Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Is appetite waning for property bonds?
Property bonds can offer a high yield and tend to be secured against physical property assets, yet sentiment is weak towards most parts of the real estate market in the UK.
The money put up by investors for property bonds is used to build properties with investors either getting their return when the properties are sold, or the money is loaned to developers with interest payments helping to fund returns to the bond investors.
Sadly life is never simple. There is no guarantee a property will sell or go for the anticipated price. And if a developer defaults on a loan, there is no guarantee they can sell off assets to pay investors back, meaning the security measure isn’t entirely secure.
The other issue to consider is liquidity. Many of these products are mini bonds which prevent investors from selling until the end of a fixed investment term.
Property financier Urban Exposure Finance is currently offering a 6.5% yield on a retail bond that comes with a double layer of protection. The proceeds will be loaned to property developers who principally build homes for first-time buyers.
Its loans will help more homes be built, thus having a positive impact from a social point of view by addressing the ongoing housing shortage in the UK.
HIGH YIELD WARNING
Urban Exposure says its 6.5% yield is lower than many other property bonds on the market because it only lends to established developers, and they won’t be prepared to pay the types of interest to facilitate yields of 12% to 18% as seen on other property bond products on the market.
‘If you’re getting a yield in the region of 14%, the bond issuer is probably lending to very inexperienced builders which comes with a lot more risk,’ says Urban Exposure chief executive Randeesh Sandhu.
However, we are currently in an era of cheap debt, so offering a 6.5% yield would imply Urban Exposure is still having to take on a fair level of risk in order to generate an excess return over the cost of funding.
The money invested in the bond is secured as a first charge on the property if anything goes wrong; the AIM-quoted plc Urban Exposure (UEX:AIM) has also provided reassurance that it will give investors their money back in the event of any problems, funded from its balance sheet which included £46.8m cash at the end of 2018.
Nonetheless, your money isn’t guaranteed to be paid back, as Urban Exposure is theoretically still at risk of going bust if it got into financial trouble.
Unlike cash up to £85,000 per financial institution, investment bonds aren’t covered by the Financial Services Compensation Scheme (FSCS). And despite plans to trade on the London Stock Exchange’s bond market, there is still the risk that Urban Exposure’s bonds are illiquid and investors may not be able to sell their investment when they want, and at the desired price, should they wish to exit before the 2026 maturity date.
Brexit presents a big risk to the health of the property market. As such, appetite for property bonds is unlikely to be high. And anyone looking at Urban Exposure plc may be concerned that the business is loss-making and its share price has nearly halved in the past year. All of these factors would suggest a 6.5% yield would need to be carefully considered — is it adequate compensation for the potential risk involved?