What are the benefits and risks of property bonds?

Property bonds have a range of benefits and risk considerations that must be carefully assessed when deciding whether they are the right investment option for you.

The main benefits are;

- Potential for higher returns than more traditonal savings and investment products.

- Typically asset-backed with security over the underlying property and/or land.

- Potential for tax free returns if the property bonds are held in an Innovative Finance ISA (IFISA), Self-Invested Personal Pension (SIPP) or Small Self-Administered Scheme (SSAS). 

- Some property bonds offer an added layer of protection by appointing an Independent Security Trustee.

- Property bonds offer experienced investors the opportunity to build a diversified and balanced investment portfolio.

As always, you should keep in mind that property bonds are an investment product - this means your capital is at risk and returns are not guaranteed.

 

For experienced investors, alternative investment products such as property bonds are becoming more and more popular.

However, there are different types of property bond. Some suggest eye-watering returns, sometimes in excess of 10% per annum.

All property bonds come with the main benefit of potentially higher returns than traditional mainstream savings and investment products. However, as with all investments, there are a number of risk considerations to take into account before you decide to invest.

1. Beware of property bonds offering unusually high returns or guaranteed returns

Returns can not be guaranteed, and they should be considered target returns and accompanied with the appropriate risk warning explaining that your capital is at risk and returns are not guaranteed.

Returns of 10% per annum or more should be treated with caution. It's difficult (but not impossible) for an issuer of a property bond to generate a target return of 10% per annum. It is more likely that target returns of between 4% to 8% per annum are more realistic and achievable.

2. Most property bonds offer an element of security, but that doesn't mean returns or repayment of your original investment are guaranteed

Here's a quick overview of how security usually works - property bonds are usually secured by way of a first or second charge in favour of the lender/investor (the same way that a bank would take a charge when providing a mortgage).

There's a key difference between a first and second charge. First charge security implies less risk. A second charge means that the holder of the first charge ranks ahead of second charge security. In the event of borrower default, the first charge lender would have a priority over the asset and cash available to repay the first charge loan.

3. Some security may be considered better than no security 

The fact that a property bond or loan is secured doesn't mean the loan or returns are guaranteed. It does help and could be considered better than an unsecured bond or unsecured loan.

However, in the event of an economic downturn, if property prices were impacted significantly this could affect the ability of the bond issuer or borrower to meet interest payments or repay any loan. 

4. Fixed term means your money is locked away and can't be accessed until the bond matures

Property bonds are usually issued on a fixed-term basis, typically between 2 years and 5 years, with returns paid either monthly, quarterly, annually or at maturity.

Generally, if you choose a longer-term and roll up your interest payment (in other words receive your interest when the bond is repaid or at 'maturity'), you can usually expect a more generous target return. 

The benefit of potentially receiving better returns than traditional instant access savings come with the acceptance of committing to a longer-term illiquid investment product.

5. Potential for higher returns but your investment is not protected by the Financial Services Compensation Scheme (FSCS)

This Is a very important point. It essential investors understand that property bonds are an investment product, not a savings product. Property Bonds are not protected by the FSCS. Beware of any property Bonds that suggest otherwise.

Fixed term or fixed rate savings bonds are currently paying around 1% to 1.5%, however, they do come with £85,000 FSCS protection in the event the provider fails.

6. Possible tax free returns with an Innovative Finance ISA (IFISA) property bond

Some property bonds come with the benefit of tax-free returns if the are ISA eligible through the IFISA.

The IFISA was introduced in 2016 to complement the existing ISA family and provide investors with tax-free returns from peer to peer loans or debt-based securities (fixed-term bonds including property bonds).

UK Government recognised the growth and importance of the UK Alternative Finance Sector and peer-to-peer (P2P) lending. In a low interest rate environment many experienced investors were attracted to the higher returns on offer through P2P lending. Returns were initially subject to income tax, however, the Government decided to create the IFISA to allow investors to enjoy tax-free returns on their investments. Obviously, a major benefit, particularly for high earning experienced investors. For example, if you're a high rate taxpayer then an IFISA peer to peer loan or property bond targeting 7.75% per annum is the equivalent of 12.9% per annum gross assuming income tax at 40%.

Are the higher returns on offer via property bonds worth the risks?

There is no right or wrong answer here. As an experienced investor, you probably have already built a well diversified investment portfolio. If you use your annual ISA allowance with a Cash ISA or a Stocks and Shares ISA, then an allocation of your annual allowance into a property backed IFISA may provide some added diversification to your portfolio with the benefit of tax-free returns. If you've used your ISA allowance it may be possible to invest in property Bonds via Self Invested Personal Pension (SIPP) or Small Self Administered Scheme (SSAS) subject to the approval of your Pension Provider or Professional Trustee.

As with all investment make sure you understand the investment product and underlying asset class thoroughly. There are many different types of property bonds - some are sensible with viable target returns - those with the promise of eye-watering returns should be approached with caution. If in doubt consult a professional financial advisor.

 


 

MAVEN Bonds are an IFISA provider specialising in fixed term property bonds.

Against a backdrop of low interest rates and a volatile stock market, the IFISA can provide an attractive investment opportunity for experienced investors. 

The property-backed IFISA has the potential to generate higher rates of return than more traditional investment routes for investors with a greater appetite for risk.

To find out more about property bonds, download our free property bonds guide.