Evaluating a loan means asking how the borrower repays, what happens if they cannot, how far collateral could fall before you lose money, and how reliable the lender or platform is at recovery.
13 min read · Level 3
I would take a lower rate on a loan with a thick cushion over a higher rate on a thin one almost every time, because in lending the downside is where the result is decided. Rates are negotiated in good times, and cushions are what matter in bad ones.
For any single loan or loan fund, work through six questions:
1 Repayment source what cash repays the loan 2 Cushion debt service coverage and loan-to-value 3 Ranking senior, junior, secured or unsecured 4 Covenants early-warning rules the borrower must meet 5 Recovery process who enforces, how, and how long it takes 6 Concentration exposure to one borrower, sector or region
Two ratios measure the cushion. Debt service coverage (DSCR) compares cash available to the payments due. A property earning 1,300,000 a year with 1,000,000 of annual debt payments has a DSCR of 1.3x: income can fall about 23% before payments are not covered.
Loan-to-value (LTV) compares the loan with the value of what secures it. A 600,000 loan on a property valued at 1,000,000 is 60% LTV. The property could fall 40% before the loan is no longer fully covered, before sale costs. At a 45% fall, the property is worth 550,000 and the lender faces a 50,000 shortfall, plus costs of selling.
Subordination decides who absorbs losses first. If a company with 6,000,000 of senior debt and 3,000,000 of junior debt is sold for 7,000,000, senior lenders recover 6,000,000 in full, junior lenders recover 1,000,000 of 3,000,000, and shareholders get nothing.
Because in lending, most of the risk is visible in advance if you look at the right numbers. A thin cushion, junior ranking and weak covenants all show up before a default.
Platform and manager quality matters more than it seems. Two identical loans can produce different outcomes depending on how quickly and competently the lender pursues recovery.
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Two property loans, both advertised at 11%.
Measure Loan A Loan B Ranking first charge second charge LTV 55% 80% (including senior loan) Income cover 1.5x 1.1x Covenants LTV and DSCR tests none Developer track 12 completed first project
If the property's value fell 25%, Loan A would still be covered (a 55% loan against 75% of the original value), while Loan B's position behind the senior loan would be substantially impaired. Same headline rate, very different risk.
Choosing between loans mostly by interest rate. The rate is the reward; LTV, DSCR, ranking and covenants describe the risk you take for it.
Divide cash available by debt payments, and the loan by the collateral's value. Ask how far each could fall before you lose money.
Check whether you hold a first charge or lien, and what other debt ranks ahead of you.
Look for tests that give the lender rights early, before the borrower runs out of money.
Ask the platform or manager for historical recovery rates and time to recovery, including on failed loans.
Limit exposure to any single borrower, developer, sector or region.
Before investing in any individual loan, loan note or private credit fund.
Do not rely on this checklist if you cannot obtain the underlying data. Missing LTV, DSCR or security details are reasons to decline, not to guess.
When construction costs and interest rates rose sharply in 2022 and 2023, a number of property development lending platforms and loan note issuers reported delayed projects, missed payments and defaults, with some investors facing extended recovery periods. Development loans, where the collateral is unfinished, were widely reported as especially exposed.
A loan secured on an unfinished project is only as good as the project's ability to be completed and sold at the expected value.
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