Last week, I discussed the rise of peer-to-peer lending and the implications for the unsecured lending market.
Unsurprisingly, crowdfunding platforms are being set up to facilitate real estate transactions, as well. Accredited investors – those who meet income or net worth requirements – can now invest like the big institutions. For example, investors on Fundrise, a real estate capital marketplace, can even help finance the construction of 3 World Trade Center.
Now that’s a very high-profile deal. But all told, it’s getting easier for private investors to assemble a diversified portfolio of commercial and multi-family residential real estate investments.
However, certain elements of the real estate crowdfunding movement are getting more than a little scary, and investors need to proceed with extreme caution.
Not only are property developers finding it easier to raise capital, but house flippers are also turning to crowdfunding platforms.
And you don’t even need a job…
That’s right, if you don’t have steady income from an employer and can’t get a loan from a lending institution with a loan officer, retail investors will still line up to finance your house-flipping endeavors. Some house flippers have crowdfunded their projects in as little as an hour.
In some respects, it seems we didn’t learn anything from the credit crisis.
Don’t worry, though, because nothing has gone wrong… yet.
So far, RealtyShares, one of a growing number of online real estate capital marketplaces, has had no defaults. The firm attributes this to its underwriting criteria. However, I believe it has more to do with where the economy stands in the credit cycle.
Nearing Peak Credit
The credit cycle refers to the ebb and flow of available credit, or borrowing capacity. I covered the credit cycle in depth in the February edition of The Shockproof Investor.
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Currently, credit is plentiful. And it’s no surprise that financial innovation is making it easier for borrowers to take on debt quickly and efficiently.
In fact, we’re rapidly approaching the point (once again) at which anyone with a pulse will be able to obtain a loan.
The supply of capital is outstripping the demand for loans. Borrowers are benefiting, but there will be pressure for lenders and lending platforms to loosen underwriting standards, which has already happened with corporate loans.
Don’t get me wrong: Crowdfunding is an exciting development in the capital markets. But everyone forgets about risk when credit is ubiquitous. Those 3% to 4% default rates that the P2P lending platforms have observed are inevitably going to spike, and the real estate platforms will experience defaults as well.
So, let’s stress the entire crowdfunding universe – including the platforms and investors – by allowing it to experience a full credit cycle. Although it will be painful for many in the short term, it will ultimately be beneficial. The longer we go without a spike in defaults, the more painful it will be.There’s nothing new about investments being collateralized by specific real estate properties. But many of the investors are new to the game.
Central bankers around the world are at war with the credit cycle, trying to delay its inevitable downturn. They’re afraid of a credit contraction and the associated rise in defaults.
And as bad as it seemed, the last default wave in 2009 was actually truncated.
I say, bring on the defaults. Allow the markets to work their magic. The sooner the speculation and excess leverage are cleansed from the system, the sooner the economy will be returned to a vibrant state.
Safe (and high-yield) investing,
Alan Gula, CFA