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How does investing into property crowdfunding opportunities actually work?
Equity crowdfunding as a way for the investor to get into the property market has seen increasing levels of interest over the past year.
The reason for this is probably twofold.
On the one hand, the prospect of rising prices makes property an attractive investment. This has been a long term trend. The Department of Communities and Local Government records that the average UK house price in 1969 was £4,640. By 2007 this had risen to £223,405.
Property expert Savills predicted a total house price growth of 14.8% at a national level over the next five years in its autumn 2018 Residential Property Forecasts and, according to Halifax, one of Britain’s biggest mortgage lenders, UK house prices rose at the fastest monthly rate in almost two years in December, with the average cost of a home rising by 2.2% compared with November.
For years, buy-to-let has been the preferred route for people to take advantage of a buoyant property market, but the government stepped in with measures to take the heat – and rewards - out of the market.
So, where now does the would-be property investor turn?
At this point, it’s probably worth underlining the difference between a property investor and a property developer.
A property developer is the person or organisation that first thinks of the scheme, identifies the site, arranges the acquisition, secures the necessary planning permissions and then project manages the delivery of the scheme. When it’s completed – or even before - they market it and sell it. The developer essentially makes the whole thing happen.
It’s evident from this that a wide range of skills and expertise is called for in a developer. They need to have a thorough understanding of the market, knowing in what areas there is demand for houses, what kind of houses are in demand there, whether there’s land available and whether it’s going for a reasonable price. They need to be able to call on reliable builders and all the ancillary trades, such as plumbers and electricians.
One other thing a developer needs, of course, is access to finance. Developers need investors.
Historically, a lot of housing development in the UK was undertaken by small independent builders. A major reason behind our national failure to build enough homes has been the decline in the numbers of small and medium sized builders, many of whom were wiped out by the 2008 financial crash. As the journalist and economist Liam Halligan has pointed out, when the UK was last building 240,000 homes a year in the mid-1980s, about two thirds were supplied by such SME builders and they developed plots quickly to aid cash flow.
In the wake of the crash, those independents who have survived, or who are trying to re-enter the market, have been struggling to source funding from traditional channels such as the banks, which are constrained by much stricter capital requirements.
Another result of the crash that is still with us is low interest rates, which mean that savers have been getting poor returns from their banks. But now, online platforms have been set up that allow large numbers of investors to invest together through crowdfunding. These crowdfunding platforms bring the investor and investee together. A refinement of crowdfunding is co-investment, which allows ordinary investors to invest alongside angel investors, institutions and venture capitalists.
Startups and startup investors were among their earliest adopters, and now the property sector has followed, but in this case earnings are related to rental income and property value rather than business performance.
This means that the independent builder or developer starved of funding can now be put in contact with groups of individual investors looking for a decent return on their money.
Property crowdfunding sites use a number of routes to enable investment into specific developments. They include buying equity in a holding company that acquires a portfolio of rental properties, and there are peer-to-peer lending sites, that effectively loan money to individuals looking to acquire properties, perhaps for buy-to-let.
In equity crowdfunding, the platform operator creates a separate company, or special purpose vehicle (SPV) for each development opportunity.
The SPV is a legal entity created for one particular purpose, which, in this context, could be a housing development. It’s usually set up as a private limited company in which investors can buy shares, which will allow the shareholder a share of the profit generated by the SPV when the houses are built and sold. Then the SPV is wound up and the investor’s capital is returned, along with any profit.
The investor’s risks are reduced, because, as with any limited company, the shareholder’s exposure is limited to the amount invested - but there’s still the potential for good returns.
If the houses sell for more than was projected, the return for investors can benefit, because the amount returned to investors is a percentage of the profit achieved equal to the proportion of equity held. If, for example, someone invests £5,000 for 1% of the shares in a small development and that development makes a profit of £250,000, then the investor will be entitled to a 1% share of that profit, or £2,500, along with repayment of his original £5,000 investment.
If the project fails and the SPV has to be liquidated, the investor should still get something back, as the original investment would be secured against the value of the land purchased. If, during the completion of the development, house prices fell and the houses could only be sold at a loss, there is still the prospect of letting them to earn the investors rental income until the market recovers.
As little as £1,000 can be invested in a property crowdfunding project, but this low barrier to entry doesn’t mean it can’t be of interest to the more sophisticated or experienced investors with significant funds at their disposal, any more than it should with any other equity.
What's more, while it is a means of investment that has a clear appeal to retail investors, institutional and professional property investors also have the opportunity to use crowdfunding sites to develop and diversify their portfolios.
Equity crowdfunding is simple in concept and practice and allows an easier way into the residential property market in a way that brings the benefits of being an investor, without the burdens of being a developer.