CROWDFUNDING. Crowdfunding has captured the mainstream imagination in the UK and is set to be the next big real estate investment trend PEER-TO-PEER

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1 PEER-TO-PEER In association with CROWDFUNDING Crowdfunding has captured the mainstream imagination in the UK and is set to be the next big real estate investment trend

2 Introduction...3 Changing Face of Property Investment...4 Crowdfunding: A Modern Take on an Older Concept...5 About CrowdLords...6 Crowdfunding Options...8 Regulation...9 Case Studies

3 Introduction to crowdfunding Crowdfunding has made its mark on many industries globally and is now doing so in the UK property market. It is estimated that the crowdfunding industry was worth 700 million in 2015, but many investors are still not aware of it. Most would say it is still very much a niche product in terms of property investment but with the traditional buy to let model becoming more costly due to tax changes and also a desire to invest with less hassle, property crowdfunding is widely regarded as being in a position to take off. According to the only indepth analysis carried out so far into the industry published in November 2016 by the Investment Property Federation (IPF), it is the British equivalent to a Real Estate Investment Trust (REIT) in the United States but it offers more in terms of transparency and higher returns and also opens out the investor base so that investing in property is no longer the preserve of the very wealthy. There is little doubt that crowdfunding has captured the mainstream imagination in the past 12 months and this should be no surprise given the poor returns on savings offered by banks, and the increasingly stringent lending criteria faced by anyone looking to raise investment capital. The view is that pooling funds with other investors not only spreads risk, but it also boosts an investor s buying power, opening up opportunities to own a share in high yielding, buy to let city centre property, for example, with a relatively small outlay. The result has been an increase in property crowdfunding platforms emerging, meaning that there is now more choice for those wishing to invest in real estate and also more choice in terms of how much to invest. It does not need to be a large amount. The PropTech industry has grown rapidly so the creation of safe, online banking and platforms to list investments means that investment is open to a wider audience. This comes at a time when large scale building of new homes is needed. The British Government now wants to build 300,000 new homes a year and has lent its support to bigger Built to Rent schemes to help meet demand, especially in cities like London, Manchester and Birmingham as a solution for young professionals who don t want to own their own home yet. There is also an ethical dimension to investing in property in this way since new developments will help with the current housing shortage and as much of the investment is with medium and smaller sized developers it will also provide employment in the housing industry. So, at a time when buy to let is losing its sheen, property crowd funding is seen by analysts as the next real estate investment trend that does not have the hassle of voids, high tax, potential low yields and instead offers a different strategy for investing in a housing market that is pushing on upward despite Brexit. 3

4 Changing face of property investment The buy to let market in the UK has taken numerous financial hits recently and some experts believe that it may never again be what it once was. But at the same time it has become much more of a business, and not everyone who wants to invest in property wants to run a business. There are specific changes, particularly relating to tax, but also to regulation and lending, which can make becoming a landlord less attractive and research shows that landlords are indeed opting out. Mark Dyason, managing director of specialist broker Thistle Finance, believes that while the buy to let market is proving to be fairly resilient it has been battered. Buy to let is not what it was, and will never be so again. What we re seeing a lot of, especially among portfolio landlords, is a shift towards specialist lenders as high street banks implement the new tougher stress testing rules, he explained. According to Lea Karasavvas, managing director of Prolific Mortgage Finance, landlords will have to look beyond the high street for borrowing. Owner occupiers and landlords are not on the same page. Home owners have been grabbing low rates while they can while the response from landlords has been far more muted, he said. This demonstrates a sustained shift as many turn their backs on the market. Landlords are waving the white flag after a severe tax bashing from the Treasury over the last two years. This is a statement of intent. Being a landlord is not a hobby, it s an investment that must pay or it s simply not worth it, he pointed out. The number of remortgages by home owners has risen faster than for landlords in the last year and, more recently, is falling slower. Many landlords are effectively signalling that the good times are over and they don t intend to stick around long enough to justify committing to a new deal, he concluded. Buy to let investing also introduces other stresses. Landlords face void periods, demanding tenants, maintenance issues, legal issues and the general need to be on top of things. It can be a hassle with or without using a letting agent. Of those thinking of investing in property, very few are rich enough to have properly diversified portfolios, while piling hundreds of thousands of pounds of partly borrowed capital into just one asset. This is where property crowdfunding comes in. According to those involved it effectively merges peer to peer finance with buy to let to give a wider range of investors access to the housing market with less hassle. Recent Buy to Let Change Stamp Duty An extra 3% stamp duty for additional properties introduced in April 2016 means that landlords pay more for each property they buy. Mortgage Interest Relief Since April 2017 tax relief on buy to let mortgage costs are being phased out, resulting in higher tax bills for many landlords. Before landlords only paid income tax on their net rental income, or profits. In the 2017/2018 year they can claim 75% of mortgage tax relief with this falling to 50% in 2018/2019, to 25% in 2019/2020 and after that zero. Lending Stress Rules At the end of September 2017 new stricter lending tests for portfolio landlords were introduced by the Bank of England s Prudential Regulation Authority. Landlords need to show mortgage details, cash flow projections and business models for every property they own when applying for a new loan. Affordability tests means monthly rental income needs to cover 125% of mortgage payments. Rent Controls In the run up to the general election the Labour Party pledged to introduce rent controls, London Mayor Sadiq Khan supports the idea of rent controls and the law has been changed in Scotland to allow city councils to introduce some form of control in areas where rents are deemed to be too high and unaffordable. 4

5 A modern take on Medieval lending Crowdfunding might seem like a very modern, 21st century idea but it isn t really. As far as property is concerned, in a way it goes right back to the construction of the great Medieval cathedrals in Britain and indeed Europe, where various investors bank rolled the construction of these buildings. The modern product is, however, a direct result of living in a digital world where money can be transferred with ease and financial products sold to investors with the click of a mouse. According to the UK Crowdfunding Association (UKCFA) the definition of crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money. Traditionally, financing a business, project or venture involved asking a few people for large sums of money. Crowdfunding switches this idea around, using the internet to talk to thousands, if not millions, of potential funders. to spread their risk across a diverse range of investments in real estate. The UK needs more homes, both to buy and to rent, and capital is needed to fund the developments. While there are a few big players in the UK property development market, a significant proportion of developments for sale and to let are provided by small, independent, local or regional builders, who need capital to fund their projects, capital that is no longer available from the banks at reasonable rates. Before crowdfunding took off, larger real estate developments were limited to institutional investors who had the necessary experience and the resources to do so. Now a much broader range of investors can get involved and are doing so. Crowdfunding provides much needed debt finance for small developers and new property entrepreneurs and it is unlikely that this trend will slow down anytime soon. As interest rates remain low, it is expected that people will try to get a better return for their money and with a little bit more regulation crowdfunders will soon establish themselves as a long term dominant force in the UK property market, said Natalie Carter, a real estate associate at Mayer Brown International in London. An analysis published in November 2016 of real estate crowdfunding published by the Investment Property Forum (IPF) describes how technology has facilitated the emergence of new approaches that might better meet investor aspirations in a climate of low interest rates and fewer traditional options. The report adds that real estate crowdfunding offers greater transparency, as well as a reduced fee structure that enhances net returns. It describes what has happened as a sprint rather than a marathon and that real estate crowdfunding is expected to continue with its rapid growth and likely to endure into the longer term. For many years a significant amount of property development and investment was funded through Joint Ventures (JV s) either entirely, without any involvement of banks, or to establish the capital needed to enable access to bank lending. Now with digital accessibility these investment opportunities are open to a wider pool of investors whilst enabling them 5

6 Making property investment easier and more accessible CrowdLords was one of the first property crowdfunding platforms, launching in the UK in The founders could see the attraction of the startup crowdfunding model used by CrowdCube, Seedrs and others, where in return for their investment, investors received shares in a new business with the hope that one day, there would be an exit that would provide significant profits. What they didn t like about investing in start-ups in this way was that the valuations that formed the basis of the investment were, at best, unverifiable and in many cases downright ridiculous. In addition, the likelihood is that most start-ups go bust and even if they don t the likelihood of the company being bought or listed is very low indeed. So, by taking the same proven model and applying it to property they could address all of these weaknesses. The value of a property investment can be verified by an independent RICS valuation. The property s ability to generate income, and therefore distributable profits, can be accurately estimated and the likelihood of finding a buyer, and therefore enabling your investors to recover their investments, along with a capital gain, is much higher than with a business. It should, however, be noted that capital is at risk and returns are still not guaranteed for this type of investment. They launched what they described as the first, true property platform in that they had a two sided model. On the one hand they served landlords and developers seeking investments for their projects and on the other provided would be investors a choice of pre-screened, prepackaged investments with varying risk/return profiles. We set out to make property investment easier, more accessible, and more productive for more people, initially through buy to lets. However, almost immediately the Government announced the additional stamp duty on buy to let properties and that made it harder to source properties that fitted our model, said founder Richard Bush. As a result, CrowdLords now offers short term investments into residential developments as well as buy to let investments. Because property crowdfunding was very new at the time, investors preferred short term investments and the move to include developments was very well received. Historically, the only people given the opportunity to make money from residential developments were super high net worth individuals with hundreds of thousands of pounds to invest. We have lowered the entry point to as little as 1,000, Richard explained. Richard and his team take their responsibility for their investors funds very seriously. We were adamant from the outset that we had to do everything we could to protect our users investments and so we created a framework, whereby, the ultimate control of the funds was in the hands of an independent director, appointed to the Special Purpose Vehicle (SPV) Limited Company that facilitates the investment. It is an additional cost that might lower the returns by a percentage point or two, but it provides reassurance way beyond the cost. As far as I know we re the only true crowdfunding platform that provides this extra layer of protection, Richard pointed out. Currently CrowdLords is, on average, funding a new investment every month as the number of users increase, largely through referrals from existing users. Their growth has been much slower than that achieved by others. Building a sustainable marketplace takes time and patience. As long as our investments continue to perform to plan, our investors receive a good return and are happy with the service, then we are content to grow at a slower rate, Richard added. The team at CrowdLords are continually looking to enhance their proposition and plan to launch debt and even ISA based products in 2018 so that they can, if required, provide the full range of finance needed by developers and landlords removing the need for bank finance altogether. 6

7 How does Equity Crowdfunding work? CrowdLords offers an equity based form of investment by issuing shares in an SPV that is carrying out the development or operating A Typical Investor John is a semi-retired, freelance writer, living in Staffordshire, an active investor with a diversified portfolio across ISA s, SIPPS, Funds, Shares, VCTs, P2P lending and crowdfunded investments. Recently he switched emphasis from growth more towards income to reflect his semi-retired, but below the national retirement age, status. I was probably an early adopter when it comes to alternative the rental property. In return investors receive a pre-agreed share of the net profits after tax whether that is generated through rental income or sales revenue. The set up can be summarised using the diagram below: finance. I also like the idea of owning shares in a range of properties without the hassle of managing them myself. I am a great believer in diversification so as well as using CrowdLords I use a couple of the other platforms depending on what s available at the time. I take my time to study the investment and the background of the developer or landlord and if I know the area as well, then that s a bonus. * *Investment returns are not guaranteed. What is CrowdLords? A property crowdfunding platform What do they do? Enable direct equity investments into residential developments and buy to let portfolios Who is allowed to invest? High net worth, sophisticated and restricted investors How is the investment made? By way of shares in an Special Purpose Vehicle UK Limited Company What are the typical returns? For buy to lets total returns of between 8% and 13% per annum. For developments total returns of between 12% and 25% per annum. Investment returns are not guaranteed. How long are the investments for? Investment terms are typically between 12 months and three years How do I register? Go to 7

8 Options for Investors When it comes to property crowdfunding the options for investors have increased dramatically over the last three years. As with all investments, the advice is to look to diversify either across platforms or within platforms. Property crowdfunding is open to eligible investors wishing to invest as well as those looking to raise money to fund a development project or buy to let. There are two main options, debt, often referred to as P2P lending, or an equity investment. For investors there can be a choice of larger or smaller developments and in return for their investment they have the potential to receive a share of the income, usually quarterly, and capital growth at the end of the term if it is a buy to let and a share of the profit for a development. When it comes to choosing a real estate product there are a number of decisions to make including what type of investment, the length of the investment Benefits potential for high returns value of the investment is linked to the property market direct investment in a tangible asset generally over a fixed term it s easy to invest in multiple projects ability to build a balanced investment portfolio flexible product choice you don t need to be a property expert a hands off investment tax planning and the type of project. Many crowdfunding property options are shorter term, just 12 months, but longer term options, over five years are also available. A debt investment generally offers a fixed return and sometimes interest is paid monthly but also quarterly or at the end of the investment. There can be different levels of LTV, almost always as a first or second charge on the property. An equity investment can be in a buy to let or a development, including refurbishments. With this option equity is held as shares in the SPV that buys the property. If it is in an income generating property, such as a buy to let or HMP, then a dividend can be paid monthly or quarterly. For developments returns are usually paid on exit. Some platforms offer the option to sell shares or loan parts on a marketplace can be available but this is not true liquidity and the investor still Risks investments can go down as well as up regulation is still evolving there will be no guarantees will be outside the Financial Services Compensation Scheme usually an illiquid investment higher returns can mean higher risks fees are sometimes payable property prices can go down may find it hard to exit. There is considerable choice when it comes to choosing which type of property to invest in. There is buy to let, refurbishment, Build to Rent, student accommodation and some more specific investments covering land acquisition and planning gain. Options available Existing buy to let properties Properties that are already tenanted where the existing owner or a prospective owner is seeking to release capital. Buy to let refurbishments Properties being refurbished to increase the rental value or converted for use as an HMO. Buy to let developments Properties being converted from residential use or separated into flats or studios and rented out by the developer. Off-plan buy to lets Properties being purchased off-plan to be rented out on completion New builds for sale Properties being built by a developer which will be sold on completion Planning gains Plots of land purchased without Planning Permission and resold once planning has been secured Renovations Properties bought at below value, potentially at auction and restored to sell at a profit. 8

9 Crowdfunding regulation in the UK The approach in Britain to the regulation of crowdfunding is widely admired around the world, according to the UK Crowdfunding Association (UKCFA) and the sector wants to maintain that position globally and be involved in shaping the future outlook of this part of the financial services industry. Most crowdfunding platforms in the UK are regulated by the Financial Conduct Authority (FCA), and platforms must obtain FCA authorisation before commencing regulated activity. However, platforms in other countries may be governed by local regulators, and there may also be regulations for nonresident investors. New rules are expected soon to update the current regulations which date from April These will come out of a review into the sector carried out in 2016 with the aim of making sure that crowdfunding firms meet all requirements to be clear, fair and not misleading with customers. The UKCFA believes that there needs to be some clarification of the rules to meet recent growth and that must also take into account the need to balance and to promote competition and ensure investor protections are proportionate to the risks. The current rules are regarded as being robust for equity property crowdfunding platforms as under FCA rules investor money is held safely by the authorised firm until the target amount for the crowdfunding investment has been raised, and that the crowdfunding platform will be able to substantiate claims made in its investment memorandums. The FCA has indicated, in an interim report published at the end of 2016, that tougher rules are required to protect investors in crowdfunding platforms and it should be easier for investors to compare crowdfunding sites with each other, or with other asset classes, and this is not always easy due to complex and often unclear product offerings. It is not unreasonable from this to expect that the FCA will demand that the platforms consider the best interests of their users by making relevant data more transparent, more consistent, and therefore more comparable. Andrew Bailey, the FCA s chief executive, has indicated that it is in the peer to peer lending sector as an additional source of capital that rule tightening is being considered as this is the section that has changed most. What we are trying to do is strike the right balance between enabling innovation and protecting consumers, Bailey said. Bailey has also indicated that stricter regulations are most likely to facilitate tougher rules on wind-down plans, additional requirements or restrictions on cross platform investment and extending mortgage lending standards to loan based platforms. FCA regulation covers: Investment based crowdfunding where people invest, alongside other investors, in businesses by buying shares or debt securities. Loan based crowdfunding, commonly known as peer to peer lending, where people lend money to borrowers, alongside other lenders, in return for interest payments and a repayment of capital over time. FCA regulation does not cover: Donation based crowdfunding where people give money to organisations or charitable causes they want to support and do not expect a return. Rewards based crowdfunding where people give money in return for a nonfinancial reward, service or an example of the product they have invested in. 9

10 CROWDFUNDING Case Study Co-investing in a central Birmingham residential development Prosperity Group is a Midlands based developer of high quality buy to let and owner occupier residential property focusing on central Birmingham. The land market in Birmingham s central core is very active and there has been a significant increase in site transactions over the past 24 to 36 months. To raise additional capital to assist 10 in securing further positions within the city, Prosperity Developments invited CrowdLords investors to take equity in one of their current developments. B1 is situated in Edward Street and comprises of 61 apartments and two commercial units. The investment was by way of Preferred Redeemable Shares delivering a 15% projected return over 12 months to its investors. Historically, to raise capital for our investments we would work with a select few wealthy individuals who would invest with us on a Joint Venture basis. With CrowdLords, it opens up the opportunity to a much wider audience, some of which are exactly the same profile as the people who buy our completed apartments as buy to let investments. This de-risks capital raising for us, but more importantly, it means that more people get to share in our success, said Joe Billingham, founder of Prosperity Group. The B1 development was listed on CrowdLords in February 2016 and according to Richard Bush, chief executive

11 CROWDFUNDING officer of CrowdLords, it proved to be a very popular investment. The advantage of the Prosperity model is that their properties are not only pre-sold off-plan but, as an experienced developer, they control as much of the risk as they can. For example, they only use fixed price, bonded, JCT contracts to mitigate the construction risk, he said. The investment was fully funded in a matter of weeks. In total, 32 people invested, on average, just under 15,000 each into the SPV set up to carry out the development. They receive regular updates on progress so they can keep track of how things are going. The development is on schedule to be delivered in 2018 at which point they will redeem their shares and receive their original investments along with a projected 15% return. While 15% per annum may seem too good to be true for many investors, the return has to be considered in the context of the other sources of capital used by developers. We use specialist lending partners for our senior debt which has a first charge and our mezzanine debt which has a second charge, so the cost to us of this equity investment is very much in the context of our other sources of funds, said Billingham. And because of our experience we manage the projects to derisk them as much as we can, meaning the risk reward ratio is very attractive to investors, he explained. All involved regard it as a win:win situation, with Prosperity Group enjoying reasonably priced capital and investors gaining access to exclusive investments previously only available to the privileged few. 11

12 PEER-TO-PEER More reports coming soon 12