The article refers to purchasing property at auction, the essential planning and steps required to complete a successful property acquisition. Although the general property market faces testing times auctions are a market where deals can and are being done.
These circumstances have led to rapidly shifting criteria by lenders; with funding lines that were previously available either being withdrawn or altered beyond recognition, therefore how can I assist you raising finance? I manage a regional finance business with access to a panel of over 100 lenders, from high street banks and institutional investors through to merchant and private banks, private wealthy individuals, groups and venture capitalists.
Whether your a seasoned property investor or a novice, there is no disputing property auctions are where extraordinary bargains are to be had at for those with a keen eye for a deal. But how do you obtain finance in a market where LTVs ratios are falling without having to employ substantial amounts of your personal money.
So why use an auction? There are many reasons why people consider buying or selling at auction; they may want to move quickly, they may be looking for a plot of land for development, the property may involve repossession, or simply that they want a quick purchase without the risk of gazumping. Also many buy to let investors consider auctions because of the variety of properties on display at any one time and by nature there a good place to bag a bargain.
With properties that are re-possessed the lender who has taken ownership of the property owes a burden of care “an equity of redemption” to the client who they initially lent monies to. This means in practice that a lender who repossesses will generally offer these types of property in an auction and so they remain places where under value properties can be acquired.
Buying or selling properties at auction can have a number of advantages for both the buyer and seller. Most of the delays associated with property transactions are eliminated, the auction and completion dates are fixed, and the sale contract becomes binding upon the fall of the gavel.
This following tips section of this article will focus on the property transaction primarily from the buyers perspective with an emphasis on the lenders that operate in this market.
Tips
Inspect the property and do as much research as possible about the property and the neighbourhood. There are house price sites on the web to find out how much similar properties have sold for.
Ensure you read all written material provided by the Auctioneer, the Legal Pack and the HIP. It is important to fully understand the contents and the terms and conditions of the auction.
Ensure sufficient funds are available for the deposit which will need to be paid at the auction i.e. often this is 10% of the sale price but you should check what the deposit will be before the auction. Also check which methods of payment are acceptable (as some methods of payment may not be acceptable such as cash or credit cards).
Most Property Auction Houses do not advertise to the public as they are still aimed at professional purchasers so you will need to make enquiries on the Web or at your local estate agent to determine when and where a property auction that might include properties of interest will take place.
Be prepared to move fast. Property Auctions take place only three to four weeks after the property auction catalogue is first issued. If you are subsequently successful at auction you will then have usually between 14-28 days only to complete. A ten day default period will follow this where the purchaser will be charged interest and can in the worst case scenarios be used to extend the 14-28 day period. Check the Auction guide small print to see what penalties this will incur.
On the auction day an intention to bid will need to be registered (either prior to the auction or in the auction room). If the bid is successful the sales memorandum will need to be signed and the deposit paid there and then.
The buyer will often be responsible for the insurance of the property from the moment the gavel falls. The date of completion when the balance of purchase price will be paid and possession will be taken will be stated in the conditions of sale.
If a property being sold does not make it’s “reserve price” then although this is generally not disclosed the auctioneer will state that the current bids are close to the reserve price. A subsequent conversation after the auction may allow you to purchase the property below the reserve price if the vendor is in agreement.
This final “tip” is worth looking at in some detail; the level of due diligence a bidder should perform prior to the auction itself. Historically, if a buyer had 20-25% of the purchase price in their back pocket then they were relatively safe going into the auction, making a winning bid and then worrying about arranging the rest of the monies at that point.
These days with funding lines restricted it is worthwhile making sure that funds are going to be available beforehand. Unfortunately, without a full valuation report it is difficult for either an investment mortgage provider or a bridging lender to be able to give the applicant a definitive decision as to the level of funds they can make available, or the rates of those funds.
An agreement in principle can be indicated but this will always be subject to the legal due diligence and the valuation report. Although the legal due diligence cannot be arranged prior to an applicants “winning bid” one variable that can be eliminated is the valuation report and therefore preparation boils down to whether or not the applicant should cover the expense of a valuation report even before they have become a successful bidder.
If the applicant is looking at a number of properties then this can become an expensive exercise, but the ability of a valuation report to highlight potential lending problems, and to get an independent valuation not solely based on the purchase price – makes in our opinion the purchase of a valuation report pre-auction invaluable.
There has been a change in the market with regards the acceptability of taking existing valuation reports and having them retyped to the ultimate lender – for example, the largest company of surveyors in the country Connells no longer accept instructions for retypes, an instruction now has to be to a specific lender only. Likewise a lender will almost always want to instruct the valuation themselves. This may mean that even if a valuation report has been prepared prior to the auction the lender may require a second valuation report with subsequent expense to the client.
The need for a second report can be minimised by using valuers who are generally acceptable on most panels but there remain no guarantees. However, the initial valuation report should enable an applicant to pin down the lender to an exact loan amount bearing in mind no subsequent issues arise during the legal conveyancing and any subsequent report comes in at the same value.
Funding lines
There are two lines of funding that can be used to complete on an auction property purchase, a mortgage (either residential or investment) or a bridging loan. Each has their own specific advantages and disadvantages as follows.
Mortgages
Generally a purchaser of a property at auction will not be using the property as their main residence so this section will concentrate on investment or buy to let mortgages.
The main advantages when being used as a purchasing form of finance is that you can generally get a loan of up to 75% of the purchase price (so long as the rental coverage exists) and the interest rate will be very keen. Unless you were planning on reselling the property then a buy to let mortgage would be the ultimate form of loan to be secured on the property so by going straight into a buy to let mortgage you avoid two sets of finance costs, the first finance cost of the loan used to acquire and the second of the buy to let mortgage itself. There are disadvantages of using buy to let finance and they are as follows.
Speed
Although a buy to let mortgage can theoretically be put into place within 4 weeks (the general time scale of an auction purchase being 28 days), due to the underwriting process generally taking longer in the current economic climate, there are no guarantees that the mortgage will be in place before the 28 days are up and you could therefore lose your deposit.
Mortgageability
A buy to let lender will need the property to be in a mortgageable state. If the property is damaged in any way, without electrics, plumbing or even a kitchen/bathroom the lender will not be able to secure a mortgage against the property.
Retention
Retention is a watered down version of the previous disadvantage. We are seeing lenders’ increasingly retaining a proportion of the mortgage until the borrower meets certain pre-conditions. If for example the property is mortgageable but in a very poor state the lender may hold back for example £20,000 until the borrower has brought the property up to an “acceptable” standard. This may make completion impossible as the whole lend may be needed to make up the full balance of funds.
LTV
A buy to let lender on a purchase transaction will lend as a percentage of the valuation or purchase price whichever is the lower.
Rental Yield
Even if a valuation comes in on target allowing a buy to let provider to lend the percentage required if the rental yield comes in lower than the minimum required for that lend then this will reduce the loan amount available. If for example a £100,000 property has a £75,000 lend offered if the rental yield comes in over £400 and the rent comes in at £350 then the loan amount offered would drop to £65,000.
Bridging Loan
Due to these previous disadvantages of applying for a buy to let mortgage at acquisition many property investors will seek to use bridging finance to complete the purchase and then use buy to let mortgages to refinance out of the bridging loan. The key advantages to a bridging loan is that as an asset based form of finance it is quicker; there are less affordability hoops that an applicant has to go through to be judged applicable and in many instances the loan becomes in essence “self-cert.” A bridging loan can also be loaned as a percentage of the Open Market Value of the property so if you have bought the property under market value you can potentially borrow a higher percentage of the purchase price than with a buy to let mortgage. Be warned however, that the days of 100% lending against the acquisition property are more difficult to arrange, the lender will want to see at least some client contribution even with a strong valuation report.
Certain bridging loans will allow you to use equity in a secondary property to essentially top-up the loan to 100% of the purchase price with a first charge on the property being acquired and a first or second charge on the additional security.
Finally, a bridging lender will not be put off by the condition of a property in the same way that a buy to let lender would be. So long as the asset has an open market value, despite its condition then generally a bridging loan can be arranged as a percentage of that value. Some funding lines even allow you to draw down further monies against an increase in the valuation of the property to help with the funding of any development works or a release of capital when the property is refurbished – allowing the developer to use these released monies to move onto their next project.
As with buy to let mortgages there may be disadvantages when utilising bridging finance and the main ones are as follows.
Expense
For the speed and relatively self-cert nature of the bridging loan you will pay a premium on the monies borrowed with rates of between 1-2% per month. In addition to these rates there will be additional valuation fees, legal fees, set-up costs and potentially exit fees. Unless the applicant is borrowing at a very low LTV it is rare in the current climate for these fees to be “rolled-up” into the loan so the set-up costs will be deducted from the loan on draw down and then the loan will need servicing whilst outstanding.
Exit strategy
A relatively recent addition to buy to let mortgage provider’s criteria is that they will require a property to be held for a minimum period of 6 months before allowing an applicant to use their loan to pay back the bridging loan (there are new mortgage products available that don’t require this six month rule). At that point the buy to let loan can be borrowed as a percentage of the Open Market Value but the applicant will have had to pay 6 months of bridging finance rates by that point.
Retained Interest
As bridging lenders are aware of this refinance precondition, many lenders in order to guarantee that they will have their loan covered for the 6-month period will stipulate that 6 months interest is retained at source. That means on a gross loan that initially looked quite good at 65% of LTV, the net loan that ultimately ends up in the borrower’s hands can be as low as 55% LTV even though of course this now results in the borrower not having to service the loan over its term. There are advantages and disadvantages to whichever form of finance is being used to acquire a property at auction and these relative merits change as the lending criteria themselves change.
Certain aspects of the depressed property market currently being experienced make auction purchases more attractive than they were, however these same conditions affect the availability of the types of funding lines that remain. Always perform minimal homework even prior to approaching a broker/lender with some knowledge on the security and what you hope to do with it, the broker/lender can then fill in the gaps in your knowledge with what products are still available and what criteria may have changed in your favour.
There is nothing that an underwriter likes better (save apart from a concrete exit strategy) than actually seeing a current valuation report on the property that they are being asked to give an agreement in principle on for a lending decision. The valuation report if supplied by a surveyor who is also on their panel so much the better.
For the sake of losing a reasonable sum of money, that this valuation report may cost the information it provides may save you thousands in the long run.
In nearly every circumstance I have found ways to assist in and am happy to speak with you about financing your next or even your first auction property purchase. My colleagues can assist you to structure your portfolio in a tax efficient manner, minimising capital gains and other taxations. Thank you for reading this property guide. I hope the information contained within will prove to be profitable for you. I urge you to take action and get started on creating your own property portfolio plan and consider your next or first auction purchase. The following words may act as inspiration, and help you to reach for the stars, good luck.
Carl Schurz – “Our ideals resemble the stars, which illuminate the night. No one will ever be able to touch them. But the men, who, like the sailors on the ocean, take them for guides, will undoubtedly reach their goal.”