“You only find out who is swimming naked when the tide goes out.” This classic Warren Buffet quote quickly comes to mind as many investors tout the strong returns they’ve earned by investing in real estate crowdfunding.
Allow me to say from the start that I’m a huge believer in peer-to-peer investing. As a founder of one of the first real estate crowdfunding platforms, I’ve been in the industry a long time. It’s incredible to look back and remember that in our earliest days we’d need 3-4 week commitments to fund a simple $100,000 single family home loan. About a year later, our customers funded a $550,000 investment in an astonishing 34 minutes!
While we were proud and excited, it also opened our eyes to the fact that many customers had stopped doing their own diligence and were simply trusting us. I have finance and investing at my core, so while it was encouraging as a founder, it just didn’t feel right. Today, this leaves me still excited about P2P investing, but a bit worried that the real estate crowdfunding industry may be focused on growth at the expense of proper controls.
Investors have since taken some lumps, which has brought them to ask advice on how I look at new deals around the industry. Lets start with what is likely the most straightforward deal: first lien debt on a single family home. These investments are really disrupting what’s more commonly knows as hard money, which according to LendingHome, represents an opportunity of about $30 billion annually.
For those unfamiliar, allow me to quickly level-set. Hard money loans, also sometimes called bridge loans, are most often used by those flipping houses. They usually have terms no longer than 1 year, pay interest only, command 10-15% interest, and have a first lien on the real estate. A common misconception is that the borrowers always have terrible credit. In reality, developers are often willing to pay this higher cost because the speed to funding (sometimes days, if they have a pre-existing relationship with the lender) allows them to command discounts from sellers for quick cash.
Underwriting a hard money loan usually comes down to three things:
One additional note on the third point above. Many loans have personal guarantees attached to them. Unless the guarantor has an exorbitant net worth, I don’t give much value to these myself. I worry that these can be handed out to everyone and/or applied to multiple investments on the same site (for those lawyers out there, I’m reminded of law school and how these are both unsecured and unperfected).
There are three other details I look for in particular with crowdfunding sites:
Ultimately, these loans will always be risky, which is why you’ll earn double digit interest rates when they go well. I still strongly believe that crowdfunding will play a large role in the future of real estate investing, and I believe we’ll need great controls and transparency in order to make that happen successfully. Have any thoughts or questions about how you evaluate these deals? Please reach out at Ray@alphaflow.com!
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About the author:
Ray Sturm is a leading entrepreneur in financial technology, and is currently the CEO of AlphaFlow. Prior to launching AlphaFlow, he founded RealtyShares, one of the P2P industry’s top platforms for real estate investing. His early career in finance included investment banking at Bear Stearns, restructuring at Lazard Frères and private equity at CCMP Capital.
Ray has a BBA-Finance from the University of Notre Dame and a JD/MBA from the University of Chicago.