By now there's a well-worn playbook for tech companies trying to upend established lending markets.
First they seek a toehold in a relatively barren corner of the market they are eyeing. For consumer lenders, that has often meant refinancing credit card debt or student loans. For small business lenders, it has usually involved courting companies that are too risky to qualify for a bank loan. Then the newcomers look to expand.
The latest target of this strategy is the real estate lending industry. A raft of startups are setting their sights on two relatively narrow niches — loans to house flippers and smaller commercial real estate loans — where they see an opportunity to establish themselves.
[Coming this November: Marketplace Lending + Investing. Hear how participants in this fast-growth niche are using data and technology to propel lending into the 21st century.]
"That's the beachhead, but it's no more the end game than Lending Club's end game is to only compete with credit card companies," said Brendan Ross, president of Direct Lending Investments, an institutional investor that follows these startups closely.
Like Lending Club, the real-estate-focused companies generally do not maintain balance sheets. Instead they run online marketplaces where individuals and institutions can invest in loans. "Real estate is one of those industries that hasn't seen a lot of transformation through technology," said Jilliene Helman, chief executive of RealtyMogul, a Los Angeles marketplace lender that was founded in 2013.
It is a strategy with a big potential upside — U.S. commercial real estate debt alone totaled $2.4 trillion in the first quarter. But the business model also faces important unanswered questions, including whether these startups can weather the inevitable next downturn in the cyclical real estate markets.
FOLLOWING THE P-TO-P BLUEPRINT
Historically, real estate has been a local business, but the online lending marketplaces want to take it nationwide. The idea is that for any specific property, there are reams of data available that can add to the analysis done by a local appraiser, and provide greater confidence about the value of the collateral.
Patch of Land, another Los Angeles firm, uses hundreds of data points, including crime statistics and walkability scores, in its underwriting process. "So we're able to sit here in Los Angeles and invest in New York and invest in Miami," said Jason Fritton, the company's CEO.
For the borrowers, who are mostly commercial developers and home flippers, online loan platforms promise an easy application process and a fast decision on a loan. "We can fund it in as little as five days," Fritton said.
Time is often critical to those in the business of buying, rehabbing and reselling real estate, said Varun Pathria, chief investment officer at AssetAvenue, a year-old marketplace lender that is focusing on real estate. In the next few weeks, AssetAvenue plans to start providing instantaneous price quotes to prospective borrowers.
"If you think of a borrower who is going through acquiring a property for renovation, typically they have to close fairly quickly," said Pathria, whose company is also in L.A. "The goal is to make it as easy as possible for people to apply."
The online platforms are also providing a new experience for individuals who want to lend to real estate developers. Individual investors are required to be accredited, which usually means that they have a high net worth, a high income, or both. These folks are able to log in and browse for investment opportunities in much the same way that home shoppers use sites like Zillow and Redfin.
Depending on the investor's risk appetite, the returns can be strong. On Patch of Land recently, loans to borrowers who planned to make improvements to homes and then resell them carried annual percentage rates of 10%-12%. But some observers cautioned that returns in real estate are likely to be lower overall than in unsecured asset classes such as personal loans to consumers.
The real estate loans that the online platforms are currently marketing tend not to attract much interest from either banks or the commercial mortgage-backed securities market — often because they are small loans, or because the deals have too many blemishes. So for now, the online platforms are competing most directly with private lenders with specialized niches.
"The banks are very limited in what they can do with commercial real estate," said Evan Gentry, CEO of Money360, an online real estate marketplace based in Ladera Ranch, Calif., that focuses on commercial loans.
Money360 protects its investors by requiring borrowers, in most instances, to have at least 30% equity in the property, according to Gentry. "We think of ourselves as asset-based lenders," he said.
It makes sense that personal loans to consumers were sold on online marketplaces before real estate loans were. Personal loans are comparatively standard products, and the borrowers are relatively easy to evaluate. Real estate is more complex, so the lending process is harder to automate.
"These aren't cookie-cutter, standardized consumer loans," noted Dan Vetter, Money360's president.
"There's certainly a manual element that exists, that will continue to exist," Gentry said. "I don't think that goes away. I don't think it can."
Some of the older real estate lenders that the new marketplace platforms compete against are raising questions about the durability of the online business model. These platforms have sprung up during a strong run for the notoriously topsy-turvy real estate market. They may not be tested until the next downturn.
"When the tide goes out, you'll find out who's been swimming naked," said Mark Mozilo, a principal at California Capital Real Estate Advisors, an investment and advisory firm.
Indeed, during the heady dot-com days of the late 1990s, a number of multi-lender commercial mortgage websites sprouted up, aiming to do for property financing what Priceline was doing for travel. None of them achieved much traction.
There are also questions about the relatively shallow ties between the online platforms and the investors who browse through their listings. Real estate investing has typically been built on close personal relationships.
"Would I rather have a relationship with somebody, or have a relationship with a website?" asked Mark Filler, the CEO of Jordan Capital Finance, which works with buyers planning to rehab properties. "I'd rather have a relationship with somebody."
For their part, the online marketplaces say they are modernizing a business that is fraught with inefficiencies. And their ambitions aren't limited to the relatively small portion of the real estate market they are currently targeting.
"It's a step-by-step process," said Pathria, whose firm offers loans on homes purchased for investment purposes as well as commercial properties. "I think you have to start somewhere, and this is where we're starting."