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Category: Finance

What’s in your property ‘Scary Box?’

Like any other business set up, property investors have to start somewhere and – if it’s something you haven’t done before, then it’s probably in your ‘scary box’. You see, […]

Private Finance

How do private lenders think?

Property is a great asset class. The problem is, it can be very capital intensive. Yes, you’ll borrow the vast majority of the capital you’ll need to finance the purchase (if done correctly), but what about the associated costs: cost of borrowing, legal fees, and more importantly, refurbishment costs?

On the forums and Facebook groups you’ll hear terms like “fixed return”, “investor funds”, or – my biggest pet peeve – “OPM (other people’s money)”.

If you’ve found an individual or company that is willing to lend you the capital to execute your project, well done. This is a feat in itself and should be commended. I’m going to assume you’ve found a private lender, or as you might call them, an “investor”. The problem with most property investors is that they think us private lenders offer money to anyone for any project on a “fixed return”, but it is seldom that simple – especially if you are new to the receipt of private finance.

Being a private lender myself, I’m hoping to help you understand how we think and behave.

Small businesses and property investors borrowed £113,498 from our company in 2019. We also invested £201,362 into joint ventures (JVs) in this same period. Now, I can’t speak for all private lenders, as we can differ quite a lot, but most of what I discuss will be typical across the board. I also have to stress that what I look for in a debt investment is very different to what I look for in an equity investment, so let’s just talk lending for now.

PEOPLE

First and foremost, do I like this person? If I don’t like them, I won’t lend to them, especially if they’re not credible. Do they have a business card? Does their website work? What previous projects have they managed? A common misconception here is that I will automatically lend if you have been on a training course for 2 days. Incorrect. We don’t just lend money “on a fixed return basis” because you understand what ‘ROI’ (return on investment) means… 

I think I speak for the majority of my colleagues when I say we look for credibility. Don’t get me wrong – I’m not saying you always need bags of experience for us to lend, but how much we are willing to lend (risk) will absolutely be influenced by your demonstrable experience. But it isn’t necessarily a barrier. I look for a critical thinker, someone who understands the project and, more importantly, who can deliver. Whilst I know some colleagues who are adamant on a credit check, I’m not.

PROFIT

Counter intuitively, I’m thinking about my borrower’s profit more than my own. Is there enough margin in their project? Can it sustain losses? To what extent can it be stress-tested? If you aren’t successful, then I won’t be. We don’t do heavy due diligence, but we will check the deal.

PERCENTAGES

This is where lenders differ enormously. In our business, we charge an interest rate of 12.5% per annum, payable monthly. One of my colleagues charges 8% per annum, payable quarterly, and I know another who charges 3% per annum, payable in full on redemption. How long the project will take is important, as this will determine how much I earn from your loan. How long is a piece of string? If you become very good at what you do, in some cases you can dictate to lenders what the rate and term will be, or cherry pick those who are prepared to lend at your desired rate.

PRESERVATION

Finally, we have to think about risk. Once that money leaves our account, we may never get it back. Managing risk is the biggest part of what lenders do. Depending on the amount we lend, I tend to get the following securities:

Fixed and floating charge over the company

This is the same as a mortgage charge on the limited company. If this company is an SPV (special purpose vehicle, due for wind up on completion) then a charge is crucial.

First/second charge on the property

If we are lending large sums of money, we will look to take a charge on the property itself. If the capital we deployed isn’t used to purchase the property, we will take a second charge.

Cross-collateralisation

If you don’t have equity in the project on which we can take a charge, we may ask if you have equity in another property that you can offer as security. 

Personal guarantee (PG)

Whilst I don’t typically look for PGs, some private lenders will. This means they can chase you personally in the event of default. 

Hopefully, this nutshell article has shed some light on how a private lender operates. Each case will be different. In terms of JVs, this is a completely different area. There is a huge set of FCA rules governing how you find and present yourself to private investors.

Working with private investors

So we’ve talked about private lenders. What about private investors? To many, this is the Holy Grail. By leveraging the resources of others, you can realise greater profits. There are some caveats, though.

JVs, or joint ventures, generally refer to businesses. However, you property investors kind of hijacked this term and applied it to property. I suppose it makes sense given that most JVs use SPVs (special purpose vehicles), which are sort of businesses! But let’s delve into the mechanics of a joint venture partnership, along with some of the ‘dos and don’ts’ that accompany it.

Much of what private investors look for is very similar to what private lenders look for but, in the case of investors, they will be much more stringent on their rules and generally go further than just doing some light due diligence. That’s because, as an investor (in equity, not debt), they become much less what we in the industry call ‘senior’ – they move to a more ‘junior’ capital position. This means that if the project fails, they will be the last people to get their money back, if they get anything back at all. 

Another important aspect of finding JV partners is a little-known directive called PS13/3. This is a set of regulations set out by the Financial Conduct Authority (FCA) that govern who, how and when you can ask people for investment capital. Fall foul of this and you’ll find yourself on the wrong side of them. Essentially, the FCA used to state that you may only advertise investment opportunities to “sophisticated investors” who can either prove that they earn at least £100,000 per year, or have net assets, excluding property and pensions, of more than £250,000.

However, these rules have been relaxed to help small businesses looking for investment. Investors can now ‘self-certify’ their status which moves the liability away from you, as long as the investors meet at least one of the criteria set out below:

  • They have made at least one investment in an unlisted security in the previous two years
  • They have been a member of a business angels network for at least six months
  • They have worked in a professional capacity in the provision of finance to SMEs in the last two years, or in the provision of private equity
  • They are, or have been within the last two years, a director of a company with a turnover of at least £1m.

This self-certification must be in writing. Once an investor has done this, the protections for them with regard to the promotion of securities by someone authorised under the Financial Services Act are removed. The relevant “risk warnings” must still be included in Promotions (your proposals).

So these guys that ask for investors on LinkedIn or Facebook have no control over the audience that sees their “Promotion” which means that the vast majority of people who read their post are non-sophisticated investors. This means that the person who posted is now in breach of Article 23 of the Promotion of Collective Investment Schemes Order, in Article 50 of the Financial Promotions Order. Unless you can guarantee your audience is made up of sophisticated investors, then you are going against the FCA’s rules.

WHAT WE LOOK FOR

Now we’ve covered the rules, what about the investor themselves? Well, as I previously mentioned, investors look for many of the same things that lenders do, except that they will go the extra mile.

Generally, investors will want to see experience. I know I do. Have you ever bought an investment property before? If so, what were the particulars of the project? How many of these projects have you carried out? And how many were successful? What can you demonstrate to me that will give me confidence that my money won’t just disappear into a black hole of inexperience? Do you have a project CV you can show me? If not, unless you can charm the proverbial pants off me, you’ll need to partner up with someone who has all this experience, or I won’t touch it with a bargepole, proverbial or otherwise. 

Investing is much more dangerous than lending, as it generally comes without many of the risk management provisions. Lenders get a fixed return, whereas the return for investors is linked to the profit (success) of a project and is therefore speculative. So in effect, unless we take equity for free and then loan the money to the business (utilising all the collateralisation tools) then we have pretty much no protection – we are relying entirely on your ability to make the project work. On the positive side, it does mean we can get involved and help steer the project, but in most cases investors are busy professionals that won’t want to do this, otherwise they would just do it themselves.

To conclude, my advice would be to put together a project CV showcasing everything you’ve done to date (include mistakes and failures). If you are new to property, partner up with someone that has experience and craft yourself a credible and professional team to impress your investor.

If you had £1,000,000 to invest, would you put it into an individual/a team who had completed and closed on 20 successful property deals, or someone who has never bought a property before..?

August lending Update

I took an enquiry for a bridging loan last week from a property investor who was disappointed when I told him he still had to pay stamp duty on his purchase. For the benefit of anyone else who has just returned from a prolonged stay on a desert island, the stamp duty holiday will be in place until 31 March 2021. However, for property investors buying additional residential properties over £40K the tax is still due, but with the threshold raised to £500k so there are savings to be made. Speak to your tax adviser for full details. 

Bridging lenders are reporting substantial increases in activity since the lockdown was lifted and with some of the larger lenders either not yet back in the market or limiting their loan to values, others have been more than happy to pick up the slack.

Some bridgers are back to lending 75%, but most seem to be capping at 70% for residential loans. There is still a fair amount of caution on the types of deals some will take on although most of the enquiries we see are for light refurbs and we’re not having any trouble placing these.

If you have the cash to put down a decent deposit and the lender can use an automated valuation model (AVM) or desktop valuation, you should be able to secure a good deal for yourself and get the funds you need quickly.

For those wishing to use bridging for the first time to refurb a property and who need cash for the works, they will have read or heard the phrase, “borrow against the GDV” (gross development value) and wrongly believe they can borrow up to 75% for the purchase and 100% of the works cost and that the lender will advance all the money on day one.  Well, sorry to disappoint you guys, that is not going to happen unless you have extra suitable security for the lender to take an additional charge on.  The lender may grant a facility to cover the works, but this will be drawn in arrears.  If I am not making this clear, ask your broker to explain.

When considering your exit strategy, be that to sell or possibly refinance to a buy to let, you may be able to get out within six months if you use the right lender.  If you are looking for a full uplift in value to pull out your cash, make sure you understand how the lender may treat this before you start your journey.

Happy hunting.

Sunak to slash stamp duty for 6 months

The Chancellor of the Exchequer is expected to deliver an economic update on Wednesday as he outlines plans to increase the stamp duty threshold up to £500,000 for the Autumn Budget.

Sunak is expected to announce a 6-month stamp duty holiday to facilitate Britain’s flailing housing sector, according to source reports.

He is understood to be drawing up plans to raise the tax threshold as high as £500,000 to remove most home buyers from the scope of stamp duty to try and help the UK economy.

He will reportedly reveal plans this week to increase the threshold at which people start paying stamp duty on house transactions. This new threshold will he put in place for 6 months and is expected to be set between £300,000 and £500,000.

First time buyers are already exempt from paying stamp duty up to £500,000 in London, and £300,000 in the rest of the UK.

Property sales in April fell to their lowest levels since records began, according to HM Revenue & Customs figures.

A 0.2% month-on-month decline in May followed a 0.6% drop in April and 0.3% fall in March – seeing the average house price stand at £237,808.

Mr Sunak is set to give an economic update to MPs on Wednesday but it is understood the stamp duty holiday will not be announced until the next Budget.

Bank of England reports huge fall in mortgage lending

There may have been a surge in English house transactions after lockdown restrictions were lifted on May 13, but the pent-up activity hasn’t translated to mortgage approvals. Far from it.

Latest figures from the Bank of England show that lending for house purchases was 9,300 in May – a drop of 6,500 less than in April when the full force of the shutdown was felt. That figure was 90 per cent less than in February this year. At the time around 140,000 new loans had been approved between January 1 and February 29, indicating a growing and healthy UK property market.

Fear lenders will ask for bigger deposits across board

Last month the majority of lenders pulled 95 per cent mortgage deals. That effectively freezes the majority of first-time buyers out of the market.

Now analysts are worried that lenders will start asking for bigger deposits across the board, causing the market to stall, rather than re-assert itself by the end of the year.

Meanwhile, lending for re-mortgages is also down with a drop of 40 per cent since February this year to 30,400 approvals. According to the Bank it’s the lowest since their records began, back in 1993.

Uncertain economy putting off home buyers

But it’s not only the reluctance of lenders that is holding back buyers. Understandably, uncertainty over potential job losses is also a big stumbling block for many individuals who had planned to move before the coronavirus pandemic hit.

In the meantime, the resurgence of buyer interest is expected to boost lending figures next month. Whether those levels will be even half of the pre-lockdown figure remains to be seen.

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Fears over first-time buyer market

The Coventry Building Society this week became the latest lender to dash the hopes of first-time buyers with small deposits. Although it said it was offering a 10 per cent deposit deal – it would only be for four days.

The list of other lenders who are no longer offering ‘first time buyer 10 per cent deposit deals’ has grown phenomenally since March. They include Clydesdale, Virgin Money and Accord. Pre-lockdown, first-time buyers could choose from 294 total 90 per cent loan to value deals with a fixed rate of two years. For a fixed rate of five years there were 137 deals on offer. By May there were only 24 and 11 deals respectively.

Only HSBC continues to offer 85 to 95 per cent deals – although these are ‘sold out’ after 30 minutes each morning. Nationwide continues to offer a 95 per cent deal (via its branches – not a broker).

The fear is that effectively shutting out first-time buyers will prevent the property market from bouncing back quickly post-lockdown.

Reasons for withdrawing the 90 per cent deposit deals were put down to the inability to provide physical valuations for properties. They also cited worries over negative equity in the event property prices didn’t pick up after lockdown. Reduced staff resources was also cited as a reason.

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