Written by Faisal Jumaily
“There was a softer attitude to lending in the past, but borrowers are more constrained with margins under increasing pressure.”
A widely accepted sign of being financially flush amongst most of the UK population is paying off one’s mortgage- clearing your debt to own your home outright. For many, this is a sought-after goal contributing to what economics defines as the ‘Wealth Effect’.
But what about the ultra-wealthy?
The world’s priciest homes are bought by the world’s most affluent people, not because of their abundance of cash but because of their ability to take mortgages with a generous loan-to-value ratio (LTV) at low-interest rates. Mostly, these loans are interest-only, meaning the owners tend not to buy into the home’s equity incrementally – they only pay to service their debt. Most of these loans are never redeemed unless the property is sold. Even when the next generation inherits an asset, a loan is once again taken out against the home’s value. “This debt is never paid off, but rather, properties are held and re-mortgaged every 5 to 10 years”, says Scott Mckinnon, director at London mortgage brokerage – Mutual Finance.
A highly leveraged real estate portfolio offers tax benefits, with the mortgaged portion of the inherited properties being immune to the 40% UK estate tax. “Inheritance planning is well managed amongst the wealthy; assets are held in special purpose vehicles (SPVs) whose shareholders change from one generation to the other to reflect changes in ownership”, Mckinnon added.
Aside from tax exemption, high leverage also makes sense from a savvy investor’s perspective. Purchasing a property through debt means that the investor’s money is working to generate wealth in two different places- the home generates a return as it appreciates, and the funds that would alternatively have been used to buy the house can now be funnelled into another opportunity to generate higher returns.
“This debt is never paid off, but rather, properties are held and re-mortgaged every 5 to 10 years”
Of course, with many such homes valued in the tens of millions, even mortgage interest rates as low as 1% can become a significant expense. Still, so long as the property sees capital appreciation above the loan coupon rate, the spread between the two creates a positive net return on the house. It then becomes a case of an individual investor’s liquidity preferences, whether they deem such an investment worthwhile- the interest payments would, of course, be a cash outflow, with the property not generating any cash returns. However, the net return paints an even rosier picture when you add rental income (should it be a buy-to-let purchase).
And that does tend to be the case, with several wealthy individuals investing in property as a diversification tool away from financial markets. These investors tend to have hundreds of millions of active mortgage positions, accessing exclusive lending facilities via international private banks.
Specialist banks offer benefits that mainstream high street banks, whose residential loans are commonly capped at £10 million, are unable to provide. With a particular focus on clearing the borrowing quickly, these banks understand their clients’ need for speed in snapping up bargains in the London prime property market. Borrowing through a private bank also has financial incentives, with investors enticed by favourable borrowing rates. At times, it’s challenging to fathom how these private banks were, at times, willing to lend at 100% LTV with such little return in interest payments.
However, according to specialists in property finance, recently, it’s becoming nearly impossible to reach anywhere near 100% LTV. “I’ve not seen 100% in the last 24 months,” said Tariq Ansari, a mortgage broker at Mutual Finance. “Even for the best clients, we’re only doing 75-80% [LTV]. There was a softer attitude to lending in the past, but borrowers are more constrained with margins under increasing pressure.”
But lending is only one of several other profitable services that these institutions offer, with most revenues coming from managing clients’ investment portfolios. Scott continued, “With private banks, mortgages are arranged with additional liquid AUM* requirements, so, the effective overall LTV is lower than simply loan value over property price”. In other words, a borrower must meet a minimum cash threshold in their account at all times or put up a portfolio of financial securities for management. In the eyes of a private banker, a cheap loan can be seen as a means of securing a client for long-term business in financial planning and wealth management. But the key is in the ‘long term’ as HNW individuals wait to get to know their banker over several years before allocating any assets for management.
If you’re looking to purchase a property and require financing, our team at Falcon Investments is here to help you with the search and buy process. We can recommend you to our industry-leading collaborators in property lending.