The Budget has put the spotlight on high net worth borrowers with changes to Stamp Duty, which have elicited a mixed reaction. Mainly concentrated in London, the sector remains the domain of a few specialist brokers and is predicated on strong relationships
In these austere times the rich have come under attack from all quarters, from protests like Occupy Wall Street to grandstanding politicians.
Bankers’ bonuses, legal tax avoidance and property taxes have all come under the spotlight but there seemed to be some reprieve in last month’s Budget when chancellor George Osborne slashed the top rate of Income Tax from 50% to 45% on salaries over £150,000.
But it meant the target then turned to expensive properties, with the government claiming it will raise five times more from the wealthiest through its measures.
Stamp Duty on homes worth more than £2m will increase to 7% for those bought by individuals and a whopping 15% for those bought by firms. The latter rate is intended to tackle tax avoidance whereby wealthy buyers set up offshore companies to avoid Stamp Duty.
Since most homes worth more than £2m are in the capital the duty has been dubbed a tax on London. But Liam Bailey, head of residential research at Knight Frank, doesn’t believe the prime market will be greatly affected.
“Demand, domestic and especially international, for prime London property is likely to remain strong,” he says. “The most obvious question is whether prices above £2m will fall in response to the new rate. There has to be an element of price adjustment and we would expect to see tough negotiations around the £2m level.”
There is more concern over the rules put in place to tackle Stamp Duty avoidance through company purchases, as Bailey says it is not always done for tax reasons.
“It seems likely that the 15% rate and the threat of an annual charge on the value of properties held will dissuade some buyers from opting for this purchase route,” he says.
“This will undermine the attractiveness of the UK as a home for their investment capital.”
The consensus is that tax rises will have some impact but the market will continue its strong growth. Knight Frank reports that prime central London property prices increased by a further 1.1% in March, meaning prices have now risen by 11.3% over the past 12 months and by 2.7% in Q1 2012.
Sales subject to contract in the £5m-plus bracket are up 93% in Q1 2012 compared with the same period in 2011, and by 42% across the whole of prime central London.
But Knight Frank believes supply is failing to keep pace, with new instructions up by just 12%, and down by 11% in the £5m-plus sector. The demand is coming from foreign buyers seeking to enter the UK property market.
Fahim Antoniades, director at Mortgage Centre IFA, says there are lots of foreign buyers in central London.
“The pool of interest is much greater than it would be elsewhere, even in the rest of London,” he says. “There is a finite level of demand in local markets whereas central London demand is potentially infinite.”
Antoniades says the buyers mainly come from emerging economies or countries with social turmoil or instability.
“The UK has a reputation for being a stable economy,” he says. “London is becoming the world’s safety deposit box.”
The last decade has seen a number of specialist high net worth brokers spring up to get a piece of big ticket deals. It is a sign of the sector’s potential that some were formed in the heat of the credit crunch.
Largemortgageloans.com began life in 2006, targeting loans over £500,000, while Coreco Group launched in 2008 at the market’s lowest ebb.
And Mortgage Advice Bureau and Countrywide set up Capital Private Finance in April 2011 to cater for high net worth clients.
The brokerage is designed to handle referrals from Countrywide’s estate agencies Hamptons International, Sotheby’s and John D Wood. The launch came after Countrywide had scoured the market and made bids for a number of brokers only to be knocked back. At the time Countrywide said it set up its own firm because there were few private finance businesses available.
Andrew Montlake, director at Coreco, says there has been a spate of brokers setting up high net worth brokerages.
“Brokers who were at other firms such as John Charcol, Cobalt Capital or Chase de Vere have set up their own companies,” he says. “I started at John Charcol in the Knightsbridge office in the 1990s so high net worth has always been my main area of speciality.”
He says the other reason for brokers moving to high net worth clients is to chase big money.
“Unfortunately, some brokers make themselves out to be specialists but they don’t have the expertise,” he says.
“It is becoming a more crowded market but some of the owners of smaller firms have been around for some time as brokers at other bigger companies.”
High net worth is seen as a specialist area by brokerages, a view shared by the Financial Services Authority in its latest Mortgage Market Review paper.
The MMR proposes to exempt high net worth clients from the advised sales process that could be compulsory for the rest of the industry.
They are also given some exemptions over interest-only deals and on acceptable repayment vehicles but some areas such as affordability checks still apply.
“It looks like there is enough understanding at the FSA to treat high net worth cases differently from mainstream deals,” says Antoniades.
“But there isn’t a complete understanding of it and only time will teach the regulator what this area is all about.”
There is also some debate about what defines a high net worth client, with the FSA putting it as someone who earns £1m or has £3m in assets. But some brokers define high net worth deals as a mortgage for homes worth more than £500,000 – or even lower.
The Consumer Credit Act also exempts high net worth clients but defines them far lower than the MMR at £150,000 annual income or £500,000 assets. This exemption came from a 2008 note from the Office of Fair Trading so the wild differences between it and the MMR appear strange.
“It is difficult to define what high net worth clients are and whether it is based on wealth or cash,” says Antoniades.
“Some people can be asset rich and cash poor, meaning they could fail an affordability test. High net worth is a fluid concept but regulators need to put it in a compartment and define it, which doesn’t always work.”
It’s not just the MMR and property taxes that pose a threat to the high net worth market, as the Independent Commission on Banking leaves some question marks around private banking. Although high net worth clients are treated more like commercial enterprises, able to assess the risks and move their money around freely, private banks were not given a general exemption from the reforms.
As private banking operates on the premise of merging retail and investment it could pose problems for the model. City law firms have been warning about the major implications to private banking in their responses to financial services companies.
A Slaughter & May report into the impact of the proposals on private banking in October 2011 suggests that most private banks would choose to operate outside the ring-fence. Only high net worth clients would be allowed to deposit in non-ring-fenced banks.
“The existing definitions of high net worth or sophisticated customers do not involve any qualitative judgement on the part of the bank as to whether the customers in question is in fact sophisticated in financial matters,” it states.
“Clearly, not all high net worth customers or private banking customers are necessarily experts in finance. Conversely, some customers with relatively small deposits may be highly sophisticated.”
The law firm says it would be useful to have an objective test as to whether customers could deposit funds in a non-ring-fenced bank. It also questions whether non ring-fenced banks will be covered under the Financial Services Compensation Scheme.
The details need ironing out so it would be wrong to jump to conclusions before implementation in far-off 2019. However, some private banks and subsequently high net worth clients may be profoundly affected by regulatory changes in the next few years.
There are more than 40 private banks offering deals for high net worth clients. They are often global banking giants such as UBS, Barclays Wealth, JP Morgan, State Bank of India, and Royal Bank of Canada, all of which lend in the UK.
However, most brokers will be unaware of them because they are notoriously secretive and only want to attract a particular type of client. One has even been known to threaten legal action at brokers touting their name too widely.
Their marketing is non-existent and they are discriminating about which clients to lend to, based on how wealthy they are. They will lend in different ways, with Barclays and Coutts providing more standard rates.
Others such as UBS, RBC, Société; Générale and Credit Suisse will look for other opportunities from clients and offer rates based on that.
Joe Cohen, director at First Action Finance, says mortgages are often the bait to attract clients and their assets.
“They are concerned more with the overall relationship,” he says. “They don’t exist purely to sell mortgages but are looking for a long-term relationship. If clients can get a good rate then many are willing to move their wealth management arm to the right bank.”
Ian Gray, senior mortgage manager at Largemortgageloans.com, says there is a certain way for brokers to deal with private banks.
“Most of the people I deal with at banks are relationship managers for around 20 clients and their main job is to grow these relationships,” he says.
“They can’t advertise and get every broker calling them. They tend to do business with someone who they have had lunch with as that is how the industry works.”
Gray adds that understanding how private banks work and the current zeitgeist in their client desires is crucial to working with them.
“It is counter-intuitive sometimes because it seems like they don’t want the business, but actually they only want the right type of business,” he says. “If you inundate them with the wrong enquiries they will refuse to deal with you.
“I spend half my time simply working out what clients these banks want at any particular time. Are they interested in doctors at that moment? Do they have an aversion to people working in financial services? It is more about soft issues rather than the strict criteria changes seen at high street banks. There is a lot of money to lend but they are picky about who to lend to. They don’t just lend the money and forget about it, it’s about relationships.”
Gray says there are plenty of private banks willing to lend but it depends on circumstance.
“Some banks such as BNP Paribas are finding it challenging as it was lending aggressively last year but then faced problems with its exposure to Greece,” he says. “Others such as UBS are lending quite aggressively now.”
Most private banks want to attract a series of investments before they offer clients a mortgage. Gray says that to get a deal clients need to invest either 50% of the loan value or £1m, whichever is higher.
“There aren’t many banks that don’t want other business from clients,” he says. “They don’t do transactional business in the same way as the high street but if the client fits their needs the interest rates can be low, such as 1.5% over the base rate.
“There are a lot of high net worth clients who have investments they don’t want to cash in yet and these can often be transferred.”
There are also opportunities in interest-only as mainstream lenders such as Nationwide, Santander, Skipton Building Society, Lloyds Banking Group and the Royal Bank of Scotland cut LTVs or restrict criteria.
Largemortgageloans.com is reporting a big uplift in enquiries for interest-only at higher LTVs and expects this to continue.
“Private banks haven’t changed their stance on interest-only,” says Gray. “As long as it makes sense they do it. We are picking up a huge amount of business from brokers referring interest-only deals to us.
High street lenders say they are reacting to the FSA’s moves but I am not sure that’s true.”
Cohen says private banks will always offer interest-only as they will always look at the overall client picture.
“I think there will be more demand for it now,” he says. “Private banks will consider pensions, savings and other assets as repayment vehicles. They will ask what they can do that is auxiliary to a normal bank and assess whether to offer a mortgage.” But Montlake is not convinced that restrictions in the mainstream market will lead to any uplift in demand at private banks.
“The only way you can get these deals is by being a high net worth client,” he says. “Customers can’t be shoe-horned into a private bank if they are not suitable. The banks are not stupid and only want clients worth more than £1m. They still need to place risk in a similar way and most will review their clients’ portfolios every three to five years.”
High net worth clients are a different market to the mainstream with their own needs and circumstances. Incomes can be substantial and uneven through bonuses and commissions, while they can vary between cash rich and asset poor or vice versa.
They are hard to put into a box, which is why regulators find it so difficult to define and deal with them. While not all wealthy individuals will be financial experts they are treated more like commercial entities. They remain largely unregulated and seek out deals with private banks to fund loans for both homes and investments.
Brokers have a vital role to play in helping someone manage so much money. Knowledge of a market is more valuable than ever at this level and clearly rich individuals will be willing to pay higher fees.
Brokers can either learn the complex market for themselves or refer clients to a specialist and take a fee. Either way the high net worth clients are out there and it is better to be clued up and grab a slice of the big money than to let it sail on by.
How a referral works
Mr and Mrs H, were first-time buyers and had just had an offer for £2.05m accepted on the property they were renting. They were looking to borrow £1,742,500 at 85% LTV on an interest-only basis.
Their broker could not find any lender that would offer such a large loan size on an interest-only basis and at such a high LTV. Mr H was a senior banker with a £300,000 basic salary and a bonus of over £1m. Mrs H was a senior manager in retail, earning over £100,000 so income was not a problem. The clients wanted to be able to make unlimited overpayments as they both receive bonuses and want to be able to pay down the loan over the next four or five years.
The broker contacted Largemortgageloans.com to find a solution and was happy for it to contact the clients direct. Largemortgageloans recognised that for such strong applicants there should be a private bank willing to offer these applicants a mortgage loan at a high LTV, if the clients were committed to reducing the LTV using their bonuses within a year or two.
Largemortgageloans placed the case with a private bank. It offered the clients an 85% LTV mortgage with an interest rate of 2.75% over the base rate and a 0.6% arrangement fee.
The bank was happy to offer the loan on the basis that the clients committed to reducing the LTV to 75% within three months. As a condition of the mortgage the bank also wanted the clients to commit to staying with it for a minimum of one year. It would allow unlimited overpayments provided the mortgage was not redeemed in full for one year after completion.
To make matters difficult the property was downvalued by the surveyor by £50,000 leaving the clients short of funds and their vendor would not move on the purchase price.
The bank agreed to split the shortfall with the clients and lend them £1,717,500 at 85.875% LTV against the property, which was now valued at £2m.
This got the clients out of a sticky situation and they were delighted to be able to buy their dream property.
The government is saying it’s OK to do well in the UK but not that well
The 7% Stamp Duty levied on homes of £2m or more in last month’s Budget is certainly a blow. It is another government message saying that it is OK to do well in the UK but not that well. On one hand the government claims that the cut to the 50% top rate of Income Tax is designed to put money back in people’s pockets but then it also claims to tax the wealthy even more through property.
However, I don’t see this having a huge impact and believe we will just end up in a situation similar to the Stamp Duty boundaries for properties worth £500,000. It becomes a no man’s land as no-one will want to price homes just above the threshold and be hit by the tax so will either settle just below or considerably above.
A far bigger blow to the high net worth market is the 15% Stamp Duty for properties bought in a company. With foreign investment making up such a large part of this market it will have a major effect unless alternative purchase structures can be sought or developed.
Some countries do not let residents personally borrow over a certain amount abroad and heavily restrict what they can remove personally from the country each year. Many foreign governments also restrict the guarantees an individual can give whereas before the company could provide these. India is a prime example of this and has restrictive borrowing rules for individuals.
It’s all a bit of a mess and we are still waiting to see how certain circumstances will be treated – for example, commercial properties being converted into residential ones.
The Budget also reduced the top rate of Income Tax, which is to be applauded as we try to attract the top earners and tax contributors to the UK. I understand the political reasons for not implementing it immediately but in such difficult times I would have thought increasing the tax revenue would supersede anything else.
It will see many high net worth individuals structure and delay their earnings to take advantage of the new lower rate in April 2013.
Rich investors will always choose London for its position as a global hub”
The new generation of bridging lenders offers a wide range of flexible short-term borrowing solutions to a diverse group of clients, including so-called high net worth individuals. Bridging can help high net worth individuals in a number of ways as it offers relatively speedy access to guaranteed funding at a time when mainstream banks have lost much of their appetite, particularly for big-ticket bridges extending beyond six months.
For individuals with substantial, but non-liquid, assets this is a considerable selling point. More controversially, in these straitened economic times, bridging has been able to provide the type of tax-efficient solutions so attractive to the super-wealthy. However, this may not remain the case for long following measures announced in this year’s Budget.
The type of property usually associated with high net worth individuals depends on the nature of the transaction or investment. In our experience, this translates to a focus either on capital appreciation or rental yield.
In the case of the former, we often encounter savvy clients keen to secure bargains on relatively undervalued freehold properties in prime London postcodes.
Assisted by a flexible short-term loan, investors might choose either to undertake a degree of refurbishment before selling at a profit, or hold on to the property for the period of the bridge before selling onto a specialist developer, also at a profit.
Other high net worth individuals are attracted to the opportunities offered by the booming rental sector. In such cases, a typical property may be located in a non-prime London suburb but one that commands excellent and reliable rent yields.
Developing a suitable property with the help of a bridge provides the lender with a clear exit strategy and the client with a realisable profit outcome.
Of course, this is not a definitive list and lenders encounter a range of property types associated with wealthy customers. The key is to be as flexible and adaptable as circumstances allow.
Taking a macro view of the high net worth market as it relates to the short-term lending sector, I’m encouraged by what I see.
Much has been made of the government’s intention to clamp down on Stamp Duty mitigation schemes. But in reality, it will have a limited impact on the market.
More importantly, high net worth clients will continue to be attracted to London for a number of reasons. These include political stability, an increasingly business-friendly environment, cultural and entertainment attractions, the English language, and the pivotal geographic position of the UK as a global hub.
Add to all this an improving economic outlook underpinned by stable, or rising, London property values, and it is difficult not to be reassured about the continuing presence of high net worth buyers.