Loan Note Investment – What you need to know

You might think the only way to benefit from property is by spending months researching the perfect location, placing the right tenants and finding the right management company. But what if instead you could get someone else to do all that hard work for you and still enjoy a profit?

Loan Note Investment or “Property Bonds” offer one way to gain exposure into property markets, at a much lower entry level, by becoming the lender instead of the landlord.

Here’s how they generally work…

1. You lend a property developer some money
2. They use that money to fund their development projects, and in exchange they agree to pay you a fixed return over a set period of time
3. Just like a bank, you’ll usually be given a secured legal charge on the property asset as your protection
4. At the end of the term they agree to repay your original loan, remove the legal charge and you walk away (or reinvest)

For passive investors, loan note investments can put your money to work straight away, and also offer some advantages vs the numerous obstacles that might be faced trying to build your own property portfolio

The Advantages of Property Loan Note Investment

• You can potentially receive a predictable fixed income over a set period of time with an agreed exit point
• Unlike traditional buy-to-let, there is no dealing with tenants, and no surprise damages or hidden maintenance costs to keep you awake at night
• No complicated taxation rules and no extra costs like stamp duty or legal fees
• Chosen carefully, you can gain the partnership of an established developer with many years of experience and a team of professionals behind them
• The lower entry point could also allow you to benefit from a more diverse portfolio, by spreading smaller sums of capital over a wider range of developers and projects

The Limitations of Property Loan Note Investment

• You’re offered a fixed return for a fixed duration of time, which means you wouldn’t benefit from long term capital growth in the properties
• Loan Note investments usually cannot be redeemed until the end of their term, but most notes are usually considered quite ‘short term’ lasting around 2 to 5 years
• Depending on the type of developer, there may be varying degrees of off-plan development risk. However, certain developers minimise that by only redeveloping existing buildings with planning permission in place
• There is nothing to say that the developer could not default on their interest payments or the final capital repayment, but that could also happen if you bought a property and suffered a void period or the property market conditions changed
• Loan Note Investment is only available to certain types of qualifying investors, so not everybody is eligible to invest in them

Why don’t these developers just lend from Banks?

It seems that since the financial crisis of 2008, banks are much more risk adverse with lending in order to meet their new holding requirements.

Although bank lending has greatly improved, the days of obtaining 100% development finance are long gone. Today, most lenders offer around the 60-65% mark, leaving a much bigger gap to fill.

These extra upfront costs and longer decision times mean developers are naturally looking at other ways to raise money.

Over the years, JV (joint ventures), crowdfunding, peer to peer lending, property bonds and loan notes have all become established ways for developers to raise money as they offer advantages over traditional bank financing.

Which ones are the best?

At a time when there is a big shortage of housing in the UK and parts of Europe, investing with developers who are helping to fulfil housing demand seems like a no brainer.

However, with so many Property Loan Notes and Property Bonds on the market – how do you know which ones are even worth investigating?

Whilst it’s possible to make in some cases ‘double digit’ returns by working with developers this way, like any kind of investment, it’s also possible to lose money too.

The type and location of the development, the company track history, development track history and the type of security offered are all factors that will change the quality and risk, so extra due diligence and care is a must.