Commercial Mortgages Are More Than Meet The Eye – Literally!

 

The term ‘commercial mortgages’ is a wrapper for number of different property related finance products. As a business we use it to describe a large amount of the work that we do for clients – and the industry commonly uses this terminology.

The trouble with a single header for multiple products – all of which are quite different in the requirements that they meet – is that in the end the header becomes a bit like an acronym – and you can’t remember what it actually means!

It can be confusing that when we say ‘mortgages’ we are actually also including short-term finance products; in this sense ‘mortgages’ refers to the fact that all of these products are all secured on property.

So when Fiducia Commercial Solutions says ‘commercial mortgages’ what do we actually mean? And who can use them? Oh, and what are they?

Commercial Mortgages:

Commercial mortgages are used to fund the purchase, or refinance of, commercial, semi-commercial or residential properties – and as we explain below the funding reason can be both to occupy the building, and as an investment.

In general terms there are 3 main uses for commercial mortgages:

•       Owner-Occupier: The purchase or refinance of the property where your company is currently trading, or the purchase of a new property to move to and trade from
•       Commercial Investment: The purchase or refinance of commercial or semi-commercial property that will be rented to another company to trade from – essentially a commercial Buy-To-Let investment
•       Residential Buy To Let: An individual or a limited company (‘SPV’ or Special Purpose Vehicle) can purchase residential property to let as an investment, and professional landlords / Buy-To-Let limited companies use these mortgages for the same purposes

In case you were wondering, residential properties are all part of the day job for Commercial Finance brokers! Just wanted to throw that out there – as it does seem a bit of an oxymoron!

Easy assumption is that all we would look at is commercial buildings – shops, offices, pubs, restaurants, factories etc. But the ‘commercial’ applies to the purpose, not the property.

Commercial mortgages are, just like residential consumer mortgages, available with fixed or variable interest rates over a range of years, and the amount that you can borrow is set as a ‘Loan To Value’ (LTV) percentage of the property value.

Existing property holdings with equity value in them may be considered towards the deposit by some lenders as security.

Affordability, Affordability, Affordability!

The amount that you will be expected to have a deposit can vary according to different factors, including:

•       If you are a commercial owner-occupier: the sector that you are in / your company’s recent financial performance / they type of property you are financing
•       If you are a commercial investor: the type of property you are financing / the sector that your tenants are in / the amount of revenue generated from the lease/s
•       If you are a residential investor: commonly come with a higher LTV than commercial property; affordability driven by valuer’s confirmation of the achievable market rent, which is stress tested against mortgage payments

We want to cut through the acronyms and smoke and mirrors to show that far from being some sort of ‘dark arts’, lenders use the same process to evaluate your business as we all might do our own personal finances.

With investment mortgages the maths is relatively straightforward; you will have a commercial lease or residential tenancy agreement in place with your tenant and the lender will ‘stress’ your mortgage with simulations of interest rate rises to ensure that even if rates were to rise from their current levels then the rental income still makes the mortgage payments affordable.

Commercial Mortgages for trading businesses have far more moving parts, as affordability is based on the future trading performance of the business.

In the absence of a crystal ball the lender has to use past performance as a guide to whether your business can service the mortgage moving forward.

Again we can draw a similarity here with a personal mortgage application – your prospective lender would want to know all about your income, together with the other debt and outgoings that you have to service regularly. From this they will derive how much ‘headroom’ you have in your finances to be able to afford the mortgage.

Bridging Finance:

This effectively does what the name suggests – bridges the gap from one point to another in a financial sense, and are a short-term property finance product, between 3-24 months in term, but the ‘common’ term is 12 months.

At the end of the loan the ‘exit’ from the loan for your company is the repayment of the loan from the disposal of the property, or ‘re-financing the bridge’ with a long-term finance product.

Bridging loans can provide a quick route to property purchase, and are commonly used to purchase property at auction and for circumstances when the normal conveyancing cycle would take too long to complete the purchase in the required time frame.

Bridging is a means to refurbish commercial or residential property, or funds to develop property – from light / cosmetic refurbishment of existing structures to ground up development of land.

‘Just’ for property transactions? Well, no.

Bridging is of course based on property as the security for the loan, but the business reason could be to release equity from a property already held by a business or director. Therefore it could be said that bridging finance is a cash flow tool for raising working capital too.

Given the specialist and short-term nature of bridging loans, interest rates can be higher than traditional commercial mortgages.

Development Finance:

On the surface a complex area of finance – but you can start to lift the lid on its application for you and your business by looking at the amount of structural work that is required on your project.

Finance terms that are available to you vary according to:

•       the initial value of the property / land (Purchase Price)
•       the costs and fees associated with the development work (Cost Of Works)
•       the projected value of the completed development (Gross Development Value)
•       your previous experience of development

Commonly used terms for variants of development:

•       Light Refurbishment: Cosmetic refurbishment with no structural changes. Includes: Kitchens, Bathrooms, Windows, Doors, Decoration and modernisation
•       Heavy Refurbishment: Contains cosmetic work, but usually renovation work including structural changes (internal walls) or changes to the footprint of the property
•       Ground Up Development: Commonly starts from vacant land, can include demolition and rebuild projects

Lenders are likely to look for projects where planning permission is already granted, even if you might vary that once you have acquired the site.

 

So it is worth your knowing that ‘commercial mortgages’ isn’t a header for a single product – and there is no ‘one size fits all’ solution.

But that is where a commercial finance broker can add so much value to you – we can listen to your full requirements and match you with the most suitable lender and product from our large ‘whole of market’ panel of lenders.

We do the legwork so that you don’t have to – how do you want to put the roof over your business or investment?

Mark Grant, February 2022.

mark@fiduciagroup.co.uk

Funding Your Business - From ‘Cradle to Grave’..

 

I’m not on this occasion talking about funding premises for an early years’ childcare business, or a 30 bed elderly care home – but if you are looking for that then my e-mail is at the foot of this Blog!

A lot of companies start their trading process with either an order from a client that they have to fulfil or having to ‘stock up’ on the goods that they sell, because customers will expect a quick delivery after they make a purchase.

Depending on the nature of their business, companies will either buy raw materials that they manufacture or assemble to create finished and saleable goods, or they will purchase ‘finished goods’ from a manufacturer or supplier – packaged and ready for delivery to their customers.

At this initial stage of their process how they fund the purchase of goods or materials has to be thought through, in combination with how they will get paid when they sell to their customers; therein lies the analogy of ‘cradle to grave’ in terms of a company’s trading process.

Trade Finance can be used to fit a wide range of business types:

o   Purchase raw materials or finished goods

o   Trade can be with UK based companies as well as overseas

o   Commonly Trade Finance lenders are also experts in FX

o   Goods can be pre-sold, or to provide a stock for sale

Your business can improve prices and terms from having the backing of a Trade Finance facility and being able to pay earlier, and Trade Finance facilities can be flexible to accommodate deposits if required on order and other costs including import VAT and shipping/freight if these are applicable to you.

In the current environment, where companies are dealing with prices rising in their supply chain, delays in receiving their orders and inflated freight and transport costs, working capital can become strained without much notice.

Funding the acquisition of goods or materials that are either pre-sold or to provide you with stock leaves crucial cash in the business to cover overheads and unexpected demands on the company.

The following are just general illustrations of how Trade Finance can work for a business – and also how you could be covered from ‘cradle to grave’ with Invoice Finance after you have sold your goods:

Many Trade Finance lenders offer Invoice Finance facilities to their clients for good reason – because they can then offer your business a seamless process without causing a large cash call on the company at any stage of your trading lifecycle.

It of course depends on the nature of your business as to whether Invoice Finance is suitable for how you deal with your customers – but if it is suitable then Example 2 demonstrated that you could complete the entire transaction without any significant draw on your cash flow.

A common objection to both types of finance is the cost of the facility and funding these transactions; beyond the fact that lenders that we work with offer extremely competitive rates on their facilities, I would suggest that these are a great example of the ends justifying the costs of the means.

The cost of funding will slightly reduce your margin on the transaction – but with very little effect on working capital, and consequently you are still able to meet other demands that you face – as well as to fulfil any opportunities that are presented to you.

We understand that every step of ’getting stock’ to ‘getting paid for stock’ can be a drain on your cash flow that you might not be able to afford without funding support – and possibly an opportunity cost if it leaves you unable to take up new opportunities.

 

If you have a supply chain, and supply customers, why not talk to us about where the ‘pinch point’ is for cash flow in your business on your road from cradle to grave?

Mark Grant, February 2022.

mark@fiduciagroup.co.uk

Commercial Mortgage? Forget Location, it’s about Affordability, Affordability, Affordability!

 

We are seeing a lot of activity in Commercial Mortgages – both owner-occupier and investment – and just like with a personal mortgage it is logical to think that one of the primary things that a lender will look at is whether you can afford to repay the mortgage – both now and in the future.

We want to cut through the acronyms and smoke and mirrors to show that far from being some sort of ‘dark arts’ it is the same process they use to evaluate your business as we all might do our own personal finances.

With a Commercial Investment Mortgage the maths is relatively straightforward; you will have a commercial lease in place with your tenant and the lender will ‘stress’ your mortgage with simulations of interest rate rises to ensure that even if rates were to rise from their current levels then the commercial lease still makes the mortgage payments affordable.

Commercial Mortgages for trading businesses have far more moving parts as affordability is based on the future trading performance of the business.

In the absence of a crystal ball the lender has to use past performance as a guide to whether your business can service the mortgage moving forward.

Again we can draw a similarity here with a personal mortgage application – your prospective lender would want to know all about your income, together with the other debt and outgoings that you have to service regularly. From this they will derive how much ‘headroom’ you have in your finances to be able to afford the mortgage.

Debt Coverage Ratio (DCR)

I did say that we wanted to cut through the acronyms – so it’s high time that we started to use them!

When a lender takes away your outgoings for debt from your income, they will be left with the current ‘headroom’ in your finances from which your company’s mortgage can be paid moving forward. But there are still variables in this number such as your business turnover decreasing, or your other costs or debt increasing.

So the lender won’t want to see that your headroom is equal to (or less than) your future mortgage payments, but a multiple of them. This is called your Debt Coverage Ratio (DCR) – and commonly lenders are looking for a DCR of 1.5x to 2x.

Calculate your Debt Coverage Ratio (DCR):

Annual Net Income Divided By Annual Debt Payments = Debt Coverage Ratio

For example:

£82,500 Net Income Divided By Annual Debt Payments £45,000 = DCR of 1.83

Using the ‘right’ Net Income

Of course it couldn’t be so easy that the lender could just cherry pick a line from your company’s last set of filed accounts and use that; oh no, they have to go and make us calculate another number that they use in their affordability calculations too!

Your existing company accounts include existing lease or mortgage payments but the lender is evaluating future affordability of a new mortgage – so the ‘net income’ that they use will have certain items added back onto it.

This generates what lenders generally call ‘adjusted net profit’ or ‘adjusted EBITDA’.

We are not qualified accountants, so these calculations really do stay on the ‘back of an envelope’ for our purposes. In simple terms take the profit before tax and add back to that items such as:

•       Lease / Rent
•       Depreciation
•       Amortisation
•       Directors’ Dividends

Case Study – ABC Ltd

We can take the case of ABC Ltd, and then put into practice the above construction of the Net Income, and then use that along with the debt in the company to derive their Debt Coverage Ratio (DCR).

•       ABC Ltd. currently pays £40,000 pa commercial lease
•       Annually ABC Ltd. make £15,000 in Asset Finance payments
•       They are applying for a 70% LTV mortgage on a £465,000 purchase price, meaning a £325,000 loan, estimated by the lender to be £32,000pa initially in annual payments

Accounting for the pandemic impact

Like a lot of businesses in the country, ABC Ltd was Covid impacted, and so if we moved forward to the current period, and included the financial year 2020/21, then that doesn’t present on its own a Debt Coverage Ratio (DCR) that the lender would see as indicating affordability.

The obvious addition to this table is the fact that the lender will strip out Covid related grants and income that are one off in nature, and this reduces the DCR to levels where the lender would not arrive at a positive decision for affordability.

But we are now three quarters into the next financial year for ABC Ltd, and thankfully into recovery mode for many business post-pandemic restrictions, and so lenders are willing to include the accounts for this new current financial year in their assessment.

The 9 months from April to December 2021 actually showed a 25%-30% increase on turnover compared to the 2019 and 2018 figures for the same period due to a ‘post restrictions’ surge in demand, and so there is something here for the lender to work with and progress for ABC Ltd.

 

We are seeing a lot of demand for, and activity in, Commercial Mortgages – and armed with the accounts and facts we can work with lenders to find suitable and affordable solutions for the roof over your business or for your commercial investment property.

Mark Grant, February 2022.

mark@fiduciagroup.co.uk