This is why it's good news that the peer-to-peer banking revolution - which breaks down the boundary between investor and lender - is spreading to property. Zopa, the oldest peer-to-peer platform, only makes small consumer loans, as does rival website RateSetter. Yet Funding Circle and ThinCats, two outfits that specialise in small-business loans, are starting to broker commercial mortgages, and one start-up, Relendex, will deal in nothing else. Thanks to these and a few other companies, private investors can lend directly to landlords for the first time.
This is appealing because it offers a way of accessing the high yields available in commercial real estate without the hassle and capital risk of direct ownership. I've written on this subject before in reference to two investment trusts, Starwood European Real Estate (SWEF) and ICG-Longbow Senior Secured UK Property Debt (LBOW), which were both launched to capitalise on the weakness of the European banks.
These funds offer a professionally managed route into the market, which is very useful in a specialist market. But both trade at a premium to book value - a premium that could turn into a discount should interest rates and return expectations rise, as they have showed signs of doing over the past month. As a direct play on the same theme, peer-to-peer lending avoids this problem.
For the uninitiated, peer-to-peer platforms match borrowers and lenders. Unlike banks, they do not use their own balance sheet to finance loans or secure deposits, instead acting (and paying themselves) purely as online brokers. Zopa and RateSetter amalgamate funds and fund requests, offering blended interest rates that reflect the balance between the two at any given point. But the business-cum-property lenders list individual borrowers, for whose interest payments lenders can bid through an online auction.
This is sometimes at a rate fixed by the broker - in which case the auction works on a first-come-first-served basis until the borrower has the funds he needs (think of the Buy it Now option on eBay). Alternatively, the auctions can be more conventional, with lenders bidding whatever interest rate they are prepared to accept and the borrower taking a blend of the lowest rates.
The interest rates vary considerably, depending on the kind of loan and security. Funding Circle's average interest rate for lenders is 8.8 per cent gross, which works out at 6.2 per cent after bad debts and fees. ThinCats, which caters to more sophisticated investors, has lent at an average gross rate of 10.8 per cent since its launch two years ago. But these averages include all sorts of small-business loans - in the case of Funding Circle including unsecured ones.
Classic property lending commands lower rates, because real estate can be more accurately valued and easily disposed of than the miscellaneous plant and equipment assets that serve as security for small-business loans. Relendex expects to offer between 5 and 8 per cent for senior loans with first charge on tenanted shops or offices. Assetz Capital, a platform set up in April by buy-to-let broker Assetz, offers a 6.5 per cent interest rate on a buy-to-let mortgage - an investment it is calling "lend to let". Mayfair Bridging, which specialises in mezzanine property lending, offers double-digit yields.
The advantage of peer-to-peer loans is that investors can choose what level of risk they are prepared to accept, and have to pay no fees or transaction costs (most business-lending platforms are funded by the borrowers). This is highly attractive for independent-minded investors - because it is so unusual - but it does throw up problems of its own.
One is the risk of under-diversification. Secured lending, particularly against property, reduces the risk of capital loss. But the borrower could still stop paying the coupons. The best way to guard against this problem is to lend to a wide range of borrowers. Managing a portfolio of direct loans may be more work than most private investors are prepared to put up with - although some platforms do help with automated lending options.
Another risk is that a default becomes a legal headache, with a fragmented base of lenders needing to make decisions about a single asset via a third-party management company. Michael Lynn, chief executive of Relendex, notes the "deadlock problems" encountered in the resolution of so many mortgage-backed securities as a salutary precedent.
Finally, there is the risk of platform failure. Peer-to-peer lending is not guaranteed by the state, as bank deposits are. One website, called Quackle, collapsed under the weight of bad debts in 2011. With websites sprouting up in ever greater numbers, investors need to find a way of establishing who is credible. My approach would be to trust established players or founders with solid industry track records. The sector is due to be regulated by the Financial Conduct Authority from next April, which should help.
I'd be surprised if peer-to-peer lending did not generate the odd scare or scam story over the next few years. These tend to be a by-product of exponential growth, which the industry is certainly enjoying. Yet a fresh source of high yield can only be a good thing for private investors. Just try to adopt the dour mentality of a pre-boom bank manager and - as always - remember the golden question of investment: what could go wrong?
