BRIDGING

Bridging loans are short-term loans, typically six to 12 months maximum with a three month minimum period, secured against property (although there are now some funders who are starting to offer a bridging facility against plant and machinery).

The advantages of bridging loans are that:

• they are generally quick to put in place, taking a week or two if all goes well, and do not tie you in long-term to a particular funder; and
• they tend to be based on the property’s value and not simply its purchase price.

As a relatively flexible source of finance they therefore tend to be used to help arrange transactions such as buying sites for

property developments, helping to achieve business purchases or raising short-term business cash.

In one example, a business sale included property which was valued at £1.5m, but which for a number of reasons was included in the sale contract at £lm. This meant that the buyers could only obtain £700,000 in funding against the property from mainstream commercial mortgage lenders who operated on the basis of lending at the lower of purchase price or valuation, which obviously would leave them with a large requirement for equity investment to fill the gap. However, they took out a bridging loan against the property instead, which was based on 70% of the valuation of £ 1.5m, enabling them to raise more than the £lm purchase price. Six months later they were then able to replace this with a normal commercial mortgage as, on refinancing, the lenders were prepared to look at valuation.

As discussed below, however, bridging loans are expensive so you should always be looking from the outset at how you are intending to repay the bridge, either by selling the asset or refinancing it, (known as ‘takeout’ finance). You should never go into a bridge without having your exit planned. If anyone you are dealing with appears to be advising you to take out a bridge without having both this and the funding of the ongoing interest charges covered you should seek another adviser immediately.

Bridging loans can be as follows.

• Based on first charges over the property, where loans of 75% (or even occasionally 80% using specialist top up facilities) of OMV are usually available, falling to 65% where given on a second charge basis.
• ‘Closed’, where the arrangements for the take-out by way of a remortgaging or a sale are in place at the outset, or ‘open’ where they are not.
• ‘status’, where the lender has satisfied themselves that the borrower can repay the loan, or ‘non-status’ where the borrower is simply operating on a pawn broking basis, that is if the borrower defaults the lender can recover their money by the sale of the property. Advances in bridging therefore tend to be driven almost exclusively by the property’s valuation.

So for lenders, the key criteria and issues in lending are:

• valuation of the property by a professional valuer on the lender’s panel;
• the quality of the property;
• the borrower’s ability to service the borrowings; and
• the viability of the proposed exit.

The mainstream banks will offer closed bridges on a status basis. For open bridges and non-status loans there are a limited number of serious players in the commercial property bridging market, mainly lending up to £2m. Larger bridging loans can be arranged, particularly in relation to potential property development sites where we have seen £10m bridges being offered, but this is an area where specialist advice is required in placing the proposal.

Bridging is, however, expensive money. As well as valuation, broker, and legal costs you can expect to pay a lender’s arrangement fee of 2% to 3%, and discounted interest rates currently of between 1.25% and 2.5% per month. Interest is either collected upfront by way of a deduction of the total interest charge for the facility period from the initial drawdown, monthly or weekly in advance, or very rarely rolled up into a bullet payment at the end of the arrangement.

Against this, being interest only, bridging loans can in some circumstances have short-term cashflow advantages over a normal commercial mortgage where regular payments would include an element of loan capital.

Paying for bridging

The interest rates quoted above are the discounted rates for prompt payment and it is normal for the full rates to be almost double these. It is crucial that you are aware of this as in the event of default on a payment (such as failing to pay exactly on the due day), you will lose the right to pay interest at the discounted rate and will be charged at the full rate.

In the event of default, you should expect all lenders to take swift and robust action to secure their lending by way of appointing receivers to sell the property. In addition you will find that the lender will reserve the right to charge administration costs incurred in dealing with any default.

If you take out a bridge where the interest is deducted from the advance on drawdown this has the advantage that you do not need to find the cash to make payments during the period of the loan. Against this, it reduces the funds you actually raise by entering into the bridge. Do not forget that at the end of the period you will need to find the cash to repay the gross amount advanced, not the net received.

The alternative is to take out a bridge on a pay as you go basis, in which case you must ensure that you have sufficient funds to make all the payments on time to avoid the increased interest costs and charges that arise on default. The results of taking out a bridge without having this funding in place can be potentially disastrous.

As defaults are an area in which lenders can make extremely high returns, and can recover these by appointing receivers to sell your property, you should take care that you are dealing with a reputable lender. While bridgers will generally be robust in their approach and expect to act swiftly in both lending and recovering, you should be cautious about dealing with lenders who appear to be willing to lend very aggressively, or who are completely unconcerned about your ability to pay the interest or to repay the loan at the end of the term. You should also check the terms of any loan carefully to ensure that:

• the rate and/or the basis of charges (for example the percentage over bank base rate) will remain set for the whole of the facility period and cannot be varied by the lender once you are signed up; and
• that there are no unexpected exit fees.

While a broker will charge you for arranging a facility (typically 1%, deducted from the advance drawn down), using a reputable asset finance broker will assist you in finding a reputable bridging lender.

If you are considering using bridging funding to raise cash for property development, you should be aware that there are specialist funding products for property development (see Chapter 15).

As this is an area of small specialist lenders, it is one where there is always a lot of change in what is on offer. At the time of writing for example, some lenders are developing alternative and hybrid products such as a two-year super bridge and a one-year bridge that automatically converts to a normal 15-year term loan at the end of the period assuming that the account has been operated correctly.

The information required to obtain quotes for a bridging loan is set out in the form in Figure 12.

SALE AND LEASEBACK

A property sale and leaseback is a technique for releasing the full value of your property into cash by selling it to an investor, while agreeing to rent the property back from them on some form of normal institutional lease. The new owner will then hold this as an investment and will therefore be looking for the rent charged to provide a reasonable current market rate of income, usually referred to as a yield and calculated as a percentage of the price paid.

To make the costs of undertaking such a deal worthwhile, many investors tend to be interested in larger commercial transactions, as a guide say over £500,000 in value.

Having said that they are a technique for releasing cash from a property that you own, of course you don’t have to have actually owned it very long, a split second can sometimes be enough. A simultaneous (‘back-to-back’) sale and leaseback, where you agree a sale to an investor at the same time as buying the property from the seller, can therefore be used as a means of acquiring the use of a property without having to find the cash for the say 30% deposit that would be needed if you were going to buy in the normal way using a commercial mortgage that raised 70% of the property value. They are often very useful, for example in management buy outs (MBOs) or buy ins (MBIs), where there is a need to make the cash available to buy and invest in the business go as far as possible, and where this technique avoids having precious capital tied up in bricks and mortar.

Moreover, when valuing a property for lending purposes, surveyors have to work on the basis that a lender may have to rely on their estimate in order to get their money back in case of default. If the valuer gives a valuation that is too high they may be at risk of being sued so they will naturally tend, within reason, to err on the side of caution as they have their PII (professional indemnity insurance) policies to consider.

In some cases therefore actual sales price achieved in a sale and leaseback can be well in excess of the surveyor’s opinion as to open market value and the value attributed to the property in the business sale, resulting in an injection of working capital into the company that the buyer has formed through which to make the purchase, either at the outset or later on.

For example, a management team bought out a manufacturing company, including its premises, which were valued for lending purposes by most valuers at £1.2m before the buy out team, which was looking to maximise their borrowing, found a valuer who would give £1.5m as his opinion. Less than a year later the buy out was in need of cash and sought a sale and leaseback with a target price for the property of £2m. They actually achieved a price of £2.3m, resulting in a net injection of cash into the business of over £lm after costs and redemption of the existing mortgage.

The value that can be achieved through a sale and leaseback will be based on the value of the property to an investor which is essentially a matter of:

yield x rent = value

However, this simplistic calculation will be affected by three main issues.

• The local market for commercial property underpins any valuation, as the investor will be concerned with what happens if their tenant defaults. For example, a manufacturing MBI arranged a sale and leaseback at £ 1.5m to raise cash much like the example discussed above. Only in this case, having paid off the bank loan, the directors then decided they still did not have enough cash to take the business forward as it was and put the company into administration within weeks of completing the deal. Fortunately for the landlord, the directors then bought the business back and continued to operate from the premises. A valuer will therefore be looking at the local level of demand for this type of property, so as to assess the local market rent and ease of finding a replacement tenant, as well as any alternative use that the site may reasonably have, such as for property development which might give it an underlying hope value.
• In investing in a property based on a lease which may run for 25 years, the investor is taking a risk in that it may find that at some point in the future its rent may not be paid. The investor will therefore be concerned with the strength of the tenant’s covenant. Renting a property to, say, a large established company with a strong credit rating and a reasonable expectation that it will be around for 25 years obviously appears to present a lower risk of default than renting to a new MBI with a high degree of other borrowings (highly geared or leveraged) that give it a high degree of financial risk. The higher the level of risk being taken by the investor, the higher the level of yield that they will therefore be looking to achieve.
• The lease terms which will be negotiable to a degree will also have an impact. Investors will typically be looking for a normal institutional form of lease. This might for example, mean a period of 15 to 25 years, with upwards only rent reviews every five years. You might, however, want or need to negotiate other terms which are more advantageous to you such as:

• rent reviews which are not upwards only;
• rights of access for third parties such as other lenders as discussed below. Obviously again, the more you look for terms that are advantageous to you and onerous for the landlord, the higher yield or rent the landlord will want.

Depending on the degree of risk involved you may therefore find a landlord looking to achieve a yield of between 7.5% and 10%.

Investors in sale and leasebacks are often individuals or property companies and not the type of financial institutions that provide mortgages. To reach these investors you can employ a number of different people to try to put a sale and leaseback in place.

• Normal commercial estate agents will act to sell your property for you, and may charge between 1% and 2% for finding a buyer. They will often require marketing costs to be paid up front. Their level of experience of arranging and negotiating sales and leasebacks will vary as will their ability to find an appropriate investor.
• There are a limited number of specialist matchmakers whose business involves building up panels of potential investors and managing transactions through to completion, sometimes in conjunction with firms of commercial estate agents. These brokers will typically charge more than an estate agency, say 3%, but this is on a success fee only basis with no marketing costs, and you are also buying their expertise and experience in this particular area.
• Finally, there are some internet based property broking web sites on which you can list your property and the terms you are seeking. This approach is usually cheaper than estate agents, at 0.75%, and enables you to hit an emailing list of many thousands of potential investors, which should allow you to quickly find out whether there is appetite for your deal. These are, however, simply marketing and introduction services and will not provide you with any support in negotiating and completing the deal.

When thinking about a sale and leaseback some key issues that you may need to consider are the following.

• As a result of the sale you will obviously lose the ownership of the property and the potential future development value it may have, so this is not a step to be taken lightly. There have occasionally been sale and leaseback arrangements which had a buyback option built in, but these are rare.
• The potential interaction of any proposed sale and leaseback with the position of other secured lenders which can often lead to problems in completing a deal. For example, a company looking to complete a transaction ran into problems over both its plant and machinery finance and its invoice discounting arrangements which included an advance against stock. The plant and machinery lender’s terms included a provision that in the event of default or the failure of the business, the lender had a right of access to the property for up to six months in order to be able to arrange and complete a sale of the equipment covered by its charge, while the invoice discounter had a similar provision in respect of stock. While the company owned the property these clauses were not an issue, but for a landlord with a defaulting tenant, any restriction for up to six months on its ability to obtain vacant possession in order to market and re-let the property was a major problem. In the event a negotiated solution was found which involved reducing the lender’s access period to three months and the company placing part of the sale proceeds into a three-month rent deposit.
• Finally there may be tax issues to take into account. Obviously the rental that you will be paying for the property will be a tax deductible expense of your business going forward, but more importantly the sale itself may crystallise a capital gain (or conceivably a loss). You should always take tax advice at an early stage in the transaction as there may be steps you can take to either mitigate the liability or, for example by changing your business’s year end, to significantly defer the payment of any tax due.

PENSION PURCHASE

For some businesses it may be possible and appropriate for the pensions scheme to raise a mortgage and to purchase the premises from the company by way of a sale and leaseback, much as described above. This injects funds into the company from the realisation of the property while the property is under the control of a known party. In some cases the pension scheme may be able to borrow more cheaply than the company can.

To be able to undertake this sort of transaction, the pension scheme must have the appropriate structure and borrowing powers. You must seek specialist advice and assistance from an Independent Financial Adviser (IFA) experienced in this area.

PLANT AND MACHINERY FINANCE

As with borrowing against property, plant and machinery finance can involve either:

• funding the acquisition of new machinery; or
• raising funds by refinancing against your existing kit.

The main types of funding available for purchasing new equipment have already been covered in Chapter 6 and are the following.

• Hire purchase, where you buy the asset by making payments in instalments over a set period which may include a final larger bullet or balloon payment at which point ownership passes to you from the finance company.
• Leases, where ownership always remains with the finance company.

These types of arrangement are readily available from a wide variety of financial institutions and to get the best deal you will need to shop around. Your starting point can therefore be as follows.

• The seller, as they may have existing arrangements with a finance house whereby they are able to arrange funding. This can be expensive, but in some cases sellers who are looking to move their products, such as car dealers, may be able to offer advantageous financing deals such as 0% interest.
• Your bank, which will have a full range of products available through its specialist in-house subsidiary.

These days, though, given the numbers of lenders, you should always consider searching on the internet where you will be able to find many providers and compare their current offerings.

RAISING CASH FROM PLANT AND MACHINERY

Refinancing plant and machinery is an increasingly popular way of raising trading funds for businesses, as banks traditionally do not ascribe significant security value to such assets for lending purposes.

Financing in this area is by way of a sale and leaseback of the assets and is driven by asset valuation.

To be financeable, plant and machinery in general has to be clearly identifiable, of significant size (so no small tools), have a significant remaining working life, and be readily removable and realisable. Machinery that is too specialised or built into a property to the extent that it would be difficult to remove will attract low valuations and be difficult to finance. Similarly, it is traditionally difficult to arrange this type of finance for IT equipment due to the steep depreciation and low residual values attaching to it.

There are three main sources of this type of refinance funding.

• The banks’ in-house asset finance subsidiaries. However, as these have a significant captive market of bank introduced leads they tend to be less quick to move on externally introduced opportunities and less flexible on deal structure. In practice, other than as part of arranging the finance for MBO/ MBIs, it is our experience that most bank owned asset financers are not interested in refinancing transactions.
• Structured finance providers, where the larger invoice discounters are adding on plant and machinery and/or property finance capabilities in order to be able to provide companies with a full refinancing package. These lenders tend to be interested in larger deals and only those that involve a debtor financing element.
• A limited number of stand alone asset financiers, who are the specialists in undertaking stand alone plant and machinery refinancing deals.

A sale and leaseback will typically be over three to five years. Interest rates vary dependent on the business circumstances, but might typically be a flat rate percentage in the range 10%-15% although there are lenders dealing at the high risk end of the market who are charging bridging levels of rates equivalent to 20% +.

Arranging to refinance plant and equipment is a relatively straightforward process that begins with a valuation of the equipment.

You therefore need to prepare a list of the available machinery giving the basic details set out in the form on page 220. Your broker should then be able to obtain a desktop valuation from the lender which will give an indication of how much can be raised.

The valuation process

Lenders vary in their approach to valuation and therefore their advance, so it is worth having your broker explore the options. Some lenders seek what could be described as a surveyor’s valuation of what the equipment is likely to be worth if sold, and will then normally lend up to 70% of this figure although one lender is now having its valuers obtain insurance cover to certify their valuations and as a result is now able to lend 100% of valuation. Others will seek a more specific dealer valuation as to what could readily be obtained in today’s market, which tends to be lower, but will lend closer to 100%. In one case the first type of valuation gave a figure of £100,000, sufficient to suggest a loan of £70,000, while the second type of value came out at closer to £10,000 where even a 100% loan to value clearly was nowhere near the first lender’s figure.

This is a marketplace with only a handful of main players so it is important not to spoil your prospects. Businesses will often contact a number of brokers to try to find them a deal in the belief that this competition will help. In practice it tends to work against you as by the time the lender has had the same deal referred into them from half a dozen brokers, the tendency is to feel either there’s something wrong with the deal, or that the client is desperate and the price can be adjusted accordingly.

It is also an area where a number of the lenders’ terms are negotiable and, whilst brokers will charge for arranging such finance, they are likely to be able to get you a better deal than you would be able to get yourself by going direct to the lender.

Having established the level of equity available, the lender may seek permission to undertake credit reference searches on the company and its directors before issuing an indicative offer of terms.

If these are acceptable, the company will need to commission a formal valuation of the equipment from one of the valuers on the lender’s panel. Once this is received by the lender, they can then issue a formal offer and the proposal is authorised by its credit committee. It is then up to the company to accept the offer and on completion of the paperwork it can draw down the funding.

The following are part of any transaction.

• All HP or other finance (such as peppercorn rentals) will have to be cleared on any currently financed assets to be included in a sale.
• A letter of priority will have to be obtained from any existing fixed or floating chargeholder such as your bank, so that the finance company can ensure it has clear rights to the asset.
• An agreement will be needed with any landlord for rights of access to allow the finance company to collect and/or sell assets from site, as well, as in some cases, an agreement as to the limitation of the landlord’s rights to distrain on plant and machinery for unpaid rent.

Lenders may also seek specific assurances as to business performance (for example that Crown debt is up to date, or an agreed schedule of repayments is being adhered to).

Lenders will also want at a minimum, directors’ warranties that the assets to be financed belong to the company and, once financed, will not then be sold without the lender’s consent.

Lenders vary in their requirement for Personal Guarantees (PGs) from directors. Some deals are done without, other lenders insist on a limited PG of say up to 25% of the sum lent to ensure that the directors adequately maintain and protect the financed assets.