By Simon Sinclair on Wednesday 19 December 2018
CapitalStackers' Simon Sinclair examines attitudes to risk within property-focused peer-to-peer lending.
The fallout from Lendy’s reported woes has launched a flotilla of lazy journalism, poorly-informed opinion pieces and Chicken Licken style warnings to investors.
Meanwhile, experienced investors in property finance are merely rolling up their sleeves and getting on with business as usual. Risk is part of life. Understanding which risks, how much of each to take and the price you exact for it is how an investor makes money.
This much would seem obvious, but not, it seems, to the jittery herd of financial journalists commenting on this particular situation. The spectrum of real estate lending is broad and varied.
At one end of the scale we find investment loans, which tend to have very strong covenants on long leases and a robust income stream that services the debt.
At the other end - bridging loans, which are short term, with repayment coming through either a sale or refinancing following an event such as the granting of planning permission.
Generally regarded as the Bellwether of property lending, bridging lenders are usually the first into the market cycle and often the first to drop out. Lending tends to be at credit card rates, since until permission is granted, there are too many unknowns (including the financial cost of any Community Infrastructure Levy or S106 Agreement - the charge that local authorities make on new developments to help fund infrastructure, schools or transport improvements - vital to support new homes and businesses in the area).
In between is a vast and multifarious landscape, taking in low-risk borrowers with low risk deals to high risk borrowers with high risk deals. It also - crucially - includes well-run platforms operating in the higher risk space that give plenty of information, have high levels of due diligence and price the risk fairly so that investors can make informed decisions.
Somewhere in this Big Country is Lendy, ploughing along in its covered wagon, braving the arrows and potholes as it goes.
Now, I don’t intend to comment specifically on Lendy’s business, save to furnish enough background to give us some perspective on the case.
Lendy recently appealed to the regulator after one of its borrowers threatened to sue. They claimed Lendy failed to give notice on loans and arrange further funds. Concerns were also raised over the fact that £112m of its £180m loan book were at least one day late.
Now, to the uninitiated, this will set all sorts of hares running. But those who regularly walk the streets of the bridging world will know that what looks like a situation going wrong is probably expected and planned for. It’s a way of increasing returns - on what, in the US, is often described as “hard money”.
With building development, just because a project is taking longer than expected, it doesn’t necessarily mean the deal is deteriorating. Lots of factors determine the progress of construction - some beyond anyone’s control, like weather.
But financiers know this, and also that when deals go beyond the due date, the interest continues to accrue. Sensible lenders will build delays, cost increases and falling values into their sensitivity analysis but still impose a fairly tight schedule on the borrower.
Whether the 12% return Lendy investors get is enough to cover their risk is a matter for them. The reality of the market suggests that if investors are getting 12%, then the borrower is paying somewhat more - and you should ask yourself what kind of borrower is happy to pay this much for their senior debt (banks don’t generally charge more than 7%).
But I will say that this is an area where the astute investor should take very great care to ensure his own risk is adequately compensated for - and to be clear, the key risk is this:
Any investor taking part in a deal that is not fully funded at the outset is entirely dependent on new investors coming on board to pay the contractor, without which the project will fail to complete.
Certainty of completion should be a fundamental prerequisite of any property deal.
It doesn’t make sense for private investors to take the liquidity risk when a big, strong bank can take it for them.
If a bank guarantees the funds up front to ensure the job can be completed, all the other investors can get involved with confidence that the deal will come to fruition. This certainty should ideally be locked in before an investor parts with a single penny.
Furthermore, financial analysis should be run on the assumption that everything is built out before anticipating any sales revenue after a conservative sales period - so that you get to the end game without having to rely on new funding coming in. If you’re investing in deals that don’t do this, you’d be right to question whether the risk assessors have a sufficiently conservative view of the world.
If you’re being asked to fund a deal that is not “Oven-Ready”, the outcome is too opaque. And unless the risks are made extremely clear, and/or the Loan-to-Value ratios are very low, these deals warrant a wide berth.
These should be fundamentals that spring to the mind of any investor. Not to mention the requirement for regular information and updates from the borrowers and monitoring surveyors. So that, at all times, the ordinary people who are funding projects are fully aware of what risk they’re taking, whether that risk is changing, and what they will earn for taking that risk.
That way, they’re informed enough to take whatever decision they want to take. Without such key information, the investors are fighting blindfold, which we don’t need the FCA to tell us is totally unfair.
Of course, there will always be bad deals and bad operators, despite the best efforts of the FCA - it's a fact of life. But among the rest, it’s a question of assessing the risk, and deciding how much money would make us comfortable enough to take that risk.
In other words, there’s no such thing as a bad risk – just the ones you’re happy to take, and the ones you’re not.