The pitfalls of P2P for inexperienced investors

Gary Bailey (pictured) is managing director of Hope Capital

Since the dramatic collapse of Lendy Finance, there has been much discussion about whether peer-to-peer (P2P) lending is impacting the bridging market and if so, by how much.

The fact is that all types of investment and lending are good when done well. P2P is a good concept, but there are key elements that must be considered before either investing or borrowing from a P2P platform such as: How the investment actually works and how astute and experienced the platform is in this type of lending.

From a lending perspective, funding a development requires experience, specialism, a huge investment of funds and a sound cashflow, not just from day one but for the whole project.  This can cause issues for inexperienced P2P lending platforms, as they are either relying on new investors to join the platform or for redemptions to be paid on existing loans which can be used for reinvestment.

If either of these scenarios don’t happen then the funds aren’t available to complete their commitment to the developer. Ultimately this could lead to the investor losing money, but also the developer being unable to complete the project, so the implications reach far beyond just the investor.

Investors are the life-blood of any P2P model, but there needs to be complete transparency so they are left in no doubt regarding what they are investing in.  It is imperative the platform makes clear the risks involved and that it is not just a savings account with healthy returns.

Many P2P investors may have little experience of the risks associated with short term lending but the amount of their investment could well be a large part of their liquid wealth. It is easy to be blinded by advertised returns of up to 12% without being aware that every high return also carries high risks.

Those at greatest risk are the ‘mom and pop’ type investors who have a little bit of cash but less knowledge of investment types. They will likely have a mortgage on their home, so could easily believe that they understand how the investment works and that there is little chance of a loss.

In reality, this perception could be their downfall. For example, investment in development finance can often be perceived to have big returns, when this is probably a riskier area of lending, especially in specific sectors such as retail development, but few investors may realise this.

There are therefore risks, both for investors but also for borrowers going through a P2P platform that is not adequately capitalised. Both the potential upsides and the downside of the investment should be as equally promoted, with examples of when things go wrong.

Lending is the easy part, however getting the funds returned is the key to success.  When investments are undertaken with both understanding and transparency, and the P2P platform is experienced in short term lending, it can be a good for the investor and good business for the lender.

As ever, knowledge, experience and understanding combined with transparency from all parties is central to success.

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