Assessing Investment Risk – Loan to Value (LTV)
All loan investments offered on the Proplend platform have one thing in common, they are all supported by way of a first legal charge secured against an income producing UK commercial property. Loan to value or LTV helps investors assess their level of risk when making their initial investment and in the unlikely event of a loan default.
The LTV reflects the loan amount as a portion of the value of the property, so a property valued at £1,000,000 with a loan of £750,000 reflects a LTV of 75%. The difference between the loan amount and the value of the property is the property owners’ equity amount, in this case 25% or £250,000.
LTV is important to investors in the loan because it reflects the amount that the property could fall in value before their capital is affected. In this example it could fall by up to 25% or £250,000 before the loan principal is impacted. The borrower is the one who takes the first 25% loss of value through their equity, this means that investors in property loans are much less exposed to the day to day volatility in the property market, as they always have an equity cushion protecting their investment.
In the event that the property fell by more than 25% then this would impact the underling loan principal. For example, a 35% fall in property value would mean that when the property was sold it returns £650,000 against the outstanding loan amount of £750,000, crystalizing a £100,000 loss to investors. This loss would be shared pro rata by all lenders based on their share of the loan.
The higher the LTV, the less of a cushion there is to absorb property price volatility and therefore the higher the risk that the loan may incur a loss of principal. The lower the LTV, the greater the cushion and therefore the lower the risk. Loan interest rates should reflect the associated risk that an investor is taking and so in theory, the higher the LTV, the higher the interest rate an investor should receive.
Proplend recognises that not all investors have the same risk and return requirements, so we created our P2P Tranche Loan Model. We have adopted a structure traditionally used by large financial institutions when syndicating £50m+ loans. Rather than a single whole loan, the loan is split into three different LTV based tranches, as we have seen, LTV is a good indicator of how exposed to risk a Proplend investor is.
Investors in Tranche C earn a higher interest rate return than investors in tranche A of the same loan, as they are lending at higher LTV levels and are accepting greater risk. As with most investments, the greater the risk, the greater the return.
What this means is that cautious investors, who invest into Tranche A, have the comfort that the property can fall in value by up to 50% before their investment is impacted. In return for receiving a higher interest rate return, Tranche C and Tranche B investors would absorb those losses.
In addition to choosing the Tranche, which gives a LTV range, you should also consider the overall LTV of the loan. For example, if the overall LTV is 55%, the loan will be split into Tranche A and Tranche B. Whilst you would normally assume that Tranche B goes up to 65% LTV (with 35% capital protection), in this specific loan it only goes up to 55% LTV. This means that even though the investment is in a Tranche B loan, the property could drop in value by 45% before the principal investment is at risk. This shows that even within a Tranche range there can still be varying levels of LTV risk.
Conclusion, when investing in P2P loans via our online platform bear in mind
- Overall LTV and which Tranche you choose to invest in is a good, but not the only indicator , of how exposed you are to risk
- Every loan is secured against property
- Proplend offers full transparency on every loan and gives investors access to our Loan Request document plus professional valuations and legal reports
- You are free to choose which loan and which Tranche of that loan to invest into based on your individual risk and return parameters
- Your capital is at risk
