Economic uncertainty means few people of employable age can expect a job for life, and the number of those choosing self-employment is growing. With this in mind, it is not surprising the number of lenders offering mortgages on a self-certification basis has increased significantly, and logically the number of self-cert borrowers who will want a commercial mortgage has also increased.
At the start of 2001, there were 3.7 million small to medium-sized business (SMEs) in the UK, making up at least 95% of businesses in all industries, according to the Department of Trade and Industry. Of these SMEs, 2.6 million were sole proprietorships and partnerships, basically self-employed entrepreneurs. According to Alodis, an organisation that offers advice to people who are self-employed, this figure is expected to increase to approximately 3.2 million by 2001. This rise will lead to an increase in demand for commercial property, and therefore mortgages, sought by the self-employed.
Despite this positive outlook for the self-employed, the weakening economy over the last 12 months has affected the commercial property market, resulting in surplus office space. According to a report from Property Market Analysis, office vacancy rates in the Thames Corridor are running at 17% ‘ higher now than during the last recession. These vacancies are thought to have been caused as a result of both tenants and landlords finding their business is not growing the way it was expected to during the boom years of the late 1990s. This is a different situation to the domestic market where demand still outstrips supply.
For those brokers new to the commercial sector there are a number of points to be aware of, although commercial and domestic mortgages are similar. Essentially, there are two main differences.
The first is the lender’s arrangement fee charged. These fees can vary be-tween 0.5% and 2% depending on the lender so it is advisable to shop around. The alternative option is a fixed fee, which is capped depending on the size of the loan. This can be agreed between the lender and the mortgage broker.
Second, the commercial application process takes longer as there are a number of considerations that need to be taken into account by brokers, lenders and applicants. These include the purpose of application, the risk element, and ‘policing’ the loan.
The purpose of application is important to self-cert lenders because, when assessing the application, both the broker and bank need to consider the purpose of the new premises to the business. If it is for business expansion, the lender will need to ascertain where the finance for this growth came from ‘ from a business bank overdraft, or from a capital account. This may affect any subsequent decision.
The risk element is also viewed in a different way to standard domestic loans. With any application, the lender will need to be made aware of all areas of the business, so the full extent of the risk can be assessed. The loan application needs to be supported by a strong business plan and the lender will require access to the accounts ‘ and in some cases will request a visit to the premises.
In these circumstances it is usual for a broker to make contact with the applicant’s accountant in the initial stages of the application, to check cashflow and net profits forecasted for at least the next three years and the business’s tax situation. This will enable the broker to analyse whether the business is capable of repaying the loan and whether a lender would view it as a viable risk.
‘Policing’ the loan refers to special performance conditions or covenants ‘ which are stipulated during the application process and are undertaken throughout the duration of the mortgage agreement. These may include the lender requesting access to the business accounts on an annual basis. If the covenants are not met, the borrower will be in breach of contract and the lender has the right to ‘call in’ the loan.
It is these complex elements combined with the actual underwriting of the loan that extend and complicate commercial applications.
There are several points potential self-cert borrowers need to consider during the initial stages. These include getting the balance right, the initial financial input and the tax regulations.
Getting the balance right is a vague term, but essentially it means they are planning for the long term, but not leaving themselves exposed at the outset. Although the current economic climate is tough, there is light at the end of the tunnel and SMEs still need to plan for growth. However, self-employed directors seeking a commercial mortgage should ensure their chosen property allows for future expansion, but is not so big that space is wasted, as it cannot be taken for granted that space can be sub-let ‘ the balance must be right.
This will have an impact on the initial financial input. When buying a commercial property the borrower will require an initial financial deposit. The size of the deposit is important as many commercial mortgages start at 80% loan to value, creating a shortfall for the business to fill which does not include the arrangement fee. Often the main source of finance for this is the remortgaging of the borrower’s residential property. Borrowers also need to be aware that when taking out a commercial mortgage it is standard for their home to be used as a guarantee. However, the guarantee can also be in the form of stocks and shares in the company.
On top of tax
One of the key factors borrowers should be made clear about is the tax regulations. A self-employed borrower should be aware of how to minimise their tax liabilities, but if it is their first commercial property self-employed borrowers should look at using Government tax regulations to their own advantage. For example, they can benefit from buying the commercial property under the Small Self-Administered Scheme. This effectively is a pension scheme whereby the borrower buys the property, and the business pays rent in the form of a pension pot. As a director of the business the borrower may obtain tax relief by putting the property transaction through the business books. However, the mortgage must be correctly structured to ensure the full benefits are gained.
As with residential mortgages, there will be a process of vetting the application. The property will need to be valued and as always the valuer’s comments will be essential in the eventual granting of the mortgage. The underwriters will look at the aspects of the application, the property, the financials and items such as the guarantees the business owners have been asked to provide.
Applying for a commercial mortgage is usually a straightforward business that is not usually drastically affected by the factor of self-employment. There is little differentiation to the process in terms of comparison to a domestic mortgage ‘ the business accounts are checked in the same thorough fashion as a borrower’s personal accounts.
Simon Biddle is marketing development manager at Preferred Mortgages
There are 2.6 million small self-employed businesses in the UK.
If the mortgage is for business expansion, the lender will need to know how the capital has been raised.
The lender may want access to business accounts and a domestic property as a guarantee.