Continuing my series on little-known and creative killer property strategies, I now have a look at lender finance. This is where lenders are super-keen to lend you money to buy a property. What’s the catch?
Lender finance is the property opportunity where the mortgagor or lender of a property offers a mortgage or loan to a potential buyer as an incentive to secure a sale.
The property for sale is usually new and one in which the lender has the power to sell as a result of repossessing it from a defaulting borrower – normally a failing property developer, builder or investor.
The amount of loan offered can be as high as 100% of the purchase price.
FOR THE MORTGAGOR OR LENDER, IT IS A CHANCE TO SELL A PROPERTY WHICH IS PROVING DIFFICULT TO SELL. FOR THE BUYER, IT IS A CHANCE TO BUY AT A BARGAIN PRICE WITH A RELATIVELY EASY TO OBTAIN LOAN.
1. Availability of the strategy
This is not a strategy which will be available at all points in the property cycle.
The strategy is most likely to be available in a serious property slump where certain lenders find themselves financially exposed on account of heavy lending to developers or builders prior to a period of steep or prolonged fall in property prices.
THAT IS WHAT HAPPENED IN THE 2007-8 CREDIT CRISIS WHEN CREDIT DRIED UP SUDDENLY, MORTGAGES WERE DIFFICULT TO OBTAIN AND BUYERS WERE IN VERY SHORT SUPPLY.
Normally when developers fall into difficulty, lenders will repossess their properties and place them with selling agents to sell for the best available price to recover as much of their money as possible. However, such was the severity of the 2007-8 “credit crunch” such normal measures were not always enough.
That was particularly the case in holiday complexes in places like Spain, Portugal and Florida where an oversupply of properties crashed against the rocks of steep price falls and a credit squeeze. Price drops above 50% were commonplace.
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By making attractive-looking mortgages available to potential buyers, lenders selling repossessed property hoped to get the best prices upon selling and thereby reduce their losses.
Loans were not made available to everyone. Usually, borrowers with an excellent credit record and high disposable income were targeted.
The bulk of the properties were built for the holiday or rental market and lenders wanted to be sure that borrowers could meet mortgage payments, even if they could not find a tenant.
2. Advantages for lenders
The advantages of lender financing for lenders are obvious:
- It is a marketing device or incentive which can attract buyers to the repossessed properties of their developers in preference to other distressed developers – thereby minimising the extent of their losses.
- By offering mortgages tied to selling the properties at set prices, they may be able to achieve prices at higher levels than the open market would allow – again reducing their losses.
- By restricting their mortgage offers to borrowers of the highest quality, lenders can improve their debt profile or risk by swapping distressed developers for low-risk buy to let investors or owner occupiers.
Generally, lender financing is a way lenders can replace poor or failing debtors with better quality debtors with a lower risk of payment failure.
3. Buyer advantages
Lender finance offers a number of benefits to buyers, notably:
- The possibility of a bargain price coupled with a readily available mortgage. (Usually when prices are falling, mortgages are normally very difficult to secure.)
- Where lenders offer 100% mortgages, buyers are able to secure a much-coveted “no-money-down-deal.”
- If the property is offered with a tenant and management, there is the prospect of a hands-free investment – which may be particularly attractive if the property is abroad.
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4. Risks for the lender
Lender finance is not without risks for the lender.
- At the point a lender offers its mortgages, property prices may have further to fall – with the outcome that the value of their loan assets continue to fall.
- Even though they may have taken great care to target the best borrowers, further fall in property prices could lead to borrower default and ongoing bad debts on their books
- By continuing to take the properties as security, lenders run the risk of retaining responsibility for any inherent issues with them in relation to matters such as planning permissions, building regulations and guarantees.
Lenders can lower their risk generally by offering the lowest loan to value (LTV) the market will take.
However, in the last property recession things were so bad you sometimes saw lenders willing to offer 100% mortgages in an effort to secure sales.
THE HIGHER THE LEVEL OF BORROWING, THE LTV, THE GREATER THE EXPOSURE OF LENDERS.
5. Risks for the buyer
Greatest risk seems to rest with buyers rather than lenders.
It is easy for buyers to be dangerously drawn into this strategy without carrying out the full range of due diligence checks they would normally carry out when buying a property – especially if the property on offer is highly attractive and in a picturesque or enticing holiday or leisure destination.
The prospect of a ready mortgage – perhaps for the full price of the property – can blind buyers to the need to follow their specific property goals and plans and avoid being side-tracked.
If buying in a foreign country, there is the risk that the buyer – even if experienced – may lack local knowledge to carry out a thorough and accurate due diligence assessment of the property being bought. In a distressed market, things like return on investment and rental return can be notoriously difficult to get right.
Other pitfalls for buyers include:
- Paying above the true open market value on account of accepting the asking price of the lender in a situation where prices are still falling.
- Running the risk of substantial further falls in property prices after they have bought. (By the nature of things, repossessing lenders are unlikely to be offering incentive mortgages if the property market is picking up; acceptance of such incentives can therefore be regarded as inherently risky.)
- Under-estimating the prospect of finding a tenant and/or the realistically achievable rent, and thereby forced to subsidise the mortgage where the property is purchased to rent out.
Buyers also need to consider with extreme caution the growth prospects of any property they buy. Future growth is not predictable with any degree of certainty.
If, for instance, a buyer had bought a property with lender finance in Spain in 2009, in some places they would have seen its value fall by over 30% by 2016. Since 2016 prices have increased modestly: 1.67% in 2016; 4.47% in 2017.
IT IS VERY IMPORTANT FOR BUYERS NOT TO RELY ON THE ASKING PRICE OR VALUATION OF A LENDER – ESPECIALLY IN THE CASE OF A FOREIGN PROPERTY.
Buyers should arrange for their own independent valuation and any such valuation should take full and frank account of prevailing mortgage conditions including: falling prices, tenant availability and true rental levels.
It is also vital for purchasers to seek independent legal advice and assistance throughout. Especially in the case of foreign property, they should not sign any agreement or pay over any money prior to consulting a lawyer fully versed in the law of the particular jurisdiction concerned.
6. Foreign property risks
In the last property recession, lender finance was typically offered in
countries like Spain and the USA, where prices were particularly savaged by the effects of the credit crunch.
If the available property is in a foreign country, buyers must also consider and assess the generic risks associated with buying foreign properties, as well as the specific risks associated with buying properties in the particular country concerned.
THE HEADLINE POINT IS THAT THE AVAILABILITY OF LENDER FINANCE ALONE SHOULD NOT BE A REASON FOR BUYING A PROPERTY.
Only if the property fully stacks up as a good investment objectively, meeting your own personal property goals and plans, should you consider purchasing it.
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Rebel Property Coach
My website is: www.rebelpropertycoach.com
Categories: 06 Strategies