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For the world of real estate crowdfunding, 2013 was perhaps the infancy period. 2014 might be characterized as childhood, with platforms making great progress but still failing to be taken seriously by the “adults.” Looking back on 2015, this year could perhaps be the teen years: fantastic growth and maturation, but also an overabundance of invincibility by both platforms and investors that created some learning opportunities.

The space is absolutely on fire, and that could mean great things for investors in the long run.  As the sun sets on 2015, I wanted to share 10 thoughts on the space:

  1. Huge Funding Numbers: As someone that remembers how hard it was to fund even a $50,000 property in the industry’s early days, I’m so proud and impressed with how many platforms are hitting huge numbers in 2015. To give some perspective, Lending Club funded just over $75 million TOTAL between the start of 2007 and the end of 2009. This year, at least four platforms have already exceeded that number. The ability to fund more capital means better sponsors, who were perhaps hesitant in the past because of uncertainty of closing, are now considering crowdfunding as a strong funding option. That means better deals for investors, and has me excited.
  2. Big Venture Capital Rounds: A number of platforms in the industry executed huge funding rounds for their businesses in 2015, perhaps highlighted by Realty Mogul’s $35 million Series B in July. It’s unclear how much of these rounds are equity vs credit lines the businesses can use to pre-fund deals. In either case, it’s capital that will help the businesses and hopefully lead to better experiences for investors. Given the numerous conversations I’ve had with venture capitalists over the last 3 months, asking for feedback and opinions on specific platforms and founders, I think we’ll see many more of these big rounds in Q1 2016. 
  3. Specialization: A few platforms like RealtyShares and Realty Mogul will still list a large variety of asset classes (e.g. single family home, office, multifamily, retail). More platforms though – particularly new platforms being launched – are narrowing their focus and working to offer their investors specialization. Patch of Land, for example, almost exclusively lists single family residential debt deals. People often debate how this fragmented industry will play out. My opinion is that I don’t see consolidation coming anytime soon (more on this next week), but in the long run I see the industry breaking down by asset class more than geography. I certainly don’t think this is a winner-take-all industry, as real estate is simply too big and crowdfunding is still only a tiny part of the funding ecosystem.
  4. Wait, some deals fail? 2015 brought maturities for a number of deals crowdfunded during the Infancy period, and that meant defaults too. Many investors expressed not only frustration, but absolute outrage when some of their investments failed.  I’ve heard it first-hand, as our users forwarded me emails from various platforms trying their best to apologize. No one wants a deal to go bad, so I empathize with these people, but experienced investors will tell you that it’s part of a normal portfolio. Even Lending Club has about a 5% default rate. To address this, platforms MUST improve their transparency. Secondly, investors are thinking more and more about diversification, which may help take the bite out of defaults (see #8).
  5. Going Offline: Real estate crowdfunding was built on words like “democratization” and “access.” The mission was ostensibly to bring deals previously reserved for institutions to the masses. However, some large platforms are now doing as much as 50% of their deals offline. Great companies like Orchard are helping to connect the ecosystem (Note: We’ve been asked a number of times if we’re competing with Orchard. We’re not, and believe we have a very different vision, and may actually become a customer in the next year). That naturally raises questions of preferences for whomever is funding the offline deals. From a finance standpoint, I understand why they’re seeking larger pools of capital to make their jobs easier. That said, I know venture capitalists are questioning the innovation of this space when so much business is now being done in what’s basically the traditional way (see #2). Much more to come on this in January, but our solution is building a platform that gives you the same power as these hedge funds.
  6. Welcome to the party, Institutions! Many of today’s real estate crowdfunding platforms were launched by great entrepreneurs like Jilliene Hellman and Jason Fritton. Like myself, neither of these two came from an institutional real estate background prior to helping to launch the industry in 2013. This year, with the business model more proven and a strong potential for venture backing, a number of platforms were launched either by institutions themselves or professionals with years or decades of industry experience. I think you’ll see much more of this in 2016.
  7. Investors Flexed Their Muscle: I once heard Ron Suber of Prosper describe marketplaces as seesaws, in which you’re constantly balancing having too much product or too much capital (Note: if you’re not familiar with Ron, google his name and watch some of his keynote speeches. He’s phenomenal.). At RealtyShares, we seemed to hit a critical mass of investors/deals in January 2014. We doubled our previous six months of crowdfunding dollars in the first six weeks of the year. Investors told me they felt like they’d discovered an unknown investment area and began to push to get into deals, and so Ron’s seesaw meant we were scrambling for more product to list. This year, I heard many investors pushing back on platforms and demanding better reporting, clearer and more timely answers to questions, and generally better performance before they’d invest more dollars. The seesaw swung, and the sites responded with lots of “invite a friend and get paid” promotions. (In full transparency, we’d love for you to invite your friends to AlphaFlow too!)
  8. Hints of Diversification: Some platforms are starting to put out more diversified offerings. From Fundrise’s “eREIT” to others offering small pools of properties, platforms are starting to embrace the value of diversification in smoothing out bad deals (see #4). We’re going to do our part to help as well.  Our members have continually asked us to help them easily invest across multiple platforms with one investment. We’ll share details on this after the new year, but we think we’ve put together something incredibly unique and powerful.
  9. Crowdfunding Overseas: Crowdfunding is already making an impact abroad, particularly in Europe, but in 2015 we found new real estate crowdfunding platforms being launched in entirely new markets. For example, PropertyShares was launched in Australia and is scaling much quicker than U.S. platforms did in their Infancy period. U.S. platforms have always talked about tapping international investors, but U.S. investors may soon find great investments around the world.
  10. The Best is Still Ahead: Within the crowdfunding world, we’re all very excited about the progress to date. To outsiders, it often seems like the platforms must be very competitive with one another. The real competition though is lack of awareness that the space exists at all. I spoke to a director of a top platform recently, and he was just back from a real estate conference in which he said he spent 90% of his time explaining what crowdfunding even means in real estate. That’s great news, as it speaks to the immense potential ahead of us.

If you’ve got thoughts on 2015, I’d love to hear them – Ray@alphaflow.com. Next week I’ll share my thoughts on 2016. Happy holidays from all of us at AlphaFlow!

If you enjoyed this post, sharing it on Facebook, LinkedIn or Twitter with the links below is the highest form of flattery. Thank you!

About the author:

Ray Sturm, CEORay 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.

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“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:

  1. Property: Many hard money lenders actually focus almost solely on this item, starting with the assumption that the deal will go bad and they’ll foreclose and still be able to recover their capital and interest. This works with more traditional hard money lending, which often limits loans to 60% LTV.  With most crowdfunding sites going to 75-80% LTV, the next two factors still carry significant weight.
  2. Track Record: Perhaps the most obvious way of evaluating whether a borrower can execute on a fix and flip plan is knowing if he has previously completed similar projects successfully.  Simply having done projects before isn’t enough. Look at similar projects: neighborhoods, price range, quality, budget, level of rehab.  These all matter, particularly as LTVs creep up.
  3. Credit Score: While credit scores seem straightforward enough, this is actually a highly debated aspect of lending today. A number of successful real estate developers experienced hardships during the 2008 financial crisis. Do you consider those, or not? That’s up to you. I’d like the sites to lay out their thinking a bit more clearly on this though.

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:

  1. Investment Structure: We’ll be digging into this more deeply with our legal team in the coming months, but in short, not all “secured” loans are created equal. I put that word in quotes because, with the entrance of Borrower Dependent Notes into the crowdfunding ecosystem, that word can mean very different things on various platforms.  I won’t name names yet, but it appears I’m not the only one who thinks there are deficiencies out there in how investors are being protected.
  2. Controls: Real estate projects are susceptible to many risks, including costs that exceed projections, a drop in local comps, and even national economic risks like unemployment and interest rate fluctuations.  A similar loan made from Wells Fargo likely includes myriad controls, like periodic reporting and loan covenants.  These often function as the canary in the coal mine, alerting the platforms (and investors) if something is wrong before things get too out of hand.  Good platforms are working on integrating these into their processes.
  3. Liquidation Plan (if any): As Warren Buffet’s quote suggests, with this rising market it’s been tough to see who has a good plan for when things go wrong.  I think we’ll learn more about this soon, but some sites have been proactive in putting together workout groups / plans.

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!

If you enjoyed this post, please share it on Facebook, LinkedIn or Twitter with the links below. Thank you!

About the author:

Ray Sturm, CEORay 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.

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“Transparency, honesty, kindness, good stewardship, even humor, work in businesses at all times.” -John Gerzema

In speaking to our customers at AlphaFlow, the biggest worries we hear almost always come down to one word: transparency.  It’s a word easily tossed out by platforms, but they often mean honesty and not transparency.  Honesty means you’re telling people the truth.  Transparency is a higher standard though, in which you’re telling customers everything.  For example,  honesty could mean telling customers that a sponsor has done 50 successful deals in the past 2 years, while transparency means communicating that there are also 3 projects from that sponsor that are currently in trouble.

The industry is growing quickly, and while many platforms are touting transparency, that word often goes no deeper into the company’s culture than the marketing team.  To be clear though, there is a difference between resisting transparency and not yet having the resources to support it well.

Some platforms have been exceptional, like Lending Club, which is incredibly responsive to our needs and is adjusting its API to help enable better reporting for our users.  Patch of Land looks to be following a similar path, understanding that greater transparency for their users is directly going to lead to long term trust and thus success.

Others have been less eager, with common excuses like “that level of data will just confuse investors.” They’re the same sort of condescending things you’d hear a Dean Witter financial advisor say in the 90s when more people were beginning to manage their own portfolios online.  They’re also the sort of excuses that I think will make those same founders blush in a year, when we won’t be able to imagine ever investing without that transparency.

Our customers often ask me what questions they should be asking that most aren’t.  It’s tough to do when you don’t know all of the potential skeletons.  Most of you have already been sharp enough to ask things like: Are the returns shown to me net of all fees?  Has the sponsor ever had a bankruptcy? (not uncommon for real estate developers who were in the business in 2008)  What is the sponsor’s track record?

These are all good questions.  Here are 5 deeper questions I’d want to answer before investing in a deal:

  1. Has the sponsor track record been verified in any way by the platform?
  2. Am I really being protected by the investment structure, or could the sponsor make money while I lose everything? (you’d be surprised)
  3. What is the track record of this sponsor for ALL deals on this platform?
  4. What is the platform’s Projected vs Actual track record for underwriting this type of deal?
  5. Did you pull the comps, or were they provided by the sponsor’s agent?

I’m also particularly interested in how platforms will handle the process of a deal going bad (default, underperforming, non-performing).  Many platforms appeared to believe, “I’m well funded and will hire good lawyers if a deal goes bad.”  However, we’ve seen many learn the hard way that it’s harder than they thought, and their investors have been kept in limbo particularly with equity deals in which forcing action can be more difficult than with a defaulted loan.

As someone who worked in corporate bankruptcies and restructuring during the 2008 financial crisis, I know first-hand how complicated these transactions can be.  I’m eager to learn who is best prepared to protect the capital that investors worked so hard to earn, and who still has work to do.  Having someone mediocre vs someone great advocating for you can make the difference between recovering everything and walking away with nothing.  Not every deal is going to go as planned, which is why one of the pillars of prudent investing is diversification.  However, being transparent with the bad lends tremendous credibility to platforms when they tout the good.

We’re continuing to work on answering a number of these questions for our users.  We’ve been pleased to have a number of platforms reach out to integrate with us and embrace transparency, and we’re hoping those resisting it will soon change their stance.  As a mentor once told me, “If you don’t like change, you’re going to like irrelevance even less.”

If you enjoyed this post, please share it on Facebook, LinkedIn or Twitter with the links below. Thank you!

About the author:

Ray Sturm, CEORay 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.

AlphaFlow - Informed P2P Investing

“Now that you’ve left RealtyShares, what do you really think of the real estate crowdfunding industry and the various platforms?” That is the most common question I’ve received from our accredited investors, venture capitalists, and deal sponsors. In response, I’ve created a series of posts to share my insider’s perspective on the industry and the players. Not only will I answer this most frequently asked question, but I’ll share how I’d look at deals, and how I might build my own portfolio.
3 things I’m keeping an eye on in real estate crowdfunding:

  1. Deal Discipline
    Many of these platforms have done extremely well in building robust sourcing pipelines and groups of active investors, like you. The result of this success for many platforms has been additional rounds of venture capital, in some cases taken at valuations you’d rarely see in other industries for companies with the same performance metrics.
    That means more resources for these companies, but it also creates two potential areas to watch: (1) Big rounds come with huge expectations, and (2) Large raises can create desperation from competitors who worry about being left behind. While fundraising for RealtyShares, I met with a number of VC firms and they usually drilled down on 3 KPIs (Key Performance Indicators): dollars raised, number of deals closed, and registered investors. Marketing can help to solve the last one, but some platforms may be tempted to lower the underwriting bar in order to help boost the first two metrics. Will they? This leads to the next item I’m watching.
  2. The Feedback Loop
    Unlike some other P2P investment categories, like consumer debt investors have been able to access on Lending Club and Prosper, real estate often has a longer feedback loop (i.e. do these investments perform as advertised?). Some sites focused more on short-term fix-and-flips, for which results came in a matter of months. Others have done multi-year deals – many as long as 10 years – so we’ll need more time to see how those perform. As deals mature, though, we’re going to get a clearer picture of which platforms and even sponsors have the best results compared to what they projected. As an investor, if you were looking to add multifamily to your portfolio, wouldn’t you want to know which platform has done the best job of underwriting these? Me too. I’ll be watching this closely.
  3. New Platforms
    As early players like Fundrise and Realty Mogul continue to prove out real estate crowdfunding, we’re seeing the entrance of many new platforms looking to tap into this market. Some are being launched by those with phenomenal industry experience and see an opportunity to create niche products that aren’t being addressed adequately yet (e.g. 1031 exchanges and SD IRA investing). It’s getting tougher to identify who is real vs who has just slapped a website together, but I think a year from now platforms that don’t even exist today will be major players offering strong investment opportunities. I’ll be watching, and I’ll share those I think are particularly interesting.

Want an insider’s perspective? Email me your question and I’ll try to address it here.
Ray@alphaflow.com. I’d love to hear from you!

If you enjoyed this post, please share it on Facebook, LinkedIn or Twitter with the links below. Thank you!

About the author:

Ray Sturm, CEORay 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.

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