When discussing the commercial sector, it is important from a lending and broking perspective to clearly define what the term means. In domestic lending the type of activity is always the same, be it lending secured on a house or a flat. In commercial lending there is far more diversity.There are two areas of commercial lending which are commercial finance and commercial mortgages. The former includes lending on things as diverse as debtor assets, IT or business equipment and even future cash flows generated from an established business model. Mortgages are specialist enough to be treated and considered independently. Some lenders and intermediaries are active in all forms of commercial finance while others focus on the mortgage element only. In this article, I will focus on the mortgage subject of commercial lending, an increasingly important aspect of intermediary life. A number of trends in the commercial mortgage market are in evidence. For example, a number of specialist commercial mortgage lenders have emerged recently and there has been more intermediary involvement in the industry as a consequence. Historically, the market has been dominated by institutional lenders which have targeted customers direct. But recently, traditional mortgage and secured loan brokers have started to add a commercial mortgage element to their offerings and specialist commercial brokers have begun to invest in their own operations. As a consequence of this heightened awareness and appetite, a number of partnerships have been formed as the commercial specialists have looked to harness the distribution potential of some of the networks and larger intermediaries. The reason behind these recent developments has been necessity. Specialist lenders emerged as it became clear that some customers were disenfranchised by the lending appetite of traditional high street lenders. These institutions have focussed their efforts on securing larger commercial mortgage business at low margins but with little perceived risk. This has meant either good quality investment covenants or a detailed and successful business occupier as judged by three years’ audited accounts, cash flow projections and detailed business plans. Many self-employed and small to medium-sized enterprises have found securing commercial mortgage finance extremely difficult. Even if criteria were met, many customers found banks unwilling to Wlend for debt consolidation or cash-raising purposes. But given a specialist lending approach, such mortgage purposes are accepted. This is now releasing vital capital for many businesses. So what has driven intermediary involvement? It seems brokers are increasingly recognising the income and market potential of commercial mortgage products. In the US, 75% of commercial mortgages are arranged through an adviser whereas in the UK there is a similar figure for residential mortgages. But it is estimated that only 15% of commercial mortgages in this country are arranged through a broker. Cleary there is huge market opportunity here. There have been some significant recent changes to the domestic mortgage market and the environment in which intermediaries now operate. Demand has been affected by interest rate movements and a slowing in house price inflation. This has acted as a natural break on remortgage activity. Against this backdrop of slower customer demand, a number of lenders have continued to grow. There have been several high profile entrants and the established players are fighting to protect market share. This has culminated in the competitive products that have been introduced in the past 12 months. Such competitive pricing on products has resulted in – and will continue to result in – lower yields for lenders and consequently lower processing fees for intermediaries. Costs have also increased with regulation, so it seems that advisers are operating in a market that is experiencing lower demand and delivering lower margin but which has a higher cost base than before. Naturally profitability has come under pressure. In such a situation, there are only two areas you can change – one is cost and the other is income. We have seen a move to cost cutting as business and operating models change to reflect the trading environment. But attention must then turn to ways of increasing revenue. With customer demand down but competitive pressures up, it is natural that many intermediaries have turned to new products and markets to supplement their incomes. Arguably the most natural area for finance brokers is commercial mortgages and secured loans. Both are related to core activity although each behaves differently to domestic mortgages. But what all three areas have in common is self-employed and small-business customers who many intermediaries communicate with and sell to day in and day out. This is the most natural shift available to brokers as they seek to broaden their horizons. The commercial mortgage sector is a more complex environment than its residential cousin, with a greater variety of properties on which mortgages are required. The purposes are similar to residential demands but can be more complex. An intermediary will come across properties as diverse as fish farms, warehouse units and owner managed public houses. They will see clients wishing to restructure their finances or use the proceeds of a remortgage to buy out existing shareholders. In many cases the mortgage finance will only fund part of the price of a business property. Intangible goodwill generated by a seller will need to be funded by a prospective buyer, increasing the equity required over and above what the borrower may be able to raise on the property. Variety means more challenge but with higher average advances, the rewards are considerably higher. In terms of products, most lenders will only lend against the market value of the property and LTV’s rarely exceed 75% to 80% of property value. Pricing reflects the higher risk associated with commercial property and 1.25% to 1.5% above base rate is a keenly priced transaction reserved for the best quality applications. This would almost definitely mean detailed financial information, projections, and an interview. Providing secured lending on commercial property can, with a little investment in time, be incorporated into a broking business. When thinking of entering the sector an intermediary will need to consider things such as whether they have the resources or capacity within the business to dedicate to establishing and or promoting commercial mortgages alongside core activities. It is an investment that needs time to deliver rewards and if that commitment cannot be made, a strategic partnership with a commercial specialist may prove a better option. Such arrangements can offer all the benefits of an inhouse team including income, client retention, client satisfaction leading to referral and repeat business without the investment in time and money. Many intermediaries find a happy medium, retaining the more straightforward enquires and partnering on the larger and more complicated finance enquires that may be generated, such as a multi-million pound development finance enquiry where a lot of work and expertise will be required. The same would not be true for a straightforward 300,000 remortgage of a retail unit. It is clear there is customer demand for specialist commercial mortgage products. This is a result of predominantly self-employed and small business operators failing to meet the criteria of institutional lenders. Intermediaries have identified the market potential and as the domestic environment becoming harder has resulted in more brokers investing time and energy in developing their involvement in the commercial sector. This investment is delivering incremental income and helping deliver better client retention at a time when the cost of generating customer enquires is at an all-time high. Stephen Johnson, sales and marketing director of Commercial First
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