What is a Property Bond?
Also referred to as property investment bonds, property bonds are a popular source of funds for property developers. The finance needed to fund the project is provided by the investor as a loan, which is usually offered during the early stages of the project to cover all or some of the costs.
A property bond is usually a legally binding contract between the property developer and the investor, outlining a variety of assurances from both parties.
The investor agrees to lend a specific amount of money to the developer. The terms of the formal agreement show how the funds can and should be allocated, interest rates and additional borrowing costs on the loan, security provided to cover the costs of the loan and when the investor will be repaid.
With both residential and commercial property bonds, one of the main points of appeal for investors is the comparatively high rate of interest chargeable on the loan. Property bonds are therefore a popular alternative investment vehicle for high net-worth individuals willing to take acceptable risks in pursuit of elevated short and long-term gains.
How Do Property Bonds Work?
The most basic fixed rate property bonds work in a very similar way to a commercial loan. A property bond will be issued by a construction company or developer, in order to source the funds required to complete a project.
Property bonds are usually secured against the property itself, in order to protect investors from losing their money if the project is unsuccessful. The investor will determine if and to what extent the security offered is both viable and sufficient to cover the costs of the loan – similar to when applying for a traditional secured loan.
Fixed rate interest may be charged on the balance of the loan on an annual basis, or cumulatively at the end of the loan period – typically no more than 2 to 5 years.
What is a Charge on a Property?
Applying a legal charge to a property bond effectively means that in the event of non-repayment, the investor has the legal entitlement to take possession of the borrower’s assets. Repossession is usually seen as a worst-case scenario outcome by all parties involved, who will be willing to make as many concessions as necessary to prevent it from becoming necessary.
However, if the developer or construction company fails to comply with all applicable terms set out in the loan agreement, the investor can take legal ownership of their assets. At which point, they will usually be sold to recoup the losses incurred, with any subsequent additional funds generated being passed back to the borrower.
What Happens in the Case of Insolvency?
Investing in property bonds is only advisable in instances where the level of risk is smaller on the basis of a viable asset-to-liability ratio. This means that when issuing a loan of any kind for property development purposes, the investor must ensure that the security provided by the borrower is sufficient to cover their expenses in full.
This way, there is minimal chance of capital loss – even in the case of insolvency on the part of the developer or construction company.
How Are Property Bonds Better than Conventional Loans?
From the perspective of the borrower, the appeal of property bonds lies primarily in the limitations associated with conventional borrowing. While many (or most) developers and construction companies work with conventional banks and lenders, it is rare for such a lender to provide all the funds needed to complete the project.
Instead, the developer is likely to be offered a maximum of 50% to 75% of the total funds required. The rest of the money must subsequently be sourced elsewhere.
Working with private investors, developers can access more money than would be available via conventional lending channels. This enables developers and construction companies to take on more challenging and lucrative projects that would otherwise be beyond their financial reach.
On the flipside, property bonds are also popular among investors for a variety of reasons:
- Fixed Rate Interest – The interest payable on a property bond is fixed over the life of the loan, which adds up to predictable and guaranteed returns for the investor if the project is successful.
- Protection of Capital – Even if the project is unsuccessful or the borrower declares insolvency, losses are smaller or avoided entirely where property bonds are secured against viable assets.
- Convenience and flexibility – The investor plays a major role in outlining the terms and conditions of the agreement, making for an exponentially more flexible and convenient investment vehicle than more conventional options.
- High Returns – Interest payable on property bonds is typically higher than that of a traditional loan, which can translate to high potential returns for investors backing the right projects.
Above all else, property bonds are attractive as they are not considered nearly as volatile or unpredictable as more traditional investment vehicles. They may not have the same lucrative potential as stocks and shares, but are nonetheless far more secure and predictable in nature.
Are Property Bonds Genuinely Safe?
Property bonds are as safe as those investing in them allow them to be. The safety or otherwise of the property bond will always be determined by the appropriateness of the terms and conditions in the contract, along with the track record, credibility and financial performance of the borrower.
In addition, the viability and value of the assets used to secure the loan provided will play a major role in determining the safety of the agreement. If the security provided by the borrower is adequate to cover all monies loaned, there is little to no risk of capital loss on the part of the investor.
Seeking independent expert advice before making any major decisions regarding property bonds is advisable, unless you are already experienced with these kinds of investments. An independent broker can help you find the ideal investment vehicles to suit your objectives, your investment budget and your risk appetite.
What Are the Main Advantages of Property Bonds?
- Lower volatility and higher predictability than other investment vehicles
- Fixed rates of interest for guaranteed returns when the loan is repaid
- Potential to charge comparatively high rates of interest for generousreturns
- All monies loaned can be secured with appropriate assets or collateral
- One of the more flexible and convenient property investment strategies
What Are the Main Disadvantages of Property Bonds?
- Your investment cannot be redeemed until the agreed term ends.
- The financial conduct authority (FCA) does not currently regulate property bonds
Get in touch…
If you are interested in property bonds though remain unsure as to whether it is the right investment vehicle for you, we would be happy to provide you with an obligation-free consultation to discuss the pros and cons in more detail.
You can count on our experienced team to provide the objective and impartial advice you need to make an educated and informed decision.