A couple of days ago I sat down with a developer (i’ll refer to him as Ben) to discuss his forthcoming project. I’ve known Ben a while and have previously invested with him, together with my circle of investors. His team’s projects have generated great returns for us (30-40% pa on equity). And we score them highly on our developer ratings matrix (8.4 out of 10).
Given this backdrop, I was excited to hear about Ben’s forthcoming project. This particular one would be a loan opportunity for investors, returning 10.5%pa. 18 month project duration, relatively straightforward build-out of 12 apartments in a liquid location in Middlesex, targeting first time buyers. So far, so good … until I asked about security. Investors would receive a Personal Guarantee but, to my disappointment, no fixed charge (1st or 2nd) on the property. This is where i lost interest and declared “i’m out”!
What is a Personal Guarantee (PG)?
A PG is a legal form of security that a borrower (property developer) provides to the lender (investor) to protect against a default. It is perceived to be reliable and robust because the legal liability stands with the developer as an individual, rather than his/her development company.
The PG is a document drawn up by solicitors and creates a legally binding liability for payment of the sum stated in the agreement. Usually, the lender/investor (or the crowdfunding platform acting on their behalf) would need an Asset/Liability Statement certified by the borrower’s accountant to verify the borrower has sufficient means to satisfy the PG in case of default.
The risks investors need to know
For an investor/lender, a PG might sound fine. After all, if something goes wrong, the developer’s own personal assets would be claimed, supported by a legally-binding document that was certified by an accountant.
Here are the risks when a lender relies solely on a PG for security:
- There is no central record of PGs. The borrower might have issued numerous PGs, to many different investors/lenders, to fund various projects. So, it may be hard to establish the extent of the borrower’s TOTAL liabilities and whether his/her assets would cover them. The PG issued to one investor might be for £100k but what if the sum of allissued PGs amounted to £10m?
- One PG does not normally have priority over any other. If several of the developer’s projects default at once, in which order do PGs get satisfied? It would be unclear which lenders get priority in their claim over the borrower’s assets.
- On the asset/liability statement, assets can be verified relatively easily. With liabilities, however, that is not always the case. There might be off-balance sheet obligations or less formal debts and liabilities that go unrecorded. So, the asset/liability statement could easily under-represent liabilities and, therefore, the means to honour the PG.
This is no reflection on the integrity of borrowers and property developers. Rather, it is about identifying the main risks for investors relying ONLY on a PG for security.
As investors, it is our job to think about scenarios which might risk our capital. In the investment world things happen beyond our control and markets occasionally decline so we need to plan for these possibilities when assessing investment opportunities.
At InvestLikeAPro, we insist on a fixed charge (on property) for all loan investments. That way, we can clearly quantify the security backing our investments. PGs are fine as an additional form of security but relying exclusively upon them is not prudent.
As ever, open to all comments and questions: manish@
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Manish Kataria CFA is a professional investor with 18 years’ experience in UK real estate and equity portfolio management. He has managed money for JPMorgan and other blue chip investment houses. Within real estate, he invests in and owns a range of UK property including developments, HMOs, serviced accommodation and BTLs.