Don’t be fooled by the green shoots – all is far from healthy in the garden. Andrew Eames of Hilton Ventures describes some of the growing scams and malpractices in the property sector
During recent weeks, industry pundits have been increasingly pointing to the first green shoots of a residential property recovery. Or put more pessimistically, a bottom having been reached. However, forgetting the spin, the reality is those involved in the industry know how acutely bad the last year has been. What people are probably less aware of, though, is the rapid growth of scams and malpractices in the sector over a similar period as both individuals and businesses have sought to exploit the situation.
Hilton Ventures has been campaigning hard over the last four months to draw attention to the most common scams and, to this end, we applaud the steps now being taken by the Financial Service Authority (FSA) to regulate the sale and rent back market. However, whilst the FSA is due to introduce an interim regime from July to tackle the most significant problems consumers are experiencing in this area – with a full regime being planned for implementation in 2010 – the reality is the problems we see occurring extend far beyond just sale and rent back.
Indeed, as a member of the National Association of Commercial Finance Brokers (NACFB), it is clear to us that not only are unsophisticated investors and first time buyers being targeted but also finance companies themselves. Below is a breakdown of the malpractices we are most commonly seeing in the sector.
Back-to-back
These back-to-back transactions occur when a layer(s) of associated buyers is placed in the middle of purchases to mask the actual purchase price of the property and negate the need for purchasers to put their own funds into a purchase. The associated buyers then pocket the difference between the purchase price and the loan amount - sometimes adding up to a few hundred thousand pounds.
An example: say a “distressed” property – or one at risk of repossession - has a market value of £180,000. To purchase it at a heavily discounted price, short-term finance, or bridging finance, is used – speed being of the essence to secure the purchase. In a traditional scenario, this would allow financing at a level of 70 per cent of market value, or in this case, £126,000.
However, say the actual purchase price of the property is just £90,000 and the investor declared this to his lender. The lender would likely either lend 70 per cent of the purchase price (£63,000) or the full purchase price of £90,000 – not £126,000 based on the market value.
Back-to-back transactions are used to maximise loan amounts, particularly from lenders who advance loans against market value rather than purchase price. To avoid this, most lenders now offer loans as a percentage of purchase price or a percentage of the valuation (usually 70 per cent on both) - whichever is lower.
By putting a layer in the middle of the transaction, such as using the investor’s relatives to buy the property for £90,000 and then sell it immediately to the actual investor himself for £180,000, the declared purchase price would be £180,000, not £90,000.
Therefore, the investor can actually get his lender to lend 70 per cent of the open market value, or £126,000, which, in turn, means that his relative/partner makes a profit of £36,000 – paid in full on completion.
As illustrated above, in order to distort the actual purchase price, a series of “back to back” transactions would be put in place on completion to inflate the purchase price given to the lender. Ultimately, the declared purchase price to the lender would be the last transaction – in this case £180,000.
In the last few months, we have seen this happening more and more. Back-to-back transactions defraud lenders into lending more than the actual purchase price and allow the purchaser to get a huge amount of cashback on the day of completion.
Cashbacks/incentives post-completion
While there may be discounts in a strong property market, they are even more probable in a less buoyant market such as the one the
A few years ago, the best a buyer of a new-build property could hope for would be free carpets and curtains, or perhaps upgrades such as wooden flooring, smarter tiles or better white goods.
Today, the emphasis is more on financial incentives. Property developers are generally reluctant to offer a straight discount off the asking price of a home and they are unlikely to advertise that a price has been reduced. Instead, they will offer buyers incentives such as cashback on completion, paying stamp duty or even paying the buyer's mortgage for a period of time.
Whilst these appear to be good discounts on the surface, cashbacks and incentives post completion again are vehicles used to inflate purchase prices in order to maximise the amount of borrowing from lenders.
Quite simply, a property’s purchase price is inflated to negate the need for a cash contribution from the borrower; the difference between the agreed purchase price and stated purchase price is “refunded” by the vendor post completion. This often occurs without the knowledge of the lawyers acting and the lender.
If a developer offers to pay stamp duty, this will be 1 per cent of the sale price for homes costing between £175,000 and £250,000, 3 per cent for those costing between £250,000 and £500,000, and 4 per cent for homes costing more than £500,000.
Conversely, in order to avoid paying stamp duty, vendors will sell a property at a stated price below the stamp duty threshold (with the agreed price being at a level which would attract stamp duty) with the purchaser refunding them post completion.
Again, those who get ‘stung’ by these malpractices are the lenders, as the main purpose of such schemes is to get as much funding from them as possible.
Whilst lenders have caught on to such schemes, they are often slow to react, allowing investors to borrow huge amounts of money to build up property portfolios often without investing any of their own money.
This process exists when a seller, often a vulnerable elderly person, is in financial difficulty and his/her existing lender is looking to repossess due to non-payment of mortgage arrears. There are a number of businesses advertising in local magazines who agree to buy properties for cash. And we have seen first-hand where these cash buyers have then effectively agreed to acquire the property for the amount due to the lenders. The incentive for the seller is that they can remain in the property – usually with a discounted tenancy agreement for 12 months. In the short term, they are also spared from having to inform their family members about the problem.
Whilst on paper this sounds good, sellers are actually losing out. The cash buyers often buy at less than 50 per cent of the market value, meaning sellers are better off disposing of the property either at auction or via an estate agent.
It is comforting to know that the FSA is looking into new legislation to regulate these types of transactions. This was only recently announced and more information is available on the FSA website.
Conclusion
There are clearly a number of hurdles to overcome and more transparency needs to be demonstrated in the marketplace to prevent unsuspecting people from falling victim to these practices. The main issue is that the above scams have been created to cloud the purchase price and persuade lenders to lend the maximum. In too many instances banks have been lending against market valuations as opposed to the purchase price, whilst lawyers seem to have turned a blind eye to the incentives and cashback issues fuelling the underlying problems.
We believe that more stringent and robust regulations should be introduced with criminal claims potentially being brought against solicitors and purchasers or investors who systematically provide false information that leads to mortgage fraud. Moreover, consumers need to educate themselves about the rules and regulations when dealing with property and the market.
And whilst we applaud the first steps being taken by the FSA regarding the protection of consumers in the sale and rent back market, we believe further steps should be taken in due course across the industry.
In the interim, Hilton Ventures will continue taking whatever steps it can both to protect consumers, whether it be through initiatives such as our 24/7 helpline or bringing attention to the malpractices that we are seeing happening in the sector. Ultimately, for there to be a stable property market, there has to be a properly regulated and transparent lending market – irrespective of the type of finance being used.
Andrew Eames is head of lending at Hilton Ventures, a specialist provider of short term property finance based in
Date: 1st, June, 2009
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