The changes across the buy-to-let sector in recent years have created an environment where the most common-sense approach for those looking to build a sustainable portfolio is to use a limited company structure.
Research from Precise Mortgages recently demonstrated that 55% of landlords intend to use limited companies to buy rental properties in the coming year – well over double the number of those looking to buy personally.
This extended post delves into some of the key fundamentals of buying rental property in this way…
Why use a limited company (special purpose vehicle) for buy-to-let properties?
To clarify, a special purpose vehicle (SPV) for buy-to-let purposes is a limited company that is created to solely hold property and nothing else. As will be highlighted below, from a lending perspective, such vehicles 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 (although there are some allowances).
SPVs have extra administrative obligations – i.e. 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). While lending in this space is becoming increasingly competitive, limited company buy-to-let payrates tend to be higher also.
However, there are several benefits worth taking note of…
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
Although there is nothing stopping you from approaching lenders directly, working with an experienced mortgage broker is recommendable. A good intermediary will find the best products suited to your own financial circumstances and the property in question. Experienced brokers also have direct relationships with underwriters and, from time to time, exclusive access to favourable product options.
As the corporate buy-to-let lending sector is relatively embryonic, new application processes are reportedly slow (up to 6-8 weeks at the time of writing) – which will be of little use when purchases are time-constrained (at auctions, for example).
In such situations, investors should position themselves to be able to transact quickly either through cash, some form of pre-existing and undrawn debt facility or – more commonly – reputable bridging finance.
Most investors would then eventually refinance (rather than tie-up funding that could be used for other purposes). Here, it should be observed that flash finance mechanisms can be costly, the 6-month rule will normally apply and lenders frown upon the ‘rinse and repeat’ and ‘no money left in’ models.
At the time of writing, 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 associated conditions and higher pay rates.
As with personal buy-to-let mortgages, investors will also incur an arrangement fee (which are also slightly higher than personal buy-to-let mortgages at the time of writing) and be subject to early redemption charges (ERCs). The costs of the more advanced form underwriting, however, are not necessarily passed on to the borrower.
To ensure there are no administrative hold ups, you should have your company formally established with a bank account. Buy-to-let SPV lenders are reportedly tightening on income assessments and will typically require at least 2-years’ worth of SA302s from the HMRC, tax overviews, 3-months’ worth of 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 which will outline your investment intentions and other key figures. Note that some or all these details may require validation.
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.
Moving forward, the ever rising using of technology within key financial processes is likely to mean that your creditworthiness as a buy-to-let mortgage borrower will be assessed on a more programmatic (as opposed to a ‘trust’) basis. Mortgage lenders are increasingly adopting more sophisticated methods of analysing open market value, rental premiums and other key figures.
Structuring a limited company for buy-to-let purposes
From the outset, to facilitate a smoother application process, 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 will usually result in a refusal.
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 (see below).
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:
Personal Guarantee or 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;
Debenture – used to protect a lender’s 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.
To explain the difference between 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;
Note that Debentures are typically “all monies”, in other words – existing, present and future loan advances will be secured;
Deed of Priority – this is 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/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.
Understanding responsibilities as a director of an SPV
Alongside HMRC tax 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. This will mean that bookkeeping and related administration should not be left to the last minute.
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 several have become increasingly strict.
Ruban Selvanayagam is co-founder of sell house fast specialists Property Solvers and a private rented sector landlord since 2006.