Property Bonds - What Property Bonds are and How They Work
If you’re an investor looking to invest in property, or if you’re a property developer looking for finance for a project, you might be considering property bonds. Here we look at what property bonds are and how they work.
What Exactly is a Property Bond?
In simple terms, a property bond, or property investment bond, is a secured loan between an investor and a property development or investment company.
A property bond is essentially a contract between a lender and a borrower. The lender lends an agreed amount of money over an agreed period for an agreed financial return.
Property bonds work on similar principles to corporate bonds or loan notes that are used by many companies to fund their activities. Property bonds are bonds that are created specifically to fund property projects.
Property bonds may also be considered to be both an alternative investment product and an alternative finance product.
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How Property Bonds Work
Every individual property bond is different. Each property bond will have its own term, interest rate, conditions and risk-return profile.
Investors can invest various amounts in a property bond from as little as £1,000 to several hundreds of thousands of pounds depending on the bond.
Property bonds can be issued for any period of time but they are usually for a minimum term of one year and a maximum term of five years.
The rate of interest or coupon on a property bond is agreed upon at the outset and is fixed. They may pay interest on a monthly, quarterly or annual basis and the capital is repaid on maturity. The actual interest rate will depend on the relevant individual project and may be related to its riskiness.
Property bonds may involve investing in, or funding, both residential and commercial buildings and/or land. They may involve schemes such as new build developments, property developments, refurbishments, renovations and conversions.
A property bond is technically a secured loan. The borrower will pledge assets, normally property, as security for the loan. A first or sometimes second legal charge is placed on the relevant assets in favour of the lender. In some ways, a property bond is a form of a private mortgage.
A contract or loan note is issued once the terms and conditions of the property bond are agreed upon. This states what the funds may be used for, the interest rate, additional costs, when the interest and capital are to be repaid, and what security is being provided.
An investment into a property bond may be made into a special purpose vehicle or SPV created specifically for that project.
Some but not all property bonds are supervised by an independent security trustee. The trustee is impartial but acts in the interests of the bondholders and takes charge of the assets which are pledged as security.
The Advantages of Property Bonds
Property bonds can offer a number of advantages for investors:
- Property bonds offer a fixed rate of interest over a fixed period.
- Property bonds can potentially offer a high rate of interest. There are some property bonds on offer which apparently offer an interest rate of 15% pa, for example.
- Property bonds are asset-backed investments. They are secured via a legal charge on a property.
- Property bonds tend to be more predictable and less volatile than other kinds of investments, such as property stocks and shares.
- Property bonds are promoted as a convenient and simple way of investing in property without the need to buy or own it or do any of the hands-on work that property investing normally involves. They can be a way of benefitting from the high returns that property development, renovation, refurbishment and construction projects can offer without actually being directly involved in them.
Property bonds may offer tax advantages to investors. It may be possible to invest in them via an Innovative Finance ISA (IFISA), Self Invested Personal Pension (SIPP) or Small Self Administered Scheme (SSAS).
Property bonds might also have Capital Gains Tax (CGT) advantages compared to actually buying and owning property.
- Property bonds do not normally charge fees to their investors.
Property bonds offer a number of advantages for borrowers too. They allow them to borrow a greater proportion of the investment needed for a project than a commercial bank would be prepared to lend and on more favourable terms. A commercial bank, for example, might only be willing to lend up to 50% of the amount needed for a property project but much more can potentially be raised using a property bond.
Property bonds allow developers to borrow money to fund a property project that commercial banks would not be prepared to lend on. These could be riskier projects that have a higher risk of failure but also offer a higher rate of return.
The Risks of Investing in Property Bonds
Investing in property bonds involves some risks. These will vary according to the individual bond.
Property bonds involve a risk that you will lose some or all of your investment. As the often-heard disclaimer goes your capital is at risk and returns are not guaranteed.
While it is true that if the borrower defaults, or even becomes insolvent, the lender will have a legal charge over the security that has been pledged there is always a risk that this will prove insufficient to repay the lender’s investment.
With property bonds, the individual investor must assess the relevant project together with the riskiness of the investment. They should look at the experience and track record of the borrower and the viability of their project. They should consider whether the security provided adequately secures their investment for themselves. They should consider the asset to liability ratio for that particular bond.
With most property bonds you cannot usually withdraw your capital until the bond matures. Property bonds are illiquid investments.
What Interest Rates do Property Bonds Offer?
Interest rates offered by property bonds are not directly linked to the base rate. Interest rates are based on a meeting point between what borrowers are willing to pay and what lenders are willing to lend at.
Property bonds currently on the market offer interest rates between around 4% and 15%.
The interest rate on a particular property bond will generally relate to its term and how risky the investment is considered to be. Shorter-term bonds normally offer lower interest rates and longer-term bonds higher interest rates. A high-interest rate normally means that the project that the bond is financing is considered relatively risky.
Investors in property bonds should carefully consider the relevant project. They should consider both what interest rate is acceptable to them alongside how much (or little) risk they are comfortable with.
Who are Property Bonds Suitable For?
Property bonds are a financial vehicle for companies who want to raise finance for property projects, and investors who are interested in investing in property projects. Property bonds may be issued by property developers, construction companies or builders for example.
Property bonds are not suitable for all investors. They are only available to certain types of investors. That is, investors who understand how this type of bond works and accept the risks they can involve.
Property bonds are not considered to be savings nor an ordinary retail investment. Those who offer property bonds are only permitted to offer them to, and accept investments from, those who are considered to be high net worth individuals or certified or self-certified sophisticated investors.
High net worth individuals or HNWIs are those whose net annual income is over £100,000 or who have net assets worth over £250,000. Sophisticated investors are generally those who hold a directorship with a company with a turnover exceeding £1m, have previously made certain types of investments or have certain professional experience in finance and can confirm that they understand the risks.
How to Invest in Property Bonds
Property bonds can be bought directly from a property development or investment company. However, they are usually offered by, and purchased through, a lender or intermediary who specialises in property bonds.
Investors should always take their own independent financial and tax advice before investing or considering an investment in, property bonds.