As Mark Carney, the new Governor of the Bank of England, announces his ‘forward guidance’ programme, here are the major DOs and DON’Ts when you lend money to a property developer or property investor.
Property prices are picking up in many parts of the country. That’s good news for the UK’s recovery. Mark Carney wants to keep things moving in the right direction by keeping interest rates low. This, of course, is very bad news for people with money deposited in banks or building societies, or in cash accounts within SIPPs.
For some time now, people have been looking for a more profitable home for their money. Many are turning to property. Lending to property developers and investors in return for a higher interest rate, through a variety of methods. Joint venture deals on a one-to-one basis. Pension loans and crowdfunding. And packaged loan notes.
In the UK, we love property. As an island race, who can blame us? The law of supply and demand suggests that land prices will always rise over time. As Mark Twain so eloquently put it “Buy land, they’re not making it anymore”.
When you invest in the stockmarket, you can literally lose everything if the company in which you entrust your money goes bust. But when your money is backed by ‘bricks and mortar’, you’ll always have something of value left if things go wrong. Even if prices plummet, you won’t lose the lot.
There’s no doubt. Lending your money to fund the right property projects can be a very profitable. But before you part with your hard earned cash, here are nine DOs and DON’Ts to consider:
DO Take A First Legal Charge On Property
This is not placed in the number one spot for nothing. To protect your loan, it’s something you absolutely, categorically must do in every case. It doesn’t have to be the property being developed. It can be a first charge on any residential or commercial property. And if you’re in any doubt the property value isn’t sufficient to cover the amount of money you’re lending, obtain an independent valuation report.
DON’T Accept A Second Charge On Property
Invariably, a second charge is no security at all. If things go wrong and the first charge lender, which is often a bank or building society, forces the sale to recover its money, the property may well be sold cheaply, leaving you with nothing.
DO Find Out Exactly How And When Your Loan Will Be Repaid
It’s always the first question to ask with every loan or investment opportunity. How and when will I get my money back? If there’s no exit strategy, don’t lend in the first place. Challenge everything put forward until you’re satisfied, with ‘what if’ questions like: What if the property doesn’t sell? What if you can't re-mortgage the property to pay me back? What if property values fall and my loan is no longer covered?
DON’T Blindly Believe What The Developer Tells You
An impressive website portraying the developer as an expert can be created in less than a day. Being directed to their comments on forums and blogs doesn’t prove they know anything. Experience can be fabricated in no time at all. You’ll find novice investors and self-acclaimed mentors at property network meetings across Britain claiming to do ‘joint ventures’. Here’s the point. Just because a developer has been on a property course, attended a seminar, bought a franchise or read a book doesn’t make them an expert. Obtain verification for everything they claim, and look online for anything good or bad about them, on relevant websites like Property Tribes and Property 118.
DO Thorough And Comprehensive Due Diligence
There’s no substitute for this. You need a ton of information which, depending on the deal, should include most of the following: a comprehensive business plan; detailed cashflow forecasts, balance sheets and projections showing how your loan will be deployed and when it will be repaid; architectural drawings; proof of planning permissions; rental demand research; comparable valuation data; credit searches on the key people and their companies; and more besides.
DON’T Be Persuaded By Big Numbers
You’ll find an increasing number of developers offering rates equivalent to short term ‘bridging’ loans. The prospect of earning 18% per year or more. Who wouldn’t want that? Unless you can definitively establish how the deal is structured, and how such a generous interest rate can be paid, avoid it like the plague. Bridging is not classed as ‘high risk lending’ for nothing!
DO Establish The True Source Of The Balance Of The Money In The Deal
What might appear to be cash ain’t necessarily so. It could be a loan from a company or a pension fund, neither of which will show up on a credit search. It could be a private, unsecured arrangement, that might just get paid back early without your knowledge, leaving little money in the deal. If isn’t genuine cash, your loan could be at risk. Always obtain full provenance for the balance of the money, including proof of where it has come from, backed up with bank or building society statements.
DON’T Be Lazy
If it were as simple as transferring money at the click of a mouse, everyone would do it. To protect your money, you must get involved. Visit the developer’s completed projects to prove their workmanship. Get stuck into the detail well before the project starts. Always employ independent professionals to help you. Increase your involvement during the development so you’re ahead of any unforeseen problems that could jeopardise your loan. That’s what big lenders do. Follow their example!
DO Expect There To Be Problems
By its very nature, there’s plenty of risk in property development, some predictable but much of it unexpected. Be under no illusion - it’s your money that’s at risk if things go wrong. So before you part with a single penny, get a thorough understanding of all the potential pitfalls. If you’re not completely satisfied with what you find, don’t lend.
Rigorously apply the above DOs and DON’Ts, and you really could be laughing all the way to the bank!
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