Many people bought property before and during the boom expecting that by increasing equity over a period of years they would get a better return than they would otherwise. The plan was to buy a property at a reasonable price, let it out for a few years, sell it on and pocket the profits. Hence the boom extended to what became known as the ‘Buy to Let’ sector.
The idea was simplicity itself. An individual or a couple with a reasonable disposable income purchase a property and let it out to tenants. Mortgages of up to 100% were easy to come by and rents were buoyant. In principle and generally in practice the rental income more than covered the monthly mortgage payments. The property increased in value year on year and in due course the sale of the property would yield a nice little profit, even allowing for capital gains tax. For many the temptation was repeated and rather than limit their ambitions to one or two properties, they bought multiple properties, sometimes hundreds.
And then the bubble burst. The continuous increase in property values slowed down and eventually began to go the other way as property sales volumes and prices tumbled. The demand for rental properties began to reduce and rental income began to fall. Suddenly those who entered the ‘Buy to Let’ sector found that they were unable to reverse the process easily. As demand for property fell so did prices. And so did rental incomes. The mortgage payments on some properties began to exceed the rental income. Letting sometimes became impossible. The term negative equity re-entered the vocabulary – in truth, it had never gone away.
Because selling properties at a loss was an unattractive option, people held on to their ‘Buy to Let’ properties for too long. Instead of the hoped for recovery in the housing market, things got worse. As a result many such investors found that they were insolvent. Their disposable income was insufficient to bridge the gap between their (multiple) mortgage payments and their rental income. Mortgage payments fell into arrears and they began to seek solutions for their financial difficulties.
Given that selling the properties would lead to shortfalls, many debtors opted to enter Individual Voluntary Arrangements (IVAs) rather than petition for their own Bankruptcy (BCY). They found that a crucial factor to be considered would be the attitude of their creditors to an IVA.
Buy to Let in an IVA
In proposing an IVA, the ‘Buy to Let’ property has to be considered from two perspectives – the net cost to the debtor of retaining the property and the equity therein. If the debtor has several or indeed many such properties, then each property usually has to be considered separately and on its own merits, so to speak.
If a property is ‘cost neutral’ i.e. the rental income is wholly consumed by the mortgage payments (plus any other valid associated costs such as insurance or maintenance) with no significant surplus or deficit arising then creditors will only be interested in whether there is any equity available in and recoverable from the property. Unsecured creditors have nothing to gain from forcing the debtor to sell a property which is in negative equity since any shortfall arising would then be introduced into the IVA and would have the effect of reducing the dividend for all creditors. If on the other hand the property has a significant amount of positive equity then creditors will expect all such equity or a high percentage of it to be introduced into the IVA. Thus the property in question may have to be sold or the equity addressed by some other means such as the contribution of third party funds or remortgage.
If the property is ‘cost positive’ and generates significant net income i.e. the rental income exceeds the mortgage payments (plus any other valid associated costs such as insurance or maintenance), then creditors will expect any such surplus income to be contributed to the IVA over the full term of the IVA. If the property is in negative equity, it is not in the interests of creditors that it be sold. If there is significant equity in the property then creditors will expect all or a high percentage of such equity to be realized by sale or remortgage before the end of the term of the IVA, usually in the fourth or fifth year.
Finally if the property is ‘cost negative’ i.e. the rental income is significantly lower than the mortgage payments (plus any other valid associated costs such as insurance or maintenance), then creditors might require the debtor to sell the property. Following such a sale, the savings made from eliminating the ‘cost negative’ factor would allow monthly contributions to the IVA to be increased. 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 retain the property, not withstanding 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.