More and more investors are buying properties within a company – but what’s the deal when it comes to getting a mortgage?
Because of the punitive tax changes (due to Section 24 of the Finance (No.2) Act 2015) on personally-owned properties which are taking effect from April 2017, a growing number of investors are using Limited Companies and commercial buy-to-let mortgages to expand their portfolios as Limited Companies are not caught by this legislation.
To be clear, you’ll need a specific limited company product: you can’t buy or refinance within a company using a normal “personal” mortgage. The choice of company mortgages is more restricted but opening up all the time.
Many of these investors want to use a mortgage to buy the property or to refinance via a mortgage following a cash purchase – and this is where lots of confusion and misunderstandings kick in. While you’ll need a mortgage broker to take you through the finer points of what’s available, in this article we’ll set out the main “structural” issues that often confuse investors looking into this for the first time…
Trading company v Investment Company/SPV
For our purposes, a “trading company” is one that has a primary activity other than purely owning and letting property. For example, a manufacturing company might buy the building it operates from, or an IT contractor (who’s set themselves up as a limited company) might buy a residential property with cash that’s built up within the business. You might have a Property Trading company doing Flips or for instance, a branded lead generation / sourcing company or a Property Management Company (PMC).
An “Investment Company” or “SPV” (Special Purpose Vehicle) is a company that only exists for the purpose of holding and renting a property or several properties. For example, I might set up a company called “ProvProp Ltd” and have that company buy a house. The company doesn’t conduct any business activity at all – it just holds the property, has rent coming in and expenses going out. The SPV might hold one property, or over time more properties might be bought and held in the same company.
Both a trading company and an investment company are limited companies – although they are distinguished by HMRC as different activities and as such have different tax reliefs applied to them (or not), particularly in the case of a trading company which enjoys Entrepreneurs relief and Holdover relief on sale of the company. However, on starting up these companies you register the company in exactly the same way in both cases, and there’s nothing special you need to do to make a company an SPV or prevent it from being one, other than applying the correct Standard Industry Classification (SIC Code) to the company. For a property trading company this would be 68100 – Buying and selling of own real estate. For a property investment company this would normally be 68209 – Other letting and operating of own or leased real estate
How lenders see the difference
If a trading company wants to buy a property with a mortgage, the lender will need to look at the performance of the company. How strong is its balance sheet? What are its outgoings? What projections is it making for the coming years? That’s because if the primary activity of the company suffers (for example, the manufacturing company loses its biggest client) it might be unable to make its mortgage payments – or could even go bust.
For a Property Investment Company/SPV, none of this matters, as all it does is hold the property, so there’s no risk from its primary activity running into difficulties. But there’s another challenge: the company will, at least initially, have no financial standing at all, because (if it’s buying its first property) it doesn’t do anything yet.
The role of the directors
In both cases, a lender will normally take a personal guarantee from each company director. This just means that if the company ceases trading or is unable to pay its debts, the lender can pursue the directors personally for the money owing: you can’t just say “oh sorry, the company failed” and expect the debt to be written off.
This is particularly important in the case of a Property Investment Company/SPV (especially a new one), because the company doesn’t have any ability outside of the property rental profits to generate cash to pay its obligations. If for whatever reason the property is not rented, i.e. there are significant void periods, then it may not be able to pay its debts. It is therefore the often the ability of the directors to pay their debts, rather than the company, that matters to the lender. We’ll come back to this shortly…
How long must the company have been running for?
There’s a common misconception that a company needs to have been trading for a certain number of years in order to get a mortgage.
If a company wanted to get a business loan (for example, a manufacturing company wanted a loan to buy a new machine to increase production), this would be true. But for mortgages for Property Investment Company’s/SPV’s, this isn’t the case: you could set up a Property Investment Company/SPV today and apply for a mortgage tomorrow. (Actually, you could even apply for the mortgage before the company exists at all.)
This is because – again – the company isn’t really relevant here: it’s all about the directors.
So, where this leads us is…
To summarise, for the majority of investors who are thinking about using a limited company to invest through (primarily for the tax advantages), the situation is:
- Your company doesn’t need to have been trading for any length of time: you can set up a company and use it to apply for a mortgage immediately.
- You, as director, are what matters. The lender will want to see that you can meet your obligations – by looking at your job, income, credit history etc – in exactly the same way as they would if you were taking out the mortgage in your own name.
- You will be asked to give a personal guarantee – meaning that you’re personally liable for the company’s debt.
Effectively, the company is just a “tax wrapper”: the company takes out the mortgage to get more favourable tax treatment, but from the lender’s perspective it’s still all about you.
What if I already have a trading company?
Say you’re an IT contractor operating as a limited company. Should you use that company to buy property?
You should take advice from an accountant on this point as everyone’s circumstances differ, but in terms of mortgages it’ll be simpler to set up a new company to buy the property (a Property Investment Company/SPV). It means that the lender won’t have to get to grips with the performance of your existing business, and it maintains a separation in case anything goes wrong in either business.
What about getting the money into this new company to serve as a deposit? Generally speaking Investors find it more tax efficient to make an Intercompany loan: so the trading company lends the deposit to the new investment company, to save the director needing to draw the money out personally then put it into the new company which is very tax inefficient. See our Factsheet on Intercompany Loans.
How does the process of getting a mortgage for a Property Investment Company/SPV differ from an individual?
Really, it doesn’t: because again, it’s a pseudo-personal mortgage anyway. There are a few fairly serious points you’ll need to consider though:
- The lender will tend to charge a higher arrangement fee, because they’ve got more paperwork to look at: there’s now you and the company to consider.
- Your solicitor will generally charge more for the purchase too. They’ll need to check the company’s articles of association and prepare board minutes, which is straightforward but extra work nonetheless.
- You’ll generally be required to obtain independent legal advice about the personal guarantee you need to give. This means that another solicitor (who isn’t acting for you in the purchase) makes sure you understand what you’re guaranteeing, and watches you sign. For the lender, this means you won’t be able to wriggle out of it later by saying you didn’t understand what you were signing – and for you, it can mean extra expense in paying for this extra appointment with a solicitor.
Charges Against Limited Company Buy-to-Let Properties
Whilst the criteria will vary from lender to lender, investors should also be aware of the following requirements:
Personal Guarantee (PG)
In a situation of default and eventual repossession, the lender will normally “fire sell” the property (usually via an auction or receivership disposal) with the proceeds being used to settle underlying mortgage liabilities. Should there be any balance, the directors and shareholders offering the PG will be fully liable. In most circumstances, however, lenders will usually not take a charge on the investor´s main residence;
Used to protect a lenders interest in a situation of default and eventual insolvency, this is a formal agreement that stipulates either fixed or floating charges alongside the terms and conditions. This document is then filed at Companies House. Note that Debentures are typically “all monies”, in other words – existing, present and future loan advances will be secured.
To note the difference between a fixed and floating charges:
A fixed charge is a “hold” on property meaning that the borrower cannot dispose without explicit permission from the lender that has control of the asset(s).
A floating charge, in general terms, is a security on an asset that has an alterable quantity or value (such as cash, unfactored debt, raw materials, fixtures, fittings or other company resources used to generate business and trade). Within a buy-to-let lending framework, the borrower keeps control of the asset but in a repossession situation the floating charge effectively crystallises. SPV lenders are less likely to use these charges as they generally rank behind preferential creditors, prescribed-part creditors and salary distributions.
Finally, the lender will want to make sure that is well protected through a Deed of Priority:
Deed of Priority
An agreement that will be drawn up should there be one or more other lenders taking security over a SPV and will establish who will be “first in line” to recover any net proceeds in an insolvency scenario. The advance will be made against the security of a particular property and some lenders may agree to have recourse against the assets of an associated and/or parent company. However, most would normally prefer to operate exclusively on a “ring-fenced” basis within each SPV.
What is the mortgage market like for limited companies?
It’s improving all the time. Because so many investors are going down this path as a result of the tax incentives, lenders are increasingly offering limited company mortgages so they can win investors’ business.
However, at the moment there isn’t as much of a range – and therefore rates are a little higher to reflect the lack of competition, and fees are often higher due to the extra work involved.
You’ll also need to consider that limited company lending can be particularly limited for more “niche” investments. For example, say there are six lenders in the whole market who will lend against properties that cost less than £50,000. If four of these lenders don’t offer loans to limited companies, you’ve now only got two to choose from.
Although there is nothing stopping investors from approaching lenders directly, working with an experienced mortgage broker is usually the best route. A good intermediary will find the best products suited to your own financial circumstances and the property in question. Many also have direct relationships with underwriters and, from time to time, exclusive access to attractive deals.
As mentioned previously, mortgages within Limited companies tend to be more expensive with 75% loan to value requirements largely being the norm (anything higher is likely to come with a number of associated conditions). As with individual buy-to-let mortgages, investors will also incur an arrangement fee and be subject to early redemption charges (ERCs). It should be noted however, that the costs of the more advanced form underwriting, are not necessarily passed on to the borrower.
This Factsheet is a summary of this subject for property businesses and is not intended as advice. This summarised information is based upon our understanding of current laws and practices which may change. Individuals should take personalised advice.
For Further Information & Services
Contact Ian Spreadbury on 0781 300 9682