Is LTV a good indicator of risk?
In a nutshell
There's no clear line that separates a high-risk investment from a low-risk one, and risk can be a very personal thing based on your financial circumstances, goals and appetite for risk. However, we recommend that investors look at LTVs as an indication of the relative risk, but it doesn't tell the whole story.
If you read our previous piece, Understanding Loan to Value (LTV) - Part I, explaining the importance of changing LTVs in crowdfunding property investment projects, we can see that LTV can be a good indicator of the consequence if something goes wrong with a project, but it is not a measure of the likelihood of the investment failing, for that you need to look elsewhere.
The Loan-to-Value is essentially a marker of the level of protection you have should things not go to plan. It shows what proportion of the value of the security we need secure when the assets are sold in order for you to get your capital back along with the target returns.
It's worth remembering that it is common for there to be additional layers of security in the form of personal guarantees and debentures, although these will not always be in place. These additional layers of protection mean that if the assets have to be sold at auction at lower than expected values, the rest of the money owed can be recovered from the borrowers assets.
It should be noted, however, that for second charge security, investors rank behind the Senior Lender and will not be paid their interest or repaid their capital until the senior loan, interest and fees have been paid in full.
Why an investment with a low LTV is not always a lower risk than one with a higher LTV
This is where the likelihood of things going wrong comes in to play. As a general rule you could say that the more there is to do in a project, the greater the likelihood that something will go wrong.
As such, a bridging loan will usually be less risky than a development loan that has the same LTV. Similarly a refurbishment might be seen as being less risky than a new build project. A development where the exit is via a refinance is generally seen to carry less risk than one where there are multiple units to sell on the open market.
That's not to say that LTV is not important - it is. But it doesn't tell the whole story. It's best referenced when comparing investments within a particular category though, for example amongst loans for single house refurbishments, the one with the lower LTV would be considered better security (if they are in similar locations, with similar demand) than one with a higher LTV. Even then, you should consider what additional security is in place and ensure the investment fits your circumstances and risk appetite.
- Are you an optimist or a pessimist in Property Crowdfunding?
- Need a hand with puzzling alternative finance jargon?
- Seven myths and one truth about Property Crowdfunding
- Understanding Loan to Value (LTV) - Part II
- Understanding Loan to Value (LTV) - Part I
- Construction workers given the green light to work despite the Coronavirus pandemic
- Is Coronavirus likely to slow down growth in the UK's property market?
- How the decline of UK's High Streets is opening the way for UK property developers
- Who should you turn to for investment advice before Property Crowdfunding?
- Is property crowdfunding a viable way to get onto the property ladder these days?
- The importance of liquidity in your investment portfolio
- FCA guidance changes ring in the new year
- Gender stereotypes in Alternative Finance; are women playing catch-up?
- How does CrowdLords compare?
- Brighton Road - Meet the Developer
- Property Crowdfunding; A Global Appeal for UK Platforms?
- Does the future of Property Crowdfunding lie in the hands of Millennials?
- Meet the Developer - Jo Hagan (5 Mentmore Terrace)
- Property crowdfunding in the wake of no-deal Brexit
- The processes of due diligence in property crowdfunding