Many commercial brokers will pay a procuration fee to residential mortgage intermediaries for cases passed to them. However, with the advent of regulation many residential mortgage intermediaries are considering a move into commercial lending as either an extra string to their bow as compliance costs cut margins, or as an escape route from regulation altogether.
However, while it is true that most commercial loans are not regulated, some of them will be. A spokeswoman for the Financial Services Authority (FSA), says: “Commercial lending is generally speaking not regulated, but there is a small proportion that will fall under the regulatory umbrella. We think it is fair to protect an inexperienced sole trader or unincorporated partnership under some circumstances.”
Therefore, brokers should be aware that owner-occupier commercial mortgages will fall under full FSA regulation in 2004 if the borrower has annual turnover of less than £1m and occupies at least 40% of the property.
One of problems for advisers who are new to this market is that the quality of the information available on the commercial property market is nothing like as comprehensive or coordinated as in the residential market. The market is also highly segmented. Commercial property covers a huge range of variation in both size of deal and type and value of security. It varies from something the size of a corner post office to Canary Wharf. There is a difficulty in getting hold of statistics in the first place and then in making any sense of them.
One of the few people to hazard a guess at the size of the market is Keith Heron, chief executive of the National Association of Commercial Finance Brokers (NACFB). He says: “We estimate the market at around £100bn per year in terms of net new lending. That figure generally excludes the huge corporate deals, became the problem is banks do not record figures in a way that would suit the broker, so broadly speaking it encompasses the small to medium sized deals. Figures are also based on the leasing market which looks to be around £30bn, and the factoring and invoice discounting market, worth around £100bn, but these are broad definitions.”
Factoring involves raising money on the basis of money owed to the company and involves the lender collecting the debt. Invoice discounting is similar but the borrower keeps control of its own invoicing.
One of the few facts the market agrees on is that around 80% of all small to medium sized commercial loans are through high street banks and building societies, but this is changing.
Paragon Mortgages is a recent entry to the commercial lending market, focussing exclusively on investment. On starting its commercial arm Paragon was not able to rely on any concrete market information and researched the market itself through discussions with a number of specialist commercial finance intermediaries.
“We talked to them about the type of client they saw, the type of property they were transacting on, and the business volume they handled. If you like we based our entry on the market on the demand from a highly focused segment of the intermediary market,” says John Heron, managing director of Paragon Mortgages.
For those new to the market, one of the key things to be aware of is that here is a difference for the broker between transacting commercial investment mortgages and commercial owner-occupier mortgages. Commercial investment – financing a property where someone else is going to take up the tenancy – is in principle similar to buy to let, made more complex by the tenants, whose quality is paramount in the deal.
Owner-occupier loans on the other hand, are viewed differently as the serviceability of the loan will depend on the viability of the owner-occupier’s business. While a commercial investment can always find another tenant, owner-occupation is inherently more risky for the lenders and more complicated for the inexperienced broker.
Keith Heron believes that commercially inexperienced brokers should avoid owner-occupier deals. He says: “An experienced commercial mortgage broker will be able to detail all the risks involved to the client and lender, something that I am not convinced that those not expert in commercial finance can do. For example, an owner-occupier may have other ways of financing a deal other than a mortgage, there could be assets in the building they could use or they could use factoring or invoice discounting, for example. However, simple commercial investments are not as complicated.”
So what are the extra complications in the commercial investment market? These deals involve business plans, accounts, details of the tenancy and a vastly more complex valuation process. These are also significant costs involved up to the point of approval, therefore there are risks involved in the applicants position, therefore more risk attaches to the advice they are given.
Pactices and prices
While there are fewer lenders in this sector there is nothing like the formula that attaches to practices and prices in the residential market. Standardisation does not really exist in the commercial market. This makes it difficult for an intermediary to recommend any particular lenders in the knowledge that it was the best deal. What a lender will offer is decided on a case-by-case basis.
John Heron says: “From an intermediary’s point of view I think that they will want to think long and hard about whether they want to handle commercial business, and if they have the necessary experience. Clearly their reputation is on the line. These deals are considerably more complicated and require a lot more work in putting the proposal together to a lender’s satisfaction.”
Lenders are of course willing to lend a hand to intermediaries. Graeme Taylor, head of commercial lending at the Skipton Building Society, says: “With the advent of regulation in the residential market I think a lot of brokers are considering a move into commercial lending. We take a fairly open view on how difficult this market can be for the inexperienced broker. We have a number that have begun to successfully handle a small number of commercial mortgages and we have geared up to deal with new entrants.”
When a commercial lender has dealings with a new broker somebody is sent out to visit them and make them aware of what they should be looking for, and what they should be providing the lender with.
Planning permission is another major issue for brokers to be aware of. Certain properties will have particular planning issues, as a financial outlet, café or restaurant for example, and the council would allow only so many of each type on a given high street. However, the principle is always the same for investment property: is there a lease in place, and what is the rental cover and what is the standing of the tenant. Competition for a given tenant or type of business, for example, is something that valuers are instructed to look at.
Most lenders vary their approach depending on the class of property. Paragon, for example, prefers property of a non-specialist nature, one easy to find a tenant for. For instance a leisure centre or pub or restaurant would be specialised. “We look for shops, warehouses, or light industrial units, the sort of vanilla commercial investment property. This is also the kind of property sought out by most investors of the type we are interested in,” says John Heron.
There is a significant amount of mixed business about, shops or offices with flats above. This is not the issue it can be in the residential market. Usually the security offered involves the whole freehold, but the commercial return is enhanced by the residential return. It is still viewed as a commercial loan.
Brokers need to be aware of other issues. Voids are far more prevalent in commercial properties than they are on the residential side, and most high streets will always have units vacant for instance. It is also useful if a broker can read business accounts.
The last thing intermediaries want is to send a case to a lender and then be told to send it to someone else. Equally they do not want to send a case to five or six lenders as there will come a time when lenders say they do not want the business as repeat applications go nowhere. It is important to talk to lenders and find out what each will lend on.
Taylor says: “What I would say to any residential mortgage broker thinking of going down this route and becoming a commercial broker is to find out what each of the individual lenders will do. It is amazing how many applications we get from people who are starting out, who send in applications that do not meet our basic criteria. Make sure the case fits.”
Regardless of the extra difficulties, this market has its attractions – not least a steady supply of business from the buy-to-let sector. It would not be unusual for an investor with a substantial buy-to-let portfolio to hold one or more commercial properties, as these investors do not necessarily see a distinction between commercial and residential, viewing the whole thing as a package.
l For anyone interested working in this sector, the NACFB runs an in-house training program especially for beginners.
Owner-occupier deals are more difficult as there are a number of different ways of raising finance.
Planning permission is a major issue, as types of commercial property in a given area are limited.
There are a limited number of specialist lenders – all of which have different criteria.