Residential real estate lending as a solution to providing steady returns
19 September 2020
Advice firms should take a closer look at residential real estate lending, suggests Matt Dickens, senior business development director at Ingenious
Advice firms have recently faced a relentless succession of challenges in the attempt to source consistent returns for clients in an environment of profound social and economic difficulty. The economic outlook globally is uncertain, which has been well reflected in the behaviour of the capital markets and in the UK specifically not only are we facing the issue of grappling with public finances, as the government considers how to pay for the high levels of economic support it has provided, but also ensuring we are well-positioned for any impact from Brexit.
Markets have certainly performed better than expected, although it is unclear how long this could last and indeed many commentators are suggesting that company valuations are unsustainable in the light of their lowered profits and dividends.
In the post-Coronavirus world, one of the most pressing investment challenges therefore is how to construct a portfolio that can provide steady returns in an environment of low or negative real returns from cash and government bonds. Gilts in particular, often seen as a “safe haven” asset, do not appear to be capable of either delivering capital protection, nor a steady source of useable income1.
Under these exceptional conditions, many investment strategies have understandably struggled to sustain either the growth or income that investors had previously enjoyed without taking on elevated levels of risk and experiencing greater volatility with its associated negative impacts.
However, Ingenious Estate Planning has been operating alternative and unlisted investment strategies for over a decade, which have produced a steady return with low volatility2 particularly over these recent times as they possess little correlation to the primary listed markets.
Why residential property
Whilst very few sectors have avoided the impact of COVID-19, in the case of the residential real estate market, the lending outlook is cautiously optimistic.
One of the reasons for this is that the affordable end of the UK’s residential real estate market benefits from some core fundamentals that have assisted it withstanding a lot of the pressures experienced by other sectors.
Firstly, there is a large and sustained supply deficit. This strong, inherent demand for more supply poses a clear investment opportunity to investors who can fund construction projects in the safe knowledge that there is an established demand on completion.
Secondly, this supply deficit has been recognised by Governments for several years and there has been a raft of policies enacted, all supportive of building more houses. For instance, the Help to Buy scheme has enabled many, often first-time buyers, onto the property ladder. This scheme means there is a well-established and subsidised group of buyers ready for whenever developers complete construction on units eligible for the scheme.
Thirdly, and more recently, the Government has acted quickly to identify the property sector as one that is key to the UK’s recovery from COVID-19. Through relaxing planning laws and offering stamp duty holidays, both the construction and sales market are being given valuable incentives that support an ongoing return for real estate investors. Now if we add in the extra desire for most to have more room to themselves, weak sterling that continues to attract overseas investors and the withdrawal of mainstream bank lending to the construction industry, there is a strong case for cautious optimism in residential real estate.
Secured lending model
Like all investment decisions, of course, there remain some risks with investing in the property market, so adopting a conservative investment strategy is key to protecting investors. Rather than take a 100% equity, or ownership, position in a housebuilder, developer or actual property, instead a portfolio-based, secured-lending model has a number of clear risk-mitigating benefits. For instance, by lending to a portfolio of developers carefully selected across a diversified pool of projects, and by both securing your loans against the projects with the senior position and earning a fixed rate of interest, rather than taking on any equity risk, there is inherently lower volatility in the returns, coupled with a high degree of security.
Senior secured property lending is an established and relatively predictable investment strategy. There are clear benefits of lending versus owning: attractive and predictable returns through fixed interest rates, the secured position as a senior debt lender, similar to a bank, diversification benefits whilst making those returns potentially more tax efficient.
By contrast, equity investments and associated valuations can fluctuate over time as the asset price changes and so it is far more vulnerable to market conditions and sentiment, and ultimately any drop in value is suffered by the investor.
In the secured lending model, any loss is initially felt by the borrower. Also realistically new loans today will result in properties for sale in 2022, by which time, based on most analyst forecasts, we expect the market to have grown further and be much stronger.
Estate planning benefits
Ingenious Estate Planning utilises this secured-lending investment strategy. The Business Relief-qualifying service is commonly used by advisers planning for their clients’ later life.
As savers and investors reach retirement and decumulation, they present a unique set of investment problems. Without careful planning, the start of this phase for many could signal the end of any capital growth and herald their savings being eroded to pay for their life’s needs.
Any investment offering both high volatility and potential drawdowns may therefore become unpalatable and while many would wish to gift savings to their children to mitigate a hefty inheritance tax bill upon their death, the thought of losing both control and access to these savings when they may still need them, means many feel uncomfortable in taking that step.
However, this does not need to be a fate accepted by savvy investors and advisers who can utilise this proven trading strategy that continues to both carefully and predictably grow investments while also potentially providing full relief from inheritance tax.
1CityAM, July 2020
2Ingenious, June 2020
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