February 12, 2019

How property bonds work

Want to invest in property but don’t have the upfront deposit and stamp duty required to take out a buy-to-let mortgage? Does the idea of managing tenants fill you with horror? For many Britons, the property market is, in their opinion, the sensible place to put your money for long-term growth so what are the options open to you? One of them is a type of investment called a property bond.

Here at Azurite, we offer a property bond focused on luxury property in Monaco. Their bond, as with others of its type, is a way for people to invest in property without having to deal with all the issues that arise when actually owning your own property.

What is a property bond?

A property bond is a way for investors to lend money to companies involved in property construction and development projects. This money is lent at interest and, in most cases, for a fixed period of time. A bond is a legally-binding agreement between you and a property construction and development company, similar to a commercial loan from a bank, and the details that this agreement sets out are:

• what the money will be used for,
• how much interest will be paid for the use of an investor’s money,
• when the initial invested amount is paid back to the investor (also known as a bondholder),
• when the interest payments will be made to the investor, and
• how the bond is secured (that is, what assets do bondholders and other stakeholders have ownership over should the promoters of a scheme fail to deliver?)

Every property bond offering is different and anyone considering investing in a property bond should carry out the due diligence required to assess the level of risk in purchasing that particular bond.

Most property bonds are over a fixed term, usually a period of between 2 and 5 years. They are this length because this is how long the developer believes they need to complete the work and then collect the money they’ll be due which has arisen from the work they’ve successfully performed. When they have received this income, you’re then paid back your original amount and your interest.

How do developers collect the work for the money they’ve completed? They will either:

• sell the property to end users
• rent out the property
• refinance the property

Risks you will need to consider include:

• do the construction costs and associated costs look realistic?
• does the price that they want to sell the development(s) for or rent them out at look realistic?
• do the management team have a track record in business, specifically in construction-related projects?
• if the bond is secured on the assets (whether complete or incomplete), how difficult would that asset be to sell, what price would it likely sell at, and would that price be enough to recover some or all of my investment and the associated interest?

These are very important questions and you must satisfy yourself that the project being financed by you, other bondholders, and any financial institutions involved sits within the level of risk you’re prepared to take.

Each property bond provider will provide an information memorandum on request to prospective bondholders. Ask as many questions (either by email, over the phone, at their office, or at the proposed site of works) as you need and trust your judgement.

How does a property bond work?

Property bonds are used to finance construction and renovation projects of all kinds, including:

• on Teesside, a property bond is the primary source of financing for an NHS retirement centre
• across Germany, property bonds are used to renovate unused and unloved listed warehouse into city centres so that they become the most desirable of luxury, high-end apartments (buyers of these properties are subsidised by the German government)
• across Yorkshire, many unused office buildings are being converted into city centre flats using property bonds

Underpinning any property bond must be a sound business plan – you get to see that business plan when you request something called an “information memorandum” from a developer. You can view Azurite information memorandum here, as an example

Property construction and development schemes which are financed by bonds are usually either exclusively financed by bonds or by a mixture of bonds and standard commercial loans (for example, by banks).

When funding large projects, whether related to property or not, banks become risk-averse and, even though they like the scheme enough to fund it, they are more likely to offer a property construction or development firm better and cheaper rates if there are others taking the risk along with them.

Once funding has been agreed, the process is as follows:

• Part of the money raised is used to purchase the land and any building on it. If it’s a construction project, the existing building (if there is one) will likely be knocked down and replaced. If it’s a renovation project, the outside and inside of the building will be altered in the way described in the information memorandum to create the new residential or commercial space planned.
• This land is then often pledged as the security in the deal for the bondholders and any other parties financing the project
• The work then takes place with the completion of the project occurring before the “redemption date” – that’s the day on which you receive back your original investment
• Depending on the scheme, you may get interest payments periodically until the redemption date. You will agree in advance with the construction company the dates on which you’ll be paid and the amount you’ll receive on each of these dates
• When the project is completed and the development either sold, rented out, or refinanced, this will be before the redemption date on which your initial sum is paid back.

What are the advantages of property bonds?

There are a number of investor-friendly advantages to property bonds. Many savers prefer to put their money into “fixed income vehicles” meaning that they know in advance how much they’ll be receiving in interest and when on the investments they make.

Unlike on peer-2-peer crowdfunding platforms for property construction and development, with a property bond, you are invested in one scheme that you have taken time to understand and assess the risks of. With many crowdfunding platforms, the platform themselves decide how to distribute the money you invest and some of those schemes may sit outside your area of comfort (however other crowdfunding platforms do offer you the choice).

For many Britons, the desire to invest in property is strong however, over recent years, the ladder has been pulled up from standard retail investors with a significant increase in both stamp duty on buying a property and higher taxation on any profits you make from rental income. With a property bond, the entire process is managed from start to finish and the management will not need your time and input. As with many types of investment, property bond investment is meant to be as passive as possible.

Many property bonds, including the Azurite IFISA property bond, are asset-backed. Although this is not a guarantee that you would receive all of your money back in full (plus any interest accrued) should a development not complete and it may mean that you have to wait to receive whatever money was recoverable until the asset had been sold, it offers a degree of risk mitigation that all IFISA-compatible investments, including bonds, do not qualify for Financial Services Compensation Scheme coverage.

What are the disadvantages of property bonds?

Property bonds are not covered by the Financial Services Compensation Scheme meaning that, should a developer go bust and the administrators are unable to sell the developer’s assets, you may lose all of your money. All of your capital is at risk with IFISA investments including peer-2-peer platforms and property bonds.

The fundamentals and calculations underpinning the business plan may be wrong. This may put at risk both the chance of your receiving all of your initial investment back as well as an interest payments promoted by the developers in the scheme.

Most property bonds, like the Azurite bond, are unlisted meaning there is no ready market of buyers for the bonds. You will, in most cases, be allowed to sell or transfer a bond to another person however there is no guarantee that anyone will want to buy your bond from you nor that they will pay you the price you want to receive for it. You should not invest money into a fixed term property bond or fixed term investment in general if you believe you will need access to the some or all of that money at some point.

The Azurite Property Bond

The Azurite Bond is a property bond offering for sophisticated investors and high-net-worth individuals, providing the opportunity to invest in the residential infrastructure of Monaco.

To learn more about the Azurite investment, please download our brochure here.

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