By: AdaPia d’Errico
The private lending industry has benefited from several years of growth in bridge financing with fix and flip, purchase, refi, and, more recently, single-family rental financing. While this growth has brought significant institutional capital off the sidelines, another group of early-adopter investors had already been making an alternative play in private money lending and investing through online real estate crowdfunding platforms.
A traditionally private industry, as the name implies, lenders and capital investment companies could not rely on general solicitation and advertising due to private placement rules dictated by the SEC through Regulation D, Rule 506(b). Then, real estate crowdfunding came along and flipped the industry on its head. Crowdfunders leveraged Rule 506(c) and took a decidedly different approach to acquiring investors. They created a user experience akin to e-commerce purchases and applied visual merchandising to present deals. Then, they simplified the process of obtaining investment information (and documentation) making it entirely digital, mobile, and available 24/7.
Having launched a real estate crowdfunding platform in 2014, I realize that what I consider standard regarding targeting an audience and acquiring clients is not the way it is done in private lending. For example, online community development, social media, brand activation, and digital marketing—these are the elements that form the backbone of reaching people who interact online, whether they are digital natives or baby boomers. We are all part of the “connected generation,” and we all use the Internet to inform hundreds of daily decisions.
Beyond the user/client acquisition phase, there are far deeper criteria for engaging with people who may be interested in investing in real estate online. One must understand online vs. offline behavior, expectations, and requirements of a potential client. Decoding the potential investor’s mindset, which may be fraught with well-founded and well-researched concerns, solving for UX (user experience) and CX (customer experience) pain points, and earning trust with a website and strategic content are elements used by the most successful online real estate investment companies.
The number of people investing online and including real estate as part of their investment mix is growing. In the recently published 2017 ‘The Americas Alternative Finance Industry Report,’ research shows that Real Estate Crowdfunding (RECF) increased by 70% to $821.0 million in 2016 from the $483.8 million in 2015. Over the three-year period, RECF saw an average annual growth rate of 160%, and it accounted for 2.3% of the total market in 2016.
The naysayers have been proven wrong. Why are investors interested in online real estate opportunities?
For most private investors, real estate crowdfunding platforms offered the first opportunities for many people to invest directly in real estate as an asset class without writing a six-figure check. That meant few people truly had access to real estate investments, particularly if they did not want to make it a full-time job. Platforms like Patch of Land and RealtyShares, which was co-founded by AlphaFlow’s CEO, Ray Sturm, changed all that by letting people invest as little as $5,000 in great projects from all over the country. AlphaFlow itself purchases loans from private money lenders and online origination platforms to build personalized portfolios for private investors. Below are some insights from our experience and our growing clientele.
What are the some of the most common investor concerns?
Many private investors are venturing into real estate investing for the first time. Their biggest concerns typically revolve around understanding investment risk and possibly feeling overwhelmed by the complexity of investing in certain real estate structures. When deals get too complicated, with multiple types of equity and complex rules and tax situations to map out how they get paid, new investors tend to pull back and wait for a simpler deal. It is one of the reasons first-lien debt on residential real estate has worked so well. The deals with clear value propositions, transparent risks and easily understandable timelines and return calculations tend to fund most quickly.
What makes investors uncomfortable?
Investors will also have a healthy dose of skepticism about investing in real estate if they have never done it before. There is also negative nostalgia around real estate due to the housing crisis and both the real effects felt by so many people and the effects that media has added to the national psyche, most recently with the films, ‘The Big Short’ and ‘99 Homes’. Also, there is discomfort around investing with a new, unknown company. Building trust with a potential client is the number one prerogative of an investment manager, or any company raising capital.
What are the online investors’ preferred investment duration and rate?
New investors—and that may mean investors new to real estate investing or new to an investment platform—typically look for investments with a 12-18-month duration. Once they make a few of those investments and see their payments arriving on time, they have a positive experience and begin to think longer term. They may be happy with their returns but not necessarily interested in repeatedly finding new deals in which to invest because of the burden of time required to do thorough due diligence on each project, and on multiple sites.
This nascent space commands a considerable risk premium from private investors, and in the first few years, many deals (debt or equity) paying less than 9% would languish. However, the last few years has taught many investors that projected returns are not necessarily going to match actual returns every time, particularly with risky equity deals. The result is a shift by investors to include first lien debt in their portfolios, in addition to better understanding the risk-return profile, especially as it relates to LTVs, judicial vs. non-judicial states, and local market factors.
Are investors’ risk/reward expectations reasonable?
A philosophy shared by experienced investors is that you can be a successful investor and incur defaults or losses as long as you have a diversified portfolio to minimize the impact of any single problem investment. Diversification includes a mix of different types of investments within each asset class of your portfolio and a solid mix of asset classes. In online real estate investing this includes diversification across platforms, borrowers, and geographies.
What are the demographics and experience levels of online real estate investors?
In the early days when crowdfunding platforms first emerged, a high percentage of customers were experienced real estate investors. They viewed the platforms as another avenue to access opportunities, particularly in attractive MSAs far from where they lived or typically did business. Because they knew how to evaluate opportunities and projects, they could make investment decisions using the information provided by the platforms, and to further diversify their investments geographically, without the need to make a trip to the property location.
In addition to this group, we have identified two other groups who are regular investors. The first group is made up of highly educated professionals like doctors, lawyers, and engineers who meet the significant income required by SEC regulations but lack time to make these investments on their own. This group is attracted to a passive income and an easy way to access investments, without a significant commitment of time or expert knowledge.
The second group is made up of successful small business owners who, like many real estate business owners, may have started out with their own small, local business and grown that over the years, and with it, their net worth has increased substantially. This group understands and is attracted to the tangible nature of real estate.
Do investors need to speak to someone at the platform? Are they happy to invest online with no interaction?
Many investors are happy to work with platforms electronically, but they often want to kick off the relationship with a conversation. Investors, both those who are unfamiliar with real estate investing and those who have been doing it for years, have many questions and want to speak to ‘real’ people. They are prudent, sometimes skeptical and very smart. They are vetting the professionalism, experience, and expertise of the company, whether they speak to a founder, a VP or a client services employee. While a seamless experience, engaging online presentation, and thorough project information are vital elements to success, investors are seeking to vet the people behind the platform to build a level of comfort and trust before investing their money – no matter how attractive an investment may be on the surface.
How important is investor communication and what does an investor expect?
Clear and honest communication is critical to building long-term relationships with investors. It is especially important when communicating the progress of a project, repayment of loan interest and principal, including delays in payments, extensions, and foreclosure proceedings. One of the reasons online investing is being adopted is that platforms have made it easy and accessible for investors to ‘see’ and evaluate a deal without needing to go on-site to see it in person, or meet the borrower or sponsor. The investor trusts the platform and the deal that is being presented for investment. However, the platform is also responsible for maintaining consistent and transparent communication about the returns ‘promised’ to the investor by way of regular updates, especially when returns do not match stated or expected payments.
If an investor does not receive those updates, or cannot easily obtain progress reports, accurate payment calculations, or is unable to reach someone at the company, their worst fears kick in. Any miscommunication, misinformation or lack of communication creates a situation in which investors cannot wait to get their money back and invest it elsewhere. Given the cost of acquiring customers in the space, that is an expensive mistake.
What percentage of investors are completely new to real estate investing – online or traditional?
Today, we estimate that about 70% of customers have never invested in real estate before working with AlphaFlow or one of the real estate platforms. Also, as we have seen from the research mentioned above, the figures for dollars invested and participants in crowdfunding is growing, but the industry still has not penetrated beyond a relatively small number of early adopters. There is still a large opportunity for reaching the individual investor at scale.
Growth in online platforms has opened private lending and investing to a broader audience. Most investors doing real estate investing online today would not have found their way to a private lender or private capital company.
Understanding the nature of online behavior, and investor requirements and expectations is a key factor in converting interest into investment. However, we cannot discount the importance of active relationship management both in earning an investor’s trust, as well as building long-term relationships based on fundamental business practices and communication.
This article originally appeared in the July-August 2017 edition of Private Lender Magazine.
About the author:
AdaPia is the COO at AlphaFlow. Previously, she was Chief Marketing Officer at Patch of Land, one of the first debt-focused real estate crowdfunding platforms. She co-founded two previous businesses and has served such companies as Disney and Mattel in brand development and online audience engagement initiatives. AdaPia is an active real estate investor and is currently doing a complete renovation of her home.