In a post-credit crunch borrowing environment, property investors and developers have grown accustomed to operating within a more professional marketplace. Although legitimate creative strategies remain, gone are the days of free-flowing speculative finance.
From buy-to-let and bridging through to development funding and accessing finance via the ‘crowd’, this extended post aims to navigate investors through the main options.
Please note that we are not mortgage brokers or financial advisors, and strongly suggest seeking suitably qualified professional advice.
Supporting a sector that has grown markedly since the mid-1990s, buy-to-let lending has shifted from being a niche commercial product to taking a significant share of the UK mortgage market.
In recent years, however, Prudential Regulation Authority (PRA) stress-testing criteria has imposed stricter standards on a landlord’s ability to access finance. Formally introduced in 2017, the aim (according to the policy itself) was to ‘prevent loosening in current industry standards for buy-to-let underwriting, curtail inappropriate lending and reduce the potential for excessive credit losses’.
Alongside a feasibility analysis of the merits of the buy-to-let property itself (i.e. confirmation that the deal ‘stacks up’), affordability assessments will closely inspect a buy-to-let borrower’s own personal financial circumstances in more detail than ever before.
Arguably having a significant impact on the sector was former Chancellor George Osborne’s enactment of Section 24 of the Finance (No. 2) Act 2015. This legislation essentially means that – by the 2020/21 tax year – just 20% of mortgage interest will be tax deductible against gross rental revenue. Treating landlords differently to other business owners, it is those that are in the higher and additional tax brackets that are at most risk of facing unfeasibly high tax bills.
Investors looking to expand into the buy-to-let sector are therefore choosing the limited company route to acquire property – typically via Special Purpose Vehicles (SPVs). This is a corporate entity, exempt from the effects of Section 24, that is set up solely for the purposes of holding property and nothing else.
Expect loan to value ratios of SPV buy-to-let mortgages of around 65-80%. Although interest pay rates are generally higher, market evidence suggests that more lenders are entering the space which could drive capital costs downwards (assuming no negative external forces come into play).
Below is a broad checklist of factors you should bear in mind during the Limited company buy-to-let mortgage application:
- Speak to your accountant, tax advisor and estate planner prior to making any investment decision;
- Undertake a detailed cost-benefit analysis to establish whether Limited Company acquisition is the most tax efficient course of action. Assuming the Section 24 legislation remains in force, this is likely to be the case (unless you are certain that you will remain in the low-income tax bracket over the long-term);
- Find a good mortgage broker with experience of Limited company lending and a solicitor that understands the additional paperwork required;
- When purchasing with cash or bridging (see below), ensure you understand what mortgage products and associated loan to values are available at the point of refinancing (observing the 6-month rule);
- Appreciate that buy-to-let mortgage financing through SPVs generally takes longer;
- Understand future tax obligation prior to acquisition (principally corporation tax and then the second layer of income tax on withdrawn dividends/salaries);
- When researching products, ensure that arrangement fees, higher mortgage finance costs and other obligations are factored into your calculations. Low rates are often not as good as they first seem;
- Ensure there will be no other forms of future revenue through the SPV other than for letting property. If you are planning to borrow through an existing trading company, lenders will generally request specific information which will prolong the underwriting process. Should the loan be granted, there may also be funding limitations, personal guarantees or fixed/floating debentures over the company;
- Note that intercompany loans to fund deposits will generally delay the application;
- Should you already be a Director of an operational SPV for buy-to-let purposes and the revenue is less than £25,000, most lenders will request to see at least 2 years’ accounts. Lenders may also request an asset/liability profile, business plan, current portfolio schedule and cashflow forecast(s);
- Ensure both your business and personal credit scores are healthy;
- Ensure that current buy-to-let business operations are healthy (no voids, unmanageable refurbishment costs or other perceived risks that may ring alarm bells);
- Set up your Limited company using SIC codes 68100 (buying and selling of own real estate) or 68209 (other letting and operating of own or leased real estate);
- Set up a Limited Company bank account and understand the extra administrative requirements with both HM Revenues & Customs and Companies House;
- Have proof of income readily available by means of SA302’s from the HMRC, tax overviews (from your accountant), bank statements and/or payslips;
- Understand your obligations and responsibilities under Personal Guarantee (PG), Fixed / Floating Debentures and Deed of Priority contracts issued by the lender;
- Have your deposit funding firmly in place prior to exchange of contracts to avoid unnecessary holdups or other issues;
Be aware that rates may vary depending on the nature of the property. For instance, holiday lets and HMOs could attract higher pay rates and loan to value requirements. Furthermore, some lenders may place a restriction based on the size or value of your property portfolio.
For more depth on the theme of better decision making in the modern buy-to-let environment, we would encourage you to read the Property Solvers Landlord’s Report.
Bridging loans – some referred to as ‘flash finance’ – remain a popular short-term solution to raise funds, particularly for flipping projects and auction purchases (see below). Due to their temporary and more flexible nature, the pay rates are notably higher than buy-to-let and other residential mortgage products.
Use this bridging loan calculator which will give you a good indication of the expected rates and repayment costs.
However, most lenders will prioritise the merits of the deal itself rather than an investor’s personal financial circumstances or other affordability assessments.
More commonly, investors present an unmortgageable (uninhabitable) property requiring refurbishment works. They will then need to demonstrate that a healthy post-completion profit margin is achievable or that value can be added through planning gain. Some also use bridging to close a financial gap – such as to purchase another property within a short timeframe when the sale of an existing asset has not completed or in a broken chain scenario.
After some desktop analysis, most bridging lenders would require an independent valuation undertaken by a Royal Institute of Chartered Surveyors-approved valuer. This will be an ‘as is’ or ‘bricks and mortar’ valuation. They will also examine the project’s viability as well as its open market value once the works are complete or through a successful planning outcome (factoring in their associated risks).
Regardless of the project’s scope, there must be a clear exit strategy and the bridging lender may also want to know about any other assets you own.
If the project is extensive – requiring structural changes, refitting, configurational or other unorthodox changes – the bridging company will want to see a track record of successfully completed works of similar nature. In such scenarios, you may also need to provide information about the contractors you are using as well as a business plan.
Like buy-to-let lending, each bridging company will orientate lending criteria around its own risk appetite. Expect to be able to borrow between 75% to 100% of the RICS valuation (you will then have to find the remainder funds plus the costs of refurbishment). Although more common with larger projects, some bridging companies will lend on the basis of the property’s end value.
To benefit from lower rates, you will usually need to show solid experience and/or a heavy capital injection from your own funds into the project (which would therefore limit the lender’s risk exposure).
Bridging loans typically require a first charge on the asset as security in addition to a Personal Guarantee (PG). Some may also place a charge on other assets you may own (although a separate RICS valuation would probably be required). The lender will essentially want to know that, should things turn sour, they could ‘fire sell’ the property and recover the loan (+ associated fees) – even if the project is not completed.
Remember to factor in entry and exit fees, which are sometimes pooled together, in addition to the broker and the lender’s own legal fees (which may be waived in certain circumstances). There may also be early repayment charges if things go well and you complete the project earlier than expected.
Here, it’s important to read the small print. Bear in mind that some bridging lenders will deduct their associated fees from the loan advance itself, whereas others will agree that you can service the loan on a monthly or quarterly basis. Alternatively, you may choose to roll up the interest until the end. This option can work in your favour from a cash flow perspective – but bear in mind that, as the interest compounds, you may end up paying more.
Relatively new to the marketplace, these bridging loans are specifically catered to buy-to-let investors. Landlords use a bridging loan structure described above funded by a mortgage company to initially purchase the property. Once the project is completed, an in-built exit strategy is put in place by means of pre-approved buy-to-let finance.
Essentially undertaking a dual-viability assessment process, an investor will only be able to complete on the bridging loan if the buy-to-let remortgage is approved (by the same lender). This means that the Prudential Regulation Authority (PRA) stress-testing / affordability criteria outlined above will be applied during the initial underwriting process.
Lenders would require pre and post works surveys and associated schedules. If the project scope is substantial, the lender will want to know that the investor has the necessary experience. The loan to value may also be capped at a lower percentage.
In terms of security, similar charging structures to standard bridging loans will be applied. Check the terms and conditions and always stress-test various scenarios. For example, a market correction could alter the resale value of the property. There will also be entry and exit fees for the bridging loan itself in addition to mortgage arrangement fees, brokerage and legal costs.
This form of finance works very much like a bridging loan, while being designed specifically with auction purchases’ rapid completion dates in mind. There are often bespoke rates and fees available.
Once you have won the bid, most auction houses require you to sign a Memorandum of Sale and pay a deposit (usually 10% of the purchase price). You will then need to complete on the sale within 28 days (sometimes more) or risk losing the deposit. Add in the obligatory auction listing fees, marketing costs and penalties, and the importance of meeting this deadline is unquestionable.
This is where an auction finance product can be useful – particularly if you are waiting to secure longer-term buy-to-let mortgage products, which are now subject to more restrictive underwriting requirements (as highlighted above).
We would suggest working with a broker who can assist you in finding lenders that are able to refinance within 6 months of purchase. Both the auction finance provider and the buy-to-let mortgage company will closely scrutinise the merits of the transaction. Similar to bridge-to-let products, be prepared for extra fees as you are effectively taking out two loans.
If you own a property with enough equity in it, you can often secure the purchase of a new property against an existing one and leverage some of your equity.
This can help if you are struggling to raise the requisite deposit to expand your portfolio, because all your cash is tied up in your existing properties. You’ll then need to arrange secondary finance for the balance – either a buy-to-let mortgage or a bridging loan, depending on your intentions.
Investors should be mindful of the risk of over-gearing, and keep in mind the fact that the property market has and always will be cyclical.
Property Development Finance
Development finance is suitable for ground-up / part-build projects, conversions and land acquisitions where planning permission has already been granted.
Much will depend on the scope of the project and the level of experience, but debt funding will be typically based on a percentage of the Gross Development Value (GDV) of the completed project.
Expect funding to lie in the region of 60-65% loan to GDV, with a maximum of 75% of total costs. Interest can be rolled up and the payments can be staged and drawn down in line with the project’s progress (which may include ‘sign off’ requirements by a qualified surveyor).
Debt financing is usually combined with equity – sourced from personal or shareholder’s capital or other resources provided by the developer, partners or investors who collectively participate in both the risk and rewards of the scheme.
It may be possible to access further capital provided that unencumbered land or other property can be used as first-charge collateral. Also, should it be discovered that planning consent can be enhanced (adding extra space or larger housing provision, for example), it’s possible to access further finance.
Mezzanine finance is sometimes also used where a developer has a funding gap. These lenders are comfortable with having a second charge but lend a lower amount (typically up to 20%). In line with the extra risk, interest rates tend to be higher or the mezzanine lender may require a profit share upon the project’s conclusion.
Due to the longer-term nature of these types of projects, expect to undergo a detailed level of risk assessment regarding all aspects of the project’s feasibility in addition to your own financial profile (track record).
Each application will be assessed on its own merits – with an emphasis on the project’s viability. Also, expect various stress-test parameters to be applied. Lenders will want to see the following:
- Full information regarding any equity contribution sources;
- Full and valid planning/permitted development consents alongside confirmation that there are no conditions laid by the Local Planning Authority or other legal precedent. Restrictive covenants, unexpired licences, regulations or other legally-enforceable conditions that would not be dischargeable/surmountable will negatively affect the underwriting process;
- Building regulations approval (separate from obtaining planning permission) through the Local Authority Building Control Service. The lender will probably want to see that a Building Standards Indemnity Scheme from an approved warranty provider will be in place;
- Proof that there are no planning blights, safeguarding directions or impending Council decisions that would adversely affect the ability to develop on the site (such as issues relating to access/circulation/easements, layout, parking, appearance and scale);
- Evidence of a full Environmental Impact Assessment (EIA);
- A positive Health & Safety Risk assessment;
- No out of the ordinary utility-related works (gas, water, electricity) will be required;
- There would be no conflicts with local development and neighbourhood plans;
- The compulsory local consultation process would not result in any undesirable consequences to neighbours and the local community. Any proposals would be well received at a local level (without any community or political objections);
- No significant impacts to employment or site usage that would be incongruous to future local economic growth of the immediate area;
- Details of any Section 106 obligations (private agreements made between local authorities and developers sometimes appended to the grant of planning permission);
- There are no other extraneous factors that could jeopardise the economic viability of any proposed development;
- Proof that there are no latent defects including adverse ground conditions, asbestos or other deleterious material/contamination issues;
- A business plan including phased project cost breakdown, cashflow forecasts, comparable evidence (to demonstrate GDV), contingency planning, timescales, cost overrun mitigation, quantity surveyor reports
- CV of experience in the property development sector;
- Details and associated credentials of professionals involved in the project (architect, planning consultant, engineer, project manager, build team);
- Evidence of fixed-price contractual agreements you have in place (Joint Contracts Tribunal or JCTs).
Debt is typically secured by a first charge on the asset. Depending on the terms of the loan, additional collateral may be required as well as personal guarantees. The lender will also send their own professional surveyor to assess the site, provide an expected market value on completion and comment on the end project’s saleability.
Entering into a joint venture partnership is an excellent way to get involved with property. However, a great deal of caution is necessary to ensure a successful outcome.
If you are planning to use equity funded or part-funded by an investor, the lender will want to see that you are genuinely inputting capital (colloquially known as having ‘skin in the game’). This is money that has come directly from you and not simply borrowed from a joint venture partner.
Note that family gifts or released equity from another property are allowed but expecting to borrow money from a third party or via unsecured debt won’t be.
Joint venture partnerships themselves can be incredibly risky and below are some basic pointers:
- Read up on the Financial Conduct Authority’s Policy PS13/3. This essentially places controls over how unregulated investments are presented to the market (the FCA labels these as Non-Mainstream Investment Schemes). For instance, if you have a project for which you are looking for joint-venture investment (in return for a profit share) any partner must be classified as a sophisticated investor or High Net Worth Individual and fulfil specific criteria;
- Know Your Joint-Venture Partner – if you are both going on the finance deeds together (assuming the lender has permitted this), there will be collective responsibility. Therefore, it’s important to understand your partner’s financial health (and vice versa). Credit reports, bank statements, bankruptcy history checks should form part of your due diligence process;
- The better you know the joint-venture partner on a personal level, the more likely it is that things won’t turn sour;
- Avoid ‘off the shelf’ legal agreements and work with an experienced solicitor to draw up contracts that should protect both parties in all eventualities (everything from physical and mental health problems to bankruptcy and death);
- Ensure the joint-venture is structured in the right way from start to finish;
- Have a good understanding of your exit position and make sure the partner is fully in agreement to avoid any future conflicts;
- If you are planning to refinance, ensure that you have at least one lender lined up (noting that they may change their own criteria by the end of the project);
- Ensure you and your joint-venture partner take out life insurance (ensure the policy enables you to buy out your partners share from the estate and covers you against potential tax liabilities);
- Always transfer funds via a solicitor and not between each other’s bank accounts;
- For goodwill purposes, be prepared to be entirely transparent during the project – sending regular financial statements, credit reporting and other updates.
A comparatively new form of funding, crowdfunding a property development project is aimed at attracting a pool of investors who contribute smaller sums as part of a collective whole. With less capital-intensive investment structures, it’s an interesting way to benefit from greater diversification and even the possibility to deploy funds through self-controlled pension funds.
Property crowdfunding firms offer equity and debt (peer-to-peer) financing and the various platforms that have emerged in the space look for projects with strong project returns, high yields, below market value or, preferably, a blend of these elements.
Each platform has its own criteria and has to go through a rigorous process under the guises of the Financial Conduct Authority (FCA). Similar to development loans – you will be required to supply RICS valuations, business plans outlining your own experience alongside the credentials of the deal itself.
Increasingly embracing social media, more platforms offer investors the opportunity to analyse deals collectively and interact with each other. This, therefore, means that you should expect your deals to be vetted closely by the crowdfunding firm as well as the pool of prospective investors.
Like most finance mechanisms, Crowdfunding will be subject to entry and exit fees. Therefore, you should check the terms and conditions of the platform.
With thanks to Together’s Daniel Owen-Parr Head of Professional & Auction sector for collaborating on this piece. Quoting JDP, click here to send your enquiry or email Daniel at firstname.lastname@example.org with finance as the subject line.
 Mortgages will be stressed at higher levels than the actual interest rate. At the time of writing, this is set at a notional default pay rate of 5.5% with a 145% Interest Coverage Ratio (ICR) affordability threshold.
 Most lenders will not refinance a property within the first 6 months of the original purchase date. However, consult the Council of Mortgage Lenders (CML) handbook to see which lenders have specific exemptions.
 Standard Industrial Classification codes identify the area of business in which a Limited company trades.
 If the lender needs to repossess the property, the proceeds of the subsequent sale will be used to settle mortgage liabilities. However, if any further debt remains, the Personal Guarantee (PG) will enable lenders to claim any shortfall from you directly.
 Debentures are used to protect a mortgage lender’s interest in the property in the event of a default. A formal agreement is signed prior to the mortgage being granted that stipulates either a fixed or floating charge. A fixed charge is a ‘hold’ on the property whereby the borrower cannot dispose or refinance without the lender’s explicit permission. A floating charge provides the lender with security over the asset that has an alterable quantity or value (examples include cash, unfactored debt, fixtures or fittings) which crystallises in a default scenario. Floating charges are less common in the buy-to-let lending space as they have a lower priority relative to other security.
 An agreement drawn-up if there is more than one lender take security over the Special Purpose Vehicle. It will establish who is first in line to recover any net proceeds in an insolvency scenario. Deeds of priority, however, are mainly used for larger loans and buy-to-let lenders typically prefer to operate on a ring-fenced basis.