The real estate investment market has seen some dramatic changes over the past ten years. The Credit Crunch crisis of 2007 led to an outburst of innovation as people looked for new ways to unite buyers with property when their traditional lenders simply said ‘no’.
And this wasn’t just a problem for first-time buyers. Many people comfortably paying off their mortgages today would not actually qualify for the mortgage they already have! Even if the value of their mortgage remained the same.
Fortunately, as time has moved on, more and more banks are starting to show greater leniency again. It is unlikely that any of them will return to the days of offering 100% loan to value mortgages any time soon. However, it is becoming slightly easier for people to enter the real estate investment market again, be it either as owner-occupiers or as Buy to Let Investors.
And it’s for this second group – the buy to let investor, for whom Real Estate Crowdfunding has become a genuine option. In this article, we’ll take a look at how crowdfunding works in a real estate environment and how investors can benefit from it.
We’ll also take a look at Peer to Peer Loans. Also known as P2P loans, investors work to remove the banks and traditional lenders from the equation entirely. P2P investors see a decent return on their investment while simultaneously helping others enter the real estate investment market.
So What is Real Estate Crowdfunding?
The concept of crowdfunding is still quite new, and it certainly didn’t start in real estate. In fact, the first recorded instance of crowdfunding was from British rock band Marillion. They turned to their fans and asked them to pre-order their next album to finance a North America tour.
But this article is not for fans of rock trivia! The fact is that the whole idea of crowdfunding is incredibly simple. A group of people come together to raise money for something, and like that, ‘something’ has quickly translated into ‘pretty much anything’, it makes sense that the real estate market would follow suit.
Fortunately, the crowdfunding of a property is not simply a matter of gathering a few friends together and splitting the cost of that property equally. At its core, that’s exactly what real estate crowdfunding is. Except that, in this instance, a platform is developed. It brings together large numbers of investors and manages the entire process for them.
Who Benefits from Real Estate Crowdfunding?
Two groups of real estate investors seem to be taking the most advantage of the crowdfunding model – buy to let investors and property developers.
The buy to let investor is typically looking at the long game. As well as proposed rental income, the investor will be aware that the typical rate of appreciation in property is 3% per annum. That equates to a total of around 6% per year once that rental income is taken into consideration.
It’s an attractive proposition. Except that the majority of banks will be looking for the investor or borrower to hold at least a 20% equity stake in the property, and for many investors, that’s an immediate barrier to entry.
Real estate crowdfunding removes that barrier, by merely allowing that same borrower to take a proportionate stake in the property. With each owner taking a smaller pay-out once the rental income is divided amongst them, each investor will recognise that, say 25% of something is better than 100% of nothing. Once again, it’s a long term plan, but the return will still prove higher than leaving their money in the bank.
One significant benefit to the buy-to-let investor is that their crowdfunding platform of choice will take care of all of the administrative issues that come with owning such a property. Finding tenants, signing contracts, collecting rents, and maintaining properties, requires the appointment of a management agent to take care of all of that. Naturally, a fee will be incurred, but it’s considered by many to be a small price to pay to avoid the hassle that comes with being a ‘hands-on’ landlord. Especially if, as a landlord, our investor is only taking, for example, 25% of the income that’s being generated.
One important distinction when it comes to real estate crowdfunding versus traditional buy-to-lets is that the investors don’t actually own the property. When the crowdfunding begins, the platform forms a company known as a Special Purpose Vehicle. It’s this company which owns the property, so the investors have shares and receive dividends in the company – not the property itself. In practical terms, there’s no real difference, but for tax purposes, the distinction must be made.
Property Developers and Crowdfunding
The other group of real estate investors that are seeing the benefits of crowdfunding are property developers. The model here varies greatly from that of the buy to let mentioned above. The project is a lot more short term, with almost all of the profits being generated in one go at the point of sale of the completed development.
In this scenario, the figures are a little more concrete at the outset of the crowdfunding project. It’s also likely that the figures will be higher too, with many investors looking to develop multiple units, rather than purchase a single home.
In the case of buy-to-let, projections are based on long term speculation. It works with much more general figures like the rise of values in a given geographical area, the increase in rental property over owner-occupied, etc.
For developers, those figures are likely to form part of a business plan comprising some 18-24 months. If a developer is putting up 10 flats costing £75,000 per unit and sell each for £300,000, then the proposed profit is £2.25m. Granted, this is an incredible simplification of a multi-million-pound project, but at its core, this is exactly how it works.
And this simple formula is an attractive one to many a crowdfunding platform. Even if the whole development is only 50% successful, the profit is still over £1m. That money will have been made inside of two years. There are no guarantees, which is why any crowdfunding platform will assess the risks of any development – as any sensible investor would!
So what exactly is P2P lending?
While peer to peer lending and crowdfunding are often lumped together, they are two very different things. Each borne out of a desire to bring more people and property together in spite of the barriers raised by banks and other traditional lending institutions.
P2P lending allows the investor to ‘become’ the bank – lending money to those investors, usually in a crowdfunding situation, to help them secure a property. Thereafter, the loan that the investor gives is repaid by the borrower. That is either by selling the property or by arranging finance with a more traditional lender.
The main difference is in what the investor actually owns here. In crowdfunding, the investor owns the equity, whereas, in P2P lending, the investor owns the debt.
And that debt is likely (or at least hoped) to be short term. With higher rates of interest than banks or building societies, borrowers are keen to either liquidate or refinance their property asset as quickly as possible. Ownership of a property can often have a bank review its decision not to offer a mortgage to a potential borrower. After all, once they actually own a property, their credit status has instantly changed. Often that’s for the better, so they’ll be looking to the banks to take over the mortgage, lower their monthly payments and repay the P2P investor as quickly as possible.
But what’s in it for the investor?
It’s all very well thinking that the whole concept of P2P lending is so that well-meaning investors can offer their money in an altruistic fashion to help people get onto the property ladder. That is not really the case!
P2P lending is currently showing annual returns of between 3 and 12%. What’s more, those figures do not appear to be affected by the fluctuations seen in the Stock Market.
But in addition to a high-interest rate, P2P lending wins on two other scales – liquidity and safety, so let’s take a look at both of them.
Investing in property is generally considered safe, and if one is willing to play the long game, a high rate of return on the initial investment is likely. The problem is that the money is locked into an asset that can, at times, prove difficult to liquidate quickly, and sometimes, not at all.
P2P lending means that the investor can spread his or her investment across multiple borrowers. Loans can be sold quickly and usually at a rate far superior to what one would get from the bank. As for safety, the money is spread over so many people, that there is a negligible risk of major loss.
Sounds like a lot of work!
How much or how little work is required is down to the investor and their choice of platform. Some investors enjoy the idea of thinking of themselves as a fund manager. They can take a look at each loan application along with its lifespan and potential for growth and choose to be as hands-on as humanly possible.
Other investors prefer a more black and white approach.
“Here is my money, now go and make me some more!”
For either investor, there is a P2P platform to suit them. Many specialise in one particular field, whereas others offer specialists in a number of different models, and can advise their investors accordingly. The three main models are lending to consumers, lending to businesses and lending against property.
Lending to consumers is the origin of P2P lending, and in its earliest inceptions, borrowers were transparent with their reasons for needing the money. In doing so, investors were able to make more educated decisions over which loans were likely to be more worthy of their investments. The most important concern here is that, regardless of what it is for, the loans in question are unsecured. This means that investors are a little warier as if the borrower is unable to repay the loan, there’s very little chance of recovering that debt.
For investors looking for a little more security, there’s the option of lending to businesses. Such loans are usually secured against property, or failing that, the directors of the company will act as guarantors for the loan, often leveraging other business assets as security.
These loans allow businesses to expand. As such, they can prove to be a very attractive proposition for the investor, fancying him or herself as a silent partner in a business on the verge of a major breakthrough in the market.
And the third area of P2P lending is when the loan is against the property. It’s worth noting that such lending is rarely utilised for the owner-occupier. From the investors’ perspective, that’s not an attractive proposition as the loan is just not short-term enough for it to be worthwhile.
Ultimately, P2P lending against property is for projects such as a ‘fix and flip’ where a property is purchased at a low price because it needs refurbishment. The refurbishments are carried out, and the property is put back onto the market at a value comparable to the rest of the street. Sometimes, in that scenario, the owner and their investor earn a very decent profit.
Of course, such projects are not without their risks. There’s no guarantee that the flipped property will be sold quickly, which means that the owners will be liable for payments against the loan until the buyer is found. However, the price of the property can always be lowered to attract a buyer. Even though the profits might be lower than anticipated, it’s unlikely that the project will run at a loss.
It’s worth noting that the majority of P2P platforms operating in the UK are currently doing so at a loss. Their backers understand the nature of this new business model and have systems in place to absorb these losses over the short term. Any decent P2P platform will have a plan in place should something go wrong.
Therefore, for the investor considering entering the P2P market, it’s a good idea to thoroughly research the market – looking for good liquidity and a good track record. Beyond that, like any investment, it’s worth considering the merits of not putting all one’s eggs in one basket. There are multiple P2P platforms available, and the shrewd investor will have portions of his or her investment portfolio in more than one of them.