High ROI in P2P Property Investments – Is It Worth the Risk?

Nowadays, investing in property through peer-to-peer lenders has gradually become popular as disillusioned savers thinking really hard on how and where to put their money to earn a decent rate of interest.

Because of the Bank of England cutting interest rates (recently to a new low of 0.25%) partly following Britain’s decision to leave the European Union (Brexit), annual returns that range from 3% to 12% really makes this an attractive option for potential investors.

The size in this sector has almost doubled in the past 12 months according to records from the Peer-to-Peer Finance Association. By the end of the first quarter (Q1) of 2015, 100,000 Britons had lent£2.6billion in the form of peer-to-peer loans. And by the end of March this year the total amount of money had blown up to £5.1billion.

In April this year, such loans became qualified to be put in the new innovative finance Isa, encouraging, even more, interest, and some of the major platforms are going through or being approved the necessary regulatory permissions to apply for Isa manager position with HM Treasury.

Nonetheless, the loans do now benefit from the personal savings allowance which the Chancellor introduced and came into effect in April this year.

Because of it, the first £1,000 of interest collected for basic-rate taxpayers and the first £500 of interest for higher-rate taxpayers is now free of income tax, although it is not applicable for additional-rate taxpayers.

However, with so many peer-to-peer platforms, models and methods to choose from, how do you know which is the most ideal and safe to invest your precious savings?

The Difference between P2P and Equity Crowdfunding 

First of all, let’s be clear here that peer-to-peer lending isn’t crowdfunding and each of the different models within each type of investment have different levels of risk.

In a crowdfunding business, a potential investor puts up cash in the business in exchange for a stake in the business or some other benefit while those investing in a peer-to-peer lending are effectively lending money (a loan) to a business or property investor which means they (the borrower) will have to pay funds back with added interest.

Meaning, there’s a possibility that a crowdfunder may lose their capital if the business goes bust while the investors in P2P lending can only hope that the business owners or property investors will be able to pay the loan and its accumulative interest.

Equity crowdfunding may have a significant advantage but only one in ten start-ups make it to their fifth birthday so the risks might be considered higher than in peer-to-peer lending.

With peer-to-peer lending, investors earn a fixed return of income through their debt investment. Investors know how much they earn and when it will be repaid right from the start. But in an equity investment, the investor can only get their profit through a share of the net profits where the value of which is only known once the property (or project) is sold/relinquished .

Also in P2P where investors invest in property lending, there is the added security or assurance of the property underlying the loan. This only means that if ever a developer fails to repay the debt, the peer-to-peer platform can at least get some of the money back by selling or taking control over the property (security) and possibly repay investors’ capital back. Stratosphere peer to peer lending is purely a secured lending on property business. Please review our peer to peer lending FAQ’s section.

The importance of this is that peer-to-peer investments are currently not covered by the Financial Services Compensation Scheme (FSCS), which is an added risk and could be losing your original investment sum completely if the p2p platform goes bust or the investment failed to deliver.

Again, at Stratosphere we secure all lender funds via a client account supported by a trustee company (acting on behalf of all lenders) which is an independent entity an completely separate from Stratosphere’s main trading company adding an extra layer of protection for all lenders participating.

Why invest in property through P2P?

One could say that investing in property is a British obsession with property buying, selling, auctioning, developing and general DIY obsessions stuffing our television screens. But not everyone can afford to get onto the property ladder as it’s simply getting tougher to get the flexible mortgage finance with the added size of a deposit required and other high ingoing costs to buy. Although many people either can’t afford or simply doesn’t want to buy or develop property themselves, they do still want to see the benefit of returns it can offer.

The return ranges from 3% a year up to an extra of 12%. Example, Wellesley & Co will pay a fixed return of 3.75% for three years alongside a mixture of connecting and development loans, whereas ThinCats gives 9% a year with many deals returning even more than that.  Please note, I’m not suggesting for a minute that the two example platforms mentioned here are my personal recommendations – you need to do your own research including us, Stratosphere peer to peer lending offering a mid range return starting from 6%.

And just like with any form of investing, the higher the return, the higher the risk. That’s why many peer-to-peer platforms out there who are claiming to lend ‘on property’ fail to work out exactly what actual level of the risk is.

For instance, some platforms will offer buy-to-let mortgages at low loan-to-values (LTV) over a two-year term while others by using a ‘bridging loan’ firm which tends to lend for a much shorter period but which is of greater risk? Bridging loans are usually used to fund from the basic refurbishment to the more sophisticated developments which carries more risk and will trigger a higher charge with higher interest rates (ranging typically between 10% and 18%). Investors clearly have better returns in this arena but the corresponding risk is consequently higher.

What’s deemed a more risky approach are ‘development finance’ packages, which can be used to finance projects that start off as simply a muddy plot of land with perhaps planning permission. Development is known for having high risks even if the developer is experienced though it promises higher returns but whether you’ll that return is another matter.

How will my investment be organised? 

Organising your investment is also very important in a peer-to-peer business. Some P2P platforms take retail investors’ cash and let them select a very specific loan secured against a specific property while others agree on letting retail investors buy the equivalent of a unit in the platform’s selection of loans. P2P businesses such as LendInvest and CrowdProperty both adopt the former method, whereas Wellesley and LandBay spread investments across a mixed selection to achieve returns.

There are platforms that give you a detailed information on the borrower, property and project plans while others give you less information.

By taking an additional level of fees so that the net return for the investor becomes less, some of these platforms that invest across a selection on investors’ behalf can be interpreted as an unregulated collective investment scheme (CIS). Please ensure you now the differences and make sure they are also a regulated firm managed by the Financial Conduct Authority (FCA).

Ordinary investors are always advised to clearly steer well clear of this type of investing because they do not fall under the financial regulator’s watch list.

Due to the high-profile downfall of the Connaught Income Fund that left hundreds of investors suffering major and unrecoverable losses in 2012, the Financial Conduct Authority issued certain rules in 2013 that prohibits the marketing of unregulated collective investment schemes (UCIS) to retail investors, limiting their promotion for qualified sophisticated investors only.

In order to be labeled as a sophisticated investor or high net worth (HNW) individual, one must earn at least £100,000 per year or have net assets (that excludes your property, pension and so on) of at least £250,000. Please check the full criteria with the FCA and their guidelines for any latest updates.

Peer-to-peer investors are less highly monitored than funds, they do not have to publish their accounts or credit policies. Investors also are not protected by the Financial Services Compensation Scheme for anything but advice. This implicates that investment in the sector should be acknowledged as medium to high risk.

Regardless of all of these issues, those individuals who are putting their money into peer-to-peer lending are usually acknowledged as not ‘sophisticated’, although many of them still don’t understand the risks and platforms are not required to point all of them out!

Think Carefully Before You Agree 

One more thing that potential investors need to be cautious of is how platforms calculate the loan-to-value (LTV) on the underlying investment.

Take CrowdProperty as an example, it lists 34 Sidney Street in Nottingham as a development project that requires a £200,000 loan in order to complete the works. Then a 50 percent LTV deal on the loan will be agreed on.

But when you think carefully about it, the developer purchased the property for £150,000 in cash (apparently) but he wants to lend £200,000 against the property which is currently worth £150,000 according to a surveyor.

So technically, that makes this a 133 percent and not a 50 percent LTV loan. Yet, when you ask from CrowdProperty a detailed explanation, they’ll come up with an excuse by saying that the £200,000 loan will be separated into what they call ‘tranches’.

The developer will take £75,000 as an initial payment, which is certainly 50 percent of the present value of the property. After the first stages of work are complete, the remaining £125,000 will then be paid out in phases during the extension.

CrowdProperty promises: ‘The £125,000 will be taken by the solicitors and be released as and when the independent monitoring surveyor inspects the development of the project and verifies the money spent at the point of inspection.”

But the fact still remains that an incomplete development is not going to sell at the same price that a fully refurbished property will, which in the case for this particular property is expected to be in the region of£375,000.

After the first payment is made from the £125,000, the LTV is certainly going to go up way above the 53.3 percent that CrowdProperty will claim to be the LTV ‘once the renovation works have been completed’.

It might appear to be complicated but it’s a critical point because LTV is the ratio that covers the person making the loan. The lesser the LTV means the bigger the cushion of capital that the property holds.

If by chance the development runs over, fails to complete, project costs more than what is originally calculated, fails to sell at a required price or fails to sell at all within the term of the loan, 12 months in this case, this cushion safeguards the investor’s money to some degree.

But if the LTV goes up to let’s say 85 percent, that cushion will surely look a lot less comfortable if the project goes ‘south’ or property values fall. Experts already give a warning that this could happen following the UK’s vote to leave the European Union.

It’s a potentially high-risk investment

The cautions that shout out from these companies’ websites speak for themselves. From a ‘you could receive up to 10% a year’ (with the emphasis ‘up to’ means that the 10% is not assured or guaranteed) to ‘returns are not guaranteed’ kind of situation. Nothing should ever be mentioned as guaranteed!

Please note that it is important that your ‘capital is at risk’ if you invest in businesses that develops property through peer-to-peer lending platforms.

Again, while the Financial Conduct Authority (FCA) is regulating these platforms, the potential investors’ money is still not protected by the Financial Services Compensation Scheme (FSCS) which currently covers losses up to £75,000 per person if the company you invest should fail (for FSCS investments). However, if you receive poor advice regarding P2P investment, it will be a different story so make sure you take the correct advice from a regulated IFA (independent financial adviser).

There are peer-to-peer lending companies though who run their own compensation schemes that aim to return the investors’ money through a contingency fund that borrowers put up by means of a credit rate fee, commonly charged at between 0.5% and 3% of the loan. Business such as LandBay and RateSetter offer investors this added protection.

Although the idea to protect your capital is fine, not every peer-to-peer platform has to do this which means that you may lose all of your investment.

A good example of this point is the recent collapse and following rescue of FundingKnight. In addition, recently, RateSetter’s Provision Fund gave a warning that it could collapse as a result of worse than expected bad debt levels. This kind of situation in a business could expose investors to possible loss.

Conclusion

Nothing is guaranteed, crowdfunding and P2P is currently not covered by the FSCS and the level of risk is normally proportional to the level of return. All this may seem obvious but then again, a lot of investors or more importantly, retail investors participating in this sort of activity get emotionally attached and carried away with the ‘shiny penny’ syndrome. It’s very important to get clear and understand all aspects before parting with any cash. After all, you spent a lot of energy and sweat making this money so why would you give it away again in flash without the correct due diligence we all need to do?

Please consider reviewing one of my free eBooks which covers elements of risk and reward (for potential lenders). Go and visit my lenders page and complete your name and email (on the right hand side area).