My $20k PeerStreet Experiment
Disclosure: I have no financial affiliation with PeerStreet.
I am a big fan of “alternative investments”, specifically real estate. In my previous posts, I talked about why I like investing in this asset class. It’s a way for me to diversify away from traditional markets like stocks, bonds, and mutual funds while trying to earn a higher rate of return. But as a busy physician, I don’t have time to actively manage a real estate portfolio so I turn to passive real estate investing as a solution. Just to make clear, currently most of my investment assets are still in Vanguard index funds and about a quarter of my assets are invested in some real estate vehicle, including syndication and crowdfunding.
My first online crowdfunding investment was on PeerStreet. PeerStreet is an online marketplace where accredited investors can invest in fractional shares of a promissory note that is backed by private real estate loans. (more on this later) The underlying loans are also known as ‘hard money loans’ and are first position mortgage backed securities. The typical interest rate for a private loan ranges from 6%-12%. PeerStreet investments are debt investments. In a capital stack, debt is referred to as senior debt, or first position mortgages, much like a mortgage on a home. In the event of foreclosure, senior debt is first line to be paid before equity.
Private money loans are made to real estate developers large and small. Most of the loans on PeerStreet are made on non-owner occupied residential homes with a few small multi-family units and commercial properties in the mix. So who are the borrowers for a private loan? They are real estate investors and developers who purchase a non-owner occupied property, rehab it, then sell it for a potential profit. Why would someone need a private loan instead of going to the bank and getting a traditional loan? There are several reasons for this.
- Income: The borrower may not qualify for a traditional loan due to lack of steady income. A developer’s income can be very lumpy- there is usually no income during the purchase and rehab phase and profits come only after a sale.
- Speed: The borrower needs to act fast. Traditional loans can take up to 90 days to issue a loan. The borrower is under pressure to get the property under contract and start rehab as soon as possible.
- Property: The property condition itself may be in such bad shape that traditional banks will not lend on the property.
PeerStreet does not originate their loans. Instead they rely on select third party lenders to originate the loans. On the origination partners, they review track records, review financials, review licensing and adherence to state usury laws, run background checks, and review legal and underwriting processes.
For the individual loans, PeerStreet performs independent underwriting using both manual process and big data analytics. They use independent valuation (BPO/ Appraisal), review legal documentation, and ensure that each loan complies with their own underwriting guidelines. After the thorough review process, the loans are placed on the platform and made available to investors.
The PeerStreet loans are secured by first liens on real estate. They are typically short in duration (6-24 months) with LTVs (loan to valuation ratios) of below 75%. The loans are made in a number of different states which allows for geographic diversification.
For this service, PeerStreet charges a fee of 0.25%-1.00% of the loan amount.
In the event of borrower default, PeerStreet handles the workout process at each stage of the default/foreclosure process. Depending on whether the loan is made in a judicial or non-judicial state, the foreclosure costs are estimated at 3-6% of the loan balance. This is to cover legal and administrative costs and fees related to a foreclosure. Other costs may include past due property taxes, property insurance, property management fees, and disposition costs.
PeerStreet also holds loans in a bankruptcy-remote entity that is separate from the primary corporate entity. In the event that PeerStreet goes out of business, a third-party “special member” will step in to serve as a trustee to manage loan investments and ensure that investors continue to receive interest and principal payments. All non-invested investor funds are held in an Investors Trust Account with a FDIC bank insured up to $250,000
PeerStreet is a relatively new company and has been open to the public for two years as of October 2017. Since then, they’ve funded loans totaling half a billion dollars with ZERO losses to investors. Currently their monthly origination volume surpasses $50 million. Their goal is to ‘level the playing field between Wall Street and Main Street’ by providing access and transparency. Their site is integrated with Betterment, Wealthfront and Personal Capital for a more seamless and convenient customer experience.
It’s important to note what investors actually invest in on PeerStreet. The investors do not own part of the actual loan itself. Instead, investors purchase shares of a mortgage-dependent promissory note, or “MDPN”. This is an unsecured note in which an investor receives stated interest and principal, provided the borrower makes payment on the underlying loans. The investor does not own the underlying property and their name is not on the property title or loan documents. In other words, when you invest in a PeerStreet offering, you buy shares of a unsecured note, the MDPN. The note is tied to the performance of the underlying loan which IS secured by the property.
Since last year, interest rates have come down and are now hovering around 7%-8%. The more attractive loans tend to fill quickly within 30 minutes to an hour so you have to be standing by to pull the trigger immediately. As a result, it is difficult to do any sort of meaningful due diligence before investing. There is an automated investing feature where you can set your criteria for interest rate, LTV, loan term, and investment amount per loan. After you are placed in a new loan, you have 24 hours to cancel the order.
PeerStreet investments should be considered high risk. In their private placement memorandum (PPM), a list of risk factors takes up 18 pages. It lists each and every way an investor can lose their entire investment. Some more important ones include:
- If the borrower does not make a payment, PeerStreet is under no obligation to pay the investor.
- The notes themselves are not secured
- In the event of a foreclosure, PeerStreet may not be able to recover any of the unpaid loan balance.
- Loan investment loss rates may be adversely affected by economic downturns, local real estate market conditions, prevailing interest rates, unemployment rate, etc.
- Information supplied by the borrower may be inaccurate or intentionally false.
- Property valuation data may be inaccurate.
- Borrower may not have sufficient experience in construction and operation.
There are many many other risk factors so the investor would be advised to read the PPM in it’s entirety before investing.
I opened an account with PeerStreet over a year ago and after a brief introductory phone interview and verification of accredited investor status, I funded my account through ACH bank transfer. When you establish an ACH, they do two test transfers with a small amount (several cents) to confirm a secure connection. After that, is was off to go shopping for loans.
Available investments are presented on an offerings page which includes location of the property, photos, interest rate, LTV, term, and total amount of loan offering. There is a status bar which tells you what percentage of total has been funded. The minimum investment amount is $1000 for each offering. When you click on ‘more info’, you are presented with more property information such as beds/baths, square feet, value per square foot, appraisal value and appraisal date, projected return chart, rate details and PeerStreet fees.
A separate investment overview page includes information on origination and maturity dates, loan purpose, strategy, property purchase price, rehab budget, and LTV.
The property’s valuation is provided in an appraisal and/or BPO attachment.
On the dashboard, I can see all my loan positions and each of their status. Monthly statements and all tax statements are easily accessible through the dashboard. There is a incentive feature that allows for a 1% bump in interest rate on a future investment for each friend referral.
I invested $20,000 divided into 4 separate investments of $5000 each.
My first investment had an interest rate of 9.5%. It had a start date of October 2016 with a maturity date of April 2017. There was a delay in sale of the property but the loan paid off in full in June 2017. I earned $310 in interest
The second investment had an interest rate of 8%. Start date of September 2016, maturity date of September 2017. The loan was paid off early in April 2017. I earned $202 in interest.
Unfortunately, the other two investments are in default, greater than 90 days late, and one is in the beginnings of the foreclosure process.
So out of four loan investments, I have a 50% default rate. Now, that’s not to say I lost my money and all is lost. One has a LTV of 69% and the other has a LTV of 65%, so there is adequate equity cushion. After foreclosure and sale, I expect to recoup my investment, hopefully with late interest and fees included. Remember, PeerStreet touts their record of zero investor capital lost. They claim that only 0.78% of the loans in PeerStreet’s portfolio have ever been in default.
So I guess my experience may be out of the ordinary and I just got unlucky.
Despite my personal experience, I really like PeerStreet. They are a transparent and innovative company providing an investment opportunity to the masses in a medium that’s never been done before. The fact that they have lost zero investor capital speaks volumes. I believe my investment experience is not typical of other investors’. Late payments and defaults are inherent risks in this investment class and are clearly spelled out in the PPM. Anyone investing in this asset type should expect a small percentage of loans to default. The real test will be how Peerstreet handles the foreclosure and attempt to return investor capital.
Would I have done anything differently, having this experience? Perhaps I could have split the $20k into twenty $1000 investments to minimize the impact of a default. However, I don’t think it would be worthwhile nor efficient to perform due diligence on twenty separate investments for such a small sum. I could have scrutinized the borrower’s credit score more carefully, but this information is not made available on every investment.
As far as if I will continue to invest with PeerStreet, I have not decided. The reason for this experiment was to see if this was a viable vehicle for a larger investment amount in the future. Sure, $10k is not going to break me, but if I had put in $100k -$200k, I’d be freaking out right now if 50% of my investment loans defaulted. Granted, I would have diversified the sum into many more smaller loans so the outcome would probably be different.
There are other online crowdfund options such as Fund That Flip, RealtyShares, AlphaFlow, and Patch of Land. Another option for debt investing would be to invest in a private debt fund which is what I would most likely choose in the future. These are private companies that originate their own loans and aggregate a hundred or more loans into a fund. An investment into the fund is automatically spread out over a hundred plus loans which makes it a more efficient vehicle. They also have a more hands on approach in overseeing their loans and closer working relationship with the borrower. However, minimum investment amounts are much higher, starting at $100K.
For the immediate term, I am in growth mode and therefore favor equity investments over debt investments. Consequently, PeerStreet does not fit my personal investment strategy. However, I can see PeerStreet serving as a short to intermediate term investment for idle cash which would be earning close to 0% in a savings account.
Lastly, since PeerStreet interest payments are taxed at the investor’s ordinary income rate, a self-directed retirement account would be the best place to hold these investments.
Other bloggers that have reviewed PeerStreet:
Mr. Money Mustache: High Efficiency Real Estate Investing with PeerStreet
Max Your Freedom: PeerStreet Review
Gen Y Finance Guy: Hard Money Lending – For the Retail Investor
The Biglaw Investor: PeerStreet Review: An Investor’s Look
Retire Before Dad: PeerStreet Review: Low-Risk Real Estate Loan Investing
Again, thanks for reading. Until next time.
Invest In Life