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Could peer-to-peer loans build strong returns?

Property-focused peer-to-peer lending offers a higher-return, but potentially higher-risk opportunity for income seekers
Could peer-to-peer loans build strong returns?

Poor returns on bonds and concerns over equity income payouts are forcing investors to consider higher-risk income alternatives such as peer-to-peer (P2P) lending. P2P lending brings together lenders and borrowers directly, and many P2P providers facilitate loans to individuals and businesses. But P2P platforms focused on property lending are growing in popularity.

Property-focused peer-to-peer platforms enable investors to lend money to property professionals and companies via loans that are secured against property. Loans are often made for property purchase or development, but some platforms allow loans for any purpose as long as it is secured against a property.

Some platforms focus on commercial while others make loans related to residential property. Platforms also differ in terms of the diversification they offer across types of properties, the length of the loans, the loan-to-value (LTV) terms offered to borrowers and the availability of bad debt provision funds.

Costs vary, with many providers only charging the borrowers for the service, while some levy a platform fee on lenders.

"From an investor's perspective, the major advantage of property P2P lending is being able to attain an attractive rate of interest with their investment backed by the perceived security of property," says Patrick Connolly, certified financial planner at Chase de Vere. "However, it should be noted that this is not a savings account, and any investment which pays a higher level of interest or income usually comes with a corresponding higher level of risk."

Platforms targeting higher returns will typically be offering loans on riskier propositions with higher LTVs, or using a subordinated debt model where investors are ranked below other loans and securities with regard to claims on a company's assets.

Steve Robson, Managing Director at property P2P provider, Capital Stackers, which advertises a return of between 5 - 20 per cent, says: "We are able to layer the risk and aim to lend subordinated [debt] to banks which take a first charge. So, we're in the junior debt space and priced accordingly but on risk ratios more reflective of senior debt pre credit crunch. We're effectively plugging the funding gap left behind following the tightening of the banking regulatory screw."

Nevertheless as long as investors are aware they are taking higher risk Daniel Kiernan, research director at Intelligent Partnership, says property P2P lending can offer a quick, cheap and easy way to get exposure to the UK property market.

"The UK property market has been very strong for a very long time and a lot of people take the view that unless we start to build more houses it's going to continue to be a strong market," he explains. "Entry-level costs [for property P2P platforms] are low - people can invest from as little as £10. They also have low transaction costs and some platforms don't charge any fees to their lenders, so it's easier for people to participate in the property market than previously. It's also easier to diversify your portfolio and hopefully reduce the level of risk you're exposed to."

The number of property-focused P2P providers is growing steadily as new providers enter the market. The latest is Octopus Choice run by Octopus Investments, a UK fund management company that manages more than £6bn of assets, including via funds such as venture capital trusts (VCT) and enterprise investment schemes (EIS). Octopus Choice is targeting a return of 5 per cent and also invests alongside its investors by contributing 5 per cent to every loan it facilitates.

LendInvest facilitates loans for property companies focused on building residential properties for private individuals and Ian Thomas, co-founder and director at LendInvest, says demand remains resilient - despite the vote for Brexit.


Alternative to buy-to-let?

Landbay focuses on the buy-to-let sector and has experienced such high investor demand for its three-year fixed-term account that it has had to close to new investment. Before it closed, the product was generating 4.4 per cent compound interest over three years.

Becoming a buy-to let landlord involves finding tenants and maintaining your property portfolio, so property P2P lending may be of interest to those who do not want this hassle.

"There's much less administration involved with property P2P lending - it's a much more passive investment than buy-to-let," says Mr Kiernan. "It has lower entry levels, cheaper transaction costs and more liquidity."

But Mr Connolly argues: "With other property investment options such as funds, investment trusts and buying property directly, the investor could benefit from both income and capital growth. While property P2P lending should pay a higher level of income than these other investments, investors don't benefit from any capital appreciation in the property values."


Borrower default and other risks

Borrower default is the main risk when lending, and property P2P lending is no exception. However, property P2P loans are typically backed by a property which can be sold if a borrower defaults - an advantage over unsecured P2P lending to businesses or individuals.

While this should ensure that the investor receives their money back, it's not quite as straightforward.

"Property is an illiquid asset and it could take some time to sell, or might sell for significantly less than expected," explains Mr Conolly. "And the sale of the property may not recoup the full amount of the investor's money - a more likely outcome in a volatile or depressed property market. Some property P2P lending automatically spreads your investments across a number of borrowers and properties. This helps to diversify your risks. However, others allow you to put your money into individual investments, so while this means there is less chance you will face a default, if you do the impact on your overall investment is likely to be bigger."

Mr Kiernan agrees that lender liquidity could be a concern if there is a downturn in the economy which leads to an increase in borrower defaults.

"You're dependent on the skill of the platform in assessing the borrowers initially and recovering the money if the borrowers default," he says. "One of the ways they're going to recover the money is by selling the property because the loan is secured against the property - [but that means] you're also exposed to the platform's skill in the property market and their initial assessment of the value of the property. The platforms also promise liquidity, but that may prove to be illusory if everyone wants to get their money out at the same time."

There's also a risk that investor demand could be higher than borrowers' appetite for debt which could compress yields and tempt providers to make poor lending decisions.

"If the supply of loans outstrips demand, the platforms might start making more and more poor quality loans," says Mr Kiernan. "Think back to the sub-prime lending we had before the crash in 2008 - it could be a similar scenario."

All of the property peer to peer providers we spoke to said they had not yet suffered borrower defaults which had caused their lenders to lose money but with the industry still very young, investors need to plan for this possibility. The majority of providers also reported they currently have borrower default rates of zero but investors need to be aware that there are different ways of calculating what counts as borrower default.

The Peer to Peer Finance Association's (P2PFA) defintion of borrower default includes any portion of a loan that has not been repaid 120 days following the original loan repayment date or where the borrower is not going to repay the loan (for example, due to bankruptacy). This definition also includes all the costs incurred in relation to late repayments. Landbay and Lendinvest are among the property peer to peer providers who are part of the P2PFA.

P2P lending is also not protected by the Financial Services Compensation Scheme (FSCS). By contrast, if you invest in a regulated open-ended fund that, for example, invests in equities, bonds or property, it is covered by the FSCS and you get £50,000 per person per firm, if the firm running it fails.

However, your money should be kept separately from the P2P platform's funds in segregated accounts so, in theory, you may not be affected even if the P2P platform fails.

But to be on the safe side, if you do invest in P2P loans, only put a small proportion of your portfolio into this area. And make sure you check the platform is authorised by the Financial Conduct Authority (FCA) and has plans in place if it were to go under. This should be the case as the FCA requires P2P platforms to have an arrangement with another firm to take over the management and administration of P2P agreements and their loan book if they go under.

Mr Connelly says: "If people are considering investing it is imperative that they have a good understanding of exactly what they're investing in and the associated risks, rather than simply being enticed by a high interest rate and the perceived security of property."

 Returns you might get from property peer-to-peer lending

PlatformEstablishedPotential interest rateCurrent default rateMin investment amount
BridgeCrowd201412%pa Av. return 2% (incl. where borrowers are being pursued for re-posession)£5,000
CapitalStackers20145 - 20%0%£5,000
CrowdProperty2014Up to 10% pa0%£500
Folk2Folk20135.5% for fixed term loans of 1-2 years where the LTV is maximum 50%0% (no late interest rate payments or lenders losing money)£25,000
Folk2Folk20136.5% for both fixed term or Easy In/Easy Out loans where the LTV is maximum 60% 0% (no late interest rate payments or lenders losing money)£25,000
Landbay2014Tracker account: 3.99% pa0% (according to P2PFA guidelines)£100
Lendinvest 20135% pa0% (according to P2PFA guidelines)£100
Octopus Choice20165% pa0%£10
Proplend 2014Tranche A: 0-50% LTV, Av. investor Return, 6.44% pa0%£1,000
Proplend2014Tranche B: 51-65% LTV, Av Investor Return: 7.73% pa0%£1,000
Proplend2014Tranche C: 66-75% LTV Av Investor Return, 9.39% pa0%£1,000
Relendex2013Up to 10% pa0%£500

Source: Provider websites and Investors Chronicle