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90%+ Loss Shows Difference Between Property Investing And Property Lending
Owning property is one of the four ways that gives 4thWay its name. As we sometimes say: “there's the savings way, the property ownership way, the stock market way, and now there's the P2P lending way: the 4thWay”.
All are equally fantastic ways to save and invest for almost everyone, each offering something different. 4thWay concentrates solely on the fourth one. (More on the four ways in Peer-to-Peer Lending Vs Other Investments.)
Regarding the property ownership way, our tagline is mostly referring to owning your own home, but it can also include other property investments.
I feel that the risks and rewards of owning property versus lending to property owners – the latter you can do in P2P lending – are not always clear. I've seen an example today that will help you get your head around it.
This particular example is not flattering. But, to be very clear, I'm not disparaging property ownership, as no type of investment works out well every time. It's just that this story clearly helps you to see where P2P lending sits against at least one type of property ownership.
A 32.7% potential reward, which now won't happen
In this example that is ongoing right now, investors became co-owners in the property (or at the very least they have legal entitlement that is effectively the same).
The projected return was a hefty 32.7% for investors, which is a greater return than in any P2P lending or similar that 4thWay covers, with the possible exception of AxiaFunder*.
The reason for the high potential return was that the investors bought into a development site and development project.
Although a more typical projected return is around 20%, this kind of investment is pretty much as risky a form of property ownership as it gets.
It's clearly different to owning a buy-to-let or your own home. It is, however, probably the most common form of property ownership that you get through online alternative investments.
The problem is, instead of making money, investors are now facing estimated losses of at least 90% of their investment.
Naming names – but it doesn't matter who it was
I'm not naming the online investing platform that listed this project in order to bash it, but rather to make it a little easier for you to build your understanding further if you decide to take a look at its website.
It's called Brickowner.
Before getting into the individual case, I want to add that 4thWay hasn't assessed Brickowner, we've had no contact with it at all as far as I can remember, and it's not under our remit. So I know next to nothing about it.
Furthermore, development projects inevitably fail sometimes, so sparse details about this one deal going very badly means nothing at all about Brickowner by itself.
Investors put in £1.7 million through Brickowner to become co-owners in a property development. On completion, it was expected to sell for £5.8 million.
Demand for property in the area and the price of property has fallen considerably, making it difficult to sell the developed flats.
20 out of 31 flats in the development have been sold. However, all of the money has gone to pay off development loans and none has gone to the Brickowner property investors.
A bank lent in the region of £3 million. Money lenders invariably get their money back before property owners, so the bank is, at this stage, still alone in getting any money paid back.
(Lenders in other investment markets and assets usually get their money back first, too. For example, those lending to a troubled business listed on the stock market – such as bondholders – get their money back before the business' shareholders do.)
Four more flats were recently in the process of selling but they all fell through, because in the current economic environment buyers were unable to secure a mortgage.
The sale of another four flats has been agreed and a fifth is close. The £460,000 that will be raised from this will still leave £400,000 to be paid to the bank.
That's not all. There's another lender that will be repaid after the bank, but before all Brickowner investors. This junior lender is owed £520,000. So nearly £1 million is still left to be paid before the property owners can dream of getting any money back.
With all these difficulties, the latest projection reported through Brickowner is that its investors could ultimately lose over £9 for every £10 invested.
Owners don't get repaid till lenders are paid all their interest
It's not just that Brickowner's property investors have to wait until all the loans are repaid. It's also that the money lenders will be paid every penny of interest they are owed before the owners get anything from the property sales.
This includes all additional interest that the money lenders earn during the delays to selling the properties.
So the senior lender in this property development probably still ultimately expects to get all its money back plus all the interest that was due to it. It's probably earning 8% to 12%.
The junior lender will also be hopeful of getting all its money and interest back. At worst, it might take a haircut on what would probably have been interest rates of around 15%-25%. And if, in the end, it doesn't get all of that interest, it means that Brickowner investors have already lost all their investment.
Being the lender yourself
If you were in that development project but doing P2P lending instead of property owning, you would either take the place of the bank or the junior lender.
The senior lender in that particular deal has been putting pressure on to get repayment of its loans and it has a lot of clout to force the issue. It will still probably get all its money back if it forces the owners to sell all the remaining flats quickly, at a cut price.
If you were the senior lender instead, your P2P lending provider would have that same power. In practice, most P2P lending providers have worked hard to treat borrowers fairly and not unduly force sales. But the point is it's within your power if it proves necessary.
What's more, unpaid loan interest has been piling up in that property deal. That means that if you had been the lender you could probably expect to earn more from the deal overall due to the delays. Yet the more you earned in this way, the less money the property owners will recover.
Property owning versus property lending
Here's a summary of the differences mentioned here between owning property or P2P property lending. Bear in mind the example today is for a development property, which is different to buy-to-let or other property ownership, but many of the points still apply:
- Property investors (owners) in development properties can earn 20% to 30% returns, if they do well.
- Any drop in property prices instantly reduces returns for property investors.
- Delays in completing and selling developments also reduce returns for property investors, while typically increasing returns for lenders, as they get to charge more interest.
- Property lenders get repaid first, so they are in a far safer position. The owner will be wiped out before the lenders would lose any money. This is still true even if you're in the junior lending position.
- Property lenders also get paid all their interest – in addition to the amount lent – before the owner makes any money from a sale of the completed development. You could earn 8% if doing this through P2P lending, or even a lot more if you're taking the junior lending position.
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