Loan note investments are increasingly being used in some property circles to fund the initial stages of new developments. But what are loan notes and how do they work?
“A loan note is essentially a contractual form of IOU between an investor and a business. For the business, it’s a way to raise capital. For the investor, it’s a chance to grow their money at a higher rate of interest than a traditional property investment would usually provide, whilst maintaining fund security.”
James Hayward, Investment Director, Farrbury Capital Partners
Loan notes are an alternative way of investing in property. They enable investors to benefit from the relative stability that property investment provides, while enjoying a higher rate of interest.
In short, investors lend money to a business (known as the ‘loan note issuer’). The arrangements are defined in a ‘note’ (contract) between the two parties. The ‘noteholders’ are those who invest.
Loan note investments are for a pre-defined period, which usually lasts between one and seven years. Interest is payable during that period. Some loan notes also offer bonus payments in order to encourage investors to leave their funds in place for the full term of the contract.
While with a loan note, tangible assets are not owned in the same way that buy to let investments (for example) are, there are still a major security in place, in the form of a Security Trustee. Therefore, should anything happen to the Loan Note issuer the Security Trustee has the power to seize all current and future assets, to ultimately liquidate, then distribute the funds to the noteholders.
There are various types of loan note. Farrbury Capital Partners specialises in general purpose loan notes. These are straightforward arrangements where investors loan money to a company and the company pays them interest before returning the initial funds at the end of the agreed period. Other types of loan notes include equity investor loan notes, consideration/vendor loan notes and convertible loan notes.
The key attraction for investors is the higher rate of return that loan notes can provide. They are a product for sophisticated and high net worth investors, rather than novices. Essentially, they are best suited to professional investors who understand the fundamental workings and risks of the property development sector and are looking to engage in a way that provides an alternative to the more traditional bricks and mortar investment models.