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How To Obtain Commercial Finance?

First Published: October 2010 | Available in: Property Articles Property Investor News

By specialist property accountant Stephen Fay ACA

With lending criteria from ‘High Street’ Buy-to-Let lenders tightening, the lending environment is becoming much tougher for property investors. Many property investors with good portfolios are now looking at commercial finance – rates and fees are often better, and lending criteria no worse than BTL lenders – but, information requirements are more stringent. 

‘What’s wrong with how I do things at the moment?’

For many investors, their only financial reporting is their annual tax return. As the main priority is reducing taxable profits, and therefore tax, this often has the effect of showing an investor’s business as being much less profitable than it really is. This is for several reasons:

Treatment of expenses

Many costs are included in tax returns that, in a ‘normal set of accounts’ would be spread over many years, or capitalised. For example, an investor taking a 25-year £100,000 BTL mortgage and paying an Arrangement Fee of 2.5% would include the full £2,500 as an expense in their tax return and deduct this from their taxable profits.

Ordinarily, this would be written off over the time that benefit obtained – in this case at £100 per year for 25 years. So, in year 1, with just this one item, profits would be £2,400 lower than in a ‘normal set of accounts’. (Note: it is still possible to obtain a tax deduction when preparing property rental accounts properly).

Including indirect costs

As property investment is a ‘business’ for income tax purposes, various ‘indirect costs’ such as travel, education, office costs, use of home allocation etc can be charged. Again, this has the effect of reducing taxable profits, which shows the property business to be less profitable than reality – since many such costs are really private expenses.

Nothing more than an income statement

Few investors have any further financial information than their bank statements written up into their tax return – this is way below the standard financial information that ‘normal businesses’ keep.

‘So what do commercial lenders expect to see?’

It sounds obvious – lenders want to see that you have a profitable business. ‘Profit’ is not the same as cash – profits can be manipulated to show the business in the best possible light. This profitability must of course be backed up by a good cash flow and a solid balance sheet. The main requirements are as follows:

Profit and Loss Account (P&L)

The P&L is the basic ‘financial statement’ that shows the income, expenses and profits of any business. It goes without saying that good businesses have a P&L that shows profits! Income and expenses are dealt with according to accepted accounting principles – which, for example, mean spreading long- terms costs such as Mortgage Arrangement Fees and refurbishment costs over the period that benefit is gained. This means that a true picture of the financial performance of the property business is shown.

The tax treatment of expenses is completely separate from the P&L – so expenses can still be deducted in a tax return.

(Simple) Balance Sheet

Whereas the P&L shows income and profits, the Balance Sheet shows the asset and liability position for a business. Lenders are generally less interested in the balance sheet, but of course it will strengthen any finance application to show that asset values exceed liabilities.

Many investors will pay for an annual revaluation of a portfolio, and book the increase in valuation in the accounts to show a ‘market value’ position – this often significantly strengthens the balance sheet. There is no requirement to revalue if assets fall in value. Liabilities can also be presented favourably to show long-term debt matched to long-term assets.

Cashflow statement

This is the statement that really separates the ‘wheat from the chaff.’ Good businesses show strong cashflow – unlike the P&L, no accounting ‘jiggery-pokery’ can be used to fudge the cashflow statement. Excess cashflow can therefore support further borrowings and – combined with profits and a strong balance sheet – is what lenders are looking for. There is no one format, so ensure your accountant knows what lenders want to see.

And finally … KPIs

Key Performance Indicators are easy stats that indicate the health of a business. For property investors, that might be: portfolio gross/net yield, interest cover, occupancy percentage and LTV. These allow a quick and easy overview of the business.

So, what’s next?

Assess whether better financial information would allow you to run your property business better than you currently do. This should be a priority for any business owner. Commercial finance is a realistic option for many investors, but the financial information required by lenders is a ‘step change’ for many investors who find that developing their financial reporting capability allows them to access new lenders and take their
property business to the next level.