Your five-minute guide to developer loan notes

When a property developer wishes to develop a property – say, for example, to create a new residential estate – it has various options to finance the development. One of these options is to issue developer loan notes.

In this article, you’ll learn how loan notes are used and some of the key elements that make them attractive as investment instruments.

What is a developer loan note?

The simplest way to explain a developer loan note is as an IOU. The investor lends the developer money, and the developer agrees to pay it back. The developer will pay a fixed rate of interest while it retains the investor’s capital.

Loan notes can be ‘secured’ or ‘unsecured’. A secured loan note is secured against the property or other assets of the developer, while an unsecured loan note offers no such protection. Therefore, a secured loan note carries lower risk than an unsecured loan note: if the developer defaults on the terms of the loan note, the assets on which a secured loan note is secured act as insurance against some or all of the capital the investor has loaned to the developer.

How loan notes work for the property developer and investor

Breaking down loan notes into a step-by-step process, the following is a simplified guide to how they work:

1. The developer takes the decision to offer a loan note, and decides the details of the loan note (e.g. the maximum amount, duration, and interest rate). The developer may need approval from its shareholders to issue the loan.
2. The developer instructs lawyers to produce loan note documentation and create the loan note.
3. The developer offers the loan note to investors.
4. Investors lend money to the developer in exchange for the loan note.
5. Investors receive the fixed interest (also known as the ‘coupon’) while they hold the loan note.
6. At the end of the loan note term, the developer repays the investor the capital that they loaned to the developer.

First and second charge loan notes

While secured developer loan notes are less risky than unsecured loan notes, not all secured loan notes are created equally: some are riskier than others. One way in which the risk differs between loan notes is if they are ‘first charge’ or ‘second charge’.

A secured developer loan note with first legal charge holds less risk than one with a second legal charge, because if the issuer does default, the first charge investor is first in line to receive repayments. An investor in a second charge loan note only receives their repayment after the first charge investors have received theirs.

Key developer loan note terms

Here are a few key terms used in the world of loan notes:

Issuer: The company that issues the loan note – the borrower

Loan note instrument: The documentation that sets out the terms and conditions relating to the loan note.

Coupon: The interest paid by the issuer to the holder of the loan note. Often, the interest rate is fixed, though it may also be paid as variable. Some loan notes roll up their coupon, and pay the interest when the loan note matures.

Coupon terms: The terms on which the coupon is paid. This will detail whether the coupon is calculated daily, monthly, quarterly, etc. and when it will be paid (e.g. monthly, quarterly, annually, etc.).

Loan note certificate: Like a share certificate, the loan note certificate is evidence of ownership of the loan note. It contains details of the holder and issuer, date of issue, maturity date and interest rate.

Redemption: When the issuer has repaid all interest outstanding and repays the capital loaned to it, the loan note is cancelled.

Convertible: A convertible loan note is one that can be exchanged for shares in the capital of the issuer. The loan note instrument will set out when this exchange is triggered (for example, at the option of the note holder or the issuer), what kind of shares are to be issued, and how the number of shares to be issued are calculated.

Understanding these terms is important: if you invest in a secured convertible loan note, secured with a first legal charge, you will want to know exactly what it is you are investing in.

Should you invest in developer loan notes?

Investing in developer loan notes could help you diversify your portfolio, and benefit from high fixed-interest payments. They can be structured to provide a regular flow of income from a lower cost of entry (some loan notes allow investment from as little as £5,000).

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.

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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.

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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%:

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:

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.

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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.

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