The stability of the commercial property market, indeed the property market as a whole, depends upon finance, the management of large amounts of money. Actually, it is not so much the stability that would not survive without regular injections, but the sustainability of current prices.
At low interest rates, it is amongst those of an educated logical disposition apparently a no-brainer not to borrow as much as possible and make a profit from the difference between loan rates and higher yielding investments. Conversely, being the business of lenders to lend, it makes sense for lenders to lend as much as possible, especially since loan arrangement and account fees can be charged, interest based on LIBOR rather than Base Rate.
Of the different types of loan available to private investors, probably the most common is property-specific: a loan for each particular property as the need arises. The agreement between lender and borrower is based on a loan-to-value (LTV) covenant, the percentage that the loan bears to the value of the property. The capital value of the property is based on the informed opinion of a valuation surveyor. Usually, there are two valuation figures: market value and forced-sale value. Market value is not necessarily the price paid, it could be more or less. Forced-sale is supposed to be worst-case scenario.
The level of risk is assessed by the lender and the terms of the loan agreed with the borrower. Every so often, at least once a year, the lender checks the value of the property to ensure the LTV is not in breach. Depending upon the type of property and/or what has happened to the market, and/or whether there is anything else to do with the management of the investment that could affect the property; a year may not be long enough to know whether the value of the property has changed.
That doesn’t necessarily mean the borrower wouldn’t be concerned about the prospect of having to reassure the lender that everything is going according to plan. When that plan includes a rent review and the expectation of an increase, a need to know the result of the rent review before the lending review of the LTV could lead to the rent review being agreed without a fight. Either that, or for any other properties belonging to the borrower being sold to improve the borrower’s own liquidity.
An investor whose funding arrangements are property-specific is generally in a weaker position in the banking relationship. I reckon it is not that lenders want to have the upper hand, so much that lenders much prefer to deal with property professionals that know what they’re doing and are likely to have a sizeable portfolio, rather than those for whom property investment is not the primary occupation and that may only have one or two properties. Another snag with what might be described, politely I hasten to add, in lenders dealing with the ‘amateur’ landlord, is that the asset quality of property is not likely to be as secure, its potential for long- term performance doubtful.
Generally, amateur landlords are better at picking losers than winners. Mostly, the sort of property they buy is of the sort that anyone in their right mind would not touch with a bargepole. That’s not to say the property would be problematic; simply that the investment potential is zilch. Having discovered the hard way that being a landlord is not a sure thing on the road to riches, one way landlords like to ensure the no-brainer margin is maintained as wide as possible is to deal directly with the tenant.
Whether that approach succeeds depends upon how knowledgeable the investor and/or whether the tenant is represented by an experienced adviser. When they get nowhere they decide to take advice, in my experience, which may not be representative; amateur investors that have, to my mind, got it wrong, regarding a recent purchase, or whose expectations for existing holdings are unrealistic, will nevertheless clutch at any straw or ray of hope that somehow a capital enhancement can be procured. With purchases at current prices, what fascinates is not only where the money comes from for such landlords to be able to afford to borrow, but also that the mortgagees have been willing to take the risk in lending.
The percentage of equity (the investor’s own money) that the lender requires of a borrower will depend on the lender’s assessment of risk in lending to that particular borrower, also competition in lending criteria between different lenders themselves. Until quantative easing and before lenders could borrow more cheaply from the wholesale money market, the margin for risk was more stable.
Nowadays credit is conjured up out of thin air in the hope that the majority of loans could be repaid before depositors would want their money back. Although minimum capital requirements have been lifted, the stress-tests that the banks have to pass to gain central banker approval are to an extent aided by an implicit assumption that if need be the government, on behalf of the tax-payer, would then come to the rescue with a bail-out.
Assuming that they cannot fail and labelling anyone that doubts the wisdom of the purchase as old-school, only young investors are certain they know what’s going to happen next. Doubts are alien. Doubts get in the way and prevent good things from happening.
Doubts can also save you from a bottomless pit. Property prices, particularly at auction where feverish excitement is rife, are not necessarily an indicator of a property’s value. Much of it is merely gambling on the foolishness of other investors. In an easy money environment many or most property will be way overpriced, but that doesn’t mean they’re going to come down in value any time soon. For that, there has to be more room for doubt.
The Rent Review Specialist