The property lending industry has not kept up with technological advances in the financial sector, encouraging entrepreneurs to develop online platforms to raise capital for lending.
Their loan portfolios may be tiny compared with the established providers of commercial property debt, but fintech firms are pioneering technology that is streamlining property lending. While many fund lending with retail money sourced through peer-to-peer platforms, some are now targeting institutional capital.
“Fundamentally, platforms are acting as a conduit, similar to Airbnb or Uber,” argues Brian Bartaby, founder and chief executive of P2P firm Proplend, which writes sub-£5 million (€5.7 million) secured property loans. “Income-seeking investors have money and are looking to deploy it; creditworthy borrowers need money and are looking to borrow. Platforms are sitting in between.”
Online property lending, which spans short-term bridging, buy-to-let mortgages, development finance and commercial investment loans, has grown in recent years. According to the Cambridge Centre for Alternative Finance, UK P2P property lending increased by 88 percent year-on-year to £1.15 billion in 2017.
“If you go back a handful of years, only one or two platforms were active. Now you could reel off 20 to 30 financing property online,” says Sam Handfield-Jones, head of P2P platform Octopus Choice, which is part of Octopus Investments.
Technology is used to bring investors and borrowers together, but also to streamline lending processes. Data are captured to part-underwrite loans faster than the traditional banking model, with loans subsequently managed on an ongoing basis.
Such lenders target parts of the market underserved by traditional lenders. In Link Asset Services’ March 2018 survey of the UK commercial real estate sector, P2P lenders were noted to provide the highest maximum loan-to-cost for development loans, at an average 87 percent. With average development finance pricing at between 700 and 800 basis points, Link noted that P2P lenders were cheaper on average than some alternative lenders, debt funds and hedge funds.
For investment loans, the survey showed they are the UK’s most expensive lenders, with average margins at 950bps and average maximum loan-to-value around 70 percent, perhaps reflecting the transitional nature of many of the deals targeted.
The UK’s pioneering ‘marketplace’ platform for property finance, LendInvest, has largely built out its consumer-facing technology and is now using technology to drive efficiencies.
“Initially our focus was taking borrowers’ and brokers’ experience online as a more convenient way for people to transact with us,” says Christian Faes, the firm’s co-founder and chief executive.
Since then, the platform has become more sophisticated, matching borrowers to wider sources of capital – from its listed retail bond; to capital from hedge funds, family offices and banks; to warehouse bank funding lines and its discretionary debt fund.
“Each loan has a different characteristic and each investor has its own investment criteria. We’re using technology to add granularity and efficiency to the underwriting process. When a borrower comes to us we check the title of the property and generate a credit score, for example; all this can be done in an automated way by pulling data from different databases, providing our underwriters with as clear and informed a view as possible to make a decision,” Faes explains.
Last July, LendInvest raised £50 million through the issue of a retail bond. In November, it sourced a funding line of more than £200 million from Citi for UK buy-to-let lending. The fact online financing in the P2P space is now more commonly referred to as ‘marketplace lending’ reflects a shift from retail capital.
“As we get more of a track record our proposition becomes more interesting to pension funds,” says Faes. “It’s an issue of scale. Four or five years ago institutions represented a much smaller quantum of funding for online platforms. Nowadays, however, we’re seeing more of our capital base coming from institutional investors. As online lenders get more of a track record and a certain level of scale, our proposition becomes more interesting to bigger institutions, such as pension funds and insurers.”
“Like consumer credit-focused P2P platforms, property P2P lending will attract more institutional capital as platforms’ track record becomes apparent,” adds Handfield-Jones.
By investing with a platform direct, as opposed to investing in a debt fund, institutions can earn “an extra couple of points of alpha” by selecting specific types of loans, asset classes and geographic locations, argues Bartaby.
However, market players say there remains huge potential in raising capital for lending from the retail market. “It’s still early days, but the premise of combining the liquidity of potentially hundreds of thousands of people represents an exciting capital base that the asset class didn’t have access to previously,” says Handfield-Jones.
Market players expect an increasing amount of investment to come from UK retail investors following the introduction of the Innovative Finance ISA in 2016, which offers tax-free returns. Platforms must apply for authorisation from the Financial Conduct Authority in order to launch an IFISA. “This will a be a big growth area in the next couple of years as people move money from cash ISAs, which suffered the worst returns on record last year,” says Bartaby.
Those firms active in the nascent online lending market face the challenge of convincing investors and borrowers that their business model is here for the long-term. The P2P market, which is far less regulated than the banking sector, has not been without its controversies. In March, P2P firm Collateral, which provided finance secured on land and property, went into administration after it emerged it did not have required regulatory permissions.
Investors must be diligent about choosing the right platform. “Depending on the platform and quality of underwriting, some platforms put a lot of deals through, which is good for their numbers, but they have a high level of defaults sitting in their loan book. The problem is more prevalent in development finance than in investment finance because developments make capital gains, not income, so you have to wait until something is built in order to sell it to find out if a loan goes into default or not,” says Bartaby.
Whether a platform has got skin in the game or is just a loan issuer is another consideration. “Alignment is important; we put 5 percent in every loan on a first loss position,” says Handfield-Jones.
Faes adds: “It all comes down to track record. You can have the best technology, but if you don’t know how to lend money I wouldn’t be investing in a platform like that. Technology is very much part of enabling the marketplace concept but it doesn’t decide who to lend to.”
While some question the longevity of the online lending model, Bartaby believes the system has the potential to revolutionise the way property is traded and financed.
“Real estate transactions and financings are very cumbersome with a lot of people involved taking fees out of the deal. What we’re doing creates efficiency that allows transactions to take place quicker and potentially cheaper. If technology can help improve the structuring process, recording sales immediately on to the land registry via blockchain for example, it will increase the liquidity of property as an asset class,” he says.
A future line of business could involve online platforms providing stapled debt. “Prior to putting an asset on the market, it would already be agreed, subject to borrower due diligence, that whoever was buying it would receive say 60 percent LTV debt,” Bartaby explains.
P2P remains a small element of the overall £180 billion of CRE debt that is outstanding in the UK currently, according to Savills’ Financing Property 2017 report. Bartaby estimates somewhere between £500 million and £1 billion of debt has been put through property platforms over the past four years.
However, “high street banks specifically in the smaller ticket market have moved out and are not interested in moving back. They have gone down the route of doing a lot of SME lending which makes them look good,” he says. “Property lending is an expensive thing for banks to do; Basel II and III capital adequacy rules will only get worse for banks, suggesting the market share platforms take will increase over time.”
How online platforms lend
Loan deals arranged through online platforms typically begin within the borrower making an online enquiry. This captures as much information as possible about the borrower, the property, the tenants, the business plan and the exit strategy.
“We complete our internal due diligence process and upload this to our platform, along with a valuation and legal report, and use technology to distribute that information among a vast number of people,” says Brian Bartaby of Proplend.
Once a loan has ‘gone live’ and investors can start putting capital into it, in Proplend’s case, it is split into three leverage-based tranches. When loans are 100 percent capitalised, contracts are completed online, although security documents are signed offline through a lawyer. Technology is then used to move money from the lender’s account to the borrower’s account.
They still have to go through the same fundamental legal processes – the fintech bit is the collection of data, the speed of the underwrite and the distribution to and funding by multiple parties.
Platforms then collect interest either monthly or quarterly from the borrower and distribute it to their investors, as well as monitoring loan covenants in the security, where necessary enforcing the underlying security in the event of default with the help of a receiver. They can also facilitate the transfer of loan investments if a lender decides it wants to trade its position in the secondary market.
“Lending opportunities are evaluated no differently to the way a traditional bank would do it, but we believe we can do it quicker and potentially better because technology and property data is becoming more readily available,” says Bartaby.
“Using artificial intelligence, for example, we can look back at how loans have performed and question whether past decisions were right or wrong in a bid to make better and quicker decisions in the future. There is potential to help even out some of the peaks and troughs property and property debt go through.”
Unlike SME or consumer credit, which are heavily algorithm-driven, lending against real estate cannot be fully automated.
“After we’ve captured information and started to build a credit file and are happy with the concept in principal, the process is the same as it is for banks. We meet the borrower and broker and send a valuer to assess the property. The difference is that a lot of platforms are customer-centric, focused on speed and ease of use because there is no replacement for on-the-ground review of an asset,” says Sam Handfield-Jones of Octopus Choice.