The Democratisation of Investing
The term ‘Democratisation of Investing’ is a mentality shift full stop. At it’s core it’s an endogenous process whereby the investment world is being shifted internally, making finance and investing in many asset classes including real estate finance, more accessible to anyone with some level of discretionary capital to participate in industries that have long been slow and traditional. It is now easier than ever to become an investor, or a provider of capital especially for those with limited disposable income. This mentality shift is being moved by three fundamental dynamics but equally carries a warning on the label:
A primary factor that has helped this process come to fruition is crowdfunding. This type of investing has been especially well received in many types of investment including the real estate sector. The Crowd provides new benefits for parties either side of any transaction or investment. Before its inception, investing in private real estate was a far greater challenge, since private securities investments (including securities of real estate companies) could not be marketed publicly. Finding deal flow was difficult if you didn’t have the resources or contacts and there was no way to access diversification. Private equity real estate was largely down to personal networking within a very wealthy and professional demographic group of people. Without these connections, the average investor would be excluded due to the ban on publicly soliciting for capital, as well as exorbitant buy-in requirements. This was a challenge too for the real estate companies, as access to capital was limited to who they knew, making capital inefficient.
With the passing of the JOBS Act of 2012 in the US, legislation preventing investors from breaking into the real estate sector was changed and the restriction on general solicitation was eradicated, so small businesses and start-ups could now raise capital and advertise their offerings in a far more public way. This idea soon travelled across a variety of asset classes including real estate. Investors were now able to get involved in private real estate deals from the convenience of their computers, and instead of needing to be an accredited investor on a six-figure annual salary to utilise crowdfunding platforms, unaccredited investors could access the world of real estate crowdfunding, with a small amount of discretionary capital.
While Crowdfunding laid the path to new ways to invest, Peer-to-Peer lending and borrowing provided the gap that private debt had traditionally played. Peer-to-peer (P2P) lending, a method of debt financing that allows individuals to lend and borrow money, without the need for mediation of a traditional financial company, has grown and is changing every day with new types of schemes in which investors can particpate. P2P websites greatly reduce the frictional costs of obtaining a loan, meaning borrowers can enjoy lower interest rates and lenders higher interest rates than they might get on their cash savings in a bank or in the cash ISAs. The mentality shift of how we deposit money and how it’s used has shifted from banking back to the hands of the individual. In short, the government has given the keys back to the individual investor.
The democratisation of investing is here to stay no matter. It’s a mind shift fuelled by technology and systems that are inefficient. It will continue through ground-breaking technological advancements and new ways of uncoupling old ways of doing things. And with more investments in technology used to process financial data, the new challengers will provide real-time investment management through tried-and-tested algorithms that factor in the current market conditions. So what used to be a service deemed suitable only for institutional or high-net worth investors, and a network of contacts, will fast become more widely available online for small investors.
(Warning: Read the Fine Print)
Recently many P2P firms have received criticism for their frequent inability to repay lenders. This happens as a result of the P2P platform’s inability and automated services that actually don’t perform the due diligence and underwriting a traditional lender would undertake. In the quest for volume, lending in some cases has come off the rails. Many SME loans today are lent to cash-hungry businesses (such as SME property developers with little or no track record) at extortionately high interest rates with the platform taking the skin or spread.
Many of these businesses are often unable to repay loans leaving the original lender out of pocket or with returns far lower than advertised. This has led to especially huge controversy and disruption in the Chinese financial market in recent years, with investors being swindled on their savings and P2P platforms collapsing due to third-party borrowers’ inability to repay loans.
Investors need not only to have a clear view of who they are lending to, but also the industry track record of the platform itself and its backers. There are a lot of clever marketing and tech people with no background in real estate development or lending, but who are very good at digital marketing and sales providing these platform services today. And when the markets go up, even a bad loan can be made good, and the market can carry the day. It’s easy to make money in a rising market carried by the tide, but when markets are where they are today, and edging lower with uncertainty over Brexit and a push on rates, a lot of work-out needs to take place for many of these outstanding obligations in order to get things back on track. Most platforms simply don’t have the skill set for this.