Private mortgage loans can be tempting for investors seeking higher yields, but lending money to a contractor or developer requires industry contacts and real estate due diligence skills that many investors lack. Assembling a diversified portfolio of loans requires deep pockets, as well.
Crowdsourcing is eliminating those obstacles. Rule 506(c) in Title II of the JOBS Act, passed in 2012, allows investment sponsors to publicly seek accredited investors for their deals. It's no longer a matter of being in with the in-crowd. Although sponsors must verify investors' financial status, once that hurdle is met they can work with an unlimited number of investors.
Real estate lending marketplace Patch of Land in Los Angeles demonstrates crowdfunding's potential. The firm made its first loan in the fall of 2013 and by the end of that year had a cumulative loan total of $459,000. The firm is now receiving $600 million worth of applications each month from potential borrowers, and the amount has been growing significantly, according to CEO and co-founder Jason Fritton.
Over 17,000 retail investors have signed up through the company's website and the firm is in negotiations with 14 large institutions, reports Fritton. As of Aug. 27, 2015, Patch of Land had funded 144 loans with a value of just over $47 million, and it returned almost $8 million to investors. Single-family residential (58%) and multifamily residential (37%) properties accounted for most of the loans.
How It Works
Prospective investors register online at the site; no accreditation status verification is required. They can view properties and projects that Patch of Land has agreed to fund, including photos and property detail, rehab plans, a description of the borrower and the investment risk. The site also discloses each property's anticipated annual percentage rate (APR) return and expected investment holding period. Most of the listed anticipated returns were in the 10% to 12% APR range and loan terms range from 30 days to 18 months.
After selecting the properties in which they wish to invest and the amount of each investment ($5,000 minimum), participants must document their accredited status. This process typically involves income verification such as Form W-2 or tax returns, net worth statements, or third-party confirmation from a CPA or other source.
Investors must have a minimum annual income of $200,000 for single filers or $300,000 for couples for the previous two years or a net worth of $1 million or more excluding a primary residence and any liabilities. Funds can be transmitted via ACH or a third- party secure escrow service. It's not quite Amazon.com, but the process is certainly more efficient than most real estate investments.
Investors receive a note identifying their participation as lenders. "That note is associated with the mortgage and the first lien position on the property underneath it," Fritton explains. "We then take that underlying note, we move it to a trustee and a custodian and then we have a blanket UCC [universal commercial code security agreement] that secures all interest and principal back to that underlying asset. So we can go out and we can tell the investors, whether they're a retail investor or an institution, that they are directly secured by the property."
Investors receive monthly interest payments for the loan's duration. At "the maturity date of the loan or upon full repayment from the borrower, whichever is sooner, you will receive a balloon payment of the remaining principal and interest," according to the website. Patch of Land earns most of its income in the form of upfront origination fees that range from 1% to 5%; it does not participate in the loans. Investments are illiquid—investors cannot cash out before a loan matures or is paid off.
