Lease option or delayed completion?

THE QUESTION

I’ve managed to secure a 3-year lease option on a large 3 bedroom, 2 reception room house.  It has an annexe attached to the rear, already set up as a studio, which I will SA straight away after mild refurbishing and decorating.

The question is, how do I finance the initial conversion of the house into an HMO with an investor if we are not going to execute the purchase option potentially for nearly 3 years?  It will stack up as all money out on commercial refinance once done to my plans,

I'm wondering do I treat it as a similar scenario to exchange with a delayed completion, do the work and go for the purchase/refinance ASAP with the benefit of not having to have paid a deposit or stamp duty until we actually purchase or do I do a small conversion and run it for a few years first?

Luckily, there is no mortgage on the property; it’s currently owned by a retired couple who are fairly well off.

Basically, how on earth do I present it to an investor with my exit plan?

THE ANSWER

You need to be very cautious as there are ways that this type of deal can bite you in the ass.  How you describe it has the potential to go very, very wrong and if you have borrowed money to do this, you could screw yourself up for years to come.

It’s good that you have established that there is no mortgage on the property, so no lender’s T&Cs to worry about breaching.

The simple truth on funding is that you cannot borrow money on a property you don't own.  As you can’t raise finance on it, you have to use your own cash.  If you don't have that cash then you can use a personal loan or credit cards i.e. unsecured borrowing (not that this is recommended, but it is possible) or private loans from an individual.

Doing this on a lease option carries a high level of risk for your cash.  This is because the contract does not obligate the seller to sell to you; it only obligates them not to sell to anyone other than you during the option period i.e. 3 years in your case.

It is possible (and I have seen it happen) that, having let you spend several thousands of pounds increasing their property, the owners decide to go incommunicado on you spinning out time until the lease option term expires. This means the property remains theirs, they can sell it or keep it and you have no recall on the money you spent on their property that has improved its value. Whether this couple would do that or not is beside the point, using a lease option contract exposes you to the risk that they could.

An exchange of contracts with a delayed completion is a stronger legal contract that is more costly for the owners to wriggle out of.  They will be required to meet the forfeiture clause of 10% of the purchase price if they pull out after exchange. However, you still can’t borrow money on a property that you do not own.

The other challenge is that you can never complete the purchase on a mortgage at a value based on the uplifted value the work will have created, because mortgage lenders only lend on the LOWER of the purchase price or value, at the point of purchase. This means that  you would still need to put down the normal deposit for a mortgage.

There is a solution, and it is one I have been teaching for several years.  Use a bridging loan to complete the purchase.  There are a few, very few, bridgers that are willing to ignore the purchase price you are paying and lend on the value you have created by the work you have done.  Once purchased you then refinance onto a mortgage to repay the bridging loan.

You also say "It will stack up as all money out on commercial refinance once done to my plans".  What evidence do you have to support that?  Most HMOs will never value on that basis, only on a standard bricks and mortar value because most HMOs do not become commercial properties, they are still residential properties temporarily being used for a commercial purpose.  As soon as they are vacant, they revert to being just a residential property. 

If you are borrowing money to finance this, you need clarity on what the end value will be as you are relying on it to repay your investors.

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