Are Property Loan Notes a Safe Investment?

By nature, all types of investments carry a certain amount of risk. Irrespective of economic conditions or specific sector performance, there is no such thing as a 100% safe investment vehicle.

As a rule, there is a direct correlation between the level of risk attached to an investment and its potential to generate a high ROI. The bigger the risk, the more attractive the potential gains.

Property loan notes sit somewhere toward the mid-range of the risk spectrum. They are far from the riskiest investment options available and in many instances have a high degree of predictability.

Nevertheless, property loan note investments always carry risks, which must be considered when considering this particular investment type.

What Are Property Investment Loan Notes?

A property investment loan note is a formal and legally binding IOU, established between a lender (the investor) and a borrower (the note issuer).

Construction companies and developers use property loan notes to generate the capital needed for various types of projects, often as a flexible and accessible alternative to traditional loans or development finance. For the investor, the appeal lies in the potential for property investment loan notes to generate an attractive, consistent, and predictable profit through agreed fixed-rate interest payments.

The investor purchases the property investment loan note from the developer, interest payments are then made throughout the course of the agreed term or at maturity (usually anything from 1 to 5 years) and the balance of the original loan is repaid in full on the agreed date.

Are Developer Loan Notes Considered Risky?

While there is plenty of scope for reducing risk by negotiating amicable terms and conditions in the loan agreement, it is impossible to eliminate all risk when purchasing developer loan notes.

The most important risks to be aware of with this kind of investment vehicle are as follows:

1. They Are Unregulated

At present, developer loan notes do not fall within the jurisdiction of the Financial Conduct Authority (FCA). This means that not only are the agreements reached and dealings between the parties involved not controlled by the FCA, but investors who face capital losses for any reason are not covered by any current FCA compensation policy.

However, the risk of heavy financial loss can be mitigated almost entirely by exclusively purchasing asset-backed property loan notes. This is where the terms and conditions of the agreement include a clause whereby the investor has the legal right to take ownership of specified assets (usually property) in the event of non-repayment.

2. Potential Delays In Repayment

Most property investment loan notes are issued and purchased under the assumption that the project in question will be completed on time. However, it is not uncommon for major and minor development projects alike to run over, or perhaps be suspended for a significant period for a variety of reasons.

Should this happen, the investor faces the prospect of late repayment of the monies provided. Interest payments may continue during this time, but repayment of the full loan balance may be delayed. Mitigating this risk means performing due diligence to verify the credibility, track record and general financial performance of the individual or company issuing the note.

3. Unpredictable Market Fluctuations

The property market is generally reliable and predictable. At least, in the sense that major shifts and downturns in performance do not often happen overnight. Nevertheless, if there is a substantial fluctuation in the sector’s performance and the developer’s business suffers as a result, issues with repayment of the loan may be inevitable.

An early exit clause in the loan agreement can prove invaluable as a mitigation measure for this kind of risk. As can ensuring the loan is secured against one or more viable assets, though there are no guarantees that the value of these assets will remain consistent long-term.

Loan Note Security

Most high-value developer loan notes are secured against assets of value – most commonly the property under construction or being worked on. Investors interested in purchasing high-value loan notes will typically only accept those secured against assets with a total value of the cost of the initial investment.

Upon signing the subsequent agreement, the note issuer agrees that in the event of non-repayment, the investor has the legal entitlement to take ownership of their assets. The assets will then subsequently be sold to generate the funds needed to repay the investor.

What Is A Corporate Guarantee?

This is another way of guaranteeing a property investment loan note, wherein other entities within a corporate group provide the necessary assurances or assets to secure the loan in the event of non-repayment.

Trustees are sometimes used by developers to watch over the developer’s property assets ensuring there is always sufficient capital to repay in a default situation.

Does The Financial Services Compensation Scheme (FSCS) Apply?

Unfortunately, no property investment loan notes currently fall within the remit of the Financial Services Compensation Scheme (FSCS). This is the same with most comparable investment vehicles, which are considered the sole responsibility of those purchasing them.

Therefore, it is of the utmost importance to ensure any developer loan notes you purchase are as low-risk as possible. While risk cannot be eliminated from the equation entirely, there are steps that can be taken to ensure that a major loss of capital is avoided, even in the event of insolvency or non-repayment for any other reason.

For more information on any of the above or to discuss the potential benefits of property investment loan notes in more detail, contact a member of the team at UK Best Investments today.