INTM518050 | Thin capitalisation: practical guidance: lending against asset values: UK third party practices - interest rate margins in property lending

An interest rate margin is most commonly expressed as a percentage or a number of basis points above a reference rate (1% = 100 basis points). A reference rate is the underlying rate on which a floating rate is based.

Some general principles on lending against property are given below:

• lenders may be prepared to lend at lower margins when there are assets available as security.

• debt made on investment property generally carry a lower margin than pre-let developments, with speculative development carrying the highest margin.

• minimum interest rates are incorporated in debt offers to ensure that the lender’s rate of return is protected.

• in considering the appropriateness of a margin it is useful to take a line from external sources, which is why considering the return on securities related to property and real estate from approrpriate commercial databases is useful. If a margin is high it may be an indication of a thinly capitalised company.

A useful third party comparator may be available where debt has been taken out by the parent company for onward lending to the subsidiary purchasing the property. However, it will be necessary to look at the group structure and compare the security and other aspects of the original and the onward debt to check that appropriate adjustments take account of differences between the circumstances of each of the borrowers - the parent and the subsidiary.

There may be several “tiers” of debt finance, which can broadly be split into senior debt (usually the first and biggest tranche) and junior debt. Senior debt (see INTM519030) is the most secure and junior debt is riskier, so debt amounts, repayment terms and margins will differ between the tranches, and the margin will increase as the lender’s risk increases. Margins will therefore be affected by the presence and terms of additional debt, their relationship to the senior debt and the impact they have on the borrower’s cash flow.