Buy to Let - IVA or Bankruptcy?
During the real-estate boom which preceded these tough economic times lots of individuals throughout the uk began to dip their toes in the real estate market in the expectation of growing equity over a period of several years in the hope and expectation that this most likely give them a good profit on their investments. Purchase a house at a not too expensive price, let it out for just a few years with the rental income covering the mortgage repayments and then sell it on, pocketing the profits. As a consequence the boom extended to what has become labeled as the Buy to Let sector. The idea was simple enough. Any individual or a couple with a reasonable disposable income obtain a house and let it out to tenants. Mortgage loans of up to 100% were easy to find and also rents were buoyant. In practice the rental income was anticipated to more than cover the monthly mortgage payments. The property was expected to add to in price with each coming year and in time the sale of the property would probably provide an excellent little gain, even allowing for capital gains tax. And why stop at one property? If the idea worked with one investment, why not go for two, six, twenty, a hundred or even more properties?
What on earth could go wrong? Two things could and did. The incessant rise in house prices slowed up and in the end began to go the other way as property sales volumes and purchase prices tumbled. All the interest in rental properties started to reduce and rental money coming in started to go down. Unexpectedly those people who went into the Buy to Let sector found that they were unable to turn back the process comfortably.
Given that sales of real-estate fell as a consequence did selling prices. And so did lease incomes. mortgage payments on some houses began to exceed the rental income and in some cases renting properties at any reasonable level of rental income turned out to be impossible. The spectre of negative equity turned out to be a reality for many people in the sector. Selling properties at a loss was a generally unappealing option. Many people retained on to their Buy to Let properties for too long hoping against hope that the real estate market would improve but it simply got much worse. In due course many many of these people discovered that they were insolvent and that their disposable earnings were not sufficient to bridge the difference between their mortgage repayments and their lease income. Thus their home loan payments began to fall into arrears and they began to search for solutions to their financial difficulties.
Due to the fact selling the houses would bring about shortfalls debtors found that their choices were limited to petitioning for Bankruptcy (BCY) or entering into an Individual Voluntary Arrangement (IVA). Picking the right option to pick relied largely on each individuals circumstances. The primary factor to be considered 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, the Buy to Let property ought to be considered from two points of views - the net cost to the debtor of keeping the property and the equity therein. When the debtor have several or indeed many such properties, then each property normally has to be treated as a stand alone and on its own merits, so to speak.
If a property is cost neutral i.e. the rental income is totally consumed by the home loan payments (plus any other legitimate associated outlays such as insurance or maintenance) with no significant surplus or deficit arising then creditors are only interested in whether or not there may be any equity available in and recoverable from the property. Unsecured creditors will not force the debtor to dispose of a property which is in negative equity since any shortfall arising would most likely then be introduced into the IVA and probably have the effect of lowering the dividend for all creditors. If on the other hand the property has a large amount of positive equity then creditors will expect all such equity or a large part of it to be introduced into the IVA. Thus the property in question might have to be sold or the equity addressed by some other way such as the contribution of third party funds or remortgage.
If the property is cost positive and yields considerable net income i.e. the lease income exceeds the home loan payments (plus any other genuine relevant costs such as insurance or maintenance), then creditors will expect any such surplus income to be contributed to the IVA throughout the entire 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 considerable equity in the property then creditors will expect all or a large part of such equity to be realized by sale or remortgage before the end of the term of the IVA, commonly 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 legal related costs such as insurance or upkeep), then creditors might require the debtor to sell the property. Following such a sale, the savings made in 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 deficiency 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 bankrupts estate 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 purchased back from the trustee for a moderate amount of money. It is not uncommon for the family of a bankrupt to buy such a property on payment of 1 plus the official receivers costs of 211. A recent change in policy by the Insolvency Service means that this buy back will normally not now take place until two years and three months have elapsed since the bankruptcy order was created.
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 realise this equity by having the property sold, with the risk that the sales price may well 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 seek to sell 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 bankrupts family and of creditors.
Where a bankrupt owns 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 bankrupts 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 bankrupts 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 appears that a small number of trustees try to assume control of such Buy to Let properties and to assume all responsibility for them: receive 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 in the position to realize the equity prior to the property re-vesting in the bankrupt person. The motivation for this change in approach by trustees is unclear unless they expect to enhance yields for creditors by taking such action. Should you become bankrupt and the trustee is planning to seize control of your Buy to Let properties, you should look to obtain legal advice on this matter.