McKee and Moore have recently posted on this blog about the problems associated with ‘generation rent’ – namely, those young (but increasingly, older) people who find themselves excluded from home-ownership. More stringent mortgage requirements have given banks an appetite for high deposits, stable earnings and a strong credit history, which renders access to the benefits of a newly buoyant property market out-of-reach for swaths of the population.
However, the desire to make money from bricks-and-mortar has led to a raft of new companies entering the market which offer financial instruments which bypass these institutional controls and allow those previously excluded to invest in property. Even if you cannot afford to own your own home, you can now easily buy a slice of a Buy-to-Let property online from as little as £500. The unrelenting financialisation of housing has come full circle – even those in ‘generation rent’ sitting in a Buy-to-Let property themselves, can now invest in one of their own.
These companies pull these invests outside of the control of banks and other institutions by making creative use of ‘crowdfunding’ platforms, where individuals can invest in start-up businesses or other projects and gain a share of the company; a process made famous by websites like www.kickstarter.com and www.indiegogo.com.
In property investment, this same structure is utilised. Investors are are pooled together to fund a ‘company’ (a special purpose vehicle formed for the sole purpose of investing in the property) which then purchases a buy-to-let property and secures the investors’ shares against its equity. The proceeds of the rent and any capital appreciation (or depreciation) is then shared between them, and the company takes either a percentage fee, a portion of the rent, a slice of the capital appreciation on sale (assuming such appreciation exists), or all three. Although the ‘crowdfunding’ sector is dominated by investments in debt and equity to start-up companies (estimated to be worth a total of £1.6 billion in the UK this year), increasingly, companies are maneuvering around the same regulations to create these bastardised models for the shared ownership of real-estate assets.
One of companies at the forefront of this industry is the House Crowd. Their introductory video outlines the procedure:
In bringing simple online access to Buy-to-Let investment to those who would never normally be able to access the sector, these products have created a secondary market which has the potential to both dramatically change the way people invest in property, and the formation of the private rental market. There is a lot to say about the potential impact these financial products, but in the tight confines of this blog post there are two points worth highlighting.
- The Absence of Regulation
The Financial Conduct Authority now regulates ‘crowdfunding’ platforms in the UK, but none of the regulations are designed specifically for the form of property investment highlighted above. Instead, they class companies such as the House Crowd or Property Moose as ‘investment-based crowdfunding’ – effectively, the regulations are blind to the existence of the property, instead focusing on the purchase of ‘shares’ in the company which facilitates the transaction. In short, somebody investing in a house is seen the same as someone investing in a startup company. There are other regulations imposed on equity-based investments by the Companies Act and the Financial Services and Marketing Act, but these are easily navigated by ensuring potential investors sign-up to the service (and agree to various criteria) before being able to view the properties on offer.
There is a growing appetite, particularly at the EU level, for re-assessing the regulatory framework these companies operate in. However, the input into this process has been devoid of any consideration the role property plays with the focus entirely on investing in ‘companies’ – not a single mention of the use of these financial tools in this way is in the the most recent European Securities and Markets Authority (ESMA) advice, nor following the European Commission’s public consultation on the issue.
Much of the due diligence which underscores good practice in this emerging industry is undertaken voluntarily by the firms themselves – not prescribed by law. Property management in particular has the potential to be a risky activity. The companies themselves decide which properties to float for investment on the cloud – the vetting and management of these rests with the company themselves or the agents they appoint. It does not follow that those skilled at the creation of financial products will be skilled at the maintenance of a property portfolio.
- The industry looks set to tip
The industry is growing at an extraordinary rate. Equity based crowdfunding investments in the UK rose to nearly £100,000 per day in the second quarter of 2014 – a rise of more than 120% on the first quarter. The crowdfunding market as a whole has grown approximately 600% in the last calendar year. The draw of very high potential returns in comparison to more traditional investments – the House Crowd advertises returns of up to 20% per annum – coupled with the British love-affair with property, promises to make the sector particularly appealing to those seeking to draw down on their pension pots following the Pensions Tax Bill or looking for alternatives to the record-low returns available in savings accounts.
A key persuasive factor with these returns in comparison to previous smaller-scale Buy-to-Let investments, is that there is some liquidity and diversification available – albeit somewhat limited. For instance, investors can sell their ‘shares’ in the property to others investing on the platform, and smaller investments allow for them to spread their portfolio across multiple properties to mitigate the exposure to risk. This comes at a cost. Creating fungibility in the system requires the dynamics between the multiple investors to be managed by the platform – for instance, if there are 12 people with shares in the property, and 6 want to sell, or if a group of investors wish to change an aspect of the management of the property. The mechanisms for resolving these issues raise some interesting academic questions about shared ownership.
Academia has hardly even begun to consider the impact of ‘crowd-funding’ on the property market – these investment-based platforms only begin to scratch the surface of what is possible and what is happening elsewhere in the world. It is hoped that as this industry grows, the regulatory framework around it steps up to the mark and recognises the profound impact these investment options could have for the nature of the property market – and the role that banks and other institutions can play in it – in the UK.
Jed Meers, PhD researcher, University of York (@jed_meers)