House-Flippers Turn to the Crowd for Quick Cash. What Could Go Wrong?by
Marketplace lenders for real estate provide speed, flexibility
But speed and property loans may not mix -- remember 2008?
Alex Sifakis never raised this much money this fast.
The house flipper from Jacksonville, Florida, crowdfunded nine deals totaling more than $9 million through RealtyShares over the last two and a half years. A July deal for $1 million took him just 12 hours.
“Generally, raising money takes so much time,’’ said Sifakis, 33. “This offers so much flexibility and time savings. It’s so much better than going to family offices, banks or Wall Street firms.’’
House flippers and property developers are increasingly crowdfunding -- tapping the virtual wallets of anonymous internet backers on platforms such as RealtyShares, LendingHome, PeerStreet and Patch of Land. For riskier ventures, such as building new homes and buying, renovating and selling existing ones, they’re finding quick financing can be easier to get online than from banks. That’s contributed to an increase in home flipping. In the second quarter, 39,775 investors bought and sold at least one house, the most since 2007, according to ATTOM Data Solutions.
The crowdfunding sites are part of the multibillion-dollar ecosystem of marketplace lenders, like LendingClub Corp. and Prosper Marketplace Inc., that match users who need money with people who want to provide it for anything from debt consolidation to elective medical procedures.
That business hasn’t always run smoothly. LendingClub is going through a rough stretch after years of rapid growth. In May, its founder and chief executive officer resigned amid an internal probe into a botched loan sale, sending LendingClub’s shares tumbling.
So far, there have been few defaults in real estate crowdfunding deals. When they happen, the platforms say they’ll pay investors the proceeds from property sales.
The business has other potential pitfalls. When it comes to real estate, faster isn’t always better. Wall Street’s home-mortgage machine of the mid-2000s valued speed over accuracy, with disastrous results, though most crowdfunding sites cater to investors and not homebuyers. Also, clicking for capital can be exploited by fraudsters who may not be who they say they are, according to Sara Hanks, co-founder and CEO of CrowdCheck, which provides due-diligence services for online investors.
“We’ve seen some things where the entity that’s supposed to own the property doesn’t actually own it,’’ she said.
To keep a lid on fraud, PeerStreet doesn’t originate loans like most of the other platforms. Instead, it created a secondary market. It buys hard-money, or high-interest-rate, loans made to real estate investors and spreads the risk among individuals, who purchase pieces of them online.
“If you’re originating and selling, you’re just trying to get as much volume as you can,’’ said Brett Crosby, a Google Inc. alum who co-created PeerStreet and is now chief operating officer. “In order to get more borrowers in the door, you start to drop underwriting guidelines.’’ PeerStreet got an early investment from Michael Burry, the hedge fund manager who was played by Christian Bale in the movie version of Michael Lewis’s 2011 book “The Big Short.”
The ease of fundraising through these nontraditional lenders could be a warning sign, according to Erik Gordon, a law professor at the University of Michigan in Ann Arbor.
“Whenever you see a big difference between the terms on which you can raise money in one market versus another market, something is wrong in at least one of those markets,” Gordon said. “It usually is the market with the least-experienced players, and they usually end up wishing they hadn’t played.”
Sifakis said he’s borrowing money at an annual rate of 14 percent over two and a half years. He keeps all the profit he makes from selling homes, he said.
Crofton, Maryland-based Caruso Homes Inc. used RealtyShares to build new houses in Raleigh, North Carolina, and Washington, D.C. Wall Street isn’t as interested in financing single-family developments in smaller and medium-sized deals, making crowdfunding a better way to fund Caruso’s projects, said Chief Financial Officer Jack Haese.
The companies are in the early stages. Patch of Land said it’s originated more than $180 million in loans, RealtyShares said it’s raised more than $200 million for real estate deals and PeerStreet said it’s funded more than $100 million. LendingHome won’t say how much it’s generated -- the company started crowdfunding only this year. Those totals are peanuts compared to platforms like Lending Club.
Jeff Bullian, a Boston-based consultant, has invested in about 30 deals on RealtyShares and in a handful of others on websites such as Patch of Land. So far, only one deal has gone bad, he said. In that instance, the platform, which Bullian declined to identify, went to bat for investors so everyone could get their money back along with a small return.
Bullian said he contributes an average of $10,000 in each deal for returns of about 10 percent to 20 percent, similar to what he was getting from a marketplace lender.
“I really like the risk profile of real estate deals compared with some other investments because they’re secured,” Bullian said. “If something goes bad, you have the asset to fall back on.”
U.S. Securities and Exchange Commission regulations require investors to be accredited, or meet conditions such as an annual income of at least $200,000 or a net worth of $1 million. Individuals generally put in a minimum of $1,000 to $5,000 and are promised interest-only payments each month, with the rest of their money back at the end of the loan term. Some enroll in automatic options that invest in a variety of deals for diversification.
Through RealtyShares, investors can raise different kinds of debt and equity. The company verifies and underwrites every offering, according to CEO Nav Athwal. Of the prospective projects brought to the company, only about 3 percent are selected to be listed, he said.
LendingHome keeps loans in a bankruptcy-remote entity so the debt and repayment streams are insulated from anything that may happen to the firm. The company had previously only offered loans to institutional investors, according to CEO Matt Humphries.
Patch of Land also keeps loans in a bankruptcy-remote entity. The company generally requires borrowers to provide personal guarantees and to put at least 20 percent of their own money into deals, according to AdaPia d’Errico, the chief marketing officer.
Sifakis, the Florida flipper, said he typically gets a $3 million line of credit from an investment firm for about every $1 million he raises on RealtyShares, giving him added buying power.
“It’s the greatest thing in the world,’’ Sifakis said. “The amount of money you can raise isn’t limited by anything but their investor base. And the investor base is growing and growing.”