Rebuilding Real Estate With Marketplace Lending
At $8.2 trillion in the United States alone, mortgage debt dwarfs all other asset classes within consumer credit. As marketplace lending has grown, its potential to transform the allocation of capital has captured the imagination of an industry, and, increasingly, the public. While this new way of lending has largely grown around unsecured consumer and small business lending, several exciting companies are working to extend marketplace lending to real estate, an effort that, if successful, promises to have far-reaching implications for our economy.
Many of the circumstances that have necessitated rethinking in the financial world apply particularly to real estate. If bureaucracy, regulation, outdated technology, and less-than-stellar customer service exist anywhere in banking, they definitely exist in the mortgage process. As anyone who has been through the process of obtaining a residential mortgage in the past several years can attest, it is not particularly easy or pleasant. These hurdles apply to commercial real estate as well.
As with any nascent industry, new entrants are offering a diverse set of business models. Below, we explore some of the most common and interesting examples of how real estate lending is being transformed and democratized through technology.
Debt Crowdfunding of Real Estate Projects
If you walk around any town or city in the United States, chances are that you will see a residential real estate project. This might be the construction of a new home or apartment building or the renovation of an investment property. An example of this is a “flip”, in which an investor purchases a property, renovates it, and then sells it at a (hopefully) higher price a short time later. A developer will need a sizable chunk of capital to finance such a project, the source of which has traditionally been from personal savings, family and friends, or various “hard money lenders”.
Now, developers have the option of obtaining project funding through an investor marketplace. On sites including Patch of Land and RealtyMogul, real estate developers can apply for loans to fund their projects through a streamlined, online application process.
The loans that borrowers receive are typically of 3-12 month duration, with APRs in the 10-20% range. The investor experience, while maintaining some parallels to unsecured consumer marketplaces such as LendingClub and Prosper, is significantly more specialized to real estate. Investors can avail themselves of a lengthy project description, property photos, appraisal information, developer biography, construction budgets, financial projections, and risk data.
Equity Crowdfunding of Residential and Commercial Real Estate Projects
It is common practice for any real estate development to be structured as its own corporation, typically an LLC. In equity crowdfunding of real estate, as practiced on platforms such as RealtyMogul and Fundrise, investors can purchase shares in one of these LLCs. Shareholders are then able to earn a portion of the cash flow that is generated from a property (e.g. from rental income) as well as the proceeds of the property’s eventual sale. While equity investing in real estate clearly carries risk, it also affords the investor the opportunity of benefitting from a property’s appreciation in value over time.
Online Mortgage Lending
While the aforementioned categories are very compelling, neither sounds quite like what most people think of as a “mortgage”. If marketplace lending can transform the way that ordinary people finance their primary residences, it will be a truly great accomplishment. LendingHome, LendInvest, and Privlo all promise great strides here. Privlo is doing this today, though only in Texas and Idaho at the current time (the others do not yet allow loans on owner-occupied properties). Privlo lets borrowers apply for a mortgage online and also has a “concierge” to walk applicants through the parts of the process that require a human touch. Borrowers can be approved for a 5 or 7 year adjustable rate mortgage with down payments of at least 20%. Unlike with traditional banks, the submission and review of documentation is performed entirely through an online portal, a welcome respite from the endless faxing or overnighting of paper experienced by most mortgage-seekers. Privlo’s value proposition sits with its ability to use data and proprietary algorithms to qualify borrowers who might otherwise have trouble securing a mortgage, albeit at slightly higher than average rates.
Early Days – Challenges & Scale
Changes in a multi-trillion dollar, highly-regulated industry do not come easily. Indeed, there are quite a few challenges that these new lenders will have to tackle in order to scale their businesses. The involvement of the U.S. government in mortgage lending casts a long shadow, including a patchwork quilt of federal and state regulations. By some estimates, Fannie Mae and Freddie Mac guarantee 77% of all mortgages originated in the U.S. If you include Ginnie Mae, which guarantees loans made by the Federal Housing Administration, that number jumps into the nineties!
In addition, few of the loan structures available in this market today resemble a traditional mortgage. One key contributor to that fact is that of loan duration. While the archetype of an American mortgage is a 30-year, fixed-rate loan, few investors would fund such a loan without a way to create shorter-term liquidity. In traditional mortgage finance, liquidity is achieved with securitization and secondary loan trading. As these innovations make their way into marketplace real estate lending, we will likely see things open up for longer duration loans and higher volume.
Perhaps the most interesting challenge is the fact that we are dealing with an asset that exists in physical space. As the old saying goes: “location, location, location”. Real estate markets are highly local, and many investors want to examine a property in person, only wanting to invest in areas where they have a knowledge of market dynamics. It remains to be seen if investors will be content with online photos and rich web-based content, particularly for properties not close to home.
For many people, a home is both their most expensive purchase and their largest investment. With mortgage lending as a $8.2 trillion industry, this is perhaps one of the largest and most important sectors ripe for disruption as marketplace lending continues its forward march.