In general terms Loan Notes have been around for a very long time and the first recorded Loan Note was in 45AD Roman times.
A Loan Note in itself is an interest bearing promissory note denoting the capital loaned, borrower’s name and address, the lender’s name and address, the terms and conditions, the Term and interest rate applicable.
It’s a useful way for businesses to raise capital, and a means for investors to get involved in large scale projects, while balancing their portfolios.
In this article we’ll discuss the property loan note as an alternative investment vehicle, and what the benefits and risks are in this type of investment.
What are Property Investment Loan Notes?
In the case of a Property Loan Notes, the capital advanced is used for property development.
Developers use property loan note investments to raise funds for their projects, while investors benefit from one of the highest interest rates currently available in the UK alternative investment market.
Property loan notes represent one way to obtain a high fixed rate of interest, and a possible alternative to the investing on the stock market, or in more conventional property investments such as buy-to-let.
What are the Risks with Developer Loan Notes?
(1) They are Unregulated
While the potential reward is high, investing in other peoples developments comes with some risk. Corporate loan notes are unregulated which means, should the property developer become insolvent, you could risk losing your capital.
Such risks can be mitigated by choosing loan notes which are asset backed. This means that if the borrower (in this case, the property developer) defaults or goes bust, the assets pledged as collateral can be sold to repay debts.
(2) You could be paid late
The developers borrow money with a clear idea of the projects they’re involved in, and the completion times necessary to make good on their repayments. However, should things run over schedule there is the possibility you could be paid late.
The best way to avoid this scenario is to do your due diligence into the credibility and performance history of the developer. Do they have a good track record of delivering on time?
In addition, check that the loan note you’re interested in has a penalty clause to ensure you will be compensated for any late payment.
(3) A Shifting Market
Any property investment relies upon the essential stability of the market itself. If the market falls substantially, and the developer hasn’t added in the necessary buffer, your capital may be at risk.
Again, researching the credibility of the developer is going to be key to understanding how this could affect a particular investment you might be considering. Many loan notes allow early exit so these clauses will help mitigate the risks of a market downturn, if you can react accordingly.
Loan Notes Security Types
Property loan note funding usually goes to a specially created limited company called a Special Purpose Vehicle (SPV) where all the land and property are held along with any liabilities. This ring-fencing helps protect the lenders (Investors) capital as there may be many projects in place at the same time. So, if one property development fails for any reason there is not a domino effect and the property developer remains stable. In this case your capital may be repaid from elsewhere by the developer.
Loan Notes Security
Ideally the best kind of security is to have your Loan Note secured against specific land and or property with values far outweighing your investment. The Loan Note ideally could be secured by a specific property and or land charge and, or an all assets fixed and floating company debenture. The all assets debenture then pulls in all company assets and not just those held in the SPV providing greater security.
A Corporate guarantee may also be offered and in effect this guarantee by the developers means that other parts of a Corporate Group may also guarantee the Loan Note.
Trustees are sometimes used by developers to watch over the developer’s property assets ensuring there is always sufficient to repay in a default situation.
Property Loan Note Investment Check List
If you are considering direct property investment and concerned about security make sure you have the following Check List at hand:
- Are there Trustees in place and what is their function?
- Is there Corporate Guarantees in place (Following assessment of Guarantors assets and liabilities)
- Is there any Charge in place to secure your investment?
- Ideally a company all assets fixed and floating debenture (Charge) should be in place
- Is there a Special Purpose Vehicle in place?
Financial Services Compensation Scheme (FSCS) for Loan Note Investors
Along with many other ‘investments’ such as stocks and shares Loan Notes are not covered by the scheme in the event of a company default. The Financial Conduct Authority does not regulate this area either so it is another reason to ensure you use the security checklist above.
If you have any questions you can email us on firstname.lastname@example.org or speak to a sector experienced regulated adviser.