The chance to achieve returns north of 10 per cent by acquiring or developing property holds a clear allure for income-starved investors. Unsurprisingly, the peer-to-peer (P2P) lending platforms putting forward such a proposition have enjoyed a surge in investment over the past three years.
P2P property platforms, which match investors with individuals looking to fund the acquisition or development of a range of property types, proliferated in the wake of the financial crisis as traditional banks tightened their lending criteria and shied away from riskier borrowers. Meanwhile, investors were given an added incentive in 2016 when the government launched the Innovative Finance Isa, which allows individuals to use some – or all – of their annual individual savings account (Isa) investment allowance to lend funds through the P2P lending market.
New lending volumes within the property P2P market rose by more than half to almost £850m during the first half of 2019 alone, according to a joint survey by lending data company Brismo and Link Asset Services.
That rising popularity has come despite increasing challenges to the market over the past 12 months. In May, Lendy – a platform that focused on property bridging and development finance loans – was forced by the regulator to wind up its operations, after rising bad debts caused a fall in new investment, leaving it unable to fully finance many of the development loans it had committed to. In turn, this exposed investors to a number of schemes that were only partly built out. Lendy administrator RSM has estimated that the platform’s 20,000 investors will get back an average 58p for every pound they invested, before costs.
Meanwhile that same month property lending business BondMason announced the closure of its core P2P business, citing an anticipated downturn in returns “over the coming years”.
In June, the Financial Conduct Authority (FCA) unveiled more rigorous rules for P2P platforms. Those included restricting marketing to retail investors to those certified or self-certified as ‘sophisticated investors’ or ‘high-net-worth investors’ and restricting investment in P2P agreements for those deemed restricted investors to 10 per cent of their net investable assets. Platforms must also clarify the governance arrangements and controls they have in place around credit risk assessment, risk management and the valuation of loans.
Yet the P2P property market has come to encompass a range of business models. Some offer products that allow investors to choose specific projects they would like to back, while others automatically invest money across a variety of loans based on an individual’s chosen risk appetite. A plethora of lending platforms have sprung up in recent years, offering short-term finance, commercial and residential property development loans and buy-to-let purchases.
There are also investment-based crowd-funding platforms, such as prime, and London residential specialist CapitalRise, which ring-fences each loan by creating a new subsidiary property company and issuing bonds to investors. However, that means that they fall under the mini-bond restrictions implemented by the FCA in January, rather than June’s P2P regulations.
What unites most P2P property platforms is that they give investors first charge over the property against which the loan has been secured. That means that if the borrower fails to repay the loan, the platform can force the sale of the property or development site, in order to return investors' capital.
For those with an even higher risk appetite, there are also platforms, including CapitalRise, that offer mezzanine loans, where investors in the platform are behind other lenders in order of priority in recouping their funds if repayment fails, since they only have second charge security on the underlying property. The average loan-to-value (LTV) is generally higher, although investors are compensated for the increased risk with a higher targeted return – between 9 and 12 per cent in the case of CapitalRise.
No free lunch
The promise of such healthy returns does not come without a commensurate level of risk. First and foremost, P2P loans are not protected by the Financial Services Compensation Scheme (FSCS), unlike cash or regulated investments such as unit trusts and open-ended investment companies offered by UK authorised firms. The FSCS pays out £85,000 per person per company on cash deposits, for claims against companies declared in default from 30 January 2017. For regulated investments, for example corporate bond funds, the FSCS covers up to £85,000 per person per firm for claims against firms declared in default from 1 April 2019.
However, there is also a general lack of understanding from P2P investors of what they’re investing in, says Ben Yearsley, director at Shore Financial Planning. “For instance, the fact the underlying borrower is probably paying 12 or 13 per cent or more,” he says. “That’s a lot of pressure on you as a borrower to get your project up and running on time.”
Platforms emphasise the extensive due diligence they undertake when allocating funds to borrowers. CrowdProperty undertakes a 57-step process when assessing potential borrowers’ suitability, says founder and chief executive Mike Bristow, considering factors including the market environment of the project, the economics of the project itself and who the borrower’s team are. Of the £2.2bn in funding applications received last year, it only granted loans of just over £60m, he says.
CapitalRise reports a similarly low acceptance rate of just 2 per cent of loan applications. “We always try to get a personal guarantee from the borrower,” says chief executive Uma Rajah. “Sometimes we get additional security on another asset.”
However, the rigour of underwriting practices will be truly tested in the event of a substantial decline in property prices. Against an economic downturn, some borrowers could find they are unable to refinance their projects and return cash to investors. There is also always the risk that the value of the asset backing the loan will not be enough to cover lenders’ initial investment or that returns will come in below the heady levels hoped for.
“Since the financial crisis, we have had a 10-year economic boom,” says Mr Yearsley. “The market hasn’t been tested in a proper 07/08 environment or when credit dries up.”
Most P2P property platforms disclose their LTV ratio as up to 65 per cent, which means the value of the underlying property or site would need to fall by 35 per cent or more for investors to lose their initial investment. By comparison, the vast majority of UK-listed real estate investment trusts have portfolios with an LTV ratio below 50 per cent.
“We are already lending in an environment where we have been under a lot of stress,” argues Ms Rajah, citing the decline in residential property prices in London and the home counties since 2014, when CapitalRise was launched in 2016.
Yet even if loans do not eventually turn toxic, there is the potential for repayment to be delayed, for instance due to project delays or the inability of a borrower to refinance their development. That is aside from the naturally illiquid characteristics of the market, although some platforms operate a secondary market that allows investors to sell their investment on to other users. For instance, CapitalRise operates a bulletin board where members can list their investment and, if a sale is achieved, the investment is sold at its current value including accrued return and the investor is charged an admin fee of 1.5 per cent. However, there is no guarantee of a sale.
“It’s very, very unlikely that all our projects finish on a contracted end date,” says Mr Bristow. “If a project runs over, the interest earned by lenders goes up to 10 per cent during that period,” he adds. CrowdProperty counts a loan as defaulted if repayment is late by more than 180 days, as defined by the FCA.
It is crucial that platforms keep investors updated when there are signs that repayment may be delayed, says Neil Faulkner, managing director and head of research at P2P comparison and research website 4thWay. “You need to know why loans are going late and what action is being taken because that’s a really key sign as to whether loans are going wrong or not,” he says.
Many platforms boast of either having defaulted loans in the single digits, or none at all, but the market is still immature and has yet to be truly tested in a severe economic downturn. The challenge for those considering investing in the P2P market in general is the scarcity of standardised data on loan performance, which makes comparing default and returns levels across the industry difficult. These types of investments are not suitable for a mass audience and are very risky – those still willing to invest in the P2P property market need to understand that they are doing so on a highly speculative basis.
|Platform||Type of property lending||Total lent||Average gross investor interest rate||Lender losses||Proportion of all historical loans either written off or in recovery||Average LTV all loans||Average LTV with auto-lend|
|Proplend||Investment property; bridging||£89,630,863||9.17%||£0||0.8%||62%||48%|
|Relendex||Bridging and development||£37,446,000||8.37%||£0||8.1%||60%**||N/A|
|Kuflink#||Bridging, development, property-backed SME||£72,819,364||***||£0||10.9%****||58%||58%|
|Octopus Choice||Bridging, buy-to-let, commercial property, bridge-to-let||£463,136,000||See note 5||£0||*****||63%||63%|
|BLEND Network||Bridging and development||£11,244,000||10.90%||£0||0.0%||65%**||65%|
|CapitalStackers||Bridging, buy-to-let, commercial property, development||£14,816,000||12.09%||£0||0.0%||54%**||N/A|
|CapitalRise||Bridging and development||£36,923,225||9.23%||£0||0.0%||63%**||N/A|
|Loanpad||Bridging and development||£12,422,500||5.00%||£0||0.0%||22%||22%|
|*LTV is based on the hoped-for sale price of the development. (Loan to gross development value.)|
|**LTV on the development loans is based on LTGDV. LTV on other loans is the usual calculation.|
*** Kuflink doesn't provide enough data for the gross investor interest rate, but for its highest-paying automated account and its manual lending account expect that it will have been around 7 per cent.
****Refers to loan default rate.
|***** Octopus Choice does not provide enough data for the gross investor interest rate. Net rates have been consistently over 4%.Octopus Choice doesn't provide enough info to calculate the precise pound amount in recovery. However, Just 22 out of 656 loans (3 per cent) are currently bad debts.|
#The original version of this article incorrectly stated Kuflink's lender losses and that 10.9 per cent of its loans had been written off or were in recovery, rather than the rate of defaulted loans. That has now been corrected.