgage to purchase the house; he will loose the monies he has exchanged with, together the high interest on top of the bridging loan. Developers and investors often use short term bridging finance to secure opportunities quickly, where the initial high interest costs are more than off set by the higher level of potential profits.
Bridging loan is usually deemed a closed relationship where the agreement lasts for a term certain, upon which the loan plus interest must be repaid. Sometimes, however it is an open ended arrangement as neither party knows for certain at the inception how long the finance will be required for.
Finally Self-build has also become more popular, where people are able to secure a parcel of land, and build their own homes be it to occupy or to sell on as an investment opportunity. Lending organisations will lend in a similar way to development finance via stage payments over the length of the building project.
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