CapitalStackers is a loan based crowd funding platform focussed entirely on UK real estate development and investment projects. Sylvia Bowden a Director at CapitalStackers, has explained in great detail the opportunities that CapitalStackers has to offers to investors.
Can you describe CapitalStackers?
CapitalStackers was launched in 2014 and one of the first platforms with Interim Permission to be granted full FCA authorisation in November 2016. Prior to that date we had been deeply involved with the authorisation process for the previous 18+ months. When the FCA announced their intention to regulate the sector we made the management decision to soft pedal on the business development front. We didn’t want to build a portfolio only to discover the business model didn’t find favour with the FCA. We could afford to do this for two reasons:
- Our overhead is low and manageable
- As a direct lending platform, we didn’t have investor monies chasing product. In parallel with the platform development and authorisation process, we could continue with our debt advisory work keeping us in contact with the market and future opportunities.
CapitalStackers is a loan based crowdfunding platform focussed entirely on UK real estate development and investment projects mainly around the major regional conurbations such as Liverpool, Manchester, Leeds, Sheffield, Nottingham and Birmingham (we think of our patch as the M62 corridor, 200 miles wide). The platform was created in response to the demand for alternative and additional sources of finance for real estate following the wholesale contraction in lending appetite by the banks. A motivating objective is also to provide investors with a new asset class giving good returns with bricks and mortar security and comprehensive and wholly transparent detail as an alternative to volatile equity markets and the current low returns from cash deposits.
Our business model is that of a pure peer to peer concept where a group of investors (lenders) directly lend to a borrower for a single specific property deal. The CapitalStackers team originates deals and presents comprehensive information in the data room accessible only to investors who have been registered and completed the KYC process on the platform. Only those deals from borrowers which get through our internal credit approval process (akin to the procedures used by the banks), will be published on line.
CapitalStackers produces a detailed appraisal and cash flow and credit paper which are supported by other available reports prior to the auction. Post the successful take up by investors, CapitalStackers then undertakes formal due diligence on behalf of the group of investors which will include third party professional reports on property title, loan security and valuation. In the case of developments, a monitoring surveyor produces an initial report covering, inter alia, budget costs, planning conditions, site investigation and procurement viability.
The loan documentation is entered into by CapitalStackers Trustees Ltd (“CTL”) which acts as the security trustee for the investors. CTL is a not for profit limited company controlled by Hallidays’ directors. Hallidays, is a 150-year established firm of accountants based in Stockport and a 20% shareholder in CapitalStackers.
Can you tell us more about the management team of CapitalStackers?
All the directors and shareholders co- invest in the deals. This has averaged 33% of deals completed to date, excluding other family members. This ratio will inevitably be diluted over time as the loan book increases in size. More information about the individual team members can be found here: https://www.capitalstackers.com/About/OurPeople
Does CapitalStackers source loans itself or does it use multiple loan originators to do so?
One of the key strengths of the origination team is their strong relationships with borrowers and professional advisers built up over the last 30 years. The directors each have many years’ experience in senior real estate loan structuring roles with the major high street banks including Barclays, Clydesdale, RBS, Singer & Friedlander. The team originates and structures all the deals relying on their historic knowledge of borrowers. Of course, some deals are introduced by intermediaries and professional advisers.
What types of deals are available on CapitalStackers?
Presently most of the borrower demand is for housebuilding and apartment development and refurbishment in locations where there is pent up demand arising from a lack of supply. SME housebuilders have been particularly affected by the high street banks’ withdrawal from this sector leaving them to find alternative top up finance.
In most cases, we are sitting behind a bank which provides the construction finance. Our ‘junior’ debt is deployed first, usually for the site acquisition but sometimes for the first one or two construction payments. Our security is subordinated to the bank and is therefore structured as junior debt with a second charge on the site.
The aggregate of the bank and our junior debt is going to be no more than 75% of net development value (i.e. Gross Development Value less the costs of selling – agent and legal fees). That LTV ratio is not pushing the envelope in terms of risk and we have the ability to layer our funding to reflect a range of risk and reward.
I’m happy to talk this through with some live examples if that would help.
What’s your average lending return after fees but before bad debts?
Returns have ranged from 8% to 23% as per the attached portfolio data summary. These returns are net annualised returns.
There have been no bad debts and there are no fees payable by the investors. CapitalStackers is remunerated from fees and interest margin paid by the borrowers.
The weighted average is 11.8% but this figure is skewed by £1.75m senior risk on a single deal. The range of returns, dependent on the layer and type of deal is demonstrated on the summary.
What is the minimum amount of investment?
The minimum amount of investment in a single deal is £5,000. It is interesting to note that the average investment across all deals written to date is £28,000. The minimum investment can be spread across different risk layers within a single deal – see below.
How does the relationship between Risk and ROI work at CapitalStackers?
Before auction CapitalStackers sets a price expectation for the borrower depending on the maximum Loan to Value ratio, other security held, perceived sales risk and the Loan to Cost ratio. The borrower is only committed to a deal if the auction is fully taken up and delivers an interest rate at or below the target rate. The LTV ratio is calculated to include the roll up of interest and the net development value is taken after agent and legal sale costs have been deducted.
Typically, the loan will be split into two or three layers at different LTV ratios and returns. Layer 1 investors at the lower LTV ratio, will be repaid capital and interest first before Layer 2 and 3 and then CapitalStackers will receive its share of margin income and any exit fee. Therefore, the interests of investors are aligned with CapitalStackers through the remuneration structure – we are likely only to publish deals where we are confident of receiving our income. If we get paid, so do the investors.
Essentially, the higher up the capital stack an investor sits, the higher the risk of loss and therefore the higher the return.
What is the most common thing that investors misunderstand about the above question?
Loan to Value risk is not a difficult concept to grasp (most of our investors will be home owners with a mortgage). We have a slide show embedded into the web site and we are developing a whiteboard animation to better explain to potential investors what the risks are for property development lending. At the basic level, these are from either cost overruns or falling values. We also explain how those risks are typically mitigated. The credit paper for each deal in the data room always covers key risks and mitigants.
It’s a bold statement but we haven’t had any investors with such a misunderstanding.
What is the dual auction process?
A better description would be dual “bid”, given there is only one auction. We have 2 types of bid – “Agreed” and “Non-Agreed”. With an Agreed Bid, the investor is accepting of a return which is less than the target rate – therefore it is automatically agreed with the borrower. An Agreed Bid will always be at a discount to the target rate or the market rate (whichever is the lower). Agreed bids cannot be outbid and suit those investors who are time poor and less price sensitive.
“Non-Agreed” bid returns are set by the investor and can be higher than the target rate but remain subject to being outbid. If outbid, an investor is alerted and can re-bid at a lower rate.
The auction period is typically 1 – 4 weeks and there is no requirement to introduce funds before bidding. Investors are given a date usually within three weeks of the auction close to remit funds prior to completion of the due diligence process.
What are the main risks for lenders and how are they mitigated?
| Risk | Mitigants |
| Deal | CS undertake in depth analysis and financial modelling (including sensitivities) and seek further professional advice from external firms of valuers, cost consultants and project monitors prior to posting any deal. There is no provision fund. The deal structure which requires our internal credit approval, will consider downside sensitivities.
The CS margin and exit fee are payable after the investors are paid in full so that CS has skin in the game and interests are aligned. The shareholders and directors have co-invested in every deal. |
| Application of funds | CapitalStackers is authorised by the Financial Conduct Authority and is compliant with client money segregation procedures. Like other platforms, loans are not covered by the Financial Services Compensation Scheme.
Investor funds are held in a ring-fenced client account before being remitted in whole or part to the solicitor pending legal completion of a property purchase. Funds remaining after completion are drawn down against monitoring certificates which are signed off by both the borrower and Security Trustee. |
| Changes to deal structure | Any change to the deal structure which requires investor approval is put to the vote with a majority or unanimous vote specified, so that investors make the decisions. |
| Security | All loans are secured by a first or second charge – the latter with a Deed of Priority with the senior lender. Development documentation includes step in rights and collateral warranties from the professional design team in the event of borrower default. |
| Security documentation | Due diligence to assess valuation, build costs, title and other risk drivers is undertaken before a deal completes. If the due diligence is not satisfactory, funds are returned to the investors in full. |
| Cost overruns | The appraisals include a contingency level as advised by the monitoring surveyor who also reports on the building contract and budget costings as part of the initial due diligence. The borrower is obliged to inject further equity at the point that any cost overruns are identified. Often there is a guarantor for the loan and cost overruns, especially where the borrower is a special purpose vehicle set up specifically for the development project. Where there is a third-party Design and Build fixed price contract, most of the construction risk is transferred to the contractor. The accounts and experience of the contractor are considered and a retention taken under monthly valuations. Sometimes there will be a performance bond in place.
There are regular monthly reports from a monitoring surveyor posted to the data room alongside the actual cashflow and updated appraisal. There is a traffic light system for highlighting any areas of concern. |
| Fall in market value | The loan plus accrued interest is usually at or below 75% of market value net of selling costs, so that selling prices would need to fall by more than 25% before there is a default in repayment of the loan and accrued interest.
The appraisals include base case and sensitivity scenarios to confirm the funding structure will accommodate a fall in value and/or delays in achieving sales. Where property could be rented, we also look at the downside scenario of refinancing with a mortgage lender as a longer-term hold. A valuation report is procured which reports on present day values with market commentary on supply and demand and comparable recent sales. |
| Borrower default | CapitalStackers Trustees Ltd (security trustee) has step in rights to the building contract and professional appointments in case of borrower default. Often there is a guarantee from the directors or parent company to meet the loan obligations. |
| CapitalStackers default | CapitalStackers is profitable, holds capital as required by the FCA and has a low cost overhead with the flexibility to cut costs to suit. In the event of failure however, there is an agreement in place with Hallidays to manage out the loan book. The cost of this is covered by the inherent margin and exit fees. |
How are the borrowers evaluated, what kind of analytics or methods are used in this process?
We consider their track record of similar projects, look at the skills and qualifications of the management team, analyse published and management accounts of the borrower, complete money laundering checks, check bankruptcy records for each director and check on perceived integrity from local knowledge. Sometimes directors are required to complete personal statements of assets and liabilities.
We spend a substantial amount of time on project analysis (development appraisals, cashflow, sensitivity, internal and external due diligence).
How many loans have been listed on CapitalStackers in 2016?
Three – but see above commentary about our focus on obtaining FCA authorisation. We also completed two large debt advisory deals. In time, the debt advisory deals will become eligible for funding on the platform when we have achieved critical mass.
How many do you plan to list in 2017?
Currently we are publishing one new loan every 3 months so that 2 deals have been listed so far in 2017. Our focus is larger loans, less frequent. Our short-term aim is to increase the frequency to one per month. We have a number of deals in the pipeline. The rate at which these are brought forward will be dependent on fund raising.
How do you define arrears or non-performing loans?
Arrears are where capital or interest is more than 2 days overdue. Loan performance monitoring and management is covered in our “Impaired Debt Policy & Procedure” document which was reviewed and approved by the FCA in conjunction with our Credit Policy.
We rate loan performance by traffic light status:
Green: The transaction is progressing according to plan and is substantially both on budget and on time.
Amber: Problems have been highlighted either by the borrower, through the Monitoring
Surveyor or through internal analysis. These problems are not considered prejudicial to the transaction and no financial loss to CapitalStackers investors is expected. If a default has occurred, it is deemed to be “non serious”. It is however appropriate to understand the borrower’s mitigating actions in more detail and these updates should be brought to the attention of the Watch Committee. The case should retain Amber status until the Committee confirms that the risk of distress or default has fully subsided.
Red: More serious problems have been identified and the borrower has defaulted or cannot avoid a future default on its loan agreement.
What are the conditions for a loan to be considered as defaulted?
(a) Any loan on which interest or capital remains outstanding after the documented maturity date.
(b) Any loan on which there is a breach of covenant incapable of being remedied.
Can you share figures on defaults and recovery rates?
8 deals have been completed of which 3 have repaid.
Defaults – Zero
Recovery rates: N/A
Is there an Auto-invest system?
No. The investors make the decision to lend on specific deals and within a specific layer(s) with all the information available to enable that.
What are strategies that you have seen investors use to make the best of the secondary market?
There has been very little secondary market activity as investors normally want to retain their holdings. We have had one investor sell to meet a need for funds and one sell for a profit who then reinvested in another deal. The investors can choose at what price to sell. Going forward, on the back of underwriting capital and the ability to regularly fund quality deals with speed and certainty, the secondary market will become energised with investment opportunities.
We are currently enhancing the secondary marketplace with a view to stimulating secondary market activity to the benefit of sellers and buyers. A seller will be able to post participations in the marketplace and stipulate the return on offer to a buyer (as opposed to fixing the price). Interest roll up and a changing risk profile and outstanding term mean that the asking price becomes out of date. The new functionality will allow a seller to set the return and sit back.
The benefit to the seller is the ability to ‘publish and forget’ whilst enhancing the base return with a view to re-cycling the cash into new primary market deals. The benefit to a buyer is instant deployment into a deal where the outcome is clearer, the term shorter and the risk reduced.
In your opinion what will the peer to peer market look like in terms of regulation and consolidation in the next few years?
There are some discernible trends being taken by the FCA in their approach to loan based crowdfunding. They are encouraging transparency and I think we shall see better, more consistent and uniform explanations of risk and return and in particular the calculation of underlying security value.
Secondly, those platforms that pool loans using an auto invest system and which are behaving more like asset managers or those behaving like banks, by taking in short term deposits and lending on longer terms, may come under different regulations. The distinction between direct and pooled platforms may become more apparent. As a result, we expect some platforms to drop out of the market, for example Lendinvest who have recently announced their withdrawal from P2P.
Scale is a critical ingredient for profitability and we expect to see some consolidation where those platforms with a strong investor base acquire others for their knowledge and skills.
The demarcation lines between AltFi and traditional funding sources are likely to become more blurred with banks taking on or creating their own crowdfunding platforms.
Do you have any special offers you would like to highlight to the readers now?
Not at the moment. We are considering the creation of an underwriters’ club in order to accelerate deal writing and achievement of critical mass.
For more information visit: https://www.capitalstackers.com/
We thank Sylvia Bowden for the interview.
