Posted on 01/08/2019 21:18:37   by   Richard Knight

Clarifying the risks to understand the rewards

In a nutshell

To many people for whom Alternative Finance is not necessarily their area of expertise, investing in property may seem like a complex, expensive and risky activity.

Despite the fact that Property Crowdfunding platforms are becoming more and more accessible to an ever-growing number of investor demographics, it would not be prudent to start up an investment portfolio without having first analysed the risks involved.

How did Property Crowdfunding become so popular?

To understand this question, we have to look back to the turn of the century, when small and medium sized businesses supplied the UK with about 40% of all new homes. By 2013, as a direct reaction to the financial crisis, that figure had dropped substantially to 25%. Often lacking enough capital, the challenge for these smaller property developers, having secured the plot to develop, was how to finance it.

The best solution was often to enter into a joint venture with High Net Worth individuals who, in return for providing the equity, took 50%-60% of the profits. With banks increasingly reluctant to support smaller property developers too, the market became a top-heavy system exclusively for the wealthy.

Over the last decade however, thanks to P2P lending and Property Crowdfunding platforms, more and more people, some of whom have a limited knowledge of both property and finance, are getting involved.

However, although the thought of potential lucrative returns can seem immediately appealing, there are important factors to consider before investing on these platforms, as the risks can be significant.

It is not difficult to see why investing in property development projects using Property Crowdfunding platforms is increasing in popularity every year. Investors benefit from the low value minimum investment amounts, sometimes as little as £100, coupled with the attractive possibility of substantial returns. If an entrepreneur, a seasoned investor, or even a relatively inexperienced individual with some capital can invest such small amounts into a range of property development projects, they mitigate much of the risk through diversification.

How quick can potential returns be?

There is also the appealing timescale of fairly short investment periods. It is common to see investment terms of between 12 and 24 months, and with returns typically between 10% p.a. and 25% p.a, often with a minimum preferred return that is paid before the developer takes any profits, the less experienced of us could be forgiven for not analysing the risks sufficiently.

In addition to this, within the crowdfunding model, investors enjoy the transparency of making their own assessments of the developer and the location before deciding to invest, as the platforms on which they operate generally offer clear and concise information of all the details.

Analysing the risks involved...

However, before logging onto a platform and risking your hard-earned cash, investors should be encouraged to carry out a detailed risk assessment for their own financial security.

Firstly, and perhaps most importantly, although most platforms have some sort of compliance oversight, investments are not covered by the Financial Services Compensation Scheme (FSCS).

This means that the investor’s capital is not covered if property values drop significantly or development projects go wrong, and therefore they could potentially lose everything.

Investment performance is also a factor in property crowdfunding. As the risk warnings dictate; the value of your investment can go down as well as up and past success is not an accurate guide to future performance. Capital returns are hugely dependent on several factors, including the general economic conditions, the property market, inflation and interest rates, and the condition and location of the property itself.

Investors should also consider the illiquidity of property. With this type of investment, even if there is a secondary market, it is unlikely that you will ever get your funds out if you suddenly need them for something else. If your projected returns are linked to an increase in property prices, then there is no guarantee that the property can be sold as the liquidity of the asset is dependent on how active the market is.

How much control do I have?

Some investors may also be discouraged by the lack of control over numerous factors in the final aspects of the development projects. For example, the people who funded the site to be developed then don’t have any say in who the tenants are, how much the rent will be, and how the property is to be subsequently managed. If you are looking for more than just short term returns on your investments before completion and then moving on, this lack of influence in the ensuing particulars of the property may be frustrating.

On the other hand, investors could see this as an advantage as none of the repairs that present themselves fall under the responsibility of them. You are disassociated from council tax bills, rent collection, and organising assistance and replacements when the boiler invariably breaks down in the depths of winter.

Making the right choices for you

Of course, as previously stated, people investing in property are usually savvy enough to comprehend that it can seem like balancing scales; this high-risk scenario where capital can potentially be lost is countered by the temptation of potentially lucrative short-term returns at attractive rates. Essentially, whilst the crowdfunding platforms clearly lay out the specifics for people interested in dipping their toe in the water, as adults we make our choices.

P2P lending and Property Crowdfunding have grown, and all the indications are that these types of platforms will continue to grow very rapidly. They have opened the doors for a demographic of people who previously were simply not able to consider investing in property, and it has sparked a reaction from the traditional banks insofar as their form of saving may well have to change forever in order to be competitive again.

The Property Crowdfunding form of investing is principally for investors who appreciate the "hands-off" approach, where you can forget about your investments for periods of time and let other people do all the work, collecting your returns at the end of the term.

However, it would be naïve to only focus on the advantages as there are clearly challenges and it is yet to fully establish itself. After all, it is still labelled as "alternative finance" and not just "finance".

In the end, your decisions should be based on your personal situation, your financial flexibility, your goals, your attitude towards risk, and your feelings towards investing in property in general.