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Calculating the value of lease options

THE QUESTION

We have an option to buy a commercial property for £200k, which is it’s current worth.  During the lease period, we plan to enhance the building to double it’s worth to £400k.

If we exercise the option and proceed to completion.  The vendor wants his £200k and that's what will be recorded on the Land Registry as the sale price, but we want to borrow against the £400k value.

Will any lenders look at lending against market value rather than purchase price if we can prove the value added during lease period?

THE ANSWER

There are two issues here:

  1. When getting a mortgage to purchase, mortgage lenders invariably lend on the LOWER of the purchase price or value. They may recognise that you have added value, but there is very little, if any, chance that they will base the amount they are willing to lend on it.  Their offer will be based on the purchase price you actually paid.
  2. More importantly, the lender may decline to lend at all, because they do not consider it to be the type of true ‘arm’s length’ transaction they require. They will assume that your option agreement means that you have an ongoing relationship with the owners and so that is not an ‘arm’s length’ transaction.

With this type of deal, the solution is to use bridging to purchase, then refinance onto a mortgage. Using bridging breaks both the link to the purchase price you are paying, which means:

  1. You can borrow against the value you have created
  2. The prior link to the owners is no longer an issue, so lenders are not focusing on who you bought the property from.

This way your property can be presented for mortgage at its current value in its finished state.

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