This article is sponsored by LendInvest
Since its inception in 2008, fintech platform LendInvest has established itself as one of the most prominent small-ticket lenders in the UK residential real estate space. The company has written more than £4 billion (€4.7 billion) of loans and amassed £2.4 billion of assets under management by offering short-term, development and buy-to-let mortgages to intermediaries, landlords and developers.
The head of funds management at the platform, Omega Poole, estimates the total annual UK market volume for lending in the segment at approximately £24 billion for residential development loans and £6 billion for bridging loans. She argues that, despite rising interest rates and a squeeze on household incomes, small-ticket lending strategies offer institutional investors opportunities for diversification and risk mitigation as the UK economy navigates an increasingly volatile macro-economic environment.
How is the type of capital that funds small-ticket lending strategies in the UK market changing?
We have seen a shift to more institutional investors over the past few years. Some large asset allocators have pivoted away from equity strategies and toward credit strategies because of economic uncertainty.
For investors that would have typically focused mainly on direct private equity real estate, allocating more capital to credit strategies gives them downside protection and an element of risk mitigation. For institutional investors, it is obviously quite difficult to access the market directly given that the loans are relatively small, so they work with platforms such as ours which have the infrastructure to source and select the right underlying loans at a volume that makes sense for large allocators.
As a tech-enabled business, we have a streamlined underwriting process, which enables the origination of a large volume of loans. When we were raising earlier funds, we attracted more family office-type investors, but as we have grown, so has our appeal to institutions – particularly mid-sized ones. They are often faced with the choice of whether to invest in a mega-fund or with a manager like us; where they are one of the more meaningful investors in the platform and get a lot of face-time directly with the manager.
What is the attraction to institutional investors of these types of lending strategies?
There are three factors. First, investors are looking to support small and medium-sized developers building housing in the UK. There is a huge, chronic, supply-demand mismatch. Research carried out by Edinburgh’s Heriot-Watt University for social housing body the National Housing Federation, showed that England needs to build about 340,000 homes every year until 2031 to meet demand. Since the 1970s, we have been building approximately 180,000 homes per year on average. The need is particularly strong in the southeast and around gateway cities. Investors also like the social value generated by developing housing for first and second-time buyers, and young families.
Second is diversification of risk. If you have a pool of smaller loans, you can potentially achieve greater diversification. In our flagship fund, the loans are usually around £5 million, and they are spread across different regions of the UK.
The third factor is the credit angle. Having a senior security package provides risk mitigation. We generally write whole loans, so they are senior secured debt, and additionally we have corporate debentures and take additional security where appropriate. For international investors, the UK is a relatively lender-friendly legal environment, should there ever be the need to enforce on the underlying collateral.
Is the challenging economic outlook impacting fundraising?
Potential investors are taking longer to carry out due diligence on new strategies. As we saw during the covid-19 pandemic, investors are focused on established asset managers. In today’s market, it would be particularly challenging for a fund manager without a track record. Because of the recent volatility in the bond markets, we are also seeing UK pension funds having to focus on other aspects of their portfolios, so they are less able to allocate than they would have been in the past. However, that is offset somewhat by the flight to debt strategies that we see in times of uncertainty.
LendInvest has securitised residential development loans on several occasions. How much scope do you see for this method of funding?
We wrote our fourth securitisation, of £270 million, in April this year for a portfolio of buy-to-let mortgages. Bridging loans too though, could, for example, also potentially constitute a good securitisation product. Securitisation structures are best for smaller and more vanilla loans that present good diversification characteristics. From a marketing perspective, by creating multiple securitisation structures, you can market different tranches of risk that will appeal to investors with different risk-return parameters. It widens the pool of investors that might be interested in participating in the securitisation.
“In today’s market, it would be particularly challenging for a fund manager without a track record”
There is a growing understanding in the market, among both investors and credit rating agencies, around securitisation of bridge and short duration loans. And typically, bridging loans are associated with upcycling or retrofitting of assets, and could potentially have good ESG characteristics, which is top of the agenda for many investors.
However, a lender must be able to generate the right quality and quantity of loans. Securitisations typically need to be of a certain scale to be efficient, because there are associated structuring costs. Historically, that scale has been approximately £250 million, but anything over £100 million would be appropriate. Securitisation is certainly a tool that can be a great way to access new capital.
How is the growth of institutional capital in the UK small-ticket loans market affecting the type of lending deals managers are looking for?
Investors still want the diversification offered by smaller tickets, but some prefer slightly larger and longer duration loans. Our flagship fund focuses on short-term bridge and development loans with an average size of about £5 million, with a term that could be up to 12 or 24 months. Given the open-ended nature of that fund, the short duration loans are well-matched with the fund’s liquidity. We have found that institutional investors have a preference for evergreen open-ended structures so that they can roll over their investment or re-up without having to keep underwriting new funds.
However, the feedback we have been getting over the past couple of years has led us to design a slightly different structure for our new fund, with institutions that have a longer-term investment horizon front of mind. Unlike our previous vehicles, this fund has a two-year initial lockup for every pound, dollar or euro invested, so that investing in this fund means that longer-term investors are less exposed to other investors’ liquidity risk. Because of this, it is appropriate to have slightly longer duration loans of up to two years for bridge or up to three years for development finance, in the £10 million to £15 million space.
What impact are rising interest rates having on the small-ticket lending market?
We have seen a change in how the market is looking at returns. Historically, we have written our loans on a fixed-rate basis. But our new development loans are now written on a floating-rate basis, which provides a degree of insulation for investors. We still typically write bridging loans on a fixed-rate basis because they are seen as a fixed transactional cost. But they are relatively short duration loans of up to 12 months and are typically paid back sooner, which means new loans can be repriced quickly in line with current market conditions.
We have also seen pricing increase slightly for certain loans, and like other lenders, we are being more cautious in our underwriting criteria. For selected products, we have reduced loan-to-values by as much as 10 percent. For others, we are now providing caps at approximately 65 percent on a whole loan basis. Developers that are considering new schemes are looking at delivery in two or three years, by which time we all hope that the market will have stabilised. In fact, there may be opportunities in the short-term for well-capitalised, nimble lenders to source more high-quality deals by providing financing to borrowers who find it has become temporarily unavailable.
We expect to see house prices decline by around 5 to 6 percent per year for the next two years, but the supply-demand mismatch is likely to mitigate the downward pressure on prices to some extent, particularly at the more affordable end of the spectrum, which is where we concentrate.
We are also keeping a close eye on the dynamics of the mortgage market. Since the financial crisis, mortgage lenders have stress-tested mortgages for the underlying borrowers at high single-digit rates, and compared to say, 2007, the proportion of interest only and high leverage home mortgages is much lower so a degree of resilience remains.
What does the economic turbulence mean for the credit quality of small-ticket loans?
The first step in mitigating market risk is around asset selection, choosing the right loans and borrowers to back. We will be paying a lot of attention to the cost contingencies that developers are writing into their loans and making sure that there is a sufficient buffer there, also ensuring that there is enough leeway in the facility to cover a rise in interest rates.
Most of our borrowers are well-established and have typically done at least three to five developments of a similar scale, so we work with a lot of them on a repeat basis. We have dealt with over 70 percent of our borrowers in the past, so if they need to change their business plan to respond to altered market dynamics, we have established relationships with them and our special servicing team can work with these borrowers to try to get the best results for everybody.