By Aaron Barry – Client Services Director. 02nd October 2019
The buy-to-let sector evolution in recent years has led to an environment where the common approach for those looking to build a sustainable portfolio is to use a limited company structure.
Most of our landlord clients intend to use limited companies to buy rental properties in the coming year – because of the tax changes which came into effect in 2016.
This blog details some of the key fundamentals of buying rental property using an SPV.
Why use a limited company SPV (special purpose vehicle) for buy-to-let properties?
Firstly A special purpose vehicle (SPV) for buy-to-let purposes is a limited company that is created to solely hold property and nothing else. SPV’s are preferred as they are easier to underwrite relative to trading limited companies.
Buying properties in this way is not without its downsides. As an owner of property within an SPV, you will incur corporation tax on profits in addition to income or dividend tax when you or any other directors withdraw funds, however- there are some allowances.
SPVs have more administrative obligations, including, producing annual accounts in a fixed, statutory format of which abbreviated versions will also have to be filed at Companies House and be publicly viewable (bar specific circumstances). Limited company buy-to-let loan Interest rates tend to be higher also.
However, there are several benefits :
When profits are compounded over an extended period within a corporate vehicle, larger amounts of capital can be deployed for future investments than would be the case if the funds were carried forward in one’s own name. Therefore, ‘mini-portfolios’ can be built where an investor can stop buying in one company (SPV) and buy in another. Each will pay down all its debts and/or generate a cash positive surplus to reinvest in properties within new SPVs as the overall business grows and becomes more efficient.
Family members can be more involved through becoming shareholders and directors, resulting in potential inheritance tax (IHT) and capital gains tax (CGT) benefits.
As a company director, investors can also pay money into a personal pension. Here, the amount of profits that the company earns is reduced and therefore the amount of corporation tax owed also decreases. Money in Self-Invested Personal Pensions (SIPPs) can also invest in commercial properties.
Buy-to-let SPV property purchasing using mortgage finance
Clearly this the area where Specialist Property Finance can help as we already know the lenders that are active in this market and have an appetite to lend to your specific type of project be it HMO, SERCO or a Buy-To-Let in the usual way. Our relationships with the underwriters and, challenger banks provides access to favourable products and understanding lenders.
New application processes are typically 6-8 weeks but can be ‘fast tracked’ in certain circumstances. However if your purchase is time critical you may want to consider an undrawn debt facility coupled with a bridge finance facility to enable you to act quickly.
Most investors refinance a bridge loan as soon as possible to a term debt product to reduce the cost of cash and maximise the profit return on the investment.
Typical terms and rates for bridge and term loans are 75% LTV of purchase price (however some lenders will provide 75% of market value) and 1% per month interest rolled up into an interest only loan. Or for the purchase on term loan this is far more likely to be 75% LTV of purchase price and circa 4% over Libor (currently 0.8%). Some lenders will also provide an additional 10% of loan funds for refurbishment costs.
Typical fees include bank arrangement fee (1.5% – 2%), legal fees circa £750, Valuation fee £230 – £1670 depending on value and calculated on a band process.
To ensure there are no administrative hold ups, you should have your company formally established with a bank account. Buy-to-let SPV lenders will need income assessments for loan serviceability and will typically require at least 2-years’ worth of SA302s from HMRC, tax overviews, 3-months bank statements and, if you are employed, your latest P60 and three of the most recent payslips.
Up-to-date information on your existing property holdings may also be requested including full address(es), value(s), outstanding mortgage(s), lender names, monthly payments and a rental income schedule.
We also suggest having portfolio, cashflow forecast and income/expenditure spreadsheets in addition to up-to-date tenancy agreements and a simple business plan to provide an Investor outline.
Prior to the lender undertaking any background checks, it is also advisable to verify both your personal (consumer) and business credit scores with a reference agency such as Experian. Any mortgage application will be classified as a ‘hard search’ and therefore leave a footprint on your credit file.
Structuring a limited company for buy-to-let purposes
From the outset, the lender will want to know that the corporate structure is set up for the sole purpose of holding property. A Limited Company SPV therefore must have limited activities. The SPV will normally be created recently and registered under one of the following Standard Industrial Classification of Economic Activities (SIC) codes:
- Buying and selling of own real estate (68100); or
- Other letting and operating of own or leased real estate (68209)
Should a borrower already be a director of an operational SPV for buy-to-let purposes and the annual revenue is less than £25,000, most lenders will request to see at least two years’ accounts as well as personal income, expenditure and other related evidence.
Background checks will be undertaken on the individual applicant(s) and director(s). Any evidence that a landlord would not be able to realistically surmount any ongoing buy-to-let holding challenges such as voids, impending refurbishments and other perceived risks can lead to a decline.
The lender will want to see no signs of future revenue through the company of anything other than letting property and will normally also refuse mortgage finance should there be concerns over other trading activities. For instance, a branded lead generation/sourcing company or a Property Management Company (PMC) should generally not be used.
Some specialist lenders may not reject such applications – however, investors should be mindful that there will typically be requests for further information (such as demonstrable solid net profits after dividend and salary withdrawals with no unexplained losses); funding limitations (higher down payment requirements); personal guarantees/a fixed or floating charge debenture over the company to which they are lending.
Here, the application period will also take longer as further checks are carried out on the company in addition to the individual and the property itself.
Should the SPV have the correct SIC code but has previously traded in another field, lenders may be willing to move forward providing that the directors can formally confirm that the company will be used for letting purposes exclusively.
Loans between companies are entirely possible but will invariably add to the already complex nature of the underwriting process. For example, in a scenario where a borrower would like to use an intercompany loan from his/her trading business to fund part or all of the deposit, the lender will want to ensure that there are no unexplained losses. Once the funds are extracted from the trading company, the business will need to remain suitably robust and well-capitalised.
In addition to confirmation of a clean credit rating, any capital being injected into the transaction will need to be readily transferable.
Security requirements for buy-to-let special purpose vehicles
While the criteria will vary from lender to lender, investors should also be aware of the following requirements:
First Legal Charge – this is the lender’s primary security and this is a first legal charge over the property asset being funded. It gives the lender the opportunity to ultimately take possession of the property in a default situation.
Personal Guarantee or PG – Most lenders will require a personal guarantee from all directors with a shareholding of 20% plus in the SPV company. In a situation of default and eventual repossession, the lender can ‘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, in other words these PGs are generally not supported by additional security.
Debenture – Most lenders will require a debenture and this is often described as a fixed and floating charge over the company’s assets.
Deed of Priority – this is an agreement that will be drawn up should there be one or more other lenders taking security over an SPV and will establish who will be ‘first in line’ to recover any net proceeds in an insolvency/repossession 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.
I would advocate that an SPV avoids a situation where a deed of priority has to be put in place to set out the priority rankings of each lender in the context of their respective debentures. Not only is there a cost involved but we are increasingly finding that some lenders are unwilling to compromise their position and this could impact on the transaction. The best way to avoid these issues is to set up a new SPV for a property purchase being funded by a different lender.
Understanding responsibilities as a director of an SPV
It’s important to understand your responsibilities as a director of a limited company.
Alongside HMRC returns, annual accounts will need to be submitted to Companies House.
Investors may also be required to notify the banks and loan providers of the performance of the company and submit year-end financials. You will need to be on top of your bookkeeping and related administration at all times.
Some lenders, for example, will want to see accounts before three months of the year end. However, much will depend on how choosy the lender is. For example, some are satisfied with the information received during the initial due diligence process, but others are not.
The lending market is constantly evolving and new rules and policies are being created following precedents the banks have experienced in single or multiple cases. Its important to keep checking in with us if you have a project coming up so you can adapt to the situation and be lender ready if you would like project funding.
Contact Aaron Barry – Client Services Director to discuss your project.