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HMRC internal manual

International Manual

Thin capitalisation: practical guidance: lending against asset values: lending against tangible assets - land and buildings

The guidance in this section applies where a loan is secured against an investment property. It therefore does not apply in the following situations:

  • loans which are secured against property that is used in a trade by an owner occupier. Different considerations apply in these circumstances because of the risks inherent in the trading business.
  • loans secured on residential property, in particular the buy-to-let market, which has shown large fluctuations in the last few years.

In recent years there has been a move towards an op co (operating company)/ prop co (property owning company) business model as trading companies have sought to realise the value of their property assets, so the proceeds may be reinvested in their businesses. This has led to a proliferation of sale and leaseback schemes involving many of the UK’s largest trading companies.

Until the credit crunch of 2008, the years since the millennium saw a rapid increase in property prices in the UK both for commercial and residential property. The UK in particular was seen as a good place to invest which resulted in an equally rapid increase in the amounts of money lent to investors both by UK and foreign banks. The UK commercial property market stood at around £762bn in 2007 of which approximately £200bn was owned offshore. By 2011 it stood at over £800bn, with the property lending market at around £230bn (according to the De Montfort report - see below).

Much of the money used to invest in UK commercial property came in the form of loans from financial institutions.

The De Montfort Report

In 1997 the Department of Land Management at De Montfort University first published a report entitled ‘The UK Commercial Property Lending Market’. It covered the lending practices of financiers to that market. Since then the report has expanded considerably and it is now published annually with a half yearly update. It covers all the major lenders both from within and outside the UK, and the vast majority of the smaller lenders.

This report may be used as a starting point when considering what third parties may lend on the security of a UK commercial property. Copies are held by the LBS property sector in Leeds, and by Specialist PT International in Bootle who deal with offshore companies with UK property holdings.

The report is a useful indicator of what a third party would have lent on the security of a property, however, it has to be used with care as it does not give the answer in any particular case, since each must be considered on its own merits, according to the relevant facts. What the report provides is a range of figures at which loans have been made. It is then a matter of considering where on the range the transaction in question would fall. This will depend on a number of factors.

The loan position consists of a “basket” of characteristics and the whole basket is considered when looking at whether the financing is arm’s length. Characteristics typically within the basket are: loan to value ratio, interest rate, security, covenants, payer’s cash flow projections and repayment terms.

The De Montfort Report identifies factors that a lender is likely to take into account. These include the following:

  • the type of borrower
  • the type of tenant
  • the terms of any lease
  • the type of property and its condition
  • the credibility of the business plan

The report looks at the following 3 types of commercial property: retail, office, industrial.

It splits each into two categories: prime, secondary. These are defined as:

Prime: A rack-rented institutionally recognised lease on a new high specification property in a prime location let to an AAA covenanted tenant* for a minimum of 10 years certain

Secondary: A rack-rented institutionally recognised lease on a 20 year old property in a secondary location let to a BBB covenanted tenant* for a minimum of 10 years certain

(*a covenanted tenant is one where the risk of default on lease payments has been passed on to a third party, normally an insurance company. The credit rating refers to the tenant)

The report also gives figures about loans for property development. Specific reference should be made in each case.

For each of the 6 sectors (3 x 2 above) De Montfort gives the following information: loan to value, margin, interest rate cover, and lender’s initial charges.

The margin is expressed in basis points (100 basis points = 1%) over, say, 3 month LIBOR which is the usual method used in loan agreements. 3 month LIBOR tends to be used because interest is paid quarterly.

The information is given in the format of: lowest, highest, average

Figures are provided for the following types of lender: UK Banks, UK Building Societies, German Lenders, American Lenders, and Other International Lenders

The report contains a range of statistics, charts, and analyses covering comparisons of loan terms, interest rates, types and locations of lenders.