Private Lending vs Real Estate Crowdfunding: Which is best for you?

Private Lending vs Real Estate Crowdfunding: Which is best for you?

There a lot of questions from investors about crowdfunding. Crowdfunding is quickly becoming a player in real estate lending even though many people in the business do not fully understand it yet. Below, we give a brief explanation of the fairly complex business model behind crowdfunding to help rehab borrowers make the best choice when funding their flip.

What is Real Estate Crowdfunding?

Real Estate Crowdfunding is a newer type of lending in which multiple investors contribute to a single loan and share in the profits when the loan is paid back.

Crowdfunding has been around for quite some time, but in other industries. Now, entire companies are dedicated to this fairly simple concept of raising money from two or more investors for projects of which investing parties will share in its profit. The genesis of crowdfunding’s success seemed to be the Jumpstart Our Business Startups Act of 2012 which opened the door for more direct marketing and solicitation of accredited investors. This act cleared the way for businesses to raise capital by bypassing some of the Securities and Exchange Commission Rules for fundraising, including removing restrictions on the solicitation of funds online.

Who Should I Borrow from, a Crowd funder or a Private Lender?

Generally, crowdfunding companies invite accredited investors to pool their money together to invest in a specific real estate project. Crowdfunding investments can be as little as $5,000, so a borrower many have a lot of crowd-funding investors, but not necessarily a single person to deal with. Deals are evaluated on a quantitative basis, rather than qualitative. Some companies offer a projected specific rate of return on all projects, while others price the deal according to the risk involved. Accordingly, not all borrowers are entitled to the lowest interest rate offered by the crowd funder. Potential borrowers can go to a crowd funder and submit their analytics on the deal, and also for some crowd funders, their financials. Once a crowd funder approves the deal, they list it on their website to solicit investments. Crowdfunding is quick. Once a deal is listed on the internet as available, funding can take place in a matter of days.

Private lenders operate quite differently. Most private rehab lenders, source their money from high net worth individuals who invest in the total fund of the company, as opposed to any one specific project. By maintaining an investment pool like this, investors risk is spread across the entire fund rather than being totally invested in a single project. When a borrower needs help with their project, whether at the time of application or during the project, private lenders have the staff to help them with the project. Although a quantitative analysis of the project is done by both private lenders and crowd funders, private lenders also qualitatively analyze each deal. This analysis makes sure that in addition to looking good on paper, the project is in line with the skill level of the borrower, that they have the financials to see the project through and that the rehab list looks thorough and complete with correct appraisal values. Adding this layer of care protects the lender, investors and borrowers, who would all share in the losses from unsuccessful project. In contrast, if something were to go wrong in a crowdfunding scenario, the borrower and investors get hurt but the company sponsoring it does not. This means that private lenders have much more incentive to help their borrowers who encounter a problem.

Mitigating Risk

There is some preliminary evidence that the rate of default by borrowers relying on crowdfunding rather than direct lenders is higher. Most sites simply list their default rate as n/a. Crowd funders say this is because their business is too new to report significant defaults. It is our opinion that one of the reasons that the default rate is higher on crowdfunding transactions is because of a lack of support in times of trouble. When a borrower has an issue after closing, there is no flexibility built into the crowdfunding model to work with them through the problem. It’s also possible that the lack of information about crowdfunding defaults may be that the companies don’t like the numbers, and as private entities they have no obligation to report them.

Private Rehab Loans Come with Free Advice and Expertise

Questions will arise all throughout a projects lifespan much more than you can think of from the outset. As a private lender, we answer hundreds of questions throughout the day before we’ve even started the project. Appraisals, draw requests, legal situations, and even requests for advice are brought up in daily phone calls with borrowers and brokers alike. In this industry, questions need to be met with answers immediately. Crowdfunding offers the perception of quickness and simplicity, but that comes with a price and is, in fact, not always correct.

Anyone who has ever flipped a home can attest to the fact that unpredictability is the only predictable aspect of real estate investing. To give an example from experience, a borrower went through their allocated rehab budget before the project was finished, but in the process, made the property significantly more valuable. If the borrower had crowdfunded this project, he or she would be out of luck. They obtained a new appraisal and the borrower was able to be lended 65 percent of the difference between the two appraisals, in addition to extending the maturity date on the loan. In other situations they had modified the interest rate and even entered into joint ventures to make their borrowers’ projects work. These are options that flippers who borrow via the crowdfunding route simply don’t have.

For most borrowers, private lending is a safer option for funding than crowdfunding. Private lenders are looking to establish long-term relationships. A crowd funder is looking to fund a specific loan by gathering money from nameless, faceless investors. A private lender is looking to make a loan through the delivery of excellent customer service and relationship building.