What are the differences between peer-to-peer lending and crowdfunding?
In a nutshell?
The Cambridge Centre for Alternative Finance (CCAF) "UK Alternative Finance Industry Report" from November 2018 states that within the past three years, there has been a 12 month period where the volume generated by Property Crowdfunding increased from £71m to £211m, almost 200%, whilst P2P Property lending generated £1.218bn for the UK's Alternative Finance industry, a 6% increase from 2016's volume of £1.147bn.
So what exactly are they and how do they differ?
The Peer to Peer (P2P) lending model has in essence, existed for thousands of years. Institutions and individuals with money have been lending to other institutions and individuals and taking a small cut since sophisticated banking began in Assyria in the Middle East around 2000BC.
The rise of Alternative Finance
However, since the Financial Crash of 2007-2008, traditional banks have offered increasingly conservative returns. The system is failing those that want to save for the future.
Add to that the constant evolution of the internet and social networks, and both P2P lending, along with Property Crowdfunding, has really taken off. This method of debt financing enables individuals or businesses to lend and borrow money using an online platform, but crucially without the use of a traditional bank as intermediary. Although P2P lending carries greater risks than traditional banking, this is seen by many as being a good thing.
Who can use these platforms?
Almost everyone can be a lender, subject to being at least 18 years old and the holder of your own bank account, choosing how much or how little you wish to lend or invest with minimum lending amounts sometimes set as low as £25. The ease with which these lending platforms are accessed, coupled with the low amounts of money required to begin investing, have made for a huge increase in the number of users considering P2P lending as an alternative to traditional lending and borrowing.
Borrowers typically go through a series of credit checks and other due diligence verification processes. UK P2P lenders and Property Crowdfunding investors are strictly guided by regulations from the Financial Conduct Authority (FCA) – a framework that offers guidance to regulated firms to help them provide investors with sufficient information to make an informed decision about entering into an investment. Upon receipt of this information, the lenders, or "crowd", can then decide whether they want to participate or not. And in principle, it really is that simple.
So, how are they different?
In some circumstances, P2P lending can involve holding high value items as pledged assets in the event of a loan defaulting, for example; gold and precious stones, classic cars, luxury items, fine art and even property or land. Should the loan default, the asset is sold at auction and the investors receive their share of the money raised, then depending on specific Loan to Value (LTV) ratios, they recover as much of their investments as possible. This means that not all the initial capital invested can necessarily be recovered, and therein lies the risk of both models.
Although both forms of lending follow the same principle insofar as investors move capital to recipients for a projected return, the difference is specifically the fact that P2P lenders are lending directly to the borrower, whereas with Property Crowdfunding, the investors are lending to a Special Purpose Vehicle (SPV), which then lends to the borrower.
Property Crowdfunding, (with equity), enables investors to benefit from the potential capital growth generated by the property. Investors collectively put funds into properties and receive returns based on any increase in value of the development. Likewise, if the value decreases, then investors share in any losses as they may not see a return and could lose some or all of the capital which they invested. Alternatively (with debt), their collective investment is generally lent to parties purchasing or developing a property and they then receive returns via interest on the debt. Because small amounts can be invested quickly and easily, and investments come with none of the responsibilities of being a landlord, it is radically different and slightly easier from many of the traditional models of property investment.
Because the Property Crowdfunding model sees the investor able to invest large sums into the projects, therefore having the potential to see better returns, the model is sometimes deemed more attractive to sophisticated investors with a great deal of financial experience, as well as more capital which they can afford to invest.
It is important to clarify that Property Crowdfunding is perceived to have the same risk profile as P2P lending and as a result, there can be high returns for both models because of the noticeable risks involved. One example of P2P lending and Property Crowdfunding being risky when investing capital is that investments are not protected by the Financial Services Compensation Scheme (FSCS).
Because of this higher-risk, higher-return market of Property Crowdfunding and the possibility of enjoying very attractive returns on investments made, since the CCAF first began tracking it in 2015, the market has generated £369m, 57% of which was recorded in 2017 alone.
For both models, in order for the loan to be funded, the more people that get involved in the investment, the better. This is because if a project is opened up to a greater number of investors, this will increase the chances of borrowers potentially seeing their loans funded much more quickly.
What's your pick, P2P lending or Property Crowdfunding?
Where it once took months to complete the formalities for a substantial loan, signing endless papers with cap in hand in front of your bank manager, as platforms evolve and more people become interested in P2P lending and Property Crowdfunding, to get a loan completely funded could go from weeks down to days, and hypothetically, even hours.
This rapid democratisation of investing money, along with the ease and surprising speed of using the platforms, has made this ancient form of lending more accessible and attractive than ever before.
As of the end of 2018, the CCAF report noticeably marked the seventh consecutive year of significant market growth for the UK Alternative Finance Industry.
It would seem that the Assyrian form of banking never stopped existing, but simply evolved at a remarkable rate to where we are today.
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