Property development is the epitome of a high risk, high reward real estate deals that many investors clamor after. But many interested investors don’t have the infrastructure or funds to get into buying and flipping properties. One strategy to get around the barrier to entry is to invest on the debt side of development projects, because it’s much cheaper to become a lender than a builder.
Bridge loans, also known as construction loans, are the most common version of debt in development. Developers in need of cash to rehab their projects call upon lenders for short-term loans, with annual yields ranging from 7 -12 percent.
Through crowdfunding marketplaces, the fragmented market of construction loans is getting consolidated, providing a one-stop-shop for both borrowers and lenders.
Patch of Land, an LA-based crowdfunding platform, is one of the few platforms focused on bridge loans. Founded in 2013, POL has loaned out over $180 million to developers. Real estate crowdfunding platforms are a dime a dozen, but POL has found a twist to differentiate themselves from the rest of the market through their pre-funding process.
POL underwrites loans, then syndicates them to the general public, taking full ownership of the loan before the property hits the platform.
“If a loan doesn’t get fully funded, it still remains on the site,” said AdaPia d’Errico, chief marketing officer of Patch of Land. “We’re not like traditional crowdfunders where borrowers need to wait for full funding to get their money. We take care of that with the pre-fund because borrowers need cash to get their project off the ground. Investors also benefit because they get to earn interest quickly and see that POL has skin in the game.”
POL also benefits from pre-funding. According to d’Errico, POL always intended to monetize the loan holding period. The firm also makes money off the interest rate, charging from one to three points on the loan, plus a servicing fee with a two percent maximum spread.
Choosing to focus on the debt side of investments is also a unique way to approach real estate crowdfunding. Underwriting a bridge loan isn’t as sexy as providing equity to build a project that includes higher upside. But loan terms are easier to understand, something d’Errico feels is important for investors.
“We made the decision to focus on the debt side because it’s an easier investment to understand. With equity investments, you’re looking at high-level calculations based on IRR over a longer period, involving many projections and assumptions that require more time to learn than most investors have time for,” she said.
Investing in debt may be easier to understand, but it’s still not without its risks. We only need to go back to 2008 to see what can happen to sure thing loans when the whole system goes down the drain. Banks turned into real estate companies when they foreclosed on first position liens. Banks and investors don’t want to sell properties — they just want to get in and out. So while the proposition of having the security of a property as collateral is a nice theory, it’s a mess in practice.
Another issue is the nature of development. Rehabbing is an art, not a science, and all sorts of issues can slow up projects. And if the project slows, the principal stays in longer, which can put the property underwater faster than you can say refinance. So getting your principle out after 12 – 18 months of a development deal isn’t anywhere near to a sure thing.
No one is saying there’s an investment out there that doesn’t have risks, but investors need to be informed of the risks that come with investing in development debt. d’Errico understands the importance of informing customers of what they’re getting into,and the nuances that go into the real estate business.
“Initiating a foreclosure to get a loan current and ensure principal is recovered is something that can cause confusion because the word foreclosure sounds scary. We need crystal clear communication to inform investors about loan management and asset management terminology in real estate lending,” she concluded.