Property development lending

Really drastic underdiversification is probably harder to achieve. (On the other hand diversification also seems to be capped, and I'm not sure that the level at which it is capped is safe for people investing in the "balanced" product. Lenders are exposed to idiosyncratic risks outside their control. The current situation is analogous to AC's packaged products, but without a provision fund. On the other hand AC's packaged products do involve a greater concentration risk - 15% of my MLIA holding is in a loan that I avoided because I didn't believe that the borrower could service or redeem the loan (the value may have been there, but I didn't believe that the value could be extracted in the time scale of the loan).)

If a black box product is wanted something like a property fund, an open ended investment product with capped outflows, would seem to fit the bill. Or some form of minibonds.

Edit: crossed with dandy .

We shall see.

They can't. They can expect to receive a return lying on a bell curve centred on the published average return. (On the other hand, if your point was that their collective mean return is that of the market as whole, that is true - except that FC seem to have lowered returns.)
I wasn't personally bothered by bots (but did disapprove of the hoovering up of D and E loans), as I wasn't in competition with them - I ran a conservative portfolio, and stopped adding SME loans when the information provided became unacceptably (to me) scanty.

Suppose three points come to mind

1. Valuations are never valid in the scenarios that matter: Valuations are normally based on a benign set of input assumptions. If the development goes anything like to plan, the valuation will probably be valid but you wont' care because it won't be really tested. The valuation only really matters in the scenario where everything goes to hell in a hand-basket. Unfortunately that's exactly the scenario that the valuation input parameters are totally invalid. Take a valuation via the residual method. The GDV is say £25mm, development costs £20mm so the residual value was £5m, loan is £3.5mm, so 70% LTV. Apply a tweak of 15% to the development costs (so £23mm) the residual value is £2mm, and LTV is 175%. Oh dear. Now you could ask for valuations to be based on a "distressed recovery outcome" or some more negative scenarios but frankly you aren't going to want to lend when it tells you the LTV is 175%.

This doesn't imply that I think valuations are good enough. They aren't. Many are terrible. It's just think it's pushing the bounds of plausibility to expect surveyors to come up with valuations in the scenarios where we really care about the valuation. I've see nothing about RICs valuation reports in 15 years of property lending (not professionally) that tells me they would be capable of generating such a scenario analysis. In reality that is our job as investors. What we do need from valuation reports is enough quantitative detail on their assumptions to be able to come up with our own scenarios.

2. More focus on default risk, not just recovery value: There is a tendency for both platforms and forumites to lump bridges and development loans together. On bridges, security is everything but this simply isn't true on development loans. There needs to be an equal focus on debt servicing coverage ratios (DSCR) and the solvency of the developer. Loans probably need covenants. Most mainstream lenders only do commercial development loans on either a fully let or 50% pre-let basis because they want some certainty over futures debt sustainability (and this creates more visibility over the valuation since it's typically discounted income, net of costs, that drives the valuation number). It's far better a development loan simply doesn't default because valuations are highly path dependent and if the developer goes down then the step-in costs for a new company to take over can suppress recovery severely. We get MSRs but, like RICs valuations, they are useful when it doesn't matter and useless in a distressed recovery.

3. What motivates the borrower paying such a punitive rate? Surely the fundamental question that needs to be asked in every loan on a platform like SS (or FS, MT etc) is what motivates borrower willing to pay 15-18% interest + fees of 4-6%? The average margin for a speculative commercial development loan (i.e not fully or partially pre-let) is in the region of 450-500bp for the senior tranche (say 55% LTC based on GDV) and 900-1000bp for the junior tranche (70% LTC), over the lender's long term funding rate (say LIBOR+100/200), with fees of say 200bp. So the borrowers on our platforms are paying 2 x this. The market clearly is not efficient but we have to assume the borrowers are at least making some attempt to get the lowest rate deal.

The question that DD really needs to answer is why are the borrowers forced to pay these punitive rates. There can be very valid reasons, such as needing the capital in a very short time period or something innocuous in the project or borrowers background that makes it difficult to approach more "conventional" lower rate lenders. But equally there may be willing to pay these rates for less attractive reasons; simple desperation, something toxic in the project or their track record etc. In my view the answer to this really is the key to whether you should invest or not. If you can see "good" reasons to pay these rates then invest, otherwise steer clear.

I suppose what I'm pushing back against is the view that you can simply look at a loan, assume that the LTV is say 65%, invest at 12% and be confident that if all goes wrong you can recover your capital because the valuation is solid. That's magical thinking. To earn such high returns, investors need to accept responsibility for doing the necessary qualitative background DD and then also then run the quantitative scenario analysis to see if the loan is a good risk-reward proposition.

As ever, very useful to have the professional view confirm many of the conclusions that p2p investors eventually reach, thanks yangmills .

The thread on the currently available FundingSecure loan based in Gosport is a perfect example I think, highlighting all of the pitfalls you mention. It pays investors rates up to 17% and yet, miraculously, with an LTV of 38% - What a bargain, eh? 

As I lack the time and skills for detailed DD, I limit myself to a few platforms which I consider to be lower risk, and which do not generate hundreds of anguished posts here every week.  I'd rather earn 7% to 9% with *hopefully* much lower levels of anxiety and risk...  I would see investing with FS, Rebs, Ly, etc just to have greater platform diversity as a backward step...