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Financing an auction purchase

ninja learning Jun 20, 2021

THE QUESTION

I'm looking for a little guidance on financing an auction property.

My brother and I have construction management experience and are looking at a house coming up for auction shortly.  We have roughly £50K to use as a deposit and to get any renovation works started.

We're considering a house with a guide price of £280K and would pay up to £300K for it.  We estimate that it would need £100k of work to bring it up to scratch, including a large extension, and would be worth well north of £500K once complete.

I have spoken to a broker I found online who have offered 65% LTV, which leaves us a fair bit short of being able to purchase and complete the project.

Are there other financing options that won't completely destroy the margin? I've considered Mezz, but rates of 20% aren't particularly attractive!

Second charge lending has also cropped up before so am interested to learn more about it. I do not have property in the UK, but my brother has £500k or so equity in his home, so it should be possible to use that.

Any guidance would be much appreciated.

THE ANSWER

However you fund an auction purchase, you will need a 25% deposit - 10% on auction day at the fall of the gavel and the balance within 28 days (usually). There will be 75% lenders out there but even 75% won’t work for you. 

On a £300k property that is £75,000. Add on the stamp duty cost, £14,000 at the time of writing, then valuation and legal fees on top and you are going to need close to double the £50k cash you have. OK, your £50k will be enough for the 10% deposit on auction day, but you face the real prospect of forfeiting that when you cannot complete the deal.

To go for a £300k property at auction you should have £100k in cash, £50k won’t cut it. You have two realistic choices: 

a) Get more cash behind you 

b) Go for a cheaper deal that your £50k can handle. 

One other possible way is to find a private investor that will give you the 80% + loan to value funding you seek. 

Two other points worth noting re that auction property with a guide price of £280k – 

  1. There is another price, the reserve price, on properties for sale at auction. This is the price agreed between auctioneer and seller as the minimum the seller will allow the property to be sold for and it is roughly 10% higher than the guide price. So a £280k guide price would mean that the seller will not allow it to be sold below £310k – ish. So you would have no chance of buying it less than that figure.
  1. Properties rarely sell close to the guide price at auctions. Often they go way over, sometimes 20%, 30% or even more above the guide price. So you may not even get the chance to buy this property at a price that allows you to make a reasonable, or even any, profit.

Mezzanine finance is at 20% precisely because the lender, by topping up the main 75% LTV finance, is taking a very high risk of not getting their money back if the borrower screws up. 

You mention your brother’s £500k equity; you could leverage that to give you a bigger 'war chest'. Leveraging usable equity in a property works to get you into bigger deals than your own cash pot allows. This can come under what is called a Cross Collateral Bridge. Usable equity is usually up to 65% of the value, less the main mortgage.

Your construction experience makes buying sub-standard properties to fix up a very viable strategy to make some good money, get your funding right and you can do well at this. Your focus should be on currently unmortgageable properties with structural defects that most people run away from, but with your knowledge you know you can fix. You will get these a lot cheaper typically and the profit margins will be higher.

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