By David Stevenson on 26th October 2015
Another week, another mega mini bond issue, this time from property group LMSL. Their East London property bond has raised £5.4m on platform CrowdBnk and the last time we looked this offer has just a few more weeks to run before closing. What should investors watch out for?
In the table below we’ve broken out what we think on first inspection are the key questions for investors in this seemingly very popular mini-bond. In simple terms LMSL Group’s East London Property Bond is a five-year, fixed-term mini-bond offering an interest rate of 10% gross interest per annum for investments from £1,000 – with the bond secured against LMSL’s Barking Magistrates Court Development. Why has it proved so popular? According to CrowdBnk investors seem to like “the combination of a secured property asset, a yield of 10%, and a five-year term” making it the largest fundraise in CrowdBnk’s history. The property bond is open for applications until 31 October 2015, but this window may close early if the £9m target is reached. According to CrowdBnk LMSL Group wants to use the “proceeds raised as investment capital for planned developments in line with LMSL Group’s investment strategy.”
According to Lahrie Mohamed, CEO, LMSL Group, said:
"We’ve been seeing significant interest from potential investors in the mini-bond since we launched back in September, and what’s been most pleasing to see is that investor appetite has come from a range of different sources. In recent days interest has spiked, and we hope that those who are considering an investment don’t leave it too late and miss out on the opportunity.”
In our humble opinion many mini bonds fail at the first hurdle which is that they are not properly secured against any sensible assets. Bonds are not meant to be equity. They are meant to be repaid, in full at the end of the term. Everything else including the rate of return, is insignificant by comparison – bonds are not meant to be risk capital like equities and thus you need to be confident that you’ll be repaid.
This mini bond at least offers decent asset backing although we note that the loan to value ratio against the underlying property assets is at 87% which we think doesn’t give you an enormous amount of headroom if East London prices suddenly collapse. We’d also observe that the interest cover on the rent roll is 1.25 which though acceptable is hardly generous.
Assets change in value and what may be worth £10m today might only be worth £8m in a few years’ time. The London property sector is hardly good value and although East London represents ‘better’ value we are still worried that a nasty property reversal could be on the cards. Maybe the Brexit debate and a slowing global economy prompts a flight of foreign capital in 2016, kicking the support out from under the prime London property markets. This could in turn have a knock on effect on less prime areas within the capital, with potentially catastrophic effects on LTV and interest cover. This is a worst case analysis but it’s not completely implausible.
For us the risk to the capital value of the bonds underlying assets is not huge but it is not insignificant. The question then becomes whether we are being rewarded for the risk we are taking? The 10% yield on the bond would be more than ample if it was say a 1 or 2 year duration but this mini bond is for five years with bullet repayment at the end. That strikes us a long time in the world of property and although the return of 10% pa is better than many other mini bonds, we’re still not entirely convinced you are being properly rewarded. If the rate had been closer to 15% we’d probably be much happier to recommend this an almost equity style risk but with a very generous annual yield.
More details on the Bond – our checklist
1. What is the bond actually secured on? Assets and cash flow?
The bond is being issued by LMSL Group Company which an estate agent estimates has over £50M in assets across 160 properties. The group has debt of £29M from a range of banks which gives it a gearing of 54% across the group. After the completion and renting out of Barking Magistrates Court (BMC) and Quayside, management estimates that the group will be generating cash flow of circa £2.9M. Their current interest servicing is at £1.5M. East London Property Bonds (ELPB) are secured against BMC through first ranking legal charge over the underlying assets. In addition to that the bondholders have recourse to LMSL Group assets but ranked behind senior debt held by the banks.
2. Any more senior ranking debt?
The group has senior debt on the rest of its portfolio but when the bond executes bondholders will be the only legal charge on BMC
3. Is it a bullet loan and is it callable?
This is not a bullet loan and it is not callable. LMSL can redeem early without penalties. The interest is paid monthly and the principal will be repaid at the end of the term.
4. What's the LTV if property secured?
The LTV ratio is £9M/£10.25M = 87%
5. Have the issuers provided a stress test model if house prices decline?
We have run tests using a variety of metrics, including rental yields, occupancy rates, the Bank of England’s base rate and the ELPB’s interest cover to determine how the ELPB will respond under pressure.
Given the nature of LMSL’s business, we believe that rental yields in particular are a more appropriate factor to consider when analysing how the ELPB may fare should market conditions alter substantially.
Sensitivities have been run to test the correlation between rental yields, occupancy rates, Bank of England base rate and pressure on the interest cover. House prices are not directly correlated to the risk to the bondholders but rental yields are.
6. What is interest cover on rental roll?
The interest cover on the East London Property Bond needs to be looked at from a wider LMSL Group perspective. LMSL Group has a covenant, enforced by the security trustee, that stipulates interest cover must be maintained at 1.25 times for the group overall.
7. Who is the borrower ?
The LMSL Group is a well-established property and investment development company operating in East London. The Group was founded in 1998 by husband and wife team Lahrie Mohamed and Shehara Lahrie when they purchased their first buy-to-let residential property. In 2001, they undertook their first residential development project and in 2015 the Group has a total portfolio of over 160 properties with a market value in excess of £50 million, which generates £2.7 million rental income per annum.