Building a profitable property portfolio in the UK requires careful planning. One strategy for property investors is converting commercial into residential properties. This can yield strong returns, particularly in a market where residential demand can outpace supply.
Funding your commercial to residential conversion project
Securing the right finance at the start is crucial for the success of any property conversion. Here are some of the options available:
- Funding for purchase only: This option is suitable if you have the funds or a separate finance plan for the refurbishment. It involves securing a loan just to purchase the commercial property.
- Funding for purchase and refurbishment: This option covers both the acquisition of the property and the costs of conversion work. It is ideal for investors who need a complete financial solution, from start to finish. This type of funding can streamline your project by ensuring you have all the necessary capital upfront, reducing delays and allowing for a more efficient renovation process.
Both options can be used to purchase commercial or semi-commercial properties, converting them into single residential units, multi-unit blocks, or Houses in Multiple Occupation (HMOs). The choice between these funding options depends on your financial situation, project scope, and timeline.
The role of Short-Term Loans (STLs)
Short-term loans, also known as bridging loans, are used to for properties which require works and are not generating an income. They are are helpful tools for property investors undertaking conversion projects. Here are some reasons why:
- Flexibility: STLs can be tailored to your project’s timeline, ranging from one month to 24 months, providing the flexibility needed for various project scopes. This adaptability allows you to manage cash flow effectively and align the loan term with your project’s timeline, whether it is a quick flip or a more extensive renovation.
- No exit fees: Unlike term loans, many STLs do not charge exit fees, making them cost-effective for short-term use.
- High initial funding: STLs can offer up to 70-75% for heavy refurbishments, and 85% funding on the purchase price for light refurbishments (normally not applicable to commercial to residential conversions). This high loan-to-value ratio can significantly lower the amount of upfront cash required, making it easier to undertake large projects without tying up all your capital.
Moreover, this is the correct loan option to use for these circumstances. If you try to use a buy-to-let mortgage to do a property conversion, you are in breach of your contract and that is not a good way to build a long-term relationship with a lender.
Key benefits of short-term loans
- Immediate valuation: On day one, you get a valuation that confirms both the current property value and the Gross Development Value (GDV), helping you understand potential returns. This early insight allows you to plan your project more effectively and make informed decisions.
- Funding for works: For heavy refurbishments, funds are released in arrears to cover project costs, based on progress assessments. This phased funding approach ensures that you have the necessary cash flow to keep the project moving forward without delays however please note a residual valuation would be used for this.
- Reduced fees for term loans: If you transition from an STL to a term loan with the same lender, you often benefit from reduced arrangement fees. This continuity can simplify the finance approval process and reduce overall borrowing costs and timescales.
If you have reservations about using short-term loans, read our blog “Short term loan myths: busting the top three misconceptions about short term loans” to learn more about them.
Deposit requirements and documentation
When securing a short-term loan, you need to provide evidence of your deposit’s source, build-up, and availability. This can include:
- Savings: Personal or business savings dedicated to the project.
- Investor finance: Funds from investors, with clear documentation and agreements.
- Sale of assets: Proceeds from selling other properties or assets.
- Gifts and inheritances: Documented proof of gifted funds or inheritance.
For limited companies, funds should be in the business account, with proper documentation for inter-company loans or director loans. Note that gifted deposits must go through a personal account before being transferred to a business account. If you want to draw on crypto currency, you should be aware that new guidelines are being issued regularly.
Understanding valuations for term loans
When it comes to moving the project onto a term loan once it is nearly complete, two types of valuations are important (particularly for HMOs and larger projects):
- Brick and mortar valuations: These are based on the property’s physical condition and immediate market value. They are typically used for standard residential properties and provide a straightforward assessment of the property’s worth. For this you can use the same valuer as at the start of the project.
- Commercial yield valuations: These are based on the property’s rental income potential, often used for HMOs with six or more bedrooms. This is most applicable when you cannot change the property back into a single dwelling.
- Residual valuation: The cost of the works, fees and builders profit are deducted from the GDV – the loan advance is then based on the figure net of these figures.
Learn more about HMO valuations by reading our 2023’s HMO Valuation Calculations.
Converting commercial properties to residential use can be a helpful strategy for expanding your property portfolio. By using short-term loans and understanding the nuances of funding and valuations, you can transform underused spaces into profitable investments.