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A Beginner's Guide: Setting up your own Commercial Mortgage Brokerage
16th January 2008
Commercial Finance Introducer
February edition
A Beginner's Guide: Setting up your own Commercial Mortgage Brokerage
With the residential mortgage market in the grip of the credit crunch, residential mortgage brokers are looking to commercial mortgages to increase their business. In the first of two articles, Adam Tyler, Chief Executive of the National Association of Commercial Finance Brokers, offers advice - and a few words of caution - on the best way of starting out.
The commercial mortgage market has long been a tempting target for residential mortgage brokers looking to expand their horizons. The principles behind both markets are roughly the same: a client is looking for best advice with regard to a loan which is secured on a property. But that’s really where the similarities end. Residential mortgage brokers who enter the commercial finance arena need to be aware of the differences and the specific challenges that both advising clients about, and arranging commercial finance can bring. And the NACFB can help.
First of all, it’s the kind of property and the kind of borrower which makes the distinction as to whether this is a commercial or residential deal and, accordingly, how it is treated by the FSA. This is one of the key distinctions between the markets: the vast majority of commercial transactions are not regulated by either the FSA or the OFT (although there are a few which sneak under the radar – see below for more details). A business client is deemed by both the FSA and OFT to be more savvy that your average consumer and therefore does not require the protection of the Consumer Credit Act or the Financial Services Authority.
However things are constantly evolving. Last year the OFT announced a change to the Consumer Credit Act which meant that loan agreements with business clients who were either sole traders or ‘partnerships of three or less persons’ would now be regulated by the OFT – unless the client concerned signed a business disclaimer. The Association recommends that all its broker members have a Consumer Credit Licence in any case which will means that members are compliant in the event that one of their clients is eligible for protection from the act.
Starting out – the basics
So before you set up your own brokerage, there are a few things you will need to sort out. First of all, as explained above, we recommend you get a Consumer Credit Licence. If you visit the Office of Fair Trading’s website at www.oft.gov.uk you will find details of how to apply and any associated costs. You should bear in mind that there is often a delay of a month or so (some of our members have reported a backlog of up to three months) before a licence is issued.
You will also need to register with the Information Commissioner (www.ico.gov.uk) to comply with the data protection act. The Association also recommends that anyone who is looking to advise clients ensures they have adequate professional indemnity insurance. Of course, if you are a residential mortgage adviser, you should have all these things in place already, but it’s worthwhile checking out your PI policy will cover you if you start to offer commercial finance advice.
In terms of legislatory requirements for starting out, that’s it. You don’t need to be registered with the FSA or comply with FSA rules and regulations for the vast majority of commercial finance deals. There are exceptions to this rule: one is buy-to-let mortgages where the property will be let to a member of the landlord’s immediate family; another is if a property is split between commercial and residential usage and the proportions of the split mean that less than 60% of the property is for commercial use.
Background
Although many residential mortgage brokers are now looking to enter the commercial mortgage market, traditionally commercial mortgage brokers came from a business banking background. This is because business bankers understand business finance and also know what a lender is looking for from a business. Despite having no broking experience, some commercial bankers find the leap to commercial broker easier that a residential broker will. This is because of the differences and challenges in this market mentioned at the beginning of this article.
But before I move on to the challenges of making the leap to commercial finance broking, I do want to outline some of the really positive reasons for joining this market. First of all diversification can offer protection in a difficult market. Adding an extra string to your bow will allow you to offer more to your clients. Commercial brokers get a good deal of satisfaction in working with businesses and watching them grow. And, let’s be honest, commercial mortgages offer a good rate of return. The average commercial mortgage size written by NACFB members is £400K. With a commission payment of (on average – according to Business Moneyfacts) 0.5% of the loan, that’s £2000 per deal available to the broker.
But, it’s not all plain sailing. So, without further ado, these are the issues a new residential mortgage broker will come across when starting out in the commercial finance market for the first time.
No products
This is usually the first shock to the system. Commercial mortgage are priced according to the risk of each individual deal; usually by adding a margin to a given base rate, either Bank of England base rate, LIBOR or the Finance House Base rate. All is not lost, however. Some innovative lenders have devised commercial mortgage products that a residential mortgage broker will find familiar. However, the high street has yet to follow suit and the products from these specialist lenders may not necessarily always be the best option for the client, so it is important for a broker to keep abreast of what lenders in the market have to offer.
There are also specialist publications available which will list commercial mortgage lenders and the types of business they will consider lending on. These include The Finance Book, Business Moneyfacts and Business Money. They also give a rough guide to the maximum and minimum margins these lenders charge, along with typical fees that the client will need to pay. Although useful, these publications can only act as a guide as there are so many variables involved in each deal. Brokers entering this market will need to make contact with the business development managers from different lenders in their area to make sure they keep a good knowledge of the rates and terms available.
No sourcing system
The result of the ‘no products’ point above, is that there are no sourcing systems either. So whereas a residential mortgage broker can use a system to advise their client from the outset of the kind of rate they will be paying a commercial finance broker will have to rely on their knowledge and skill within the market to give an idea of pricing. Also, individual knowledge and skill is needed when looking fro a lender who will consider a particular deal. Take public houses, for example. Although many lenders say they will consider this kind of business, only an experienced broker knows which of those lenders are interested in doing the deal and giving the client a good rate.
No income multiples
Another reason for there being no sourcing system (and an explanation as to why the specialist listing publications can only act as a guide) is the way that risk is assessed for a commercial mortgage deal; in other words the way a lender calculates whether they are willing to lend, and if they are, at what rate they are willing to lend.
Whereas for a residential mortgage, the terms are usually fairly straight forward (3 times joint salary up to 85% loan to value, for example) for a business proposition there is the need to be able to read and assess accounts and balance sheets (assuming a business has one), put together a SWOT (Strengths, Weaknesses, Opportunities, Threats) analysis and look at and evaluate business plans as well as assessing the experience of the business owner manager as it largely his experience and skill which determines whether the business prospers or fails.
Is the client looking to purchase just a property, or are they looking to buy a going concern (i.e. the entire business which is currently trading)? Has the business been valued as well as the premises? A bank will need to know all these things to assess the risk and rate of interest for lending to the client.
Despite the challenges many residential brokers do make the leap very successfully to broking commercial finance and enjoy the benefits that the commercial market has to offer. The aim here isn’t to scare people off from writing commercial mortgages, but simply to make brokers aware of the skills and knowledge they will need to succeed in the commercial finance market. A bad decision, or bad advice, could mean that a business goes under, with all the attendant repercussions for the owner, his or her family, and any employees caught in the crossfire. But for brokers willing to make the commitment to put in the hours the rewards are there. And there is help and support available so you don’t need to do it alone.
Next time I will take a look at the help and support available and also the other kinds of commercial finance available to brokers and their clients.
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