The Investment Opportunity in Peer-to-Peer Mortgages

Alternative finance is fast growing up and becoming a mainstream option for adventurous investors, with more and more the platforms looking to raise money for their own rapid expansion plans helped along by a wall of institutional money flooding into the space. In the last few weeks for instance we’ve seen small mortgage lender Landbay announce a gigantic £250m infusion of institutional cash for its buy to let lending platform while crowdfunding equity platform Syndicate Room is this week kicking off its own £1.2m fund raise which should help it compete with more established rivals Crowdcube and Seedrs.

a group of houses

The Landbay deal is I think potentially the most ground breaking bit of news, helping to push buy to let mortgage lending into the mainstream of p2p lending – and offering an asset backed source of steady income for rates starved investors. In simple terms Landbay is a bit like specialist buy to let lenders such as Paragon, except that you the retail investor provide the capital via its lending platform. It offers its investors on its marketplace the chance to invest in either tracker rate mortgages or 5 year mortgages through lots of bite sized small loans to a diverse bunch of underlying properties (although given how young the platform is, investors can actually only lend out at the moment for three years).

For that 3 year term the investor gets 4.4% pa while the tracker rate pays out 3% pa over the base rate, which currently amounts to 3.5% pa. Both products involve lending to buy to let landlords where the average loan to value ratio is running at around 66% - the minimum loan is for £50,000, while the maximum is £500k. To date £5.5m has been lent out across 33 different properties, with 70% in the greater southeast/London region.

Crucially the buy to let landlord who’s lent money by Landbay gets a quick decision on the mortgage, plus a bullet style repayment system where they only pay back the money at the end of the product term. Landbay charges the landlord between 2 and 2.25% in fees for the mortgage plus a margin of around 0.90 to 1% pa.

By my calculations Landbay is very much not the cheapest on the market. Five year fixed rate Buy to let (BTL) mortgages can be picked up for between 3.5 to 4% pa (plus fees that are usually somewhere around 2%) from a wide panel of mainstream bank lenders. Across the entire BTL market spectrum, variable rates seem to be running at an average of 3.86% according to Moneyfacts research.

By comparison if one looks at the current LandBay loan book the largest single mortgage is for a 4 bed semidetached somewhere in SW19 – this is £384,000 loan, backed up by monthly payments of £2,000 (£24,000 pa) with a loan to value ratio of 61% and a borrower rate of 4.5%. Obviously the very cheapest mortgages are usually only for the most secure customers – ticking every one of the bank’s underwriting criteria – but I guess there’s still a vast market out there, especially working through specialist brokers such as Mortgage for Business or The Buy to Let Business (both intermediaries for Landbay). For the first quarter of 2015 for instance total lending to this sector stood at £36.2 billion, a year on year increase of 5.4%.

The announcement of the £250m deal, which is due to come on line in July, is a real attention grabber. It matters because it tells us that big institutional money is coming into the space which will make Landbay a bigger, more liquid, beast in its fight against competitors such as LendInvest (which has traditionally focused more on bridge lending to buy to let landlords) and Proplend (specialising in commercial mortgages).

From what we know an “unnamed” bank has agreed to serve up £250m per annum to Landbay via a funding line which will be provided as a “structured warehouse facility split into subordinated junior (15%) and senior (85%) debt. A European asset management firm is providing the junior debt (mezzanine) in support of the facility, with senior debt provided by a major UK bank. “ As I understand it the £250m won’t come in straight away, instead there’ll be a gradual build up with say just £5m deployed in September and them more every month following. 

Landbay also announced that it “aims to complete the world’s first P2P Residential Mortgage Securitization in 2016”, although it’s also fair to say that 12 months is a long time in the world of high finance. But if Landbay does manage to get its mortgage book securitised into one market based instrument, growth could explode.

That extra liquidity and institutional backing will I suspect make investors take note – with 3 year government securities yielding around 1%, Landbay’s yield looks interesting. By comparison Zopa will offer you 4% per annum and Ratesetter 5.1%, but be aware that both of these platforms lend unsecured loans against consumers. With LandBay by comparison you’re loans are secured against hard, real assets with plenty of equity in the game. Landbay also mimics its mainstream P2P consumer rivals by having a protection fund which is currently running at 1% of the total loan book value. It reckons that the average UK buy to let repossession rate is running at under 0.10% though investors should probably play closer attention to rent arrears rates which are currently running at around 1% for 3 months –this measure of 3 months’ rent arrears hit a peak of 3% back in 2008/9.

The two big questions for me are not whether the Landbay yield stands up to the competition (they look attractive though not over generous especially when compared to LendInvest’s average yield of 6.5% pa admittedly from a different lending proposition) or whether its protection fund is big enough (probably). For me the real challenges relate to Landbay’s ability to scale up and find enough credit worthy borrowers which in turn depends mightily on the health of the buy to let market.

At this point I suppose I may as well put my cards on the table as regards the latter concern – I can’t help but think that the buy to let mortgage is looking expensive, and potentially unrewarding in terms of capital gain. I also think that whatever government comes into power is going to take aim at the buy to let market over the long term in terms of tax treatment. Paradoxically I also think that prices might continue to rise as will rents (unless Labour puts a stop to it via rent control legislation) in the short to medium term. Pension’s liberation has released a wall of money that will inevitably flow into the sector, underpinning prices even as interest rates start to slowly increase. But a day of reckoning is fast approaching and I can’t help but think that there is a massive wall of institutional money ready, willing and able to fund a massive increase in brand new, corporate private rented accommodation for relatively low yields of less than 5%. That will help push down rents overall, and I think that many buy to let landlords will struggle cope as this urge of new property units hits the market in the next decade.  Set against this caution though is a stark reality – regardless of investment source, we need more houses. UK government numbers show that in the 25 years between 2012 and 2037 the UK is expected to see an increase of just under 10 million in its resident population, or 400,000 per annum. Those massive numbers are I suppose more than enough to allow for sustained buy to let expansion, higher rents AND an influx of big corporate private landlords! 

Regardless of my own gloom about the buy to let sector, Landbay could be set for rapid growth – helped along by its own fund raise on the Seedrs platform earlier last year. Platform fund raises like this have started to attract a lot of attention as they in effect allow you the private investor to bet on the rise of alternative finance via an investment in the actual platforms doing the fund raising. This strikes me as an interesting capital growth, equity based story although you are of course investing in early stage, unlisted private businesses, with all the very obvious risks.

The latest platform to hit the market (Assetz has only recently finished its own fund raise) is crowdfunding equity outfit Syndicate Room which is looking to raise £1.2m based on a valuation of £7.2m.

A bit of background first. In the crowd equity space the top three platforms are Crowdcube (which itself raised £1.5m from private investors for a 21% stake in 2013), Seedrs and Syndicate Room. Each has their own USP or raison de’tre.

Crowdcube is still by far the biggest platform and generates the most publicity but Seedrs has pioneered its own distinctive approach based around a fund structure where the platform carefully picks the projects it wants to back. Syndicate Room has copied the approach of a fantastic US/Israeli platform called OurCrowd which focuses on bigger, more mature businesses looking to raise larger sums of money from the crowd. Crucially that bigger ask in terms of up front capital raised compared to say Crowdcube is to some degree mitigated by a due diligence structure where experienced angel investors or venture capitalists champion businesses they’ve already put money into. The crowd benefits from the same terms as these experienced investors and in effect piggy backs off the due diligence process.

Syndicate Room has notched up a few big publicity wins in recent months including involvement in the first crowd/stock exchange funded residential real estate investment trust, backing a new Hollywood film by director Simon West and helping AIM listed Sandal offer a crowd backed ISA. Rather like its bigger competitor Crowdcube,Syndicate Room tends to focus on tech businesses, be they in healthcare, engineering or software. So far it’s backed 33 businesses with £22m of investor’s cash, with the average funding round size around £650,000.

If we look solely at the existing trading numbers, the £1.2m investment and the £7m price tag looks ambitious. To date the business has had revenue of £296,000, and lost £442,000, with next year losses expected to hit £1m as the platform ramps up for growth. To be fair though Syndicate Room it says it has “broken-even in several of the recent months, but the company is not yet profit-making on a regular basis” although by the year after next, profits should hit £334,000, then rising to £3m three years out.

Crowdfunding equity always has to be one part hard numbers, one part ambition/hope, even when you are backing the platforms themselves! If as an investor you adopted conventional equity based investment criteria, being honest, virtually no crowdfunding equity project would probably ever see the light of day! Crowdfunding is all about spotting early stage potential and buying into the potential for growth. On that score Syndicate Room’s fund raise seems to be set at a sensible valuation – virtually the same as Crowdcube’s 2013 raise – and the platform has guaranteed that all investors will receive shares carrying equal rights to vote. My guess is that the fundraise will attract a lot of enthusiasm, with all the shares being snapped up quickly. If you think it’s one for you, move fast!

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