What happens to your money when the collateral has to be enforced in real estate crowdlending
"Deal secured by a first-ranking mortgage". You read that on the listing, your shoulders relax and you carry on scrolling down to the return figure.
IN THIS ARTICLE 6 sections
That's understandable, because the word "secured" sounds like a safety net. But collateral is not insurance that gives you your money back if the project goes wrong: it is a right to recover what you are owed from something specific, ahead of others, after a process that takes time and costs money.
To know what would happen to your money on the day it has to be enforced, you first need to look at two things: what type of collateral you have and which asset it is over. Let's take them in order.
The types of collateral you'll see, from strongest to weakest
They don't all carry the same weight, even if they take up the same line on the listing.
This is the strongest. If the developer doesn't pay, the mortgage can be enforced against the property, the property sold and you are repaid from the proceeds. The word to look for is the ranking: with first ranking you are paid before anyone else, and with second ranking you are paid only if something is left once the prior creditor, usually a bank, has been paid in full. That one word changes the risk more than any other detail on the listing.
If the developer defaults, the investors take over the shares of the company developing the project. It sounds similar, but it isn't the same: you end up with the company, its half-finished building work and its debts too, and someone will have to manage all of that.
The developer, or its parent company, is liable with its own assets. It is worth exactly what those assets are worth at the moment they are needed, which is something that is almost never on the listing and is worth asking about.
Accounts that money cannot be taken out of without authorisation, amounts withheld until the building work is certified, insurance policies, letters of commitment. They help make sure things are done properly, but they are not something you can collect from if the project fails.
Collateral is only worth what the asset is worth
This is the part that decides whether that mortgage is any use to you.
Collateral is a right over a thing, so everything depends on how much that thing is worth and how easy it is to sell. The first is measured by the ratio between the amount lent and the value of the asset, the well-known LTV (loan-to-value): if 50% of its value has been lent, there is plenty of margin for a forced sale to cover the debt; if 80% has been lent, the margin is thin and any fall in price eats it up.
The second is less technical and doesn't show up in any percentage: a finished flat in a city with demand sells, while a plot of land without a building permit in an area with no activity can take years to find a buyer. The same mortgage over two different assets is not the same collateral.
And it is worth checking when the valuation was done and who signed it, because a value from two years ago describes a market that no longer exists.
Enforcing collateral isn't a matter of pressing a button
This is the part almost nobody mentions beforehand, and the one that surprises people most when it comes.
When a developer stops paying, nobody turns up the next day with your money. Proceedings to enforce the collateral are started, and they take months, often years, with legal costs along the way that come out of the amount recovered. The asset is usually sold on worse terms than in an ordinary sale, because it is sold when it has to be sold, not when it suits. And if insolvency proceedings are involved, the timescales stretch out even further.
The usual outcome is neither black nor white: part of the money is recovered, later than expected. That is why collateral reduces what you can lose, but it eliminates neither the loss nor the wait.
If you invest in equity, there is usually no collateral
It is worth saying clearly, because it is often confused.
Everything above usually applies when you lend money. When you invest in the equity of a development you are not a creditor, you are a shareholder: there is no mortgage in your favour, there is nothing to enforce and you are paid last, once everyone who lent money has been paid. In exchange, what you can earn is not usually capped at an agreed interest rate.
It is neither worse nor better, just different. That is why it is worth bearing in mind that the return on an equity deal is not directly comparable with that of a loan secured by a first-ranking mortgage, as they involve different levels of risk and different legal structures.
Collateral is plan B
No deal is designed to end with a mortgage being enforced.
What is expected is that the building work is finished, the flats are sold or the bank refinances, and that you are paid with that money on the scheduled date. Collateral is what remains if that doesn't happen, which is why looking at it helps you gauge the damage in a bad scenario, not spare you from analysing the good one.
Put another way: a weak project with good collateral is still a weak project, just with a less bad way out.
