Part 1: Don’t be easily Swayed by your Bank.
A COMMON piece of advice given by mortgage brokers to Commercial property investors — at least, by astute brokers — is to keep securities for each loan separate. In other words, any form of Cross Collaterization (as it’s known) is to be avoided at all costs.
So, just what is Cross Collaterization; and why is it so bad?
Put simply, it is the combining of one mortgage registered against two or more properties (or sometimes even your business) as security.
This is the preferred structure for banks when dealing with clients with multiple properties because …
- It is simpler than arranging multiple loans; and
- Because this structure allows the banks maximum control over any future dealings with you, as their client.
Point (2) is exactly the reason why Commercial property investors and developers should avoid this structure whenever possible.
The control banks can exert has a huge impact when borrowers …
- find themselves in financial trouble;
- are actively looking to grow their portfolio; or even
- simply trying to sell one of the properties.
The global financial crisis exposed the dangers of poor loan structuring. And there have been countless cases of people having serious trouble extracting themselves from situations, where all their assets tied into the same facility.
Let’s take a look at Case Study
“Mick” was a formerly-successful business owner, who had several properties (both residential and commercial) as well as boats, fast cars and several large business assets.
Mick actually had a very simple loan structure: Just two loans with two separate banks, covering all of his property and business assets. This structure kept the banks happy, and enabled him to access slightly lower rates.
The problems started during the global financial crisis when Mick’s business took a turn for the worse. And simultaneously, the property market went backwards in the locations where Mick owned his properties.
Mick suddenly found himself with a very high LVR on all properties; plus his business was also a struggling business to generate sufficient income to meet all of his commitments. And as if this was not enough, he had two banks and a landlord breathing down his neck.
Because of his loan structure, every move he made needed to be approved by the banks — including refinancing of any of the properties, sale of assets or releasing the securities.
To make things worse, Mick was put into credit management (a bank’s way of describing their internal debt collectors) by one of his lenders, which meant his ability to negotiate solutions with them was further diminished.
Bottom Line: If Mick’s loans had been properly structured, he could have potentially sold down assets and used the proceeds in the most efficient manner. But because his assets were totally tied up, he had effectively lost control of all his assets.
Next week, we’ll work through another couple of Case Studies — just to help you avoid similar situations occurring, down the track.