Real Estate Crowdfunding Experiment #1 – Background and Introduction

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After I took out roughly $7,500 out of my P2P lending experiment, I started looking for another place to put my money at risk. 🙂 I decided on trying out real-estate crowdfunding, which tries to make real estate investing (either through equity or debt financing) more accessible to individual investors. Right now, all of the major sites require you to be an accredited investor as defined by the SEC. Keep in mind that these investments can be quite risky and that this is an experiment with a small portion of my portfolio set aside specifically for such purposes.

I’m going to be upfront; I didn’t spend an enormous time vetting each and every website out there. I swapped a few quick e-mail questions with a few sites and signed up with some of them (you have to sign up for a free account in order to view the investment opportunities). Due to my analytical tendencies, I missed a bunch of them because the good ones were often fully funded within 24 hours. Other times, I had time to do more research and simply never got back around to it. I finally set some simple criteria and decided that I would jump on the next one that fit the bill. The criteria:

  • Try out one of these new crowdfunding real estate websites – Realty Mogul, Fundrise, Realty Shares, Patch of Land, and others.
  • Single or multi-family residential property.
  • I wanted to be a lender, and the loan must be secured by the property, in the first position.
  • Short-term financing deal with 1 year term or less.
  • Loan-to-value of under 80%, based on my own rough numbers.
  • At least 10% annualized return (10% APR interest).
  • Invest only $5,000 per property.

I found an investment that fit, electronically signed the required documents, and the deal appears to have completed funding. Here are the results:

  • Patch of Land
  • Single-family home in West Sacramento, California
  • Loan is secured by the property, in the first position. Also have personal guarantee from borrower.
  • 6-month term (roughly April 15th to October 15th), with the goal of a quick rehab and reselling of the property.
  • LTV is 78% per my rough numbers.
  • 11% APR interest, paid monthly.
  • $5,000 invested.

pollogoI’m not sure exactly what details of this investment I am allowed to share, so I’ll save that part for later. It will be good for you guys to pick apart, but it doesn’t really matter for other investors as the project is already 100% funded. I’m just waiting on my first interest payment in May, and hope to be done by October. At the end of the year I will get a 1099-INT.

Here’s part of the pitch for Patch of Land:

Patch of Land is a curated real estate debt crowdfunding platform that sources, originates, and underwrites loans to professional, experienced real estate developers. Patch of Land is one of the first real estate crowdfunding platforms. We have been building a strong track record of funded projects and investor returns since 2013. We are considered one of the top 5 real estate platforms by leading crowdfunding publications.

Loan proceeds are used to rehabilitate residential and commercial real estate properties across the country. Loans are secured by the underlying property and personal guarantees from the borrowers. Patch of Land then matches those loans with accredited and institutional investors for funding. Loans are issued for terms of 12 months at rates ranging from 10 to 18% APR, paid monthly to investors.

What I liked about Patch of Land is their stated commitment to individuals provide significant funding and also that many of their borrowers are experienced individual real estate investors. In that way, it’s almost a peer-to-peer feel, as opposed to institutional investors providing the cash to large real estate organizations.

Along those lines, Patch of Land recently completed a $23.6 million round of funding, and $3.6 million of that came from SeedInvest, a crowdfunded start-up investing firm. So technically, I could have also been a part-owner of this start-up as well. For now, I’ll stick with being a “real estate lender” and maybe I’ll add the “venture capitalist” title later. I would like to invest another $5,000 into partial ownership of a commercial property via another crowdfunding site.

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Comments

  1. Do they actually verify that you qualify as an “accredited” (aka rich) investor? If not, is there any actual mechanism to stop non-accredited investors from participating?

  2. This is interesting. Looking forward to seeing how it goes.

  3. I’ve placed investments with RealtyShares, RealtyMogul and Fundrise. At RealtyShares, I placed a number of $5k equity investements in projects relating to individual properties. At the other two, I placed single, larger investments—a single property (Hamptons) at Fundrise and a mobile park investment fund at RealtyMogul.

    All of my investments at RealtyShares have been paying their interest precisely on time. One of the investments was paid off early, returning exactly the 19% annualized return that was promised along with the original capital.

    My investment at Fundrise went a number of months without any updates posted to the website. The website did report interest “earned”, but that didn’t correspond to interest paid out. When I emailed them about the project last week, they responded that the property has just placed under contract, and that we should receive our principal and interest within a week.

    My investment at RealtyMogul has made one scheduled interest payment, but it was lower than anticipated.

    In all of these investments, the investor takes part ownership in an LLC that is formed to fund the project, and receives K-1s at the end of the year to reporting earnings and losses. What I didn’t realize, was that this requires that you file a tax return in each state where the LLCs exist (evidently).

    Of the three services I’ve tried, the Fundrise website seems the best designed, and their projects seem the best researched and unwritten. They also take on the largest investments—many with minimum investments of $50k. Event though I haven’t been happy with the level of reporting, I would probably invest again with them.

    I would definitely continue to invest with RealtyShares. They seem to focus on smaller projects—often single homes—with short durations on the order of months or up to a year. This lets the investor get quite diversified. On the other hand, that diversification can carry additional costs related to the tax reporting in various states.

    All in all, even though the first investment to have fully run its cycle returned 19%, I’m still not comfortable enough to commit to it as a permanent class in my overall allocation. Why? Because an interest in minimizing overhead would lead one to make a few large investments. But I’m not a real estate expert, and the only way to mitigate that information/expertise risk would be to heavily diversify (just like note diversification at LendingClub). But that diversification brings a lot of overhead, in tracking and reporting.

    In the long run, I’ll probably just stick with REIT ETFs.

    • Thanks for sharing your experiences!

      Tax issues are primarily what I e-mailed each site about, as I didn’t want any more tax stuff wasting time (and thus decreasing my real ROI). That’s why I decided against equity at this time and instead focus on debt. With this loan, Patch of Land assured me that I should just get a 1099-INT at the end of the year. Of course, if the loan defaults and we have to take ownership of the property that will be messy but at least educational in my opinion about the process.

  4. This is interesting. One thing I can’t understand is how are you getting 11% if mortgage rates are at 3%. In other words, if I wanted to buy a house I would get a 3% mortgage instead of looking for a private citizen loan at 11%. We are flooded with free money by central banks around the world. Interest rates are negative in Europe, which is insane. That means if you loan someone money, you have to pay them interest. So, in this crazy world you are getting 11%. Sounds too good to be true.

    • 3% loans are only for owner-occupants that conform to the requirements of Fannie or Freddie or similar. They also take 30+ days to close and require a lot of documentation.

      This is a loan for an investor who never intends to live in the property, needs the money fast because the property is in distress or foreclosure, and intends to flip the house in a short period with a ROI much higher than 11% annualized. In the past an investor would have to go to a hard money lender at rates that high or even higher. If you pay off a 11% APR loan in 6 months you’re only paying 5.5% flat and the investor plans to earn a lot more than that on the leveraged flip.

  5. Joanne S. says:

    Interesting idea.

    I did a bit of research and found a comprehensive listing of some of the main sites – http://www.crowdcrux.com/top-real-estate-crowdfunding-websites/

    Looks like there’s a lot of competition in the space already.

  6. Small world – I live in West Sacramento. I’m curious what street this is on as there are two distinct sets of houses, ones built <2005 or so that are usually from the 1980s or before and a newer wave built in 2005+. This is probably one of the older ones.

    Re: interest rate of 11%, I am nearly certain that the borrower(s) did not qualify for a standard mortgage, else they would have pursued one. So this investment has much greater risk than other vehicles, leading to the higher interest rate. That's just a basic law of economics – higher return = higher risk. There are some opportunities for a free lunch but they are few and far between.

  7. The investment Patch of Land is rolling out is commonly called, “hard money lending”. I have personally been a private hard money lender for over ten years and regularly earn a rate of 12% plus loan points. I lend on local properties from borrowers I am familiar with. These rates are very high but are just for a short term business opportunity. Many real estate investors (house flippers) depend on private financing as traditional lenders do not lend on distressed properties, have long underwriting periods that are not practical for opportunistic investing when immediate cash is needed for the best deals. Experienced investors and home builders work the cost of this capital into their business plans.
    The problems I have had with companies packaging these loans to small investors is their ever increasing desire to do more volume at the expense of loan quality, eventually leading to high default rates etc. I now do private loans myself with great results. Thanks for taking the plunge with Patch of Land, will following the results.

    • Thanks for sharing! Yes the debt crowdfunding for these SF properties is pretty much hard money lending.

      Yes I agree the loan quality will probably go down, either that or the interest rates will go down, or some combination. In return I get easier diversification ($5,000 per property), convenience (click click and I’m done), and greater availability of opportunities outside my local area. It will be interesting how it shakes out.

    • Dan–
      I think these websites/platforms are seeking to disintermediate hard money lenders but offering better rates to the borrowers and offering ease of execution (sit at your computer), a lower entry point ($), and easier diversification to the capital providers/lenders.

      I would be really interested to hear more about your experience doing hard money lending. How did you get into it? What kind of legal structuring do you do? What kind of security/collateral do you get? How do you find good borrowers? What kind of rates do you charge including origination? How common are defaults? Any case studies of a project that went south? How big is a typical loan?

      Thanks!

      • Hi Andy,
        I really like this space in investing as the risk/reward ratio is attractive as traditional lenders have for the most part exited this type of lending and entrepreneurs have taken over. I got involved in this business as an extension of my Real Estate Investing, I am a full time landlord and found private lending was less time intensive, had a great cash flow and complemented my equity holdings which had lower cash flows, hard work with capital appreciation benefits.
        As far as legal structure I lend as an individual and hold a first lien deed of trust. i have a local lawyer draw up all the documents, the borrower pays all the fees. I typically charge 12% with 3 loan points plus the borrower pays the related costs to close. Since I have been doing my own lending I have never had a default, however I have been through many horror stories with companies that originated loans that I participated in.
        As to finding borrowers since I am in the “business” I know of more borrowers than I have money to satisfy. I only work with people I know in the local Real Estate market, I would consider a referral but never had to go that far. If you are not in the Real Estate Business, you need to gain an understanding of the local market to properly evaluate a lending situation to find borrowers simply join local Real Estate clubs, connect with Real Estate Agents that work with investors and start talking about your services… pretty soon you will have more interest that money to lend. you could take out ads but that usually attracts the wrong people. You only need one or two reliable borrowers who are full time flippers to make a business. The loans are typically about 75% of purchase price but that can vary based on reliability of the borrower. The size of the loans really relate the price of Real Estate in your market. To break up the commitment I often partner with my self directed IRA. Like many things this is a business that takes a certain amount of learning to do well, a good attorney that works in this area would be of great help and do lots of research before taking doing one. i have been in the Real Estate business over 30 years.

  8. I to have started experimenting in this space over the last year. I have 2 debt and 1 equity investment at Realtyshares. So far things have been going well. Tax time was not to big of a deal. Received K1s in a timely manner. All my deals have been under 1 year.
    I will say these deals are getting more popular. When I first started, I could research over the course of a day or two before a deal was fully financed. Now the under 1 year offerings by repeated/trusted groups fill in the manner of hours.
    I am waiting for a deal to be completed in full before I allocate more portfolio space to these offerings.
    Curious on what others think – for a debt offering, would you lump this in with your bond allocation or real estate?

  9. thanks for this informative post. i was also looking at investing in the real estate crowdfunding space but only knew of Prodigy Network (which invests in NYC commercial real estate, minimum $10k).

    i’ll check out the sites you mentioned. maybe i’ll consider residential property too

  10. Thanks for the post. This looks very interesting, especially with the 11% return. I assume Dan’s comment is on track with the high return rate, in comparison to “normal” lender rates. If you have been made aware of something different I would be interested to hear about it.

  11. Michael S says:

    Thank you for another great post about your experience. Because the property is located in California, I suspect that the borrower is local. Given this, I would not put much value on the personal guarantee. The framework of California law makes it very inefficient to collect against a borrower personally when payment of the loan is secured by real property. In general, the lender will simply foreclose on the real property collateral and waive its rights to a deficiency judgment against the borrower. You can find myriad discussion online about the “one action rule” and California’s anti-deficiency statutes. My point is, you are really lending against the property only.

    Because these loans are crowd sourced, I also wonder what the reality of a loan default looks like. Is the loan syndicator prepared to credit bid at a foreclosure sale, take the property back and market it for sale? The relationship with the investors may not be strong enough to worry about protecting. Also, we know that the borrower intends to rehab the property and sell it within a year. What happens if they run into trouble and the property is only a gutted shell. Where does the money come from to finish the project to protect the collateral?

    This type of transaction is probably possible because of the strength of today’s market, but the future is unknown.

    I like the rate of return and will be following this closely.

    • I agree, personal guarantee isn’t worth much. Thanks for the info specific to California.

      Agreed that strength of market is important, that’s why I like the 6 month term.

      Will post more details on the deal later after I get the green light.

    • I have a lot of the same questions about what happens if this project goes south. The syndicate holds a lien, presumably, but where are they in the capital stack relative to other mortgage holders, vendors of building materials and/or contractors (labor), local utilities, and the tax authorities. Presumably subordinate.

      I would love to see some data on these platform’s total recoveries and also default rates. They probably are too new to have much, but it will be interesting to see that information over time.

      • @Andy — From what I’ve seen, the holding structures of the investments can vary greatly from investment to investment. On Fundrise, for example, right now users are discussing one investment, where it seems the sponsor’s personal guarantee might simply apply to the investor’s right to a portion of an underlying LLC as opposed to the ultimate financial interest in his project. This is probably why, long run, I won’t do much more investing in this area — because the investor stills need to have the expertise to verify each investment. (It’s not like LendingClub where the overhead of investing in 2500 notes isn’t much more than investing in 100.)

  12. What is typical minimum bite size for crowdfunding deals in the this space? $5k? I would prefer smaller minimum like $1k so I can diversify better (assuming there is enough quality deal flow). Obviously tax reporting burden is higher, but if I only want to play with $25k or so on this space, I feel MUCH better if I can spread that across a portfolio than taking 4-5 bigger bets.

  13. Interesting… I will be following. What’s the minimum amount to invest? Any data on the default rates?

    • Patch of Land’s stats page is pretty cool (https://patchofland.com/statistics/). So far they’re reporting a zero percent default rate. Of course that figure can’t last forever, but pretty good for the amount of deal flow they’ve put out (over 90 fully funded loans). Also the minimum investment amount is $5k. Pretty good if you’re just trying to get your feet wet.

  14. Hmmm… wonder what happens in case of default. The LLC usually takes possession, but then what?

    I’m also curious about this state tax thing… I get K-1s from other stocks I own, but don’t pay local taxes on those. I live in Texas so don’t pay state taxes in my home state either. Filing state taxes in another state would be a deal breaker for me.

  15. Patch of Land, Realty Mogal and Realty Shares all state minimums of $5000.

    Fundrise seems to have minimum share prices of $1000-5000, but it seems to vary based on the investment.

  16. Fascinating and will be watching. I own rentals and they can be a bear. This seems like a better way to get some cash without most of the hassle.

    That said a REIT ETF probably is a safer investment in the long run.

  17. Your (shameless) plug aside, you make a valid point. But i believe that in a matter of mere weeks, perhaps months, the regulations concerning the need to be ‘accredited’ will be greatly relaxed, opening RECF platforms like PatchOfLand to significantly more investors.
    Then, this entire industry stands to seriously explode even more than it has already if that’s even possible. Thnaks for sharing.

  18. I took the plunge and also put in 5K for patchofland; very easy and straightforward to
    set it all up; they seem like a solid organization;

  19. For anyone interested, I posted an article outlining how I track crowd-source real estate investment performance using the iBank software for Mac OS X.

    http://dafacto.com/how-to-track-crowd-sourced-real-estate-investments-in-ibank/

  20. This is great information! As the economy evolves, it’s good to see potential investors exploring nontraditional paths to property ownership. It’s interesting how the popularity of crowdfunding has moved into real estate.

  21. be careful using these guys; they don’t seem to do a very good job of checking their borrowers; yesterday I was about to invest in a property in silicon valley, and decided to check the borrowers just in case; I googled their names and low and behold I found this:
    http://mortgagefraudblog.com/mortgage-fraud-intertwined-in-fraudulent-visa-scheme/#more-22779
    http://www.mercurynews.com/cupertino/ci_28789184/cupertino-sunnyvale-four-residents-indicted-h-1b-visa

    the two borrowers were just indicted for visa fraud and money laundering; they were using money from their illegal business to buy property through patch of land; I emailed patch of land about this and a few hours later got a call from their CEO thanking me for bringing this to their attention; I was floored that they did not know about it; this news was reported sept 4th 4 days before patch of land sent an email informing everyone of the latest loan offering in silicon valley;

    • Perfect example of why the accredited investor requirement is not changing anytime soon. I’d love to participate in something like this, but until the SEC decides there’s enough interest among smaller investors and a reliable way to filter who can complete their own due diligence, then some of us have to remain on the sidelines. Living on Ohio, we can’t even invest through peer-to-peer lending. Might as well get into real estate the old fashioned way and keep an eye on foreclosures!

    • @skg — Thanks so much for this. I’m really torn about crowd-sourced real estate investing. On the one hand, my experience so far, over the course of 14 months investing at Patch of Land, RealtyShares, RealtyMogul, Fundrise and RealCrowd has been *great*. Every deal has returned what was anticipated, capital has been repaid when expected, etc.

      Having said that, it seems clear that with so many platforms competing for marketshare, we’re bound to see a drop in underwriting quality with the pressure to maintain (and increase) deal flow. What you discovered in the case of Patch of Land would seem to be a clear example of this. Despite the good results I’ve experienced so far, this one incident really causes me to hesitate on continued investment, and rethink what is the best approach to participate in this asset class.

      Thanks again for the head’s up!

      • yes, I am also reconsidering whether to make any more investments; this incident really shook me up out of my complacency; you are lucky to have had good results for far; what also got me was that I checked patch of land website the next day and they changed the status of the silicon valley property as fully funded when the day before it was barely funded; there was no explanation or note as to what had happened; they acted as if everything was normal and the property has no issues; not very transparent; most of the users are still unaware as to what actually happened; makes you wonder what other properties had problems and they never informed anyone;

        • Hi @skg — In my view, the alternative to Patch of Land, is something like RealCrowd. The minimum investments are higher (e.g. $25k), you interact directly with the sponsors and have to deal with the tax-time overhead of being an LLC member, but you at least have the opportunity to invest with large, well funded, real estate investment companies that have long track records. What attracted me to Patch of Land was the ability to get wide diversification, at lower entry levels, and the tax-time convenience of a simple 1099.

          But with minimum investments of $5k, though, a single total-loss investment can kill overall platform return. (It’s not like LendingClub, where you can invest in thousands of notes, such that total-loss on some notes doesn’t kill overall return.)

          Still a lot of head-scratching to do…

  22. Hi Jonathan, just wondering if you have any updates on the experience you have with realty mogul, did it turn out to be successful?

    • I actually haven’t made any investments with Realty Mogul. These investments are a little speculative for my tastes, so I am only investing in them using my side “experimental” money account. I made a $5,000 investment with similar site Patch of Land, but my primary reason for picking them was the short 6-month term (although it is ending up longer anyway).

      • Jason Riedel says:

        Jonathan,

        It appears your investment with Patch of Land is still on-going. Did this work out favorably for you ?

        Thanks,
        Jason

        • Yes, it is still ongoing. The house is listed on the market. The loan allows the borrower to extend the term subject to certain conditions, and that is what they have done. I believe I get a little bit extra interest or fees on top of the normal APR. I’d probably rather be cashed out just so I have the money in hand and can then move onto another money experiment, but I’ll take a few more month of 11% interest.

          Anyone want to buy a house in Sactown? 🙂

  23. Jonathan,
    do you know when patch of land sends out the 1099 interest tax form for 2015?
    I couldn’t find this anywhere on their web site
    skg

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