Property development loan bonds offer investors the opportunity to lend their money to a property developer and earn interest on the loaned funds. In this article, we will walk you through the three main reasons we believe you should consider development loans for your portfolio.
1. A defensive investment strategy
In basic terms, when you invest in a development loan the loan is secured against a development that only needs to be sold at the Loan-To-Value (LTV) percentage in order for your capital to be returned. Here is an example:
A developer borrows £7,000,000 against a development that is valued at £10,000,000.
The loan itself is made up of two parts, a first charge senior loan and a second charge mezzanine loan. The first charge loan is £5,000,000, or 50% LTV, and the remaining £2,000,000 brings the total LTV to 70%.
The terms of the loan are such that once 50% of the development has been sold, the first charge part of the loan must be returned to the lender(s), and then once 70% of the development has been sold the second charge part of the loan must be returned.
Now, even if you invested in the loan during second charge, the development only needs to be sold for 70% of the valuation in order for you to have your capital returned. If you feel that this achievable then you could consider that this is a somewhat defensive investment strategy as you are not relying on the capital appreciation of the properties in the development in order for you to make a return. Your return comes from the interest earned during the term of the loan.
In the example given, property prices would have to drop 30% before your capital became at risk of not being repaid, and in this scenario there are also steps that can be taken to maximise the chances that lenders get their money back.
There are of course risks here, and there are no guarantees. But, if you believe in the fundamentals of the deal on offer and that the LTV is achievable even if property values fall, then you could consider development loan bonds a defensive investment strategy.
2. High Yields
Due to the nature of the risks involved and lack of appetite among banks to lend above 60% of a project’s value, development loans provide access to high yields for alternative lenders.
The more risk a lender takes, the higher the yield they can command. In the example mentioned above, the first charge lenders will be getting an interest rate of 5-6% on their capital, whereas the second charge investors will be getting 10% or more. This is because the first charge lenders have taken on less risk, the development only needs to sell for 50% of the valuation in order for their capital to be returned. This is compared to the 70% sale price required for the second charge lenders before their capital is returned.
Where you sit on the risk-reward spectrum is your choice. But for those with the appetite, 10% yields are possible even in today’s market.
We believe that any good investment strategy has diversification at the heart of it. Returns are never guaranteed, but investors can build a portfolio where the chance of losses are mitigated and diversification is a key part of that.
Think of it in two ways. Firstly, the sheer number of investments you have. One property is a poor investment portfolio in our opinion. Anyone who has invested in property will tell you that there are ups, and there are downs. Boilers break, tenants can leave or councils can add a wild card to your hand for better or worse, to name a few.
Having multiple property investments in your portfolio, in multiple locations mitigates some of these risks. Property Partner makes it easy to diversify your capital across multiple investments, many of which are made up of multiple properties (our largest student investment contains 80 rooms for example). It is unlikely 100 tenants will all stop paying rent, or that 80 boilers will break in a given month or year. The same is true for investing in development loans. Loans secured against schemes involving the construction of multiple properties are more appropriate investments we believe, and investing your capital across multiple developments again spreads your risk.
Second, are your returns coming from a diversified source of investments? If all you do is invest in one type of asset, albeit in lots of them, are you diversified? If your portfolio is made up 100% of retail shopping centres, you are probably regretting that decision as the high street goes through a state of flux and you over exposed to sentiment and/or market dynamics in that particular type of property.
Investing in development loans gives you exposure to a side of the property market that you might not have, new builds, but it is also allows you to diversify the source of income in your portfolio. The ability for students to pay rent for example is different than the ability of developers to pay interest. If all of your income is dependent on one segment of the market you may be unnecessarily exposed to dynamics in that area. If you have not done so already, development loans provide an additional source of income for investors to consider in their mix.
At Property Partner, development loans are only available to investors who have classified as Sophisticated or High Net Worth. It’s important that you understand the risk involved before making an investment. These articles make for a good introduction to the detail and risks involved with development loans:
Introducing property development loan bonds
Key risks of investing in property development loan bonds
Property finance: what are the different types
Our latest development loan is available for investment Wednesday 20 February. We hope you’ll consider it to be part of your portfolio. Investors will be able to invest in this loan using their standard Property Partner account, or in our new Innovative Finance ISA.
Capital at risk. The value of your investment can go down as well as up. The Financial Services Compensation Scheme (FSCS) protects the cash held in your Property Partner account, however, the investments that you make through Property Partner are not protected by the FSCS in the event that you do not receive back the amount that you have invested. Past performance is not a reliable indicator of future performance. Forecasts, if stated, are not a reliable indicator of future performance. Interest and capital returned may be lower than expected. Gross rent, dividends, and capital growth may be lower than estimated. 5 yearly exit protection, exit on platform or exit in line with Opportunistic Fund strategy, subject to price and demand. Property Partner does not provide tax or investment advice and any general information is provided to help you make your own informed decisions. Customers are advised to obtain appropriate tax or investment advice where necessary. Financial promotion by London House Exchange Limited (No. 8820870); authorised and regulated by the Financial Conduct Authority (No. 613499). See Key Risks for further information.