Predicting the Property Market For P2P Lending
Certainly, it's not much of a prediction to guess that, over the long term, house prices will rise. I mean that's very clear. So I'm concerning myself today with short-term house prices, which can be more relevant when lending anyway.
House-price movements change the risks in lending, especially property lending. Rising house prices help to make your property lending safer. Falling house prices reduce the cover you have on your loans, in the event that the borrower is unable to repay, and the property needs to be repossessed and sold.
This affect can be amplified during a sale in a falling market, since a rush to get it done can sometimes lead to selling at considerably less than the going rate.
You'd think that this means 4thWay and lenders should pay close attention to property prices and the latest forecasts, wouldn't you?
Actually, you shouldn't.
So much for the property experts!
I used to keep a database of forecasts from dozens of prominent property-market forecasters. These forecasts stretched for two decades from the late 80s to the late noughties and included two major property price crashes.
What I found was that none of the forecasters – not a single one – had a better than random chance of guessing how the property market was going to perform, even in ordinary times. As often as not, the forecasters were seriously wrong about the size of the price movements and frequently wrong about the direction of them too.
Their results were shockingly bad. My only conclusion was that the professional economists are either deceiving themselves or, more likely, they are releasing forecasts as a cheap trick to get their names, and their employers' names, in the papers.
As J. K. Galbraith, the respected and irreverent economist, once said: “The only function of economic forecasting is to make astrology look respectable.”
It's even worse that experienced journalists peddle these soothsayings to their readers, long after the time they must have realised that these things have zero value.
Prior results don't mean squat
It's very human to look at the recent past and attempt to project those patterns to the future. You might think a big rise will lead to more rises. Or even that a big rise means a “correction” is due, for example.
Some years ago I analysed decades-worth of data from Halifax, Nationwide and the Land Registry. I found that looking at the previous one month, two months or three months, it was impossible to predict what would happen in the next one to three months.
There are exceptions to the rule – probably
I think there are exceptionally rare times when predicting what will happen to house prices in the short term can be done quite reliably, if you understand economics. And if you are prepared to wait a generation in between each forecast!
During the 20 years I kept my database, there was one time when I believe a sensible and accurate prediction in the movement of house prices for the following six months was not only possible, but also easy.
It happened some months into the price crash that started around 2008. The reason forecasting further big falls was possible then is that every single economic indicator was pointing heavily downwards.
Usually, of the many different indicators on the economy, there are some pointing down and some upwards, and so there are always arguments on both sides. Sometimes there are a lot more going one way than the other, but it turns out that this doesn't improve forecasters' accuracy.
But when all nine planets align, I believe that could turn out to be an exception. (Although it will take me a few hundred more years to be able to prove that to you statistically!)
How to use house prices in your lending
In some ways, I regret telling you that it was possible to predict house prices on that one occasion. In particular, I sort of regret telling you that there are exceptions to the rule.
Because as soon as there's an exception it means many lenders – as well as other investors or property buyers – will be looking for those opportunities to guess the market's direction. And I think when people look for things, they're likely to find them – every single time.
Basing your lending or investing decisions on what you think will happen to property prices in the next few months or years is simply reckless. The record conclusively shows that you have no better than a random chance of getting even half-close to guessing the movement in prices.
It's not rational, so it's not good investing. One of the two biggest mistakes* that investors make is going with their gut, going with emotion, going with their overconfidence. Please don't make that mistake. Please think rationally about this.
When lending, leave the arrogant guesswork somewhere else and use house prices solely in this way: ensure that the property lending you do has a large amount of cover in the house-price valuation.
The level of cover you want varies depending on precisely what the P2P lending company offers you in terms of all the loans' characteristics, the skills of the people behind the P2P lending company and its record (or lack thereof).
But I can give you some rough rules of thumb to work from as a baseline:
For residential mortgages of the type that homeowners usually take out, or for stable, creditworthy landlords with ordinary mortgages on residential properties that they are renting out, this might typically mean a maximum loan of 80% of the property value and an average of approximately 70% or better.
If its commercial property (shops, restaurants and so on) with close to zero bad debt in a normal economy, you want a loan that is a maximum of 75% of the property valuation, and an average of around 60% or better.
If the lending you're doing involves a high proportion of loans that fall very late, you'll want even more cover if you can get it, although the reality is that you might have to settle for higher interest rates to offset the increased risk.(as well as high interest rates).
If it's development lending to quality, experienced developers, you preferably want a maximum 70%-75% cover on the initial loan, with 70% ideal. With each further tranche that the developer receives for completing building milestones, you want the total debt to stay at around that level as the property value ultimately rises.
If the P2P lending site offering the loans is a swinger, you'll want even more cover, with such loans typically being for less than 50% of the looser property valuation.
It's rules like the ones above that have enabled the best banks and non-bank lenders to maintain profits in lending year in, year out. It's not teams of over-priced forecasters that have won it for them.
In addition, always be prepared for some losses on some property loans, even with such cover. And be prepared to wait for months or years for some of your bad debts to be recovered.
Independent opinion: 4thWay will help you to identify your options and narrow down your choices. We suggest what you could do, but we won't tell you what to do or where to lend; the decision is yours. We are responsible for the accuracy and quality of the information we provide, but not for any decision you make based on it. The material is for general information and education purposes only.
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*The other one of the two biggest mistakes is looking for evidence to support what you want to be true, rather than looking for evidence to try and destroy your best-loved ideas. This is called “confirmation bias”. If you want to lend in something, search for the reasons not to do so!