The ability to analyse real estate collateral and avoid higher risk assets is a valuable skill for P2P investors. Many peer to peer loans are secured by real estate collateral. The amount that lenders advance against a property value can vary, but it tends to go up to a maximum of 70% (a 70% ‘LTV’). In theory, this means that investors should not lose money if the loan defaults, as the collateral will be worth more than the outstanding loan balance. The reality can often be different though. Why? The selling price of properties can frequently be significantly lower than the valuation report. Some properties can take much longer to sell than expected. Relying on a stated LTV is a quick way to create problems for the future. No investor can predict these outcomes correctly every time, but in our experience there are some shortcuts to identifying the collaterals that are going to create problems if a loan defaults
#1 - Pay very close attention to the type of property and prioritise the lower risk ones
We think it is very important to focus on the type of property a loan is secured against when assessing the risk of a loan. In our experience the riskiness of the different classes of property ranks as follows (least to most):
Lowest risk – Residential property in towns and cities.
Medium risk – Commercial (retail and offices) located in towns and cities with tenants in place. Residential property located in rural and remote locations
Highest risk – Industrial properties, land, farms. Commercial properties with no tenants
#2 Avoid real estate with very high or low values
Many investors are indifferent to the amount of a real estate valuation, as long as the LTV seems to be appropriate. We think that is a mistake. Properties with very high valuations can have a very thin market if the property needs to be sold. There can often be very few buyers looking for assets in that price range, and obtaining finance can be much more difficult to achieve for the buyer. There tends to also be a lot less certainty over the valuation as there have been fewer comparable transactions.
Very low valuations is less of an issue but they can also create issues. A low valuation may indicate that there is almost zero demand for property in that area. It can also indicate that a property requires a lot of capital expenditure or has other issues.
For loans secured by residential property a valuation range of between £200,000 – £1,500,000 in the South East of the UK, and £100,000 – £800,000 elsewhere is ideal.
#3 Learn to spot valuation report 'red flags'
If you spot any of the following in a valuation report, it could be a signal that the collateral could be difficult to sell at the stated valuation:
- Valuer cannot identify any recent sales of similar properties nearby
- Property has some planning and consent issues
- There are a large number of properties listed as being on the market nearby that are similar
- Property requires capital expenditure that has not been properly costed or specified
- The valuation is uncertain as the asset has a unique use (such as a factory)
- The nearest properties recently sold, or that are currently on the market, are located a long distance away
#4 Monitor the 'defaulted loans' lists of P2P platforms
One way to get a feeling for assets that are not performing well is to review the lists of secured loans that have gone into default. Lenders will usually provide updates on the status of selling a property and the challenges they have been facing. Some asset types that tend to appear regularly include nursing homes, farms, guest houses / guest house conversions, and industrial properties.
#5 Many valuation reports are very poor - it is worth checking the information provided
We think that the general standard of valuation reports produced in the UK is generally fairly poor when it comes to calculating an accurate valuation. In our experience, valuers are very poor at capturing the following when they perform valuations:
- Differences in property sizes between the house being valued and other properties. Many valuers use properties with a similar description, such as ‘3 bedroom house’, rather than valuing on the basis of £ per square metre which is more accurate. This can lead to overvaluation of smaller properties.
- Recent market price trends and changes in liquidity / time to sell are often ignored, and rarely captured in the valuation amount. This is a problem when market values start to soften.
- Differences in quality (location, condition etc) between the property and the comparables are often ignored or not properly captured. This can lead to overvaluation of properties that require significant renovations or are in poor locations such as busy roads.
There are many sites available in the UK and Continental Europe that can help investors perform a quick cross check of property values. Zoopla and Rightmove are good options for researching real estate values in the UK, and similar sites exist in most European countries. Cross checking a valuation is particularly important if they contain some of the ‘red flags’ we highlighted above. Checking the valuations of some assets, such as land and industrial assets can be difficult, and for this reason we prefer to avoid them.