Date: March 07, 2022
Modified November 14, 2023
Reading time: +/- 2 minutes
The line between passive or active investing is frayed. Where (for the time being) fiscally attractive investments can be made in box 3, many investors choose this option. We are not tax specialists and therefore do not advise for one or the other setup from a tax law perspective. Always consult a tax specialist if you are in doubt as to what extent you actually qualify as a passive box 3 investor in certain activities. From a legal perspective, we can, of course, advise. Ciaran O' Connor and Reinier Pijls therefore provide an overview below with tips on what to look out for when investing in real estate.
In terms of legal concerns when choosing Box 3 or a Limited Liability Company (B.V.), obviously the limited liability of a B.V. is a factor, especially if you make riskier investments. In fact, the main rule in our legal system is that a director of a legal entity is not liable in private for the debts of that legal entity. This is called "the shield of legal personality." For this reason, buying through a B.V. may be preferable to buying in Box 3.
If you buy through a B.V., most bank lenders, especially the smaller investment banks, make it a condition of a mortgage loan that the shareholders of the B.V., as natural persons, jointly and severally guarantee the obligations to the bank, or at least guarantee at least a portion of the financing. This is a point to consider.
If you want to finance investment property, bank lenders will usually relate the maximum lending capacity to the "market value in rented condition." Note that this is a different value than the "vacant value" - read: the "normal" purchase price paid for an empty property.
This is because the "market value in leased condition" is largely based on the annual bare rental flow coming from the property. This annual bare rental flow is capitalized at a certain factor, resulting in the "market value in let condition." Thus, the amount of rental flow plays an essential role in the valuation.
As a rule, a financier of a real estate transaction makes money available only if there are securities in return. Collateral confirms that in the event of non-repayment, the financier will still get his money.
A non-bank lender may require the same collateral that a bank lender generally requires such as a mortgage lien on the property purchased and liens on receivables (often rental income, insurance and bank accounts of the borrower). Alternative securities include (bank) guarantees, joint and several liabilities of other group companies, and/or sureties by the director in private.
It is important for the non-bank financier to check carefully whether financing has already been provided by a bank financier to the borrower. If this is the case, chances are that a first mortgage and/or pledge has already been granted in favor of the bank financier and/or in the agreement between the bank financier. The non-bank financier can then at most obtain a second mortgage or lien. This is disadvantageous because when the proceeds of a foreclosure are distributed, a second mortgagee or pledgee will only receive something once the first has been fully satisfied. So it is important to pay very close attention to this as a non-bank financier!
Also, the loan documentation between a bank lender and borrower often contains a variety of contractual prohibitions. For example, the loan documentation between a bank lender and borrower will usually contain a prohibition for the borrower to:
This is called ringfencing.
As a rule, therefore, a bank will have to agree to a second mortgage right in favor of a non-bank lender. Experience shows that banks are not immediately sympathetic to this, but under circumstances are willing to cooperate in order to make a second mortgage right possible. After all, a fruitful cooperation can lead to a flywheel for both the wealthy party and the non-wealthy party, which also benefits the bank.
In addition to obtaining collateral, the risk to a nonbank lender can be mitigated by requiring that the financed property be purchased by a special purpose vehicle, known as a Special Purpose Vehicle (SPV). Such an entity contains no "old" debt. As a result, the risk of bankruptcy is very low. This is all the more true because the SPV performs work only with respect to the property purchased.
In short, there are many opportunities for non-bank financiers to properly frame their position.
If parties purchase real estate jointly and operate this real estate jointly (or have it operated), then - in the event of a joint purchase - as a rule they will also each become the undivided owner of the real estate. For that reason, it is advisable in any case to conclude a cooperation agreement with each other, including agreements on the method of cooperation, the distribution of profits and costs and the possible exit of one of the parties.
In larger real estate transactions, there may be multiple parties providing financing in addition. It is not desirable for the financiers to obtain a joint security interest - mortgage rights, liens on rental income, etc. - etc. All sorts of problems then arise, for example, if one of the financiers wants to get out or transfer its loan or if the financiers are not on the same page if the property is to be expropriated if the real estate investor fails to meet its obligations.
In practice, therefore, there is a need for one party to obtain, administer and possibly enforce the security interests if the financing is not repaid. The party designated to obtain, administer and enforce security interests is usually called the security agent or security trustee. This security agent is often a financier himself or a special purpose vehicle (an SPV). The role of this security agent is therefore to administer and, if necessary, enforce the security rights on behalf of the (other) financiers.
As a result of this blog, do you have questions about the legal concerns when investing in real estate? If so, please contact Ciaran O'Connor at c.oconnor@pvdb.nl or Reinier Pijls at r.pijls@pvdb.nl or fill out the contact form below!
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