By Frazer Fearnhead on Wednesday 9 May 2018
Frazer Fearnhead, CEO and co-founder of peer to peer lending property platform of The House Crowd, weighs in on whether P2P firms should fear a rise in interest rates.
It’s often assumed that the fortunes of the P2P lending industry are directly tied to the rate of interest levied by central banks. There’s certainly some logic to this idea. After all, P2P lenders are usually positioned as an alternative to conventional retail banks – and when interest rates rise, so does the utility of your run-of-the-mill cash savings account.
It’s therefore no surprise that speculation around a possible interest rate rise in the near future (and potentially further rises over the next few years) has caused some concern amongst P2P lenders. As Blend Network’s Yann Marciano says: “If you can get two per cent from a cash savings account, then why take the extra risk for only a little bit more?”
If you run a P2P lending firm that offers returns in the low single digits, you’ll certainly be feeling the heat. Truth be told, we may not see the predicted interest rate rise materialise at all. But if it does, it doesn’t necessarily spell doom for P2P firms.
The level of anxiety caused by the recent rate rise is partially due to the fact that we’ve been in a low-interest environment for some time: November 2017 saw the first increase in ten years. The P2P industry, being quite young, has never really known anything else – and it’s natural to react to uncertainty with fear.
It’s also true enough that interest rate rises do make conventional banks more competitive in the eyes of investors: lower risk and higher returns make for a potent combination. But here’s the thing: the returns for a conventional savings account won’t be that much higher. A 0.25 per cent rate rise – like the one in November – may damage P2P lenders on the lower end of the scale. Those with a better calibrated risk/reward proposition will likely be fine.
In industries such as property investment, for example, financial institutions may be at a clear disadvantage. Buy-to-let investment has slumped 80 per cent over the last three years due to tax and regulatory changes: a 3 per cent stamp duty surcharge, the gradual removal of mortgage interest relief, and harsher mortgage rules have seen net investment fall from £25 billion to £5 billion.
An interest rate hike will only serve to further deter would-be buy-to-let investors, who will find it harder to repay more expensive mortgages. These investors are attracted to the property market because it promises a stable, reliable income. The risk-to-reward ratio of purchasing a house with escalating expenses (including letting agent fees and regular repairs) and no assurance of tenants to rent it out is simply too great to consider.
But if the number of landlords is declining, interest in the property market isn’t. The desire to invest in something as tangible and long-lasting as real estate endures – and P2P lending can provide a way of indulging this desire without running afoul of rate rises.
The ailing buy-to-let market has paved the way for alternative routes to property investment, and secured, short-term P2P loans have become especially popular.
It’s not hard to see why. Alternative finance doesn’t necessarily live or die according to what the banks are offering: its appeal lies in the method. If it was about providing incremental improvement on cash savings accounts, it probably wouldn’t have become a thriving industry in the first place. Lenders in this space are playing a different game entirely. This is particularly true of P2P property lending: it offers many of the advantages of conventional buy-to-let investment, but with a shorter commitment and (typically) higher returns.
Because loan periods can last between 6-12 months, nobody’s money is tied up for long – and because loans are secured against the underlying value of a tangible asset (the property), it’s easy to assure investors that they’ll get their capital back. After all, with a loan to value ratio of around 70-75 per cent, the market would have to fall by 25-30 per cent for anyone to lose out. Given that the market didn’t crash that badly during the 2008 financial crisis, investors have every reason to be confident when it comes to P2P lending. At The House Crowd, for example, we paid out 9.2 per cent p.a. on average between 2015 and 2018 – significantly higher than you’d get with a cash savings account.
That said, returns are variable, markets are unpredictable, and it would be foolish to overcommit to any one investment method – however effective it may appear to be. But P2P lending isn’t the only alternative way to invest: within property alone, an investor can choose from equity investment, development loans, peer to peer short term secured lending and tax-free wrappers like the IFISA.
Exploring a range of options is ultimately in the best interests of any investor. An interest rate rise might make a cash savings account appealing to conventional and cautious investors, but it won’t do anything to convince disillusioned ex and would-be landlords that the buy-to-let market remains an attractive proposition – especially when greater returns can be found elsewhere.
The people who are interested in P2P lending want the profit associated with attractive asset classes, but they don’t want the hassle. They want to invest in businesses, but they don’t want to wait years to see if the founder’s vision is realised. They want to invest in property, but they don’t want to find tenants, pay an estate agent, or lose their profits to ground rent, stamp duty, or the myriad charges and fees associated with owning a property and having a mortgage. They want an alternative, and they won’t get it from banks – however much interest rates rise.