Many British P2P loans are secured by UK real estate. How should investors create a defensive portfolio?
The UK will soon leave the EU. Over the coming months there will be endless discussion surrounding the terms on which this will happen. Negotiations do not currently appear to be going well. While a negotiated outcome is still likely, a ‘hard Brexit’ is still a possibility.
Many P2P investors hold loans secured by UK real estate. How much risk does Brexit really represent? And what’s really happening right now in the UK property market? We turned to 4 property experts who are active in this field to give us their views, and some tips on how to avoid mistakes.
How would you describe current trends in real estate demand and selling prices?
Yann: We see a two-speed UK property market. The London and South East market are weak and we believe will remain soft for the next few years. The North of the UK (including Northern Ireland and Scotland) are seeing strong demand and lack of supply, especially for mid-priced housing units. In places such as Northern Ireland, properties are being sold off-plan and at a price above expectations.
Narinder: Properties with a value under £500k are still moving – over that, there are limited buyers, many of whom are waiting for Brexit updates before making any further moves. The new BTL tax rules have caused a lot of smaller landlords to leave the market, and as such the bigger players are dominating.
Rohin: The notable trend we are seeing is the very substantial foreign capital flows keeping the bid remarkably firm for institutional grade UK property assets.
James: There are several factors currently affecting house prices. The overall size of the housing stock is still expanding very modestly compared to demand (a 100,000 shortage per year). This supply shortage continues to support prices. However, there is a lot of uncertainty due to Brexit, which means that rates are likely to remain low. Government policies are also having an effect, making it harder for people to obtain mortgages and reducing the attractiveness of buy-to-let investments.
Everyone is talking about Brexit. How much of an impact would a ‘hard Brexit’ have on real estate prices?
Rohin: It’s impossible to say, but price volatility would certainly not be surprising following a ‘hard Brexit.’
James: The last period of extreme property market stress was during the global financial crisis. Over this period the market showed a huge amount of divergence across regions and the headline housing market dropped a little below 19%. With the strong, long term, underlying supply and demand dynamics together with a buoyant rental market we feel that it is unlikely that prices would fall any further than that. We also believe that the impact on property prices would vary hugely at the regional level. In order to assess this we carried out some research to investigate the divergence between the pricing of flats versus houses. It indicates that there was more likely to be a pullback in the higher value properties. The main areas at risk were in the London commuter belt in areas such as Stevenage, Watford and Luton.
Yann: While we believe the chances of a ‘hard Brexit’ still remain low, should such a scenario materialise we certainly think that London and the South East would be more affected due to 1) the weight of the financial industry in the capital, 2) the expats living in the capital and 3) stamp duty affecting higher-value properties. We do know that firms within the financial sector are relocating their workers to continental Europe; these are workers who have lived in London for several years and may own property that will likely sell off at some point. So all in all, we see the London market remaining weak for the next few years. We focus on regions with low supply, so even in the event of a hard Brexit deal, the supply-demand fundamentals are there.
Narinder: When we voted to leave, everyone was up in arms and predicted a decline in the property market – yes there has been a correction in the prime London space but other areas such as Manchester, Birmingham and Bristol have seen an uplift. I still believe properties under the value of 500k will move as there is a shortage of these but the bigger value properties are likely to suffer.
Which geographic locations have the best prospects over the next few years?
Narinder: I think Brighton, Birmingham, Manchester, Leeds, Sheffield and Liverpool have the best prospects.
Yann: We are more active in the north of the UK. There is an acute shortage of housing, especially mid-priced houses, across the north of the UK and we believe these regions will outperform Greater London and the South East over the next few years.
James: While parts of central London have seen property prices fall over the past year, other areas — particularly those around regional city centres — have seen relative strength in their property prices over the same period. Strong investment opportunities remain available. Investors should consider other factors such as large, impending infrastructure projects. Take HS2, the planned high-speed railway link from London to Birmingham, the East Midlands, Leeds and Manchester. These factors can help regional markets to buck the national trend. Regions facing the least pressure from a ‘hard Brexit’ scenario would be regional hub cities such as Doncaster.
What types of loans are you currently declining, and why?
Yann: There’s several types, such as lack of experience of the developer, location, level of leverage required, lack of planning, unsound/risky exit strategy and lack of liquidity of the underlying asset.
Narinder: Our three most common reasons are that the LTV is too high, there is no clear exit in place or that the borrower has heavy adverse credit.
What’s your view on commercial real estate? What should investors steer away from?
Rohin: Online shopping is having a destructive impact on ‘High Street’ retail. Investors should consider the longer term secondary effects of this dynamic.
Narinder: There are good commercial investment opportunities in the market place where the right due diligence is done. Properties to avoid include short leases, low quality covenant, and inexperienced individuals.
Yann: We tend to focus more on residential assets because they are more liquid.
James: Commercial real estate is a very specialised marketplace. The pricing of property is driven by many factors that extend far beyond any comparison to the valuation of residential housing. Most people are able to relate to understanding, assessing, comparing and the concepts around the valuation of the ‘bricks and mortar’ that we need to live in. Making the step into commercial real estate it something that is not easy.
Some British secured P2P platforms have seen rising defaults recently. How can investors know whether a platform is doing sufficient diligence and the collateral values are realistic?
Yann: We think lenders must do their research before deciding which P2P platform to use. P2P is not a product in itself, it is rather a tool that gives lenders access to deals. So, lenders must ensure they do their due diligence on the platform they are going to use. At Blend Network, we perform a full manual due diligence process by meeting with the borrower and visiting the site. We release a full information pack on each deal that contains detailed information such as RICS valuation, project details, team experience, exist strategy and local area information.
Rohin: This is a very interesting subject and not a happy one. The short answer is to look at the business model of the P2P lender. Where the P2P lender has none of their own capital exposed to a default, and where they are competing for deal flow with established bank and non-bank lenders, there is a very clear adverse selection risk. That is, there is a tendency for loans that more disciplined and experienced lenders turn away on the first look to end up with P2P lenders, and hence the larger-than-expected number of defaults. This, combined with low levels of disclosure on some platforms and the low barriers to entry under the P2P regime – which has resulted in a proliferation of platforms all competing for dealflow – has led to this rather worrying state of affairs.
Narinder: It comes down to the quality of underwriting and credit risk analysis – there is shortage of skilled people in the industry and this is evident through the defaults. Some situations you cannot prevent as there could be mitigating circumstances, however the lenders need to assess each case thoroughly before investors’ money is put at risk. P2P platforms should be more transparent (like us) so that investors can make an informed decision before deploying funds.
James: The key area that we believe investors need to understand over coming years is the true risk of the underlying investments that they are taking on. For this reason we recommend a full understanding of the two key metrics that need to be assessed with regards to loans. The key questions to ask are – What is the probability of the borrower defaulting? If the borrower defaults how safe is my loan principal? Is the borrower incentivised to default under any circumstances such as falling asset values or a tough market backdrop? How much will I recover if there is a default, and when? Investors should differentiate between intermediary platforms that link them directly with a third party borrower and essentially take a commission, versus investment platforms that act as an investment manager. The latter will have additional FCA authorisation and, in adhering to their high standards by way of comprehensive due diligence and sophisticated valuations, this makes for a longer term alignment with the interest of the investor. Those platforms with an experienced investment team following a strict investment policy are more likely to provide longer term performance.