Peer-to-peer property lenders promise to transform your fortunes - but is it worth putting your capital at risk for the high returns they claim to offer?
Investing in property through peer-to-peer lenders is increasingly popular as disillusioned savers scrape around for somewhere, anywhere, to put their money to earn a decent rate of interest.
With the Bank of England warning a rate cut is now on the horizon following Britain's decision to leave the European Union, annual returns of between 3 and 12 per cent look even more tempting.
The size of the sector has nearly doubled in the past 12 months, according to figures from the Peer-to-Peer Finance Association. By the end of the first quarter of 2015 100,000 Britons had lent£2.6billion in the form of peer-to-peer loans. By the end of March this year the cash figure had ballooned to £5.1billion.
The returns promised are high but whether you'll see them is another matter
In April this year, such loans became eligible to be put in the new innovative finance Isa, prompting even more interest - though as yet none of the major platforms has received the necessary regulatory permissions to apply for Isa manager status with HM Treasury.
But the loans do now benefit from the personal savings allowance introduced by the Chancellor and which came into effect in April this year.
Through it, the first £1,000 of interest earned for basic-rate taxpayers and the first £500 of interest for higher-rate taxpayers is now free of income tax, although it is not available for additional-rate taxpayers.
But with so many peer-to-peer platforms, models and methods to choose from, how do you know which is the most suited to your hard-won cash?
P2P versus equity crowdfunding
First-off, it's important to note that peer-to-peer lending isn't crowdfunding - there are different risks associated with each.
PEER-TO-PEER PROPERTY LENDERS
Funding Circle: Originally a platform lending to businesses, Funding Circle recently branched out into peer-to-peer lending against assets or property worth up to £1million as well as development funding. Minimum investment is £20 with typical net returns around 7 per cent a year.
Landbay: Invests in buy-to-let only with customers' capital invested across a portfolio of properties. The firm has committed to independent stress tests to Bank of England standard. Includes a reserve fund to protect investors' capital. Minimum investment is £100 with annual returns around 4 per cent.
LendInvest: Invests in buy-to-let, bridging and development loans, always secured against property. Until recently the lender also offered second charge loans as well but has pulled back from this following Brexit. Investors can choose specific properties to lend against. Minimum investment is £100 while investors can expect to earn upwards of 5 per cent a year, with the current average return at 7.2 per cent.
Ratesetter: Lends to a mixture of individuals, businesses and property developers. Investors don't choose what loans to invest in, Ratesetter 'takes care of that for you, matching lenders and borrowers directly' in line with your risk appetite. Includes a reserve fund to protect investors' capital - however it has just issued a warning on reserves available. Rates vary depending on the loan and length of investment with longer term loans reaping higher returns. Minimum investment is £10.
ThinCats: Invests in businesses but secures those loans giving additional protection to investors' capital. Minimum investment is £1,000, with investors able to choose deals and corresponding rates of return - averaging 9 per cent a year over the past five years.
Wellesley & Co: Invests in buy-to-let and bridging loans and is heavily into development finance. Investors' money is pooled across the whole portfolio rather than specific properties. Minimum investment is £10 with returns on a fixed three-year term up to 3.75 per cent.
While those putting money into crowdfunded businesses exchange cash for a stake in the business or some other benefit, those investing in peer-to-peer lending are effectively providing debt to a business or property investor in exchange for them paying interest on the loan.
That means crowdfunders risk losing capital if the business they back goes bust while peer-to-peer investors are pinning their hopes to property investors, developers or business owners being able to afford to repay that loan plus interest.
Equity crowdfunding can have significant upside but with only one in ten start-ups making it to their fifth birthday, the risks could be considered higher than in peer-to-peer lending.
By investing in debt through peer-to-peer, investors earn a fixed return. They know what they can expect to earn and when they can expect to be repaid right from the start.
This is different from an equity investment, where the return is obtained through a share of the net profits (if any), the value of which is only known once the property is sold - as long as everything goes according to plan.
Through P2P, if investors are funding property lending, there is the added security of the property underlying the loan - which means if a developer goes belly up and fails to repay, the peer-to-peer platform can at least recover some of the money lent by selling the property and potentially repay investors' capital.
This is important because investments made into peer-to-peer are not covered by the Financial Services Compensation Scheme so if the platform goes bust or the investment doesn't work, not only do you not get the returns you were expecting, you also risk losing your original investment sum completely.
Why invest in property through P2P?
Investing in property could reasonably be described as a British obsession with property buying, selling, auctioning, developing and decorating programmes filling our television screens.
But with mortgage finance harder to get and the size of deposit required to buy, it's simply not accessible to everyone.
Many people recognise they neither want, nor can they afford, to buy or develop property themselves but they do still want to see the benefit of returns available.
These range from 3 per cent a year up to in excess of 12 per cent - Wellesley & Co will pay a fixed return of 3.75 per cent for three years against a mixture of bridging and development loans, while ThinCats averages 9 per cent a year with many deals returning even more than that.
But as is the case with any form of investing - the higher the return, the higher the risk. And with so many peer-to-peer platforms out there all claiming to lend 'on property' it's not always easy to work out exactly what the risk is.
For example, some platforms only lend buy-to-let mortgages at low loan-to-values over two-year terms; others will lend for much shorter lengths of time through what is known as a 'bridging loan'.
Bridging loans are typically used to fund basic refurbishment and therefore carry more risk, allowing the lender to charge more interest - anything between 10 per cent and 18 per cent a year. This clearly offers investors better returns but the risk is consequently higher.
Even more risky is development finance, which can be used to fund projects that start off as simply a muddy plot of land and planning permission. Development is notorious for going wrong, even where the developer is experienced.
The returns promised are high but whether you'll see them is another matter.
Peer-to-peer: Investment cash is not protected by the Financial Services Compensation Scheme
How will my investment be structured?
How the peer-to-peer platform structures your investment is also critical. While some platforms take retail investors’ cash and allow them to choose a very specific loan secured against a specific property, others allow retail investors to buy the equivalent of a unit in the platform’s portfolio of loans. LendInvest and CrowdProperty both adopt the former method, while Wellesley and LandBay spread investments across a mixed portfolio to generate returns.
Some platforms give you detailed information on the borrower, property and project plans. Others give you the bare minimum.
As well as taking an additional level of fees so the ultimate return for the investor is less, some of the platforms that invest across a portfolio on investors' behalf can also look suspiciously like an unregulated collective investment scheme.
This is a form of investing that ordinary investors are nearly always advised to steer well clear of because they do not fall under the financial regulator's beady eye.
Indeed, following the high-profile collapse of the Connaught Income Fund that left hundreds of investors suffering significant and unrecoverable losses in 2012, the Financial Conduct Authority published rules in 2013 banning the marketing of UCIS to retail investors, restricting their promotion to sophisticated investors only.
To self-certify as a sophisticated investor or high net worth individual, you have to earn at least £100,000 per year or have net assets (excluding your property, pension and so on) of at least £250,000.
Peer-to-peer lenders are less highly regulated than funds, do not have to publish their accounts or credit policies and investors are not protected by the Financial Services Compensation Scheme for anything but advice, meaning investment in the sector should be recognised as medium to high risk.
Despite all of these issues, it is commonly acknowledged that those putting their money into peer-to-peer are usually not 'sophisticated', with many not understanding the risks and platforms are not required to point all of them out.
Check the fine print
Another thing to be really wary of is how platforms calculate the loan-to-value on the underlying investment.
For example, CrowdProperty lists 34 Sidney Street in Nottingham as a development project requiring a £200,000 loan to complete the works. The loan is pitched as a 50 per cent LTV deal, which it sort of is - sort of.
In fact, when you look at it more closely the developer bought the property for £150,000 in cash (apparently), he wants to borrow £200,000 against the property which a surveyor has said is currently worth £150,000.
Technically, that makes this a 133 per cent LTV loan. However, when you get into the detailed explanation from CrowdProperty they've avoided saying this by splitting the £200,000 loan into separate 'tranches'.
The developer will receive £75,000 as an initial payment - which is indeed 50 per cent of the current value of the property.
Once the first stages of work are complete, the remaining £125,000 is paid out in phases during the extension.
CrowdProperty promises: 'The £125,000 will be held by the solicitors and released as and when the independent monitoring surveyor inspects progress and verifies money spent at the point of inspection.'
But the thing is, a half-finished development is not going to sell at the price a fully refurbished property will - in the case of this particular property, that projected future sale value is estimated to be £375,000.
At some point after the first payment is made from the £125,000, the LTV is definitely going to spike way above the 53.3 per cent that CrowdProperty says will be the LTV 'once the conversion works have been completed'.
It sounds complicated but it's a critical point - LTV is the ratio that covers the person making the loan. The lower the LTV, the bigger the cushion of capital there is in the property.
If the development runs over, fails to complete, costs more than originally anticipated, fails to sell at asking price or fails to sell at all within the term of the loan - 12 months in this case - this cushion protects the investor's money to some degree.
If the LTV spikes to say 85 per cent, that cushion suddenly looks a lot less comfortable were the project to go south or property values to fall - something experts have warned could happen following the UK's vote to leave the European Union.
RateSetter has admitted loan defaults were worse than expected, and this could squeeze its provision fund
You could lose the lot
The warnings that blare out from these companies' websites speak for themselves. They range from 'you could receive up to 10 per cent a year' (with 'up to' being the point to note) to 'returns are not guaranteed'.
It's also important to note that your capital is at risk if you lend to businesses that develop property through peer-to-peer platforms.
And although these platforms are now regulated by the City watchdog, the Financial Conduct Authority, investors' cash is still not protected by the Financial Services Compensation Scheme which usually covers losses up to £75,000 per person if the company you invest in should fail. (Though if you receive poor advice regarding P2P investment, the scheme may cover you.)
Some peer-to-peer lending companies run their own compensation schemes that aim to return every penny to investors through a contingency fund borrowers contribute to by way of a credit rate fee, usually charged at between 0.5 per cent and 3 per cent of the loan. Both LandBay and RateSetter offer investors this added (though not guaranteed) protection.
In theory this should protect your capital but not every peer-to-peer platform has to do this. That means, you may lose all of what you lend.
This point has been hammered home very recently with the collapse and subsequent rescue of FundingKnight and the warning last week that RateSetter's Provision Fund could become depleted as a result of worse than expected bad debt levels - both of which could expose investors to potential loss.
It's for exactly the risks outlined above that the financial regulator got rather uncomfortable with the sector a few years ago and has just recently managed to get some of it into its grip.
From April this year, the FCA has started to regulate all advice given to investors on peer-to-peer lending. That means an adviser must be sure they are giving you the best advice for your circumstances - for example, not advising you to put your money into a high-risk but potentially high-return peer-to-peer fund or loan if you're about to retire.
The other thing regulated advice means is that the adviser must have done a reasonable amount of research into the various peer-to-peer platforms and what they offer.
Taking financial advice before you invest in peer-to-peer does afford you some protection - you can submit formal complaints against the adviser if you think that it was bad advice and may be in line for compensation in the future.
If you take no advice and the firm goes bust, taking your life savings with it, you have no recourse to anyone.
If you do decide to take this relatively high-risk property investment option and go for it, it is a good idea to know exactly where your money is going.