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Many business owners have considered, at one point or another, dipping their feet into the property market. The first question that usually pops up is whether you should buy the property in your name or through a limited company. Both options have pros and cons — and we’ll cover some of them in this article, along with some important considerations.
The first big decision you have to make as an entrepreneur is whether to start your business as a sole trader or establish your business as a limited company. A limited company is a legal structure that draws a clear line between the legal obligations of the owners and the business itself. Any entrepreneur that wants to set up a limited company to trade in the UK will need to register at Companies House.
Once incorporated, the limited company becomes a legal entity, thus the owners of that business cannot be held liable for any outstanding debt, and can only risk losing what they have invested in the company. In contrast, a sole trader can stand to lose everything. Hence, acquiring a buy-to-let property via a limited company makes sense given the tax benefits and availability of buy-to-let mortgages. And, importantly, if things don’t work out, you only lose what you put in.
In the last, the UK property market has offered a healthy return on investment, despite the cyclical nature of real estate. As a result, the sector continues to attract first-time buyers. When you purchase a buy-to-let property, you expect both an increase in the price of your property and rental income from tenants to cover your mortgage and maintenance costs.
Due to increasing costs, the net return (rent minus fees, maintenance, insurance etc) from investing in buy-to-let properties has decreased. It is doubtful whether capital appreciation will exceed the rate of inflation. Bear in mind that when you sell the property you will be subject to capital gains tax. This is distinct from inheritance tax, which is only payable when you inherit something of value. It is worth looking at a quick example of capital gains tax for a buy-to-let property.
Homes Ltd purchased a buy-to-let property for £700k and incurred £50k in legal/real estate fees, and a further £50k in home improvements. That year the owner and sole director of Homes Ltd, had personal income of £70k. Given that he never lived in the house when he sold the property in January 2022 he received £1m for it. But once the sale was agreed he became liable for £52k in capital gains tax, which equates to roughly 28%. In contrast, limited companies don’t need to pay capital gains tax, but instead, pay corporation tax at 19% (financial year beginning 1 April 2022.) So the lower tax bill for limited companies on selling a property might make it worthwhile, depending on your particular situation.
If you are thinking of building a property portfolio, the first step is to set up a limited company by registering with Companies House. First, you will need to think of a name for your company and an address. Second, you will have to list the directors and shareholders — you will only need one director, which can be yourself. Next, you will need to list a business activity that is related to letting a property.
After the company has been created, you will then need to open a business bank account and then register to pay corporation tax. Keep all of these records like annual returns and confirmation statements, unless you have an accountant who can help you with tax returns and business expenses. It’s not difficult to establish a property company, but getting a buy-to-let mortgage can be challenging.
If you are thinking of purchasing a buy-to-let property you will need to secure a commercial mortgage. On average, among high street lenders, you will need a 25-35% deposit for a commercial investment property. An aspiring private landlord, with a deposit of 40% plus will have access to the best deals available if the rest of the application is comprehensive. Commercial mortgage rates are usually higher than residential mortgage rates, as the risk posed to lenders is higher. And, because there are more residential lenders than commercial lenders, it’s more difficult to shop around. Consequently, commercial mortgage lenders often charge a premium.
High-street banks are the most obvious choice to secure a buy-to-let mortgage, but the eligibility criteria may be too stringent for many buyers. You will need to have a solid grasp of property development finance before you go down this road, as commercial mortgages can be complex for first-time investors.
This is often the reason why new buyers will turn to specialist lenders who can be accessed via lending platforms. The advantage of a lending platform is your specific needs will be matched with a lender who can offer the best rates and terms for the particular type of property you are looking to acquire. They will be able to find a lender that deals with higher-rate taxpayers or if you are already set up as a limited company. Always make sure that the lender you deal with is authorised and regulated by the financial conduct authority. If they are regulated by the financial conduct authority, you can have more peace of mind. Many scammers pretend to be legitimate firms. You can check if a lender is authorisied by entering their name or reference number on the FCA homepage.
The obvious benefits of the major banks are that if you’re eligible, their rates are tough to beat. They’ll often lend against the OMV and offer quite high LTV, which means you may get a larger mortgage, and the big banks are also more likely to have shorter and less onerous tie-in periods.
The downsides are that their criteria can be more difficult to satisfy. They require a fairly high DSCR, which means you need a higher income to service the same amount of debt than you would with other lenders, and if you have recent credit issues they’ll often turn down your application outright. Also, the process of applying for a commercial mortgage can take a long time with the major banks, with decisions regularly taking more than 3 months.
The challenger banks generally have a greater appetite to do business, and can help some of the businesses that their high-street cousins can’t. First, their DSCR requirements are usually lower, which means their income threshold for commercial mortgages can be easier to satisfy. They will also consider applications with credit issues in the last two years, which the major banks won’t usually do.
Challengers sometimes offer interest-only repayment options up to the maximum LTV, which makes sense for businesses who buy their premises for cashflow reasons rather than capital gains — for example where the interest-only mortgage payment would be less per month than their current rental payments.
The downsides of the challengers come down to cost and flexibility — in general, they’re more expensive than the high-street banks, and will often have higher exit fees for the duration of the mortgage, which may limit your options if your future is uncertain.
Challengers may also agree the commercial mortgage amount based on a 180-day marketing period rather than the OMV, which can potentially lower the amount you can borrow.
Compared to both types of bank, the smaller specialist lenders are a lot more flexible overall. If you want a commercial mortgage but haven’t been in business long, the niche lenders may be your best bet, because they are often prepared to lend to shorter trading histories and have lower affordability criteria (DSCR). In some cases, it’s even possible to use projections instead of trading history if they’ve been signed off by an accountant.
The specialist lenders may also be more flexible in terms of location, considering applications for mortgages in most areas of the UK and in some cases even offshore territories. These situations will be looked at on a case-by-case basis, however.
As you might expect, the downside of these types of lenders is the cost — they’re usually more expensive commercial mortgages than those you’ll get from the banks. The smaller lenders tend to lend against the FSV too, which is usually lower than OMV and therefore can significantly reduce the percentage of the property value you can borrow.
They’ll also have longer terms, and more restrictive exit fees. For example, you may have a tie-in period of 8 years on a 10-year mortgage with exit fees ranging from 2–6% — significantly more restrictive than the banks. Having said that, if your situation means you’re only eligible for the specialist lenders, the comparison with major banks is irrelevant.
Asset Lending & Property Team Lead
Vivek Seda is the Asset Based Lending & Property Team Lead at Funding Options. Vivek has been in the commercial finance industry for over five years, helping SMEs in the UK access over £40m of funding in that time. He also supports the business on working on corporate finance and structured transactions successfully funding Acquisitions and MBOs for businesses.
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