Crowdfunding v peer-to-peer secured lending
In his previous post, Frazer Fearnhead examined traditional property investment v crowdfunding.
Although they are often lumped together under the banner of ‘property crowdfunding’ and although both involve raising finance from a crowd of people who pool their resources, most people don’t appreciate that crowdfunding and peer-to-peer lending are in some ways distinctly different.
Here’s how they differ:
Equity Crowdfunding means you acquire shares in a company in exchange for your investment. You will be entitled to a share of rental and sale income by way of dividend.
If there is no profit to be shared out, you will not receive a dividend.
If the property purchased falls in value it is likely your shares will do likewise and you may lose money.
Should you wish to sell your shares you are free to do so at any point provided you can find a buyer. Any profit you make upon sale of your shares will usually be subject to CGT (after the annual allowance has been taken into account).
It is important to recognise that although most people believe ownership provides them with more security, when an asset such as a house is sold, any loans taken out against that property are paid out before shareholders receive their dividend. The creditors therefore are in many ways in a stronger position than the actual property owner/ shareholders.
Many people prefer equity crowdfunding as it gives them a real share in a property and a sense of something solid and because they receive both the benefits of a profit from rental income and in any capital growth of the property.
Historically investing in property has proven to be one of the best ways for most people to provide for a healthy retirement income crowdfunding gives you the opportunity to do so in a hassle-free way. It should however be regarded as a medium to long term investment and not a quick win.
Equity investments such as these where risk and reward are shared are normally regarded Sharia compliant and suitable for Muslim investors – though that is a personal decision for each investor.
As far as tax treatment go – as from April 2016 the first £5000 worth of dividend income you receive will be tax free which can make it a tax efficient investment.
Alternatively, debt based property crowdfunding or, to give it its commonly used name peer to peer secured lending, tends to involve short investment periods of 6-12 months. Borrowers are people for whom normal bank finance is not suitable or not available and they are prepared to pay a high rate of interest for a short period. Typically, they are property developers looking to refurbish and flip a property or us the loan for other business purposes. They pay a premium for these short term loans (aka bridging loans) which means the lenders can expect excellent rates of returns – typically 9-10% p.a. with The House Crowd, for example.
Your money is secured against the borrower’s property by the registration of a legal charge in the same way a bank secures a mortgage loan.
As noted above, lenders get priority over shareholders in terms of being paid out when the property is being sold which can make it a very secure investment provided you only invest in properties up to a modest loan to value in case the borrower defaults and the property has to be sold.
For example, we only invest in properties where the money lent is less than 75% of the RICS valuation of a property. That way there is a decent cushion should the property have to be sold quickly at a discount in order to repay lenders.
You do not receive any equity in the property and thus will not benefit from any capital growth but you will have the benefit of knowing what return you will receive and how long your money is likely to be tied up.
The bridging finance industry has been around for decades but crowdfunding companies now enable small investors to get involved in this lucrative market by making loans of just a few hundred pounds.
Peer-to-peer lending will be available under the Intelligent ISA wrapper shortly making your returns tax free.
Peer-to-peer lending is not Sharia compliant as interest is paid to investors.
One of the basic rules of investing is to diversify and spread risk. It is likely therefore to make sense if you spread your investments over both equity and debt based investments and benefit from the tax breaks afforded to both.