Investing in property vs. investing in loan notes

Key differences and similarities between property and loan note investing

Many professional investors are finding that the benefits of investing in developer loan notes are too attractive to ignore. The high rate of fixed interest paid gives them a huge advantage over the lower and fluctuating yields paid by way of dividends in the stock market. With investment capital guaranteed, investors don’t suffer the volatility suffered by stock market investors.

The question is, should you invest directly in property, or invest in developer loan notes? This article examines the key similarities and differences between investing in property and investing in developer loan notes.

Location vs. collateral

When you invest in property, it is important to assess the property fundamentals that underpin a development or property investment. You’ll be concerned about fundamentals that include shops, schools, transport links, major employers and major investment. The stronger the fundamentals, the better the potential for long-term profits from rental income and value growth.

When investing in loan notes, you should also be concerned that the property fundamentals underpin the development’s potential. This will be the foundation of the fixed income and capital guarantees. However, you should also examine the collateral that guarantees your capital – the property itself, the track record of the developer, and the corporate guarantee on the capital invested.

Ownership vs. rights to possess

This is probably the most obvious difference between direct investment in property and investing in developer loan notes:

  • When you invest directly, you become the named owner of the property.
  • When investing in developer loan notes, you may have a right to possess (known as a lien). If the developer (borrower) defaults on promised payments, the investors can make a claim against the collateral (property) and may take possession of the property itself.

Developer vs. tenant

When you invest in buy-to-let property, you become a landlord and will need to manage tenants. While you may decide to hand this work to a professional investment property manager, the responsibilities include finding and vetting tenants, undertaking property maintenance, chasing and collecting rental payments, staying up to date with landlord laws, and handling complaints from tenants.

As an investor in developer loan notes, you manage the borrower. The workload is lighter, though you will need to maintain an eye on the development’s progress and the wider market to ensure that your investment performs as you expect.

Credit vs. tenant

As part of your responsibilities as a buy-to-let investor, you will need to vet the tenant and ensure that they have a suitable credit score and a regular income. You’ll want to know that they can afford the rent and that they are likely to pay it when it is due each month.

When investing in developer loan notes, you should undertake similar credit checks – though on the developer (borrower), rather than the tenant. This isn’t done by a credit score, but instead by analysing and understanding the underwriting behind the loan note and the developer, their accounts and balance sheet, and the standards that act as the foundations of the loan note agreement.

Property deeds vs. loan note instruments

A property investor will sign a contract of sale and receive the property deeds when the investment is completed. The deed is public notice that the investor is the new owner of the property.

When investing in a developer loan note, a ‘loan note instrument’ is signed by the issuer. This sets out the terms and conditions under which the loan note is issued, including schedules, terms and procedures for holding meetings of note holders.

Leverage

The benefits of leveraging in property investment can boost returns because you are making money on other people’s money. You leverage by investing using a mortgage and making a profit on the borrowed funds.

For example, you might invest in a £200,000 property by paying a deposit of £50,000 and borrowing £150,000. If the value of the property increases by 20% and you then sell the property, you will have sold it for £240,000. After paying off the mortgage of £150,000, you will be left with £90,000, including a profit of £40,000 – or 80% on the capital you invested.

While not impossible, it is unusual, difficult and often expensive to invest in a developer loan note using leverage. Therefore, you won’t be able to benefit from leveraging in the same way (if at all) when investing in developer loan notes.

Who can invest in property vs. loan notes?

Anyone can invest directly in property, providing they can raise the funds to do so. The ability to invest in developer loan notes is restricted. There are detailed rules and regulations governing who they may be offered to, as well as who can promote them, advise on them, and arrange investments in them.

The rules also dictate who must be involved in the offering of loan notes and the operation of structures involving loan notes.

In summary

Developer loan notes are a good way to invest in property, diversify your portfolio, and benefit from high fixed-interest payments. However, while there are similarities between direct property investment and investing in developer loan notes, there are also some key differences. Because of certain complexities of loan note structures, not everyone will be eligible to invest in them.

To learn whether you can take advantage of the benefits of investing in developer loan notes, 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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About the Author

Brett has over 20 years experience in all facets of property, he owns various companies centred around property and is the driving force behind the education and training at Gladfish. His companies have sold over £850 million in UK and London property and he manages over 1200 properties through his estate agency chain. Today he shares his time between UK, Australia and Singapore. He is married to Arlene and together they have 4 kids.

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