Recently, Natasha Yea, director at Next Route Finance, posted on LinkedIn about an “experienced developer” returning to the market despite losing hundreds of thousands of pounds of investors’ money in previous deals, where unsecured loans had been used. A challenge, she argued, was these can complicate due diligence.

A common tactic for investors doing their homework is to pick out a developer’s shareholder at random and question them. However, with unsecured loans these investors are not shareholders as the deals are not structured as equity.

“Private individuals, who often support developers on an 'unsecured loan' basis, are often uneducated on how property development funding truly works,” said Natasha, expanding on her post.

“It is the more complex of funding structures in the property industry and classed within the 'high risk' category per the FCA, so more due diligence should be undertaken.”

Due diligence and personal guarantees

Should a loss in these deals occur, investors will often be behind other parties in terms of getting money back. Banks will often hold the first legal charge over the security - land or property – and therefore be first in place to seek the return of money. This means investors are at risk of losing their money through unsecured loans.

According to Natasha, some developers will offer personal guarantees (PGs) in these situations but lenders should be wary.

“Security can be an illusion if these developers give out PGs like sweets, are they even worth the paper they are written on? Often not!” warned Natasha.

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“Should a litigation process be required, not only is this costly (will certainly wipe out any potential interest that was due) but the developer may not have a strong personal net worth so 100% of zero is still zero.”

So how can due diligence be approached in such circumstances? Mackenzie Byrne does not work with unsecured loans, only structuring deals where there is a single equity investor who will take a second charge or become a shareholder, but the firm’s director of comms and sustainable finance Jake O’Leary has some tips.

“Track record is key – how many similar projects have they completed and successfully exited?” said Jake. “Ask for directors’ CVs and a summary of recent projects.

“With regard to project-specific information, the developer should have (at the very least) a decent appraisal, as well as a clear exit strategy. And then, of course, valuation and QS reports should be undertaken.”

Dealing with difficult questions

Sometimes this due diligence can unearth instances where a developer has lost money before. Anyone working in the industry knows developments can fail for a multitude of reasons, but this can still be vital information for investors considering new projects.

Here, Natasha said transparency is key and a prior failure does not necessarily equate to anything untoward that investors need to be wary of. Finding out more about these situations, and why a failure transpired, is critical, she argued.

“It's good to speak to previous investors if you can, especially when money was lost as it will highlight the developer's 'character',” said Natasha. “Did they continue to communicate with the investors and try to mitigate problems as they arose or did all communication stop and cause unnecessary anxiety?

“Projects may fail again or obstacles could certainly arise so you want to know the type of person you're dealing with. Preferably someone who has integrity, is willing to risk a bit of their own money too (have skin in the game) and is a great communicator.”

Mackenzie Byrne’s Jake agrees and says openness and honesty is the best approach. If a developer has a good explanation, and is willing to answer investors’ difficult questions, this should be seen as a positive. However, Jake warns: “If the developer doesn’t have a convincing narrative around this, or is evasive about certain details, that could be a red flag.”