A scandal over unregulated mini-bonds targeted at small investors and banks snubbing permitted development rights has led to major criticism of the development industry.
Three years after the Financial Conduct Authority was first warned of problems, the UK watchdog is now clamping down on unregulated, speculative mini-bonds marketed to retail investors. These bonds are used to finance often risky and, in extreme cases, fraudulent development.
At the same time, 60 small investors who backed mini-bonds from developer Magna Capital have banded together to take action over lost money. Magna is now courting fresh investment in a race to avoid insolvency.
Get rich quick
Tensions are rising in the development market, as companies raise capital from mini-bonds but find themselves unable to secure further funding from banks wary of PDR schemes. Magna’s challenges follow the high-profile failings of Inspired Developments and Signature Living, both of which raised money in the mini-bonds market.
“Both [retail mini-bonds and PDR] have a significant gap in the regulation where those who want to exploit it can,” said funds consultant John Forbes. “They are get-rich-quick schemes offering implausible rates of interest [some have offered interest rates of up to 18%]. The bonds themselves and the underlying vehicles were completely unregulated and there was no supervision.”
A temporary ban implemented in January 2020 has now been made permanent. “There is a fallout in the short term, because that source of funding has been cut off to the businesses that relied on it,” says Forbes. “In the longer term, it is entirely beneficial that retail investors are protected.”
Amid rising costs in the wake of the pandemic, lenders and banks are refusing to back schemes that are not deemed fit for purpose.
Jonathan Vandermolen, chief executive at Vandermolen Real Estate, is selling a part-built PDR development in Bracknell, Berkshire, for receivers. The developer put the flats on the market and agreed sales but the banks refused to provide mortgages.
“Building societies and lenders are now looking at these buildings a bit more carefully and seeing that they are office buildings. If you can’t get mortgages you can’t sell the flats,” he says.
Tarnished reputation
Vandermolen adds that more of these schemes in out-of-town locations are now hitting the market as receivers seek to recoup funds for creditors. But he notes that small flats typically offer high yields for investors to acquire as rental assets. And with lengthy and costly planning processes, he expects ongoing take-up from developers. “There is definitely a place for permitted development in the future of residential,” he says.
The British Property Federation has been lobbying government to withdraw or amend recent proposals to allow PDR conversions of most commercial premises to residential.
“The big concern I have about PD is the locational context – there is no control over that,” says Ian Fletcher, director of policy at the BPF. “They are not great places to live. They are often used by local authorities for temporary accommodation and that is creating quite a lot of reputational damage for the development industry as a whole.”
He adds that strong regulation in the UK is a major factor in attracting investment, both domestic and international. “Investors know that what they are investing in is going to offer adequate protection.”
Forbes says that the usage of unregulated mini-bonds in this space “tarnishes the reputation” of real estate investment “with lurid stories about fraudulent schemes”.
In response to the worst cases noted by the FCA, he adds: “It’s not a huge volume of it, but there are those unscrupulous people who did use this and effectively defrauded people of their life savings.”
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