Renting out residential property is still good business, with yields of 9-10 per cent a year available, particularly in some of the UK’s property hot spots such as Leeds, Bradford and York.
However, changes to the rules governing buy-to-let – namely the levying of an additional 3 per cent of stamp duty on second homes and the abolition of full tax relief on mortgage interest – have helped spur the growth of alternative residential property investments that do not involve direct ownership of bricks and mortar.
These include peer-to-peer lending arrangements, crowdfunding schemes and property bonds, all of which promise attractive income streams – and some of which can sound too good to be true.
With peer-to-peer lending (P2P), investors are introduced to a business or property developer via a platform and lend cash in return for interest payments on the loan. Cutting out the middleman – in this case traditional lenders such as banks – means that interest rates as high as 12 per cent a year can be offered.
However, P2P is largely unregulated, and while a few platforms are now well-established, including Zopa, RateSetter and Funding Circle, many new entrants have limited track records, which is inevitable given that the market grew by some 40 per cent in 2016 alone.
Retail investors are attracted to the idea of exposure to property and development without having to stump up the cash required to buy actual property. Although investors do not benefit from capital growth, they stand to earn a return that is fixed in advance, and they know that their capital should be repaid on a certain date.
P2P investment periods vary, but they tend to be short: buy-to-let mortgage terms are typically two years, and bridging and development loans have terms of six to 18 months. The latter are used primarily by developers looking to refurbish and ‘flip’ a property, or by business owners who need cash quickly and are therefore prepared to pay interest of up to 14 per cent a year. Lenders are not charged fees, so the interest stated is the amount investors receive.
The risk for investors is that a borrower may not be able to pay the interest or repay the loan. Bad debt for P2P platforms averages at around 2 per cent a year. Loans are secured against properties by the registration of a legal charge, so a modest loan-to-value ratio will reduce risk .
Many platforms operate a maximum loan-to-value limit of around 60 per cent. Loans through Relendex, for example, have an average loan-to-value of around 60 per cent. The firm says that, to date, it has returned an average of 8.78 per cent a year on its bridging and development loans.
The way each platform operates affects the risk level of a loan. Some, such as LendInvest, CrowdProperty and ThinCats, set your investment against a specific property, which you can select and assess yourself; others, such as Ratesetter, Wellesley, Assetz Capital and LandBay, offer units in a portfolio of loans, the latter in buy-to-let properties only.
Investors need to read the fine print on how a platform has calculated the loan-to-value on an underlying investment, as some split their loans into different tranches, which can distort the true overall loan-to-value ratio. There are some practical drawbacks to consider. Investors can sometimes face an initial delay while the loan completes before they start earning interest on their investments.
In addition, at the end of the loan term, they may have to wait for the borrower to repay the loan, although they should continue to earn interest in the meantime. If the borrower defaults, the property will be repossessed, which could take many months, and the sale price could fall short. Critically, although P2P platforms are now regulated by the Financial Conduct Authority, the investments themselves are not covered by the Financial Services Compensation Scheme, so if the provider goes bust or the investment fails, you risk losing your capital.
The collapse and subsequent rescue of FundingKnight demonstrates that this is a real possibility. Some P2P platforms, including Assetz Capital, LandBay and RateSetter, run their own contingency funds to instil investor confidence. These are funded by borrowers, who contribute 0.5-3 per cent of the loan, but nothing is guaranteed.
Demand for P2P property investment has been driven by the launch of the Innovative Finance Isa (IF Isa), which allows loans to be held tax-free.
Most IF Isa wrappers, however, are inflexible, so investors cannot withdraw or move funds across from other Isa accounts in the same tax year. This, the platforms say, allows products to remain charge-free, while it enables investors to sell loans freely on a platform’s secondary market. Only a few P2P Isa platforms, including LandlordInvest and Landbay, offer a flexible IF Isa.
Crowdfunded lending works in a similar way to P2P lending, in that an investor’s capital is secured against a borrower’s property. However, borrowing businesses tend to be start-ups or early stage enterprises with businesses plans put together by entrepreneurs themselves, so the timing of capital repayments is uncertain.
Additional fees are sometimes levied with crowdfunding products. For example, Crowd2Fund offers a product secured against commercial premises or residential property belonging to directors willing to offer their homes as security, but the platform creams off a 1 per cent annual fee on both interest and loan repayments to investors when they are repaid.
The platform estimates that investments – which start at just £100 – will provide an APR of 6-8 per cent before fees and bad debts are factored in. Crowd2Fund’s first property-related loan is a £300,000 advance for a Savile Row tailor looking to expand internationally.
Another route into property investment is a property bond, which may be offered by any property developer looking to raise cash for a development project – typically a complex such as an apartment block or holiday flat development, and normally for a period of five years.
Some of these have been marketed by IFAs, who should then be on the hook if a scheme fails or it transpires that an investment was not appropriate for an investor’s level of acceptable risk, or if a fraud occurs and it turns out that the IFA had not carried out due diligence.
Some, but not all, property bonds are unauthorised collective investment schemes and embody their worst features, such as hard selling. Such products should only be sold to so-called sophisticated investors, defined as those who earn at least £100,000 a year or have net assets of £250,000, but in practice this requirement is often fudged.
Many people are lured into these investments because they believe they have a good understanding of property, simply because they have experience of buying a home and they talk about property with friends and colleagues, and also because the returns promised – typically of around 7 per cent – are much more attractive than anything that can be earned on deposit at a bank or building society.
However, property development is notorious for running into delays and incurring additional costs. London Property Holdings, for example, recently rescheduled its debt because its housing developments in Wales are three years behind schedule.
A different but similar-sounding firm, London Property Bonds, has teamed up with estate agent Robert Holmes & Co to offer investors returns of 8 per cent a year for lending cash to developers looking to refurbish properties in Wimbledon, London. The idea is to take on properties that will command a significantly higher price after relatively modest improvement. The bond also offers a share of any uplift in the value of properties when they are sold.
Deals are often compelling, but don’t invest too much in one region or sector. Bonds are available based on a diversified pool of loans, for example Minerva Lending’s five-year bond, which offers 7 per cent a year.
Don’t ignore traditional commercial property funds, which quietly re-opened last October after closing in the initial Brexit shock and have returned to their former levels without so much as missing a dividend payment.
A few funds include residential exposure. Premier Pan European Property, for example, has about 20 per cent invested in German residential property, which enjoys a healthy supply/demand dynamic.
Consider also quoted real estate investment trusts (Reits) such as Secure Income Reit and the new LXi Reit, which buy properties with ultralong leases such as hotels, theme parks and retail sites.These offer bond-like returns and dividends of around 5 per cent a year.
The first government-backed fund of build-torent homes, PRS Reit, started trading in June. Run by an arm of Sigma Capital, an Aim-listed developer, it will invest in new residential homes in large towns and cities. It has partnered with developers Countryside and Keepmoat. Specialist trusts investing in student accommodation, such as GCP Student Living, are also well placed to benefit from supply and demand imbalances.
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