Hardly known, increasingly in demand: bearer bonds for real estate investments

Bearer bonds have so far played a subordinate role as a component of real estate financing. Yet they offer interesting advantages, especially for institutional investors.

Bearer bonds have long been established in corporate financing: internationally active corporations or medium-sized market leaders have been using them for years to raise capital. In the real estate industry, on the other hand, bearer bonds have so far led a rather niche existence. However, given the current market conditions with increasedinterest rates and more restrictive lending by banks, they are increasingly coming into focus as an instrument for raising capital on the one hand and as an investmentopportunity for institutional investors on the other.

Flexible structure, firm commitments

But what is behind this instrument? At its core, bearer bonds are a fixed-interest security that investors can easily include in existing securities accounts.

In the financing mix, the bearer bond typically appears as a second debt component: after the bank’s senior loan, but before equity. In terms of accounting law, it is therefore debt capital, often in the form of a qualified-subordinated tranche. The advantage for investors: They receive a fixed payment entitlement, which – unlike equity – can be secured by contractually regulated interest and repayment agreements and is usually serviced once or twice a year.

Another advantage is that the design is extremely flexible. In addition to classic fixed interest rates, variable components can also be integrated, which can be dependent on success or sales, for example. This variable part is usually distributed once a year. The bearer bond therefore offers enormous freedom of design and can be tailored to the respective real estate project and the individual requirements of the investors.

The maturities of bearer bonds for real estate investments are usually five to ten years. They are thus guided by the usual bank financing periods and ensure that the stability of the overall financing is guaranteed throughout the entire holding period.

Tradable – with and without a stock exchange

The form of the issue also offers advantages for institutional investors. Bearer bonds can be issued both listed and non-listed. Non-listed bearer bonds can be implemented faster and more cost-effectively, as they do not require admission to the stock exchange. They are particularly suitable for investors who value discreet processing and lower transaction costs. Trading here takes place within the framework of so-called OTC transactions (“over the counter”), in which a counterparty must be found and an individual price negotiated. Listed bearer bonds, on the other hand, are associated with higher regulatory burdens, for example due to prospectus requirements and admission procedures. In return, however, they are easier to trade, because investors can sell their positions at any time via the stock exchange.

In addition, bearer bonds can also be issued via a so-called umbrella structure in the context of larger transactions. In this case, several bearer bonds are bundled in a superordinate vehicle, so that a more efficient placement on the capital market is possible. In the case of bonds of funds, it is also possible to obtain a rating and assess the default risk and repayment capacity. This offers institutional investors an additional, external second audit. The rating is usually reviewed annually and can therefore be a valuable tool in risk management.

Financing module with potential

At the same time, it is clear that the bearer bond has a higher probability of default as subordinated debt capital. In case of doubt, it is only serviced after the bank, and in the event of losses in value – for example due to vacancies or falling market prices – investors can lose part of their capital. Anyone who invests in this instrument must therefore be prepared to bear an increased risk . In return, he awaits a correspondingly higher interest rate. Typical premiums compared to bank financing are 50 to 100 basis points. This means that the bearer bond in particular to professional investors with an interest in distributing dividends and good risk management. The following applies:: Those who rely exclusively on maximum value appreciation through sale will have a hard time with this instrument. If, on the other hand, you are looking for stable distributions, you will find a suitable, also in risk management is a building block for his portfolio that can be easily controlled.

The bearer bond in practice

An example from one of the top 7 office locations in Germany shows what such an investment can look like in concrete terms. Investments were made in an office property on the outskirts of the city. The property, a typical administrative building from the early 1980s, was owned by a large German investment company for a long time. Most recently, the property was completely empty and was in great need of renovation.

The property is located in a formerly industrial area, which is being transformed into a multi-purpose commercial district in the course of structural change and offers long-term development prospects – typical of many German cities with a comparable industrial history. A developer who had already successfully implemented similar revitalisation projects secured the property and planned the reactivation via a modern usage concept with shared offices, flexible areas and a roof garden, supplemented by social infrastructure in the form of a daycare centre on the ground floor.

Praeclarus took over the structuring of the financing as well as the ongoing support for the institutional investor. The total investment was around 20 million euros. About half of this was provided by a bank via a classic loan with a ten-year term. The remaining ten million euros were covered by two further capital components: Five million flowed into the project via a fixed-interest, subordinated bearer bond with an additional performance-related component. A further five million were brought in via profit participation certificates, which acted as equity and formed a buffer within the overall financing.

The investment follows a long-term buy-and-hold approach with a focus on stable income and value retention. The bearer bond offers a fixed annual interest rate of between four and five percent, supplemented by a performance-related component. After deduction of structural and administrative costs, this results in an annual net distribution of around 3.5 to four percent. At the end of the term, the full repayment of the capital employed is also planned. The bearer bond – like the bank loan – is designed for ten years. Towards the end of the term, Praeclarus examines together with the bank and investor whether an extension makes sense or whether the property should be sold.

Result

The bearer bond is used for institutional real estate investments not yet a standard instrument – but that is likely to change. Especially in a market environment in which Institutional investors are increasingly attaching importance to a high degree of flexibility, predictable distributions and attractive returns, these advantages of the instrument are coming more into focus.