Commercial update

Angela Faherty

October 20, 2007

Commercial mortgages are more than just the flavour of the month. They are turning into the flavour of the year. Not only are brokers waking up to the huge potential of commercial finance but lenders too are falling over themselves to attract their business.

Lenders are shrewd enough to want to build up a strong relationship with the broker, not just on the residential front but now on the commercial side as well.

Both parties look like they have spotted a growth market and are keen to help each other capitalise on it.

Like a supermarket, many lenders want to be a one-stop shop for brokers offering all finance solutions products under one roof. Failing to offer a decent commercial mortgage package could be a risky de-selection.

Even with the present credit crunch, there has been no dramatic repricing of commercial loan products. They continue to be highly competitive. This is a perfect opportunity for mortgage intermediaries to take advantage of lenders appetite for business.

Commercial offerings

With many lenders falling over themselves to attract your commercial lending deals, consider what else they have to offer, which may include excellent broker relationship management, speedy processing of the loan, as well as other additional benefits.

The vast majority of lenders engaged in the commercial mortgage market deploy high-quality sales personnel and underwriters to support the intermediary market. But this doesn’t always mean value is being added to the service. Brokers report inconsistency. Many residential brokers simply don’t wish to get directly involved in commercial mortgages due to the specialism and complexity.

At West Brom Group we are launching a new specialist subsidiary to leverage the market opportunity. This new entity is in response to the fact that we see commercial mortgage broking as a very big new sector – a massive missed opportunity for most residential brokers. By investing heavily in infrastructure and expertise, we intend to make it easy for mortgage brokers to handle commercial mortgages and to generate significant new income streams. Easily.

The ball is firmly in the lenders’ court to differentiate their offerings. One under-rated quality is the level of expertise needed to find and secure a decent commercial mortgage. This is where a good broker earns his corn.

Halifax and Alliance & Leicester (A&L) are just two lenders that are pulling out all the stops on the commercial front. One driver behind Halifax’s decision could be the skinny margins and its slipping market share of residential loans.

A&L’s push appears to be a serious foray into business banking. The strategy probably works on the premise of offering a decent commercial mortgage proposition, then cross-selling current accounts and a raft of other insurance and associated products.

Halifax came up with an innovative deal which has been successful for the group – a commercial offset mortgage. The rate is as good as the innovative concept. Many businesses are flush with cash so why not use this liquidity to offset the cost of borrowings? The arrangement fee is on average less than 1 per cent and around half a per cent makes it back to the broker as a fee. This could be a major factor in how Halifax has doubled its commercial lending book within the last 18 months alone.

An upward trend

Market statistics relating to commercial mortgages are not as easy to come by as those for residential, but there is definitely an upward trend. Commercial development activity is often a good indicator of what’s happening in the market, and the good news is that growth in commercial development is at its highest in three years. This includes both the public and the private sector. More development activity clearly means more opportunity for lenders and brokers to originate mortgages.

Property transactional data shows that private individuals made a staggering £3.7 billion of investment directly into commercial property during 2005. This supports the trend of private landlords looking to branch out and add commercial holdings to their portfolio. Lenders are experiencing significant business from commercial borrowers of all shapes and sizes; there is prosperity in the £150,000 to £250,000 range as well as in the £1 million plus bracket.

Many small businesses and sole practitioners want to buy the freehold to their premises or are simply refinancing the deal to take advantage of cheaper rates.

Leaseholding can be fraught with problems and raises uncertainty about how long the arrangement will last. Owning the freehold eradicates this uncertainty and provides reassurance to the small business.

There is also a very strong and resilient band of private investors looking to make greater returns from property than they do at present. This includes seasoned buy-to-let investors who are starting to get anxious about squeezed rental yield in the residential sector. They may already own rental flats or houses and may be looking to spread their risk by diversifying into commercial property.

And there is much more variety available. With residential buy-to-let you have a basic choice of buying a flat or a house to lease to tenants. But with commercial property investment, it could range from a shop with flat above to a serviced office block. It could even be a warehouse or a hotel room.

Speedy development

The commercial property market is developing at great speed. Some equity investors may have been panicked by the Summer’s volatility in world stock markets and may now be looking for an alternative home for their cash.

Property has always been a favourite port in a storm for worried investors in times of turbulence. People like to see a tangible asset in terms of where their money is being invested, and now their horizons are changing. From a modest flat in a university town or busy city centre, investors are now considering retail space and offices. It’s a perfect opportunity for a broker to capitalise on.

Lenders are fully supportive and most of the big boys have dedicated staff ready to handle the business and get the application handled quickly. The big four banks still attract the lion’s share of the commercial lending market through a combination of inertia on the part of the customer and lack of knowledge that better deals might lurk elsewhere.

Broker power

With such a fiercely competitive market, brokers have the power to shop around for the very best deals and for broader lending criteria. Commercial mortgages can come in at about one to 2 per cent higher than standard deals but even these margins are under competitive pressure.

If clients wish to borrow a decent amount of money, they should find it easier to negotiate a keener rate. Where a transfer of their business banking is stitched into the deal, the rates on offer might get even better. Despite the negotiable nature of rates, there is naturally still a margin which reflects the increased risks perceived in commercial mortgage lending.

Whether in the commercial or residential sector, people love headline returns. If you take the Bank of England Base Rate as your bench mark – currently standing at 5.75 per cent – anything above this is seen as a wise investment. Even some easy access savings accounts pay over 6 per cent at the moment.

So when you consider that yields on residential properties can be just 4-6 per cent, they don’t look so attractive. While investors might see some capital appreciation, many enter into it purely for the income. Compare this to the 7-8 per cent your client could achieve on commercial property and it’s no wonder that business is booming. But clients must go into it with their eyes open.

Eyes open

Businesses tend to have longer-term horizons than individuals, such that contracts tend to be longer. Whereas a short-term rental contract of six months is very common in residential letting it’s more likely to be years for a business. This offers a valuable piece of security. But, of course, voids do still happen so clients must make sure that they are prepared for it. If your client is highly geared then any void may put huge pressure on them.

As one major lender observed: “Business is very active. Commercial lending is driving the market.” So somebody must be doing something right.

As a forward-thinking intermediary, just make sure it’s you.

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