House Flippers Turn To Crowdfunding Platforms For Financing

David Berneman isn’t developing an app. His company isn’t venture backed. In fact, his business is about as low-tech as it gets: He buys houses, fixes them up and flips them.

But he too is funded by the crowd.

Berneman’s family business, Golden Bee Properties, borrowed $1 million to buy a West Los Angeles home that he plans to renovate and expand before putting it back on the market. The money didn’t come from a bank but from 44 small investors, some of whom put in as little as $5,000.

Berneman and his backers came together through crowdfunding, which enables businesses to publicly solicit investment from individual investors online.

“It’s like a Kickstarter for the real estate industry,” Berneman said. “It allows people to get into real estate investing in a way they wouldn’t have been able to before.”

Although crowdfunding is closely associated with tech startups, the practice has found a niche in real estate and in house flipping in particular.

Between September 2013, when equity crowdfunding was first permitted under new Security and Exchange Commission rules, and September of last year, investors pumped $870 million into crowdfunding platforms tracked by New York data provider Crowdnetic. Nearly a quarter of that amount, $208 million, went into real estate projects.

That’s more than biotech, alternative energy, tech wearables, online gaming and social media startups combined.

Although data providers don’t track the number or dollar-volume of loans going to house flippers as opposed to developers of larger projects, more than a dozen real-estate-focused platforms offer loans to them. And a handful of Southern California startups specialize in the market.

Patch of Land in West Los Angeles made about $61 million in loans last year, mostly to house flippers, and PeerStreet in nearby Manhattan Beach made $40 million, almost entirely to them.

“There’s a crowdfunder popping up once a month now, and the low-hanging fruit is the fix and flips,” said Jonathan Lee, a principal at George Smith Partners, an LA real-estate-financing firm.

Entrepreneurs behind the financing platforms find house flipping attractive because banks don’t participate and there are no big, established players.

Traditional mortgage lenders want to know a borrower’s individual credit history and income, and probably wouldn’t allow a borrower to have loans outstanding on half a dozen properties at once, not an uncommon practice among flippers.

That has forced most house flippers to rely on a hodgepodge of small private lenders, wealthy investors or friends and family for capital. Today’s crowdfunding platforms enable flippers to tap into a much larger investor network. The platforms are open to accredited investors, who have to make more than $200,000 annually or have a net worth of at least $1 million.

“It’s an industry that’s been relying on knowing a guy who knows a guy. It’s ridiculously inefficient,” Jason Fritton, chief executive of Patch of Land, said about financing for house flipping.

And while house flipping might lack the cachet of tech, it’s a relatively safe bet compared with the risky world of startups, said Eric Smith, director of data analytics for Crowdnetic.

“Real estate is a tangible asset,” he said. “It’s not like you’re going out there trying to buy into the next Facebook.”

Flippers traditionally are financed by “hard money,” or short-term loans with double-digit interest rates that are secured by a hard or tangible asset, in this case real estate.

Like hard-money lenders, crowdfunding platforms guard against risk by securing the loans to the property and lending for less than its full value.

If a borrower goes bust, the lender takes title to the property, which, in theory, can be sold for more than the loan principal. PeerStreet, for instance, typically will only lend about 75 percent of a home’s value.

“They don’t look at income or tax returns. They’re looking at the property and the project. Is there profit to be made?” said Christian Fuentes, an LA-area real estate agent and house flipper.

For investors, the steep interest rates, ranging from 8 percent to 13 percent on an annualized basis, translate into attractive yields.

“It’s just not the kind of loan a bank can make, so the interest rate is higher,” said Brew Johnson, chief executive and co-founder of PeerStreet. “(But) when done correctly and lent to good borrowers, it’s a great loan.”

The platforms also provide quick and relatively easy money.

Berneman and Golden Bee have been flipping houses since 2002 and used to finance projects by tapping into a Rolodex of about 30 wealthy contacts. Each investor would have to be convinced that it was a good idea to go in on a deal.

“If you have to go to a dentist or a family doctor to get an investment, it can be time consuming,” he said. “Hemming and hawing can cost us a deal.”

Berneman likes the speed that crowdfunding platforms promise.

Patch of Land can issue a check in just a couple of weeks, assuming that a loan meets its underwriting standards. The loan is then offered up to the 17,000 investors signed up on its site.

Golden Bee in November bought a two-bedroom house in West LA. The company paid about $1.2 million, with $1 million coming from Patch of Land at an annual interest rate of 12 percent.

Berneman is planning a $750,000 expansion and renovation that will add more than 1,500 square feet of space, along with new plumbing and wiring. He estimates that the house, built in the 1930s, hasn’t been renovated in 50 years.

“We’ll be knocking some of it down to the studs,” he said.

Berneman hopes to sell the house for as much as $2.5 million once it’s back on the market this fall. Golden Bee would stand to make $575,000, not including the cost of financing.

Searching for investors willing to put their cash into house-flipping projects is also time-consuming for the small hard-money firms that have traditionally lent to flippers, many of which rely on the same type of wealthy investors.

Just like flippers, those lenders are turning to crowdfunding platforms.

Until it started working with PeerStreet, LA-area hard-money lender Golden Capital sold its loans to a small group of rich investors, all of them worth at least $5 million, said James Golden, one of Golden Capital’s owners.

“There’s millions of people out there who have $10,000,” he said. “But there aren’t that many who have $5 million.”

Over the summer, Golden Capital lent $233,000 to Fuentes, the real estate agent, to buy a bungalow. Golden kept some of the loan but sold most of it, $194,000, to 25 investors on PeerStreet.

For Fuentes, it was a pricey loan, carrying a 10 percent annual interest rate and $7,000 in loan origination fees.

Still, he came out ahead. After four months of work spent on about $25,000 in renovations, including painting, landscaping and new kitchen cabinets, he sold the house for $339,000. He cleared nearly $40,000.

The interest that Fuentes paid was spread around: 1 percentage point each went to PeerStreet and Golden Capital, and 8 percentage points to investors, an attractive yield compared with many other investments.

So far, though, the crowdfunding platforms haven’t proved as popular in other parts of the real estate market, including for commercial projects needing millions of dollars.

Downtown LA development group Rising Realty Partners, which has a portfolio of large office properties, is an investor in Fundrise, a Washington, D.C., real estate crowdfunding platform.

Even so, President Chris Rising said he hasn’t raised any money for projects through the site, given the rates of return demanded by small investors.

“We just did a deal in Burbank,” he said, referring to the LA-area city. “I wanted to give Fundrise the business, but it was just expensive money.”

Whether real estate crowdfunding remains popular with investors is hard to predict. It has existed for only about two years. And during that time, residential and commercial real estate prices have been heading in one direction: up.

The acid test will be seeing if such loan terms help the crowdfunding platforms weather a sharp housing market downturn.

“Eventually, somebody’s going to have losses,” Patch of Land’s Fritton acknowledged.