Peer to peer lending guide
By Roxana Mohammadian-Molina -
Having emerged just over 10 years ago in the aftermath of the global financial crisis, alternative finance has come a long way and is playing an increasingly central role in the mainstream financial ecosystem.
Terms such as peer-to-peer (P2P) lending are now a regular part of many investors’ everyday vocabulary, yet some confusion still exists around some of the technicalities.
So, for all of those investors who are interested in learning more about how they can do well while doing good with P2P lending, here we aim to de-mystify the concept and bust some of the jargon to help ensure investors up to speed and ready to go for it when a deal next catches their eye.
When and why did P2P property lending emerge?
Over the decade, traditional lenders have tightened up lending across many sectors, including development finance.
According to a report by the Home Builders Federation (1) ‘availability and terms of financing for residential development has become extremely difficult for small housebuilding companies over the past decade or so. Lenders have drastically changed their attitudes to the sector since the Global Financial Crisis’.
Meanwhile, the UK suffers from the most serious housing crisis in decades due to a shortage of supply.
The UK’s housing shortage has been described by successive governments as the nation’s most urgent and complex challenge and solving it as “the biggest domestic policy challenge of our generation” (2).
At the same time, over the past decade interest rates on bank deposits have been very low and savers have been getting penalized for holding cash at the bank in a near-zero interest rate environment.
Consequently, investors have been hunting for yield, somewhere to put their hard-earned money so that they can earn a decent return.
P2P property lending offers investors the possibility to invest in property-secured loans that offer a higher return compared to holding cash at the bank.
However, unlike cash at the bank, P2P lending is not protected by the Financial Services Compensation Scheme (FSCS) and does involve risk to invested capital.
In a nutshell, P2P property lending brings together lenders who want to invest their money with borrowers who need money to build homes.
What is P2P property lending?
In the context described above, P2P property lending has emerged as a way of connecting private investors with experienced property developers.
P2P property lending platforms operate as property lending clubs where private individuals can connect with, and lend money to, experienced property developers.
Different platforms will fund different types of projects, so prospective lenders need to assess the types of loans offered by different platforms.
Generally, P2P property lending platforms do not simply connect lenders and borrowers.
What they are essentially doing is managing the lenders’ investment from start to finish by underwriting and credit-checking borrowers, transferring funds on lenders’ behalf to the borrower and then collecting any repayments when they are due.
P2P property lending platforms must carry out an exhaustive due diligence process on prospective loans.
It is important for prospective lenders to understand the various steps of the due diligence process.
Let me talk you though the due diligence process.
How does the platform do its due diligence on which loans to list?
Generally, there are 5 key steps to the due diligence. Different P2P property lending platforms will have different processes, but what is discussed below is the process at Blend Network:
- Meeting the borrower and visiting the site: We like to say that eyes tell more than balance sheets.
By meeting the borrower and discussing the project, we are able to get a good understanding of whether the borrower can deliver the project he/she is promising.
It is important to look at the borrower’s experience and track record, his/her team’s experience as well as similar projects he/she has done in the past.
- Analyzing the project: Part of the due diligence process is to understand whether the project makes sense.
This should include things such as analyzing the local property market, supply and demand, rental market, local schools, hospital and amenities, the borrower’s financials including his/her assets, liabilities and credit history.
This will enable us to get a detailed picture and assess the project viability.
- Analyzing the exit strategy: Lenders obviously want to get repaid when the loan expires.
So, it is vital that a key part of the due diligence is to understand how the borrower plans to repay lenders, or in other words what is his/her exit strategy from the project in order to repay the loan.
This could be selling the property/properties or re-financing with another lender.
If the exit is to sell, research on the local property market needs to be carried out so that we are comfortable with the borrower’s ability to sell within the timeframe and the price he/she is planning.
If the exit is to refinance and hold the properties as buy-to-let, research on the local rental market needs to be carried out to ensure we are lending less than what the borrower can refinance at.
A clear exit strategy always needs to be in place.
- Ongoing monitoring: It is paramount that ongoing monitoring of the loan is carried out.
This is in order to ensure that the project is progressing as expected, and if there are any issues, these issues are spotted in time to try address them as fast as possible.
- Releasing funds in tranches: If all funds are released upfront and the borrower told ‘good luck, see you in 15 months’, there are a number of risks: risk that the borrower will use the funds to finance another project he/she is in trouble with or risk he/she wastes the money and doesn’t build as promised.
Overall, there is less control over the use of the lent funds.
That’s why it is key that funds are released in tranches and a survey is done after each phase before releasing the next tranche.
Different platforms differ in their due diligence approach. So, it is key that prospective lenders do their own research on which platform to use and assess each loan before deciding to lend.
How do I do my due diligence on which platform to use?
Track record, transparency and reputation are key points to look at. Most P2P lending platforms will provide their track record.
If they don’t, lenders should ask for that information.
Transparency is another key point to look for. Different platforms will disclose different amounts of information on each loan.
For example, at one lending platform every loan comes with a full Information Pack (IP).
This IP includes information such as the team behind the project, their experience and previous projects they have done, what they are intending to do with this development, local area including school and hospitals, exit strategy, a RICS valuation report, planning and build appraisals.
This information enables prospective lenders to have the material they need to make an informed decision.
Reputation is another key aspect when considering which platform to lend with.
Having good reviews, repeat lenders and borrowers, having won industry awards and recognition are all indicators of a good reputation.
What is the security behind my money?
Different platforms will have different security held against the loans on offer.
Some platforms will take a first charge on the property. Some others will take second charges.
Having a first charge means that in the event the borrower can’t repay the loan, the platform will step in and exercise its first charge over the asset to try and recover investors’ money.
Having a second charge means there will be another lender first.
Is P2P property lending regulated?
Yes. The P2P property lending sector is regulated by the Financial Conduct Authority (FCA) to help ensure that both lenders’ and borrowers’ interests are protected.
That said, when lending on P2P property loans, like with any other investment, your capital is at risk.
Roxana Mohammadian-Molina is chief strategy officer at Blend Network, which provides development finance and bridging loans to experienced small and medium (SME) property developers across the UK regions.
 Reversing the decline of small housebuilders: Reinvigorating entrepreneurialism and building more homes’ by the Home Builders Federation.
 Source: https://www.theparliamentaryreview.co.uk/news/may-solving-housing-crisis-is-the-biggest-domestic-policy-challenge