Equity is a common method of investing into property development projects (see also our article on Mezzanine Finance). Put simply, an equity investment typically means buying shares in a newly formed company, set up to buy, develop and sell property, in return for a share of the profits. Unlike a debt product, which pays a fixed rate of interest, projected returns for equity are determined by an expected profit figure and therefore can be subject to change where the actual profit amount is higher or lower than expected.
Order of Payment
On a typical development project, which is part funded by investor equity, returns are paid to debt and equity providers in the following order; senior debt (secured by a first charge) is the first to be repaid; next equity investors (developer & investors) are repaid their capital; and finally, the equity investors (developer and investors) receive any profits.
Alternatively, it is also common for equity investors to sit ahead of the developer in the order of payment. In this scenario returns may be paid to debt and equity providers in the following order; senior debt (secured by a first charge) is the first to be repaid; next equity investors are repaid their capital and any profits; and finally, the developer is repaid its capital and any profits.
The investors’ return is based on an agreed profit share between the investors and the developer (eg 50:50), which would be set out in the relevant legal agreements. As noted above, projected returns are determined by an expected profit figure and therefore actual profits may be higher or lower than expected. Returns are typically repaid at the end of a project once the completed units are sold and/or refinanced.
The exact terms of an equity investment can vary for each project. For example, it is common for an equity investor to receive a preferred return on their investment (eg 10%pa), as the first allocation of profit to reduce downside risk and in return for a developer to receive a higher share of profits over the expected profit amount (eg 75:25).
An equity investor holds security in the form of its ownership of the legal title of the property and does not commonly take the form of a legal charge over the property. As a result, an equity investment would commonly be subordinated to the senior lender who would have a first charge over the property.
The terms of an equity investment may be included within a shareholder agreement and articles of association, which would regulate the relationship between the equity investors and the developer. There may also be a separate developer management agreement between the company that holds the property (‘PropCo’) and the developer, which would incorporate the terms associated with the construction of the development.
Homegrown is a property crowdfunding platform, which provides all types of investor with the opportunity to back UK residential developments, by investing as little as £500. Homegrown uses both equity and mezzanine loan investments to fund property developments.
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