The global financial markets provide the perfect avenue for wealth creation. Unless you are going into business, investing in the stock market, the bond market and properties among other financial instruments provide arguably the perfect ticket to riches.
Even successful entrepreneurs are known to diversify their wealth by investing in other financial instruments. Stocks and currency trading are a force of attraction for younger people, but as we get older, fixed income and the property market become more interesting and relatively more reasonable.
But what if you could capitalize on the accretive advantages of both the property market and fixed income? This is an intriguing prospect for sophisticated investors seeking higher returns than what you could get from the fixed income market.
Investing in property bonds
A property bond is basically a loan issued by a construction company to secure financing for property development. Investors provide the financing to the developer in exchange for a periodic rate of return paid in the form of interest. The property under development can also be used as collateral to secure the amount invested, which the developer returns in full upon maturity of the property bond.
One major advantage of a property bond compared to other forms of fixed income investing is the level of returns that investors stand to receive. Statistically, property bonds pay high fixed returns of 10%-12% per annum based on the location of the property and the average bank lending rates. For comparative purposes, the current US 3-year bond yield stands at 1.462% while the 30-year fixed mortgage rate is now pegged at 3.72%. On Tuesday the US bond yields sank further after another round of weak manufacturing data.
The US ISM Manufacturing PMI for September plunged to the lowest level in 10 years, coming in at 47.8 versus a consensus estimate of 50.1. On the other hand, the monthly change in the US house price index for August beat expectations of 0.3% with 0.4% according to the data released late last month.
Therefore, despite the cracks beginning to appear in the economy property prices continue to rise. This trend is mirrored globally with global housing demand also increasing especially in developing and emerging markets. On the other hand, there clear warnings regarding the growth of global economies according to a World Bank report released in June this year, which now sees the global economic growth slowing to about 2.6% in 2019, down from about 3.0% in the previous year.
This slowdown makes capital investments in the stock market less attractive with risk-sensitive investors more inclined to move some of their wealth to fixed income securities. And as discussed at the beginning of this article, property bonds are now becoming an interesting alternative for fixed income investors especially due to the level of returns. The bullish outlook of the global property market also provides an added advantage to investing in property bonds.
Property bonds are asset-backed, which means that in the event that the construction company defaults payment, then the assets that were used as collateral are sold to compensate the investor. This payment is especially guaranteed if a legal charge is applied to the property bond at the time of issuance.
Generally, the firm that issues the loan must have the right to seize the assets under development. It works the same way mortgage house buyers use the house as collateral against the amount they borrow from their lenders.
Property bonds also provide investors with an opportunity to access their funds before the maturity date by taking advantage of ‘exit options’ provided in the bond agreement. This can be very useful especially in case the investor is in urgent need of cash. However, this also means that investors forego any future interest payments due. The exit options must also be part of the original agreement for them to be binding.
In summary, property bonds provide investors with a more convenient option of investing in the property market. They are particularly a good option for passive investors looking for stable regular payments.
Interest payments from property bonds are also often higher than what investors would get from dividend payments for investing in stocks. They also do not attract the level of volatility and risk experienced in the stock market. These features add to the accretive benefits of investing in property bonds.
Conclusion
Many people ask why construction companies would choose property bonds over borrowing money from a bank. This is often the wrong question because most property developers that issue property bonds do that to compliment financing from other sources, which include bank loans.
Essentially, if a property developer exhausts all the available funding options and still finds themselves in need of more money for their development projects, then issuing a property bond becomes an attractive option. Over the last few years, property bonds have continued to become more popular in developed markets as sophisticated fixed-income investors use them to diversify their investments.