Many mortgage intermediary firms are being confronted by tough market conditions. Regulation has resulted in increased costs for smaller businesses, which means they are having to run faster to maintain profit levels, never mind about increasing them. At the same time, the IT revolution, together with price competition, has created a commoditised marketplace where lenders are increasingly trying, and able, to attract mortgage customers direct.
The standard solution always suggested to any business facing a threat to its traditional activity is ‘diversification’, and this is what many mortgage intermediary firms are already doing. Many firms have strengthened their presence in the secured loan market and, to counter the Home Information Packs (HIPs) threat, far-sighted intermediary firms will be looking to form alliances with HIP providers. Coming nearer to my home territory, we are seeing increasing participation in the commercial mortgage market from residential mortgage intermediaries as they seek to maximise the earning potential from marketing efforts and their client database.
Strong parallels
Simplistically, commercial mortgage lending draws strong parallels with the residential industry, as the lender can advance a sum of money secured on land or buildings and base decisions upon the affordability of the applicant. There are differences, predominantly around property title, valuation mechanics and the nature of income proof, but fundamentally the client is still looking for finance and is able to offer property as security. These clients are, in most cases, the same customers intermediaries and advisers are speaking to day in, day out, in regard to their personal finance or insurance business – and it makes perfect business sense for brokers to explore the opportunities of helping secure finance against commercial as well as residential property.
The residential mortgage market is a wonderful example of a highly evolved and successful market – product diversity, multiple distribution channels, IT, valuation and conveyancing support systems are widely developed. In contrast, the commercial mortgage market has yet to enjoy this level of investment or evolution. When reviewing the industry in preparation of our entry in 2002 the market was very traditional in its approach, with the high-street clearing banks playing a dominant role and most mortgage business transacted one-to-one with the borrower as part of a finance package that could include insurances, term loans and overdraft facilities.
Having adopted a whole new approach and brought the benefits of specialist lending, including focus, service, product innovation and broker distribution, to the sector, new lenders have followed our lead. We are now seeing a commercial mortgage market with stand alone products that cater for a wide range of credit profiles, and one that provides improved service and completion times. As this has been delivered, the business case for brokers to grow their involvement has been demonstrated and distribution is becoming intermediary led. However, spending time and resources on diversifying into an unknown market sector is not to be undertaken lightly. Those businesses that are thinking about expanding into commercial mortgages will be looking at many factors before investing in a new area of trading and asking some pertinent questions. How big is the market and how good is its growth potential? How easy is it to understand the issues and advise clients correctly? How do I get enough business through the door to make this new area of trading worthwhile? Will the financial rewards be enough to compensate for the added workload?
Regarding the size and shape of the commercial mortgage market, it’s important to understand what is happening in the small-to-medium enterprise (SME) sector, which forms the broad base of UK businesses and in which there is the greatest potential for intermediaries to introduce commercial mortgage business. In August 2005, the Government’s Small Business Service published statistics showing that there were an estimated 4.3 million business enterprises in the UK at the start of 2004 (excluding Government and non-profit organisations) compared with 4.0 million one year earlier. Almost all of these (99.3%) were small, with 0 to 49 employees; 0.6% were medium sized (50 to 249 employees); and only 0.1% of the total was made up of large businesses with 250+ employees. The vast majority of UK businesses (around 73%) are sole proprietorships, partnerships comprising only the self-employed owner-manager(s), and companies comprising only an employee director. Industries in which small (0-49 employee) businesses dominate include agriculture (90%); construction (75%); and real estate/renting (55%). While the number of businesses overall remained stable at 3.7 million between 1995 and 2001, the rate of yearly growth has been increasing since then and the highest growth has been in the most recent years. Self employed workers now amount to 3.6 million, which represents a 112% increase since 2000.
The reason why these figures are significant to the commercial mortgage market is not only to do with the large overall numbers of potential borrowers. According to the Annual Small Business Survey 2004/5, 53 per cent of all small businesses intend to grow in the coming two to three years and they view the main obstacle to growth as obtaining finance. Business growth, almost without exception, creates the need for larger premises – at which point business owners will be confronting the question, ‘Do I pay more rent or do I invest in buying a property?’ Many individuals are well aware of the increase in value of their residential property which, according to the Halifax House Price Index, has increased by 164 per cent over the last 10 years. Few would pass up the opportunity to experience similar gains on their commercial premises, if a way could be found to purchase rather than rent – and that’s where the smart broker will be able to create opportunities for expansion.
Turning to the UK commercial property market itself, the total value is around £600 billion, according to the Bank of England’s lending returns, with annual lending to SMEs and the commercial property market at around the £150 billion level. Interestingly, from the point of view of the non-specialist mortgage broker, there are nearly 48,000 commercial property transactions a year with a value of less than £1 million – a level which is now comparable to an increasing number of deals in the residential sector. In addition, capital values in commercial property look very strong with an estimated increase of around 14% predicted this year by the NACFB compared with a predicted increase in residential values of around 4%.
It’s clear that residential mortgage brokers looking to expand into commercial mortgages will not want to start with £ multi-million, complicated property deals but will prefer to gain some experience nearer to home with something that more closely resembles their core residential business. This brings us to the question of generating business in the commercial sector, how it is achieved and whether the business is introduced to a specialist partner or the commitment is made to dedicate internal resource to this area.
Modest beginnings
Thankfully, unlike launching a completely new product in a new market, levels of business in the commercial area can be built up from very modest beginnings. If we start with the premise that the small business owner is an ordinary person who has a residential mortgage already, then one easy way to start to generate commercial business is to quiz your existing database about their commercial mortgage needs. You may already know which of your residential clients are self-employed and, if you don’t, then adding this question to your residential factfinds could help to build up a database for future mailings. Brokers specialising in non-conforming should also bear in mind that the self-employed and small business owners tend to be entrepreneurial by nature and less risk averse than the average – which can result in the normal elements that make up a non-conforming profile: arrears, CCJs, bankruptcy and Individual Voluntary Arrangements (IVAs). Particularly as the last two (together classed as ‘insolvency’) have increased dramatically over the last few years since the Enterprise Act deliberately made bankruptcy less of a stigma and quicker to discharge.
Marketing and attracting business
The best starting point is always the easiest – ask yourself how do you market and attract business? Whichever methods work, look for a way to add the commercial message. Do all of your business introducers know you can potentially assist with commercial property finance? Do your customers know you could help provide a solution in this area? Do your internal staff and teams realise this? Consider adding messages about commercial property to any advertising, communication or display space in your office. If nothing else, all these actions will give you the opportunity to offer something new and fresh to existing activities.
Finally – will the rewards make the extra work worthwhile? We have always encouraged the formation of strategic partnerships between brokers and commercial specialists, and entering into these partnerships will provide the easiest starting point. Under such an arrangement, until intermediaries are confident enough to submit cases themselves, they can generate enquires and pass them on as introductions, thus earning incremental fees of between 1 per cent and 1.5 per cent while they widen their understanding of the commercial sector and gain more knowledge. This may lead to developing in-house facilities, or brokers may choose to retain this partnership approach as they experience the income benefits, the client solution benefits and do so without direct involvement.
