All through the real-estate boom which preceded the current recession men and women in britain started to dip their toes in the property market in the expectation of increasing equity over a period of five to ten years in the hope and expectation that this probably would let them have a really good yield on their funds.
Acquire a property at a good cost, let it out for just a few years with the rental money taking care of the mortgage repayments and then sell it on, pocketing the gains. As a result the boom extended to what grew to become the called the ‘Buy to Let’ sector. The idea was simple enough. A person or a couple with a decent disposable earnings get hold of a house and let it out to tenants. Home mortgages of up to 100% were easy to come by and rents were buoyant. In reality the rental income was anticipated to more than cover the monthly mortgage repayments. The house was expected to add to in price over time and in time the sale of the property would undoubtedly yield a nice little return, even considering capital gains tax. And why stop at one house? If the plan worked with one property, why not choose two, six, twenty, a hundred or even more houses?
So, what could go wrong? Two things could and did. The persistent rise in property prices slowed down and gradually began to go the other way as property sales volumes and prices tumbled. All the interest in rental properties began to reduce and rental profits began to fall. Suddenly those people who got into the ‘Buy to Let’ sector discovered that they were not able to reverse the course of action readily. Given that sales of real-estate dropped as a consequence did prices. And so did rental earnings. The mortgage payments on many properties began to go higher than the lease income and in some cases letting houses at any sort of reasonable level of lease earnings turned out to be extremely difficult. The spectre of negative equity had become a reality for many in the sector. Trying to sell properties at a loss was a extremely unappealing option. People held on to their ‘Buy to Let’ properties for too long hoping against hope that the housing market would get better but it simply got much worse. In due course many such people found that they were insolvent and that their disposable income were not sufficient to close the gap between their home loan payments and their lease income. Thus their mortgage payments began to fall into arrears and they began to search for solutions to their financial problems.
Due to the fact selling the properties would result in shortfalls debtors discovered that their options were limited to petitioning for Bankruptcy (BCY) or entering into an Individual Voluntary Arrangement (IVA). Picking the best solution to go with depended for the most part on each individual’s circumstances. The primary factor to be looked at in an IVA is the disposition of the creditors and in BCY the attitude of the Official Receiver and/or of the Trustee.
Buy to Let in an IVA
When it comes to proposing an IVA, a ‘Buy to Let’ property needs to be thought about from two points of views – the net cost to the debtor of keeping the property and the equity therein. If the debtor have several or indeed many such properties, then each property normally has to be looked at on its own and on its own merits, as it were.
If a property is ‘cost neutral’ i.e. the lease earnings are completely consumed by the mortgage payments (plus any additional valid related costs among them insurance or servicing) with no significant surplus or deficit arising then creditors will only be thinking about whether there may be any equity available in and recoverable from the property. Unsecured creditors are not going to push the debtor to dispose of a property which is in negative equity since any deficiency arising would most likely then be introduced into the IVA and probably have the effect of decreasing the dividend for all creditors. If alternatively the property has a considerable level of positive equity then creditors will expect all such equity or a high percentage of it to be introduced into the IVA. Thus the particular property in question may have to be put up for sale or the equity addressed by another way such as the contribution of third party money or remortgage.
If the property is ‘cost positive’ and provides a lot of net income i.e. the lease income exceeds the mortgage payments (plus any other valid related expenses such as insurance or maintenance), then creditors will expect any such surplus income to be contributed to the IVA over the full time frame of the IVA. If the property is in negative equity, it is not in the interests of creditors that it be put up for sale. If there is substantial equity in the property then creditors will rely on all or a high percentage of such equity to be realized by sale or remortgage before the end of the term of the IVA, normally in the fourth or fifth year.
Finally if the property is ‘cost negative’ i.e. the rental earnings are significantly lower than the mortgage repayments (plus any other genuine related costs such as insurance or upkeep), then creditors might require the debtor to sell the property. Following such a sale, the cost savings made from getting rid of the ‘cost negative’ factor would allow monthly contributions to the IVA to be enhanced. If the property was in positive equity, any equity realized would be contributed to the IVA. Obviously, if the property was in substantial negative equity, the shortfall following its sale would be claimed as an unsecured debt of the arrangement. This could depress the dividend to such an extent that it would be in the interests of the unsecured creditors to allow the debtor to keep the property, notwithstanding the fact that its retention would be ‘cost negative’. However, once the property is no longer in negative equity, creditors might require that it be sold and the savings introduced into the IVA.
Buy to Let in Bankruptcy
The bankrupt’s property vests in the trustee immediately on his appointment taking effect or in the case of the official receiver, on his becoming trustee. The trustee can disclaim any onerous property and any property in significant negative equity would be regarded as onerous property.
Property with equity of up to £1,000 – looked at as de minimis – can be bought back from the trustee for a moderate sum. It’s not at all out of the ordinary for the family of a bankrupt to acquire such a property on payment of £1 plus the official receiver’s costs of £211. A recent change in policy by the Insolvency Service ensures that this buy back will usually not now take place until two years and three months have elapsed since the bankruptcy order was made.
If the equity in the property is in the range of £1,000 to £5,000 then the trustee may try to register a charge on the property rather than seeking to realize this equity by having the property sold, because of the risk that the sales price might not achieve market value and that the equity realized might not cover the cost of sales.
If the equity in the property exceeds £5,000, the trustee may try to sell off the property and to realize the equity for the benefit of creditors and to pay the costs of bankruptcy. The bankruptcy laws deal in great detail with the rights and duties of the trustee and of the bankrupt and with the rights of other parties such as the bankrupt’s family and of creditors.
Where a bankrupt possesses one or more ‘Buy to Let’ properties it appears that there has been a relatively recent change in the attitude of some trustees to the treatment of such properties. Historically where there was little or no equity in such a property, trustees allowed the bankrupt’s family to ‘buy back’ the property and allowed the bankrupt to manage the letting of the property and the servicing of the mortgage. Any surplus income thus generated would constitute part of the bankrupt’s disposable income and be subject to an income payments order. Thus the trustee would receive payments from the bankrupt for up to three years.
More recently, it would appear that some trustees seek to seize control of such ‘Buy to Let’ properties and then to assume all responsibility for them: collect all rental income; pay the mortgage and all associated insurance & maintenance costs; deal with all rental and tenant issues and take all the regular decisions regarding the properties. If the properties go into significant positive equity in the first three years of the bankruptcy, the trustee would also be able to realize the equity prior to the property re-vesting in the bankrupt person. The reason for this change in approach by trustees is unclear unless they expect to increase dividends for creditors by taking such action. If you become bankrupt and the trustee is intending to seize control of your ‘Buy to Let’ properties, you should seek to get legal advice on this issue.