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There is no doubt that the economic challenges brought about by the coronavirus will be the subject of many case studies and reviews in years to come. How was such a seemingly simple virus able to sweep the world, bringing economies to their knees and push investment markets into freefall?
While it is fair to say that property prices have maintained their value relatively well compared to stocks and shares and other investments, there will be some challenges ahead. Since the potential impact of the coronavirus became more real, many ultra-high net worth and high net worth individuals have switched to maintaining and increasing their liquidity. At this moment in time cash is king and likely to remain so for many months to come.
There are numerous ways in which you can preserve and even increase liquidity, even in these challenging times:-
Just this week the Bank of England slashed UK base rates for a second time to a historic low of 0.1% with a whole raft of additional funding made available. We have also seen similar action taken by the US Federal Reserve and the European Central Bank with unprecedented global activity to support national and international economies. Even though headline mortgage interest rates will not fall on a like-for-like basis compared to base rates, there will certainly be a softening in mortgage rates in the short to medium term. As a consequence, many real estate investors/home owners will have the opportunity to remortgage their property assets on significantly improved terms.
Even a fraction of a percentage point reduction in mortgage interest rates will make a huge difference to cash flow on multi-million pound mortgages. This will then introduce a buffer in the short to medium term acting as something of an insurance policy against further investment market volatility.
Managed correctly, within an individual’s financial constraints, debt can offer extremely useful leverage. While the use of interest only mortgages is perhaps more commonplace today there are still investors who favour a more conservative approach in the shape of repayment mortgages. The ability to pay down capital and interest on a monthly basis can save huge interest charges further down the line. However, as payments on repayment mortgage arrangements are often significantly greater than their interest only counterparts, they can have a serious impact on short term cash flow.
Therefore, in the coming weeks and months we expect many investors to look at switching from repayment mortgages to interest only arrangements. There is a double whammy here, on one hand, interest rates have fallen so mortgage rates should be softer. There is also the opportunity to use this additional release of cash flow to take advantage of real estate opportunities which are likely to materialise in the short term.
In recent days we have seen the UK and Italian governments announce financial backing for mortgage payment holidays for both residential and commercial arrangements. There are certain conditions attached to these payment holidays and as a consequence not all mortgage holders will qualify. If you do qualify, it would be foolish not to take advantage of this significant short-term boost in liquidity even if the “missed payments” will need to be repaid further down the line – with additional interest. At this point, it is worth noting the ongoing reduction in worldwide interest rates and the fact that interest on missed payments will be relatively small.
For those who do not qualify for the government-backed payment holidays there will likely be a degree of flexibility from their mortgage providers. In reality, if mortgage providers squeeze their clients in the short term they may end up with significant losses in the medium to longer term. Offering a degree of flexibility at the moment would allow clients to shore up their liquidity as a means of seeing them through the challenging weeks and months ahead. When markets return to some degree of normality, as they surely will, all parties will eventually return to a much firmer financial footing.
Since the 2008 financial crash, the luxury property market has seen a significant increase in asset values. So, even though we are in challenging times with stock markets in freefall, many luxury real estate investors will have the opportunity to remortgage their properties and release equity to enhance short-term liquidity/cash flow. As we touched on above, this type of operation introduces a buffer between financial assets/liquidity and financial liabilities. When you also consider the historically low level of UK and worldwide base rates, the cost of this equity release is relatively low.
The fact that many ultra-high net worth and high net worth individuals tend to be asset rich but perhaps liquidity challenged means they have assets they can use as collateral and a form of insurance. This is a win-win for both parties, investors are able to utilise their assets to enhance remortgaging terms and lenders have an additional level of insurance.
As real estate investors look to maximise their short to medium-term liquidity, and access to cash, it may be worth looking at offset/flexible facility mortgages. The benefits of these particular types of mortgage arrangements are more acute in the current environment where savings rates are negligible. The way in which these types of arrangement work is simple; the outstanding capital balance on a mortgage is offset against savings held in an account with the lender.
The balance on the savings account is not locked and available to the client as and when required – a degree of flexibility. Obviously, as funds are removed from the savings account this reduces the positive offset to the mortgage debt thereby resulting in an increased interest charge. In the current environment, a client with £100,000 in savings account offset against a £1 million mortgage will be receiving minimal interest. Even if we work on a 2% savings rate (very unlikely) this will result in gross interest of £2000 per annum. If we work on a 3% mortgage rate, the interest saving on the £100,000 offset is £3000 per annum – a net benefit of £1,000 per annum. This is before we even take into account tax charged on interest, especially for higher rate taxpayers.
So, while it is obviously beneficial to maintain a high level of savings to offset mortgage interest charges, this type of arrangement does offer a significant degree of flexibility.
Such is the competition in the global mortgage market that many lenders will look to improve terms and conditions for their clients if they are looking to transfer to different products. The bottom line is that if a lender is unable to offer competitive rates on an alternative type of product then the borrower will look elsewhere. There is now a huge array of different mortgage products available such as fixed rates, variable rates, repayment, capped rates, interest only, offset as well as AUM arrangements. Different mortgage products will suit different economic environments and for those looking to increase liquidity there may well be the opportunity to switch products.
While it will obviously depend upon the type of product you are switching to, there may well be the opportunity to bring additional assets into play as collateral. This would reduce the risk to lenders and allow borrowers to improving their funding terms and conditions. Remember, the cost to a lender of retaining an existing client by reducing margins will likely be significantly less than the cost of replacing their business.
As some real estate investors look to increase liquidity/cash flow, many lenders will be determined to retain clients in these challenging times. Therefore, mortgage customers requesting a further advance with their existing lender are often looked upon favourably. This is not a new mortgage but merely the adjustment of the terms and conditions on an existing arrangement to release additional capital.
This type of request would obviously be considered within the financial constraints of the individual client. There may be additional lending capacity due to a relatively low LTV, increase in property value or the fact that they have already made significant mortgage repayments. The interest rate relating to a further advance of funding will likely be different to the existing mortgage. However, when you bear in mind the recent drop in worldwide base rates this can be a very useful and efficient way of releasing capital for investors.
Such has been the recovery in luxury property prices since the 2008/9 financial crisis that many real estate owners have seen a significant increase in their equity stake. In challenging markets such as today this can prove extremely useful in improving liquidity/cash flow, redirecting funds to shore up short-term finances or even to take advantage of investment opportunities. So, how does a second charge work?
In effect a second charge involves a second mortgage where equity in a property is used as collateral. The first charge held by the original mortgage will always hold precedent but the idea behind taking a second charge is that the value of the property is more than enough to repay both mortgages with additional headroom on top. In many ways this is a specialist market and there tends to be more flexibility and potentially better terms available through the private banking/niche lending sector.
As the term suggests, a lender providing finance via a third charge over an asset will rank behind the first charge and the second charge. This type of transaction is very common in the bridging market allowing access to short-term funding for a variety of different reasons. Traditionally, assuming constant market conditions, the first charge mortgage tends to be cheaper, the second charge more expensive and the third charge more expensive still. This reflects the power of each charge over the asset with the two previous charge holders repaid first in the event of financial difficulties.
The interest rate on third charge borrowings will reflect the degree of equity in the property as well as the amount of funding and duration. The greater the level of unused equity in a property the stronger the negotiating position for the borrower. While perhaps not for everybody, there is no doubt that third charge borrowings do have a role to play in a number of different scenarios.
It is fair to say that the UK buy to let market in particular has been targeted with regards to tax increases and tighter regulations. That said, the buy to let mortgage market is extremely competitive and with a reduced number of participants there is scope to negotiate attractive refinancing terms. It is possible to benefit from two different elements, a reduction in mortgage interest rates as well as the ability to release further equity in a property.
As a buy to let investor gathers more experience and has perhaps been able to push through rent increases, this will also strengthen their position with regards to refinancing. So, for many private landlords that can be a real opportunity to release funding at relatively low interest rates using existing assets as collateral. Vanilla buy to let mortgages are available through many traditional banks but larger funding arrangements tend to be exclusive to private banks/niche lenders where there is often greater flexibility.
In recent weeks we have seen worldwide stock market collapse, investors running for the hills and share prices in freefall. The truth is that we have been here on numerous occasions and markets will eventually recover. The main problem at the moment is uncertainty and extremely limited visibility in the short to medium term. So, for those looking to increase their liquidity/cash flow it may not be sensible to sell any near liquid assets they hold such as stocks, shares, bonds and equities. So what are the alternatives?
Looking at worldwide stock markets on a long-term basis there are still reasons to be optimistic for the future. So, many ultrahigh net worth and high net worth individuals might look towards securing short to medium term loans against their near liquid assets. There would still be the matter of a LTV ratio to consider, depending on the type of asset, with volatile assets often attracting low LTV ratios. The mix of near liquid assets would heavily influence the exact terms and level of borrowings but there is certainly potential to release funding.
A significant majority of ultrahigh net worth and high net worth individuals tend to operate multiple businesses often via different company vehicles. In many cases there may be the opportunity for these asset rich companies to negotiate business loans to enhance their short-term cash flow. As interest rates have recently fallen worldwide it may be possible to negotiate very attractive terms. These terms may also be enhanced by relatively high levels of security in the form of quality business assets (and even future income streams).
One of the more straightforward and often immediate funding options is a business overdraft. In relative terms this type of funding will attract high interest rates but it can be flexible and a useful form of insurance for the borrower. Business loans can be secured and unsecured but where possible it is favourable to use assets as collateral to keep interest charges as low as possible.
One of the many options for those looking at increasing short-term liquidity/cash flow is bridging finance. Secured against an asset, future sales proceeds or an expected cash injection such as a pension lump sum payment, bridging finance can last anything from a few days to a few months in duration. The interest rate on bridging finance is in general appreciatively higher than standard mortgage/secured loan funding. This is a reflection of the potential short-term challenges and the often flexible nature of the term. However, it is a very useful and a very quick means of raising short-term capital to increase liquidity/cash flow.
Whatever types of loan funding you are considering the criteria and the basics are the same. The greater the degree of uncertainty the high the interest rate, the more collateral available the less risk and the lower the rate of interest. Therefore, in the weeks and months ahead it is highly likely we will see ultrahigh net worth individuals and high net worth individuals looking to secure funding using cars, art, boats and other luxury assets as collateral. Lenders will require different levels of security against different asset classes. This is because the current market value of an asset may not always be reflected if a relatively quick sale was required as a consequence of financial difficulties.
In general, secured loans offer a means by which to maximise assets available at the time without being forced to sell the assets in question. This immediate injection of capital could be used to shore up struggling businesses, fill funding gaps or finance attractive investment opportunities of which there will likely be many in the weeks and months ahead.
The key to maximising liquidity/cash flow is to ensure that you not only utilise income available but also assets to hand. If you can use for example an antique car as collateral against a secured loan this would offer an immediate injection of capital to cover a funding gap or potential investment opportunity. The key is the fact that the asset would only be sold if the borrower encountered financial difficulties and was unable to afford loan repayments in the future.
There is no one size fits all when it comes to utilising assets/income to maximise liquidity although with interest rates now at historic lows funding costs are extremely attractive. If you require any advice regarding the raising of capital/liquidity in the short to medium term we would welcome the opportunity to discuss your situation in more detail. We are experts in creating bespoke structures which will dovetail with your income and assets available. Maximising borrowing capabilities within an individual’s financial constraints is the key.