Thinking of Investing in Property Bonds or Mini-Bonds? Read this first!
Maybe you’ve been investing for years but never touched bonds, maybe you are completely new to the whole concept of what bonds even are. It doesn’t matter. This is the complete breakdown guide of what property bonds are with a specific look at property mini-bonds.
The aim of this guide is to make it as simple as possible for you to understand the pros and cons of getting involved in property bonds. Many of the terms used by industry veterans can be difficult to understand and can lead to miss-placed investments, this guide will try to avoid all of that and go back to basics.
What are Bonds? How do Bonds Work? Are Bonds Safe?
To start the explanation we need to go back to the very beginning and take a look at what Bonds are in their most basic form.
What Are Bonds?
A Bond is essentially a loan. In many cases, a Government Body, Local Authority, Company or Municipal will exchange a Bond for money from an investor. This Bond will be issued for a specific period of time, normally between 2-10 years and will give the investor a monthly percentage return on their original investment. Once the Bond reaches the agreed upon length of time, it matures, and the investor can collect the original amount of money they gave to the company.
How Do Bonds Work?
Companies normally issue bonds because while the returns on investment that they offer investors are typically higher than many savings accounts, it is cheaper for the company to pay back bond holder than it is bank loans.
If a company needs to fund a project many will try to avoid banks due to their typically restrictive debt ties and covenants included in many of the direct corporate loans they offer. In another scenario, they might only be able to obtain 70% of the capital they need in the form of a bank loan and are looking for other streams of revenue.
The result is that a win-win scenario can be created in which the company receives the capital it needs from a pool of Bond investors who in turn receive a better interest rate than if they invested their savings in a standard savings account.
An example of this could be seen as such:
A company called Borris Bathtubs needs £100,000 for a project (these numbers are lowered for simplicity purposes).
Boris Bathtubs sells a 5-year Bond to Gary (and a number of others) for £2500 with an interest rate of 6% per annum.
Gary then receives over £10 per month for 5 years until the Bond Matures and he receives his original £2500 back.
In total his investment has made him around £750.
Without taking compound interest into consideration, if he had invested the same amount of money with high street savings account offering 3% interest per month, Gary would have made £375 in the same period of time.
Borris Bathtubs is happy, they got to fund their project and Gary, along with the other Bond holders, are happy because they made some money.
Are Bonds Safe?
This seems too good to be true, and that’s partly because it is, there are a few good reasons as to why people still opt for savings accounts and other forms of investing other than Bonds. One of the primary factors is that Bonds aren’t entirely risk free, there are a number of different ways your capital can be at risk.
Interest Rates can Change
This isn’t a big deal, a Bond holder who holds out until maturity will still receive the original sum of money offered in regards to both the interest and the original investment amount. However, if for example, rates rise from 6% to 7%, the Bond still holding the 6% rate will be worth less. Therefore if the Bond holder wishes to sell the Bond on to make some quick cash, it won’t be valued at the amount it was previously bought for due to new ones on the market with better rates.
This can happen for various reasons. Three of the main ones being if the company or body offering the Bonds needs to get more money faster, either to extend the budget of the project or because the original offer didn’t attract enough attention. The other one is market fluctuations, something that can also be impacted by a number of different factors such as the economy or inflation rates.
Default Risks
This refers to the possibility that a Bond Issuer will default on the agreed upon payments. This can happen if the company goes into dire financial trouble and can result in the Bond holder getting little to no returns or some cases, losing all their money entirely.
The level of risk obviously depends on the entity that is issuing the Bond, Governments have a low level of risk due to their ability to open different income revenues and cover costs. However, companies that are more instable financially will have a high level of risk, typically to help attract investors, these companies will offer higher interest rates.
This is one reason why investing in Bonds requires a lot of research, you could be investing in something high risk but with lower potential returns than other high-risk ventures.
Despite this, Bonds are still considered to be a reasonably safe investment, especially when compared to the volatility and seemingly unpredictable trends of the stock market, and as a result, are heavily invested in by people nearing retirement and individuals looking to diversify their portfolio.
By investing in Bonds, those with a large portfolio that includes high risk investments, the reliable profit can be used to potentially offset any equity losses.
Property Bonds
So what’s the difference between Bonds and Property Bonds? Well, you might’ve guessed it; Property Bonds focus on a similar style of investing specifically dedicated to the housing market.
Property Bonds are almost exclusively issued by corporate companies, and as we learned in the above section, this automatically means they have a higher risk profile then Government issued Bonds. These Corporate companies can come in a few varieties but are most commonly property development companies who flip houses and real estate.
This market is reasonably stable, and investors can rest assured that an experienced property development company with level headed management will continuously turn a profit. These companies can, however, be greatly impacted by market changes or adjustments to the law.
Property bonds are normally issued for 2-5years with an interest rate of 6-10%. These Bonds are typically bought at cash value but on occasion pensions like SIPP or SSAS can be used.
To help encourage investors to buy Property Bonds many investment companies will act as a third party go between that issues the Bond on behalf of a property company and invests their own money alongside that of the new Bond-holder. This helps to reassure those purchasing Bonds as it provides the impression that the investment company would only be putting their money in on something that is a reliable investment.
Property Mini-bonds
Mini-bonds are a form of alternative finance that hit the UK in a big way back in 2015 and made some huge traction. They took off following a rise in excitement surrounding the opportunity to invest in companies that operate below many investors’ radars. They offered larger returns than other traditional types of investment.
Just like Bonds, they are essentially loans, however, they do differ in a variety of ways. Mini-Bonds cannot be traded on any market or listed for sale, meaning that you have to be a lot more confident in your investment before you commit. Once you’ve bought a mini-bond you must hold it until it matures.
Outside of the property market, a number of companies such as John Lewis and CrowdCube have used Mini-Bonds to help secure debt-based finance. This source of revenue has allowed them to balance out the difference between shareholders available capital and that of its debt liabilities. You can find a more in-depth description here.
The biggest risk in this is that if the mini-bond holder wants to get their money back in the event of the company going bankrupt, then they will have to join a large number of other creditors all after the same thing. Unfortunately, because the mini-bonds are unsecured, the holder will not be a priority and will be served behind secured debt holders, such as banks.
The advantage that Property Mini-Bonds offer is that their interest rates can be higher than traditional bonds. If you need a first hand example of the returns you can expect, there are a number of companies that provide very useful Property Mini-Bond Investment calculators that help bring clarity to your risk and return.
Despite the potential downsides, there have been a huge number of success stories and these Bonds should certainly be considered as a viable option by those who are looking for more returns than can be found in traditional Bonds.
