P2P Marketplace Lending and Institutional Investors
Communications technology and its facilitation of peer-to-peer real estate marketplaces like RealtyMogul.com have enabled smaller (but still accredited) investors to participate more broadly in specific commercial real estate investments. Yet the development also affects institutional investors, who may through these marketplaces gain access to opportunities that they may not earlier have focused on.
Institutional investors are often focused on larger “core” or Class A projects. A sizable market also exists, however, in $15-30 million “small-balance” value-add properties that are often the focus of many real estate companies and which can often offer higher return rates than the “core” investment plays.
The Growth of Peer-to-Peer Lenders
The relatively small share of marketplace peer-to-peer lending companies (such as LendingClub and Prosper) as compared to other non-bank sources (as indicated in the graph below for credit markets generally) indicate the small base from which the entire peer-to-peer lending industry is starting, and the large growth prospects available to it.
The origins of these marketplace lenders, including those in the real estate space, often lay in focusing on investments that were not currently well-serviced by traditional institutions. The best of these companies now themselves often participate in top-flight projects -- yet because of their initial focus, they can often remain uniquely positioned to provide institutions with a prime source of deal flow relating to “non-core” real estate projects. This is important because value-add and opportunistic investments can often offer better yields and more diversification than core, Class A properties -- and institutional competition is already heavy in the latter market.
Asset-based real estate lending to investors rehabilitating single family homes or larger (but still "small-balance") commercial properties, for example, can be more profitable than many other private lending opportunities. Most industry followers estimate that hard-money loans account for about 1% of the residential mortgage market. Assuming annual debt originations in the overall residential lending market of over $1 trillion, this leads to an annual residential “hard money” market size of approx. $10 billion. Deal flow relating to properly underwritten, high-yielding real estate loans is increasingly attractive to many institutions.
Strategic allocations of some assets to non-core markets is often considered by institutions -- but sometimes rejected because of the additional internal resources needed to gain expertise in those new market areas. Marketplace lenders that prove themselves able at performing initial diligence and analytic functions, however, can offer institutions ready access to deals where the bulk of the screening has already been performed, thus potentially opening up a whole new market area for institutional investors. The recent announcement by Realty Mogul of its partnership with an institutional purchaser of first-lien “hard-money” residential mortgages is indicative of this new trend.
Many marketplace lenders also sell whole loans to institutional buyers, so that these buyers are themselves listed on the property titles. While these marketplace lenders remain closely tied to the individual investors that drive the “peer-to-peer” portion of their business, these complementary relationships with institutional investors are increasingly driving much of the companies’ growth. Having ready and willing buyers of whole loans available to them means that these marketplace lenders can remain focused on loan origination and careful underwriting. Such synergies with institutions lets the marketplace lenders be less concerned with the “demand” side of the investments, and to concentrate on loan production in areas where they have particular expertise.
Additional real estate lending deal flow may be increasingly important to institutions if CalPERS’s recent decision to divest itself of hedge fund investment eventually leads other institutions to follow suit and shift some of their assets toward additional real estate holdings. The move into commercial real estate lending has been made more viable because of the general recovery in the sector. Institutions seem to be less focused on more risky speculative investments and more on real estate lending – and the marketplace lenders offer an entrée into a sector of the commercial real estate market that many institutions hadn’t previously focused on.
Internet-based companies have often also shown themselves at being proficient with collecting huge amounts of data and processing that data far more cheaply and quickly than more traditional off-line businesses. Marketplace lenders may, over time, demonstrate an edge in collecting and acting on a variety of customer and financial data across a variety of areas of the commercial real estate investment business.
At RealtyMogul.com, for example, we are making use of a huge trove of credit data that is available with respect to real estate loans and borrowers across the country. Smart use of this data can help the company to modify its pricing algorithms; if done properly, this could lead to reduced loan losses and better overall returns for investors.
This points to another reason why institutions may be interested in partnering with marketplace lenders -- because of their potential to be a disruptive force in the industry. The movement toward P2P investing is already playing out in the consumer and small business credit space, with LendingClub and OnDeck Capital likely to soon complete IPOs at significant valuations. The growth of these companies has been nothing short of phenomenal; Lending Club has doubled its loan origination volume each year since 2007. Banks’ role as the primary source of consumer credit may well, over time, increasingly threatened by P2P platforms.
Can peer-to-peer lenders do the same in the institutional real estate sector? The larger ones, despite their original focus on “non-core” real estate assets, are increasingly offering high-level opportunities to their investors, and thus are already beginning to play in the upper-tier markets now dominated by larger institutions. As this trend continues, institutional investors may well find that partnering with marketplace lenders becomes more of a competitive necessity. Institutional decision-makers should consider how partnering with these peer-to-peer companies may open up the path to new markets and products that are complementary to the institution’s existing areas of concentration.
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