Despite institutional banks offering historically-low interest rates, the real estate crowdfunding market is quickly growing, outpacing forecasted results every year. Through crowdfunding platforms, investors are achieving more than 9% annual return on their capital. This high return comes directly from the high-interest rates that crowdfunding platforms offer developers for funding—so why are developers looking for alternative lending forms when banks lend with cheaper rates?
On the debt lending side, the best explanation is based on the strict requirements of institutional banks. After the real estate crash in 2008, banks became very cautious when lending to housing developers; the assumption was that the real estate market was too volatile, and that final project value may not fulfil developers’ expectations. Without a strong track record and well-established relationship with the bank, obtaining a loan was not likely. If the developer was lucky enough to receive funding, it was often with interest rates in excess of 9%.
Enter crowdfunding platforms, offering quicker and more streamlined lending processes. Underwriting standards for crowdfunding platforms tend to be more flexible and transparent. Such platforms can be ready to issue a loan in as little as 5 days, depending on project complexity. This is a significant factor when working with fix and flip projects or bridge loans which typically need financing sooner.
Usually, fix and flip or bridge loans are very dynamic transactions. Developers are constantly looking for good underpriced deals. Once found, actions to acquire such property must be expedited. Although a target property may be underpriced, its value is still significant for a developer to pay in cash when waiting for bank financing. That cash, or working capital, is better used as down payments to develop more than one project. No developer wants to freeze their working capital for a long period of time.
Crowdfunding platforms’ underwriting is more thorough than institutional banks, but with less bureaucracy. Banks have a very complex management structure represented by multiple entities and borrowers must be submitted to all of them. In the case of crowdfunding, there is only one entity between lenders and borrowers: the crowdfunding platform. The loan issuance process is usually most dependent on the borrower itself: how fast the borrower can present quality documentation for underwriting.
Another benefit that crowdfunding platforms can provide is mezzanine financing, which includes preferred equity and mezzanine debt. This attracts developers who are looking to fill the gap between equity and senior debt financing, with typically just bigger development projects requiring mezzanine financing. These projects include approximately 5–20% mezzanine and up to 70% senior debt financing, with the rest covered by developers’ equity. Mezzanine financing costs more than debt, but less than equity: investors usually expect 13–20% annual return.
In summary, crowdfunding is a good alternative for developers who do not have time to wait or do not qualify for loans from institutional banks, or when additional financing is required. Crowdfunding platforms connect developers with investors, whose combined capital can provide what historically only institutions could.
Author : Egle Nemuraite
About the author :Egle Nemuraite is a research analyst at Sharestates, a robust online marketplace for real estate lending and investing. Prior to Sharestates, Egle worked as a property analyst, and brings to the team her expertise in real estate strategy and finance management.