Need to borrow money for your next real estate deal? Probably.
Last week we looked at retirement accounts as a source of real estate funds, in our series Unconventional Loans for Real Estate Investing. This week, we’ll look at a relatively new way to borrow money: from total strangers you’ve never met.
Peer-to-peer services have exploded with the advent of the Internet. It’s suddenly possible to borrow money from everyday folks across the globe, whom you’ve never met, in a way that wasn’t imaginable a generation ago.
Remember Napster? They didn’t invent the sharing economy or peer-to-peer model, but they sure popularized them.
Since then we’ve seen the rise of apartment sharing services (Airbnb, VRBO), peer-to-peer car sharing services (Turo), office space sharing collectives and more. But most importantly for our purposes, peer-to-peer lending and crowdfunding services.
First, it’s worth pausing to define peer-to-peer lending versus crowdfunding. Peer-to-peer (P2P) lending websites offer personal or business loans, with defined loan terms like interest rate, amortization and the term timeframe. The lending decision is more based on your credit, income, balance sheets and other traditional lending fundamentals. Crowdfunding is more akin to raising money by offering equity and stakes in your project, and will consider your story and potential for growth rather than just past performance (more on this later).
The two largest peer-to-peer lending websites in the US are Prosper and LendingClub, who specialize in personal loans up to $40,000. If that number looks small to you, well, keep in mind these are designed for personal loans, not mortgage loans.
Besides the obvious disadvantage of the loan limit, what are the pros and cons of these P2P services?
Among the pros are speed and flexibility. You can get a loan in as little as 72 hours, with few questions asked. They won’t decline your application just because you have ten mortgages already (assuming your credit is good). If you just need a small amount of money for your next real estate deal, but you need it fast, these lending services may be spot-on.
But the loans aren’t cheap, even if you have good credit. The interest rates usually shoot up alongside the loan amount; if you have good credit and only want to borrow $5,000, you might get a decent interest rate. Want to borrow the maximum $40,000? Think 18-25% interest, amortized over a maximum five-year term.
If you’re thinking you might borrow a regular mortgage and simply use a P2P loan to cover the down payment, think again. Mortgage lenders directly ask you on the loan application if any part of the down payment is borrowed, and Uncle Sam has a word for lying on loan applications: fraud.
The question has actually been raised whether peer-to-peer lending services are even truly among peers anymore. There are rumors that Wall Street banks are behind 80-90% of the funded loans on Prosper and LendingClub. It’s not a little old lady kindly lending you money for your project, it’s the cold circuitry of an algorithm at Morgan Stanley evaluating whether you’re a good investment.
The online landgrab/gold rush is underway, for real estate crowdfunding. With more than 125 real estate crowdfunding websites up and running, and $484 million invested last year through them, money is surging into the industry. More than three times as much money actually, than in 2014.
Crowdfunding websites are more flexible than peer-to-peer lending sites. Investors can fund projects that offer an equity stake, a piece of the action. Or they can lend money interest-only, or lend on fixed amortization schedule, or make a balloon loan.
Many of these websites thoroughly screen the borrowers themselves, and underwrite and fund the deals. They then hope that online investors will invest in the deals, to cover the capital outlay and free up cash to fund the next set of deals.
Historically, businesses (including real estate investors) could not publicly advertise opportunities to invest money in their “private security investments.” Likewise, Average Joes were prohibited by Uncle Sam from investing in these kinds of investments: only accredited investors could do so, and to be one you had to be wealthy.
Not anymore. As of this year, the federal government changed the rules for for private securities investments, allowing everyday people to invest money through real estate crowdfunding websites. If an outside investor likes the look of a particular real estate project, she can invest as little as $1,000 in that project.
And for outside investors who prefer to invest in a pool of loans, rather than a single investor’s project? Increasing numbers of crowdfunding sites are offering this pooled investment format instead.
Theoretically a developer or real estate investor could borrow an indefinite amount of money from crowdfunding websites, but the underwriting process is longer than personal P2P lenders. Qualifying borrowers will likely wait at least a week for money, and more often 3-6 weeks.
Specialty Services & Everything in Between
Many of these websites offer funding for a specific niche. For small business loans, FundingCircle is an available option. For consumer debt, British company ZOPA is still very much powered by peers. And of course there are plenty of platforms for real estate investing.
The most popular are Lendvious, Patch of Land, Money360 and RealtyShares. But don’t expect these online services to replace your conventional mortgage; with RealtyShares interest rates starting at 9% for residential loans and 12% for commercial loans, these are not cheap. The loan terms, conversely, are teeny tiny: 6-24 months for residential, 1-10 years for commercial loans.
Patch of Land offers residential loans starting at 7.99%, and for slightly longer terms up to 36 months. But these are interest-only loans, at a maximum loan-to-value (LTV) ratio of 80%. And trust me: your real-life loan terms will be worse than these advertised best-case scenarios.
In other words, these real estate-oriented funding websites have more in common with hard money lenders than with traditional mortgage lenders.
Still, for short-term funding of a renovation project, a flip or maybe bridge financing, these could work nicely. On the commercial side, they could be a workable alternative to traditional commercial loans, for borrowers who can’t yet qualify for better loan terms.
The upshot is that these are one more option in the toolbox. No miracles here, or even a first choice option, but P2P loans are worth keeping in mind. You never know when you’ll need a quick $40,000.
Next week: the next in our Unconventional Financing for Real Estate Investing series will cover hard money loans. Keep your eyes peeled!♦
Have you tried P2P or crowdfunding websites for your real estate investments? How’d it go? Would you recommend it for other investors and landlords?