The commercial mortgage market in the UK is about to undergo a period of rapid expansion and mortgage brokers are well positioned to capitalise on the opportunities this will generate.
The rapid growth in this sector is due to a combination of related factors. First, the construction market is going through a boom time at the moment and there is a considerable amount of new commercial property being built throughout the country. This, combined with a healthy stock of existing properties, means there is a good supply of offices and commercial buildings to choose from.
Second, with interest rates at an all time low, not only are business people more inclined to consider purchasing commercial property rather than renting, but investment in commercial property has become considerably more appealing than investing in the stock market. Many business people are using the tax advantages of purchasing properties using Self Invested Personal Pensions (SIPPs) and Small Self Administered Schemes (SASSs), rather than depending on the lack-lustre performance of traditional pensions to finance their retirement. Commercial property has a good record in terms of return on investment and business people are increasingly seeing this as a more attractive option than paying rent – which is ‘dead’ money.
Third, commercial finance is starting to become more readily available and obtaining a loan is no longer the tortuous and time consuming exercise it used to be. However, the market for commercial lending still has a long way to go, and for borrowers who have unusual circumstances or an impaired credit record, finding finance can still be an unnecessarily difficult process. New lenders are revolutionising this sector of the market, but it is true to say that in terms of maturity the commercial sub-prime market is at the stage the residential sub-prime market was at ten years ago.
The reason more lenders are showing an interest in commercial lending is because of growing demand. At the moment, only 14% of commercial borrowers in the UK use a financial adviser to help them secure finance, whereas in the USA 70% of commercial borrowing is intermediary generated. Recent experience shows the number of enquiries received from brokers is growing daily, with around 50% of brokers enquiring about commercial finance.
Historically, if asked about commercial finance most brokers would have referred clients to a specialist broker or simply said ‘no’, but the frequency of enquiries now coming from customers is such that many brokers recognise they are turning their backs on a significant potential profit opportunity. In reality, arranging commercial finance is not very different to arranging residential mortgage finance and, with the help of specialist lenders and packagers who can take responsibility for much of the paperwork involved, brokers should not be afraid to make the effort.
Commercial lending also takes on added significance when considered within the context of regulatory changes taking place in the mortgage and general insurance markets. Not only is commercial finance another string to a mortgage broker’s bow, but it is also one of the few areas of lending which will remain outside the control of the Financial Services Authority. This is particularly relevant to brokers, who may be considering becoming introducers because they do not want to incur the expense or effort involved in becoming either directly authorised or appointed representatives.
Commercial lending is a logical development for mortgage brokers, as many of their clients will be self-employed and running their own businesses. Small businesses which have been operating for less than three years can find the task of obtaining finance difficult. This is precisely where organisations such as Commercial First and Lancashire Mortgage Company are attempting to set out their stall by adopting the approach used by many sub-prime lenders when considering applications from self-employed and small business borrowers.
Mortgage brokers have the opportunity to generate a worthwhile income stream from commercial business. Procuration fees are competitive – typically 1% of the value of the loan – and brokers can also charge an additional arrangement fee of up to 1% (the average loan value is usually twice that of residential mortgages). This compares favourably to mainstream residential mortgages, which pay between 0.25% and 0.5% of the loan and sub-prime mortgages, which also pay up to 1% of the loan value. Most commercial loan deals are also usually only available up to 75% of the value of the property, which means that many business owners will want to raise additional finance using their own residential properties as security – remortgaging is therefore a further opportunity, along with the sale of related insurance products.
Commercial lending provides brokers with an ideal opportunity to provide an ‘added value’ service to their clients. In an era where residential mortgages are readily available on the high street, via the phone and on the internet, brokers are increasingly having to accept that their role is to provide advice to customers who have specific issues to resolve – either non-standard circumstances or an impaired credit record.
It is becoming difficult for brokers to add value when it comes to arranging a standard residential mortgage, where the only issue is the cheapest rate. Commercial mortgages fit the intermediary channel very well: every application is different and clients want and value specialist advice. For borrowers, arranging a commercial mortgage is something they will probably have never done before and it is therefore understandable that they want ‘hand-holding’ through what they perceive to be a daunting process.
Commercial loans can be arranged for a multitude of purposes and they are not restricted to offices and traditional business premises. Shops, hotels and even undertakers can all have finance put in place. Lenders will take different approaches to the way in which they value commercial loan applications, and it is important for brokers to understand the differences between lenders. Some lenders will value a proposition on a straight ‘bricks and mortar’ basis, which is the way in which most residential property is valued. An alternative approach is to value on a ‘red book’ format, which takes account of the purpose for which a property is being used.
Take, for example, a wine bar. As a wine bar, the property may be worth £400,000 (the red book value) but, due to its location and layout, it may only have a value of £250,000 if it were sold as an empty building. Some lenders, typically banks and asset finance companies, may provide a valuation based on Pinder or Taylor reports – this basically looks at the worth of the business as a going concern. Different approaches will result in different valuation figures.
So what is needed to help this sector of the market mature and flourish? More lenders, a greater choice of products and more financial advisers being willing to give it a go, but there is good evidence that all of this is happening. I suspect that what is needed more than anything else at the moment is education – of both brokers and borrowers. Brokers need to build their knowledge of this sector and that will come largely from experience – by generating and submitting client applications. Similarly, borrowers need to understand the merits of buying rather than renting. Ironically, low interest rates, which have made commercial mortgages attractive, are turning borrowers away from other forms of investment and have put the spotlight on the benefits of owning commercial property as part of a balanced investment portfolio.
The rise of the buy-to-let market, another form of commercial property investment, has encouraged homeowners to consider other forms of investments, particularly bricks and mortar; not to mention investing in property abroad. Business people no longer take the view that business premises are a liability and are starting to realise their importance not only as a base for their company’s operations, but as part of their financial planning.
Commercial lending is going to grow in importance. Brokers should therefore ensure they are able to capitalise on the opportunities this growth will generate.
Procuration fees in the commercial market tend to be around 1% of the value of the loan.
New lenders are coming to the market but commercial sub-prime is where residential sub-prime was 10 years ago.
Commercial LTVs tend to stop at 75% offering the opportunity to also arrange deposit finance for many borrowers.