Developer Loan Notes

Why stock market investors are turning to property developer loan notes

Leave volatility of values and income behind and enhance portfolio returns

If you sit down with a financial advisor, you’ll likely be told that the best investment historically has been stocks and shares. You’ll likely be told that your returns depend upon the time in the market, rather than timing the market.

Yet, if you look at the FTSE 100 Index – which measures the performance of the top 100 companies in the UK – you may be surprised to find out that, had you invested in the FTSE 100 at the beginning of December 1999, at the beginning of December 2018 your investment capital will have shrunk by around 3%. During those 18 years, the FTSE actually fell by almost 3%:

Property Developer Loan Notes

Effectively, the return on investment in the FTSE 100 since the new Millennium has been limited to the dividends paid by its constituent companies. That’s around an average of 3.5% per year. This is still way ahead of the interest you might have been paid had you invested in bonds or cash instead of the stock market. However, it is some way behind the income you could receive by investing in developer loan notes.

What is a developer loan note?

Developers borrow money to build residential schemes. In recent years, since the Global Financial Crisis, developers, like all other businesses, have found it more difficult to get financing from traditional lenders and banks. To plug this gap, they started to offer developer loan notes to investors.

Effectively, a developer loan note is an IOU. The developer takes an investor’s cash investment and uses it to get a development off the ground and completed. In return, the developer pays a fixed interest to the investor and returns the investor’s original capital at the end of a predefined investment period. The investor’s investment capital benefits from a legal charge on the property.

The difficulty of investing in the stock market

You’ll notice that at the end of an investment period (typically between one year and seven years), the investor is repaid their capital. That’s a guarantee that investing in the FTSE 100 over the previous 18 years couldn’t give:

  • If you had invested at the end of 1999 and sold in 2002, you would have lost around half your investment capital
  • It would have taken another four and a half years for your investment to get back to its 1999 level
  • If you remained invested, you would have seen your investment capital fall by more than 40% in the next 18 months…
  • …before climbing to your original investment amount again in 2014

Of course, if you had timed your investment correctly, then between 2002 and 2007 you could have doubled your investment capital. The same result would have been achieved between 2008 and 2014.

The problem, is, of course, that to maximise your investment in stocks, you must be a great timer of the markets. You could, of course, leave it to the professionals and invest in managed funds. You’ll pay a management charge for the privilege. There is also no guarantee that a managed fund will outperform the FTSE, either – research by Vanguard shows that 90% of managed funds underperform the index they are trying to beat! If the professionals can’t outperform, how are you meant to?

Consequently, what we’re witnessing is stock market investors turning to developer loan notes. Their capital is guaranteed, and they receive a very attractive interest on the money they invest with (lend to) a developer.

Dividend trouncing interest on developer loan notes

Given that investment in the FTSE 100 has produced no capital growth over the last 18 years, investors are left to rely on dividends. But history tells us that dividends cannot be relied on, either. When corporate profits fall – as they did during the Great Recession following the Global Financial Crisis – companies slash their dividend payments.

So, stock market investors are left with the conundrum of volatile share prices that may mean a huge capital loss if they need to take their money out of the market while depending on dividends that are not reliable.

Developer loan notes work entirely differently. In many cases, your capital is guaranteed (though, of course, this is subject to risks as with any investment). While you invest for a set term (usually between one and seven years), many loan notes will allow you to withdraw your capital on annual anniversaries. But it is the interest that developer loan notes pay that really excite investors.

Typically, the interest rate that developer loan notes pay sits between 8% and 15% per year. Plus, many developer loan notes add a bonus each year, to encourage investors to remain invested. In this way, the interest paid on a developer loan note may accrue as follows:

Developer Loan Note

An investor who invested, say, £100,000 in a developer loan note with the interest and bonus specifications would receive a total of £120,000 in interest – a return of 120% over seven years. Plus, the investor would be repaid their capital at the end of year seven. This is income that simply can’t be matched by FTSE 100 dividends.

In summary

Investing in developer loan notes helps to diversify an investment portfolio, with a time-limited investment that guarantees capital and pays an exceptional rate of interest. Investment can be withdrawn in line with the loan note’s terms and conditions, providing greater flexibility for investors.

If you have an investment portfolio that is concentrated in the stock market, and you are concerned about volatility and low income from dividends, it could pay to learn more about developer loan note opportunities. You can dip your toe in with a modest investment – some developer loan notes allow you to invest with as little as £5,000.

To learn more about the benefits of investing in developer loan notes, and how they may enhance your investment portfolio returns, contact one of the team at Gladfish at +44 (0) 207 923 6100. We’re looking forward to speaking to you, and think you’ll be as excited about the loan note market as we are.

Continue Reading Other Articles in the Series:

benefits of investing in developer loan notes  Risks when you invest in developers loan notes  Why stock market investors are turning to property developer loan notes  Investing in Property vs Investing in Loan Notes  How loan notes work in property development


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Developer Loan Notes

5 risks when you invest in developer loan notes

How do investors mitigate risks and maximise developer loan note potential?

The benefits of investing in developer loan notes include a lower point of entry (some loan notes allow investment from £5,000), a known and enhanced regular income (typically between 10% and 15% in the first year, and often benefitting from bonuses in subsequent years), and flexibility of investment (you can develop a portfolio to suit your objectives with developer loan notes offering different payment periods and maturity dates).

However, as with all investments, there are risks. In this article, you’ll learn about the main risks and how these risks can be mitigated and managed to maximise your return from investment in developer loan notes.

Risks of developer loan notes

Developer loan notes are considered a higher risk than direct property development – hence the higher potential returns. The primary areas of risk are as follows:

1.    Developer risk

When you invest in a developer loan note, you are investing in the ability of the developer to deliver on their promise to complete the development scheme. If the developer fails to complete the development, the scheme may need to be sold to another developer. If the purchase price is less than the expected completion value, you may lose interest and capital.

To mitigate this risk, make sure that the developer is experienced and has a good track record of delivery. By carrying out comprehensive research and due diligence on the developer and the development proposed, you should ensure you invest in the best developer loan notes.

Another element to ensure is attached to a developer loan note as collateral, by way of a charge of the property or other assets. This will maximise the chances of being repaid in full should a development not realise the expected profits to repay the loan note in full.

2.    Late repayment

If the developer has been unable to sell the development in time to repay the developer loan notes, you may have to wait for the return of your capital. This could jeopardise other plans you have for your invested capital.

It can be difficult to accurately predict the completion date of a development. There are so many variables that come into play that may cause delays. These include adverse weather conditions, problems with suppliers and contractors, and a slower sales market than anticipated.

By examining the past performance of the developer’s projects, you will get a good feel for how good the developer is at planning a scheme and working with others. This is part of your due diligence work. By investing in developer loans with penalties attached for late payment, you further incentivise the developer to deliver as planned.

3.    Market risk

Market risk is inherent in any property investment. Economic shocks may cause property values to fall, and make selling properties at the expected values more difficult.

By considering the scheme’s expected value at completion and investing with a good buffer to this, the investor helps to protect themselves from market risks. A detailed analysis of the scheme and local residential market should help to ensure that you invest in only the best development sites.

In addition, an investor should conduct annual appraisals to ensure that the project is on target and that the market has not changed markedly from previous expectations. Many developer loan notes allow sales at one-year anniversaries, and if the market has taken an unexpected turn south, then these annual selling periods could help to protect your investment from future market risks.

4.    Senior lender risk

If the developer has secured lending from a senior lender, and the senior lender demands repayment (for example, if the developer defaults on interest payments), then the developer may be forced to accelerate sales and not achieve the expected profits.

Before investing, you should ensure that you also examine existing lending agreements and the relationship between the senior lender and developer. Where the developer has worked with the senior lender previously, this is evidence of a track record of a good working relationship.

5.    Liquidity risk

If you should want to withdraw your capital early and the developer is unable to repay your capital, you may have to wait until they are able to repay. This is similar to the late repayment risk discussed above. This is why we always recommend investing only with developers who have a good track record of identifying the best development sites and delivering schemes on time.

In summary

The risks of investing in developer loan notes are not so different from those of investing in off-plan property. By taking action to mitigate these risks, you can maximise the potential of their investment while sleeping soundly at night. The main strategy to mitigate risk is to undertake comprehensive research and ensure that you invest with developers that have a good track record of selecting and developing profitable sites, and which have also consistently paid interest and capital repayments on time.

To learn more about the benefits and risks of investing in developer loan notes, and how they may enhance your investment portfolio returns, contact one of the team at Gladfish at +44 (0) 207 923 6100. We’re looking forward to speaking to you, and think you’ll be as excited about the loan note market as we are.

Continue Reading Other Articles in the Series:

benefits of investing in developer loan notes  Risks when you invest in developers loan notes  Why stock market investors are turning to property developer loan notes  Investing in Property vs Investing in Loan Notes  How loan notes work in property development


Invest with Loan Notes

7 benefits of investing in developer loan notes

Could developer loan notes enhance your portfolio returns?

Developer loan notes are becoming increasingly popular with investors. Essentially, this is because the investor gets to act like a bank: lending the developer money in return for interest payments – and we all know how much banks make when they lend money.

However, it is not only the interest that makes developer loan notes attractive as investment vehicles. In this article, you’ll learn about the seven major benefits of investing in property developer loan notes.

Benefit #1: Income and profitability

Developer loan notes offer investors a great rate of return to the investor. Because you are lending the developer the funds to get a development off the ground or through subsequent stages of development, you’ll find that you benefit from a higher income level than from most other comparable types of investment.

Without your investment, the developer may not be able to progress with building on a site, or its plans could be delayed as it waits for other financings to be arranged. Either way, your investment moves the developer toward its goals and profits faster – and this results in a premium on your return.

Typically, the interest you would receive ranges between 8% and 15% in the first year, and with possible bonuses added in subsequent years, the percentage can extend far above this.

Benefit #2: Ideal for shorter-term investors

Developer loan notes have maturity dates, on which you will be repaid the capital that you effectively loaned to the developer. The developer does not want to continue paying premium rates of interest for any longer than needed – doing so eats into its forecast development profits.

Therefore, the developer will issue loan notes for the capital it needs, and it is in its favour for it to lend for as short a time as is necessary. The quicker it completes a development, the less it will pay in interest and the greater its profits will be.

Typical timeframes for investment are 12 months to five years, though these can be shorter and longer. This is ideal for those investors who do not want longer-term investment, or who have plans for their capital at a certain date in the future. For example, if you have school fees, an interest-free

loan repayment, or perhaps a mortgage to pay off, in a few years, a developer loan note could provide exceptional returns to meet your objectives.

Some loan notes come with the provision that the developer could repay the loan earlier than maturity date – meaning you get the pay-off sooner than anticipated.

Benefit #3: Flexibility

Many developer loan notes are offered with built-in flexibility. If you need your capital sooner than the maturity date, the loan note may allow you to withdraw earlier. To do this, you may need to give notice (of, say, 30 days) and withdraw your investment on an anniversary of your original investment.

You might also invest in loan notes that pay interest on different payment cycles – for example, quarterly, half-yearly and annually. This allows you to structure your income for when you need it.

Benefit #4: Passive income with little management needed

It is easier to manage several loan notes than several properties. A computer and phone are all you need. Plus, once you have invested, there is little management to do – other than check that your income is flowing when it should.

There is no dealing with tenants, and no unexpected maintenance bills to pay. Tax liability is easily calculated.

Provided you have done your research first and invested in loan notes offered by experienced and financially secure developers, then this could be the ultimate passive investment.

Benefit #5: Collateral

Developer loan notes are tied to specific developments, meaning you benefit from identified and named collateral as security. As the development matures, this collateral increases in value. Effectively, the risk you take decreases as the developer builds. With your investment tied to real property, you have tangible security backing your investment.

Benefit #6: Diversity

Investing in loan notes helps you diversify your investment portfolio. You get to profit from the efforts, experience and business of the property developer. You get to profit in a similar way to how banks and other lenders profit.

Benefit #7: Investment minimum is smaller

The last of the major benefits of investing in loan notes is that the minimum investment amount is much smaller than when investing directly in property. Some developer loan notes allow an investment from £5,000. This means that it is much easier to spread risk between developers, and also that the financial barrier to entry is lower.

In summary

When investing in developer loan notes, investors are rewarded for providing finance to developers. With a lower investment amount, it is easier to diversify your portfolio across several developer loan notes as well as benefit from diversifying your investment portfolio by using different types of investment asset.

Developer loan notes are ideal for investors who have a shorter timeframe and also desire the flexibility for early access to their capital. They are flexible in their nature, and a loan note portfolio can be constructed to help you benefit from different income payment dates and maturities.

To learn more about the benefits of investing in developer loan notes and how they may enhance your investment portfolio returns, contact one of the team at Gladfish at +442079236100“>+44 (0) 207 923 6100. We’re looking forward to speaking to you, and think you’ll be as excited about the loan note market as we are.

Continue Reading Other Articles in the Series:

benefits of investing in developer loan notes  Risks when you invest in developers loan notes  Why stock market investors are turning to property developer loan notes  Investing in Property vs Investing in Loan Notes  How loan notes work in property development

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