How do Property Loan Notes Work?

Property Loan Notes are a financial instrument usually used to raise development capital for property developers.

Loan Notes can be an attractive way to invest in the UK property sector without the hassle of managing the property yourself. Loan Notes allow you to sit alongside institutional investors investing in major property development projects otherwise unavailable to you.

Property Loan Note Life-cycle

In essence there are key stages in a Property Loan Note lifecycle and they are:

1. Property Site Development identified
2. Outline Planning Permission applied for to local council if not provided
3. Formal legally binding planning permission granted by Local Council
4. Developers seek funding for the project by issuing a property development specific loan note solely available to institutions, companies, experienced investors, essentially retail investors are excluded
5. Interest payments start as agree as outlined in the terms of the loan note
6. Special Purpose Vehicle (SPV) is created ring-fencing liabilities and assets protecting investors and developer alike
7. Land is bought and detailed Planning Permission submitted
8. Once Planning Permission is granted a gross development valuation (GDV) is completed by an authorised valuation agent
9. The development project is sold to a major investment institution such as L&G, NU, AIG, Morgan Stanley etc. If the project cannot be sold or is wanted bank finance is sought
10. The investor capital is repaid

Local Council Planning Permission

Generally local planning permission should make a decision within eight weeks but with major complex projects this can take a lot longer. Councils have the right to say yes or no to any planning proposal so the presentation and application usually requires agents. These agents have a detailed understanding of the local planning application process but things can go wrong so the project’s early life is at its highest risk.

Loan Note Funding and Promotion

Once legally binding detailed planning permission has been granted in writing the risks reduce to the development project greatly and funding is usually required. Loan Note investments are not open to the average individual ‘retail’ investor. A retail investor is an individual who has not invested in loan notes previously; you are not a high net worth earner; will have less than £200,000 to invest (not including home equity); not a director of a company with a £1m turnover. In simple terms if you are the average investor you are not allowed to invest in this sector.

This kind of investment is not covered under the Financial Services Compensation Scheme and the products themselves are not regulated as they are designed for a more sophisticated investor.

Assuming you meet the allowed criterion then loan notes can play a profitable part of your overall portfolio.       

Investment Yields for Loan Notes

Typically, investment yields can be quite high as the overall investment returns to the property developer can be quite spectacular. You can normally select when you want your interest paid to you and this can be monthly, quarterly or annually. Be aware, dependent on the Loan Note the capital may be restricted as to when you can withdraw it, but capital withdrawal annually is often available.

Your income is paid into a nominated bank account provided by you until the term ends. There may be other benefits paid as well as the interest such as bonuses so it is worth checking if this is the case.