Part 2 - Crowdfunding Company Pitfalls
Unfortunately, due to the more recent availability of these types of investments on the market, the average investor is simply not experienced enough to see through the smoke and mirrors orchestrated by the crowdfunding companies.
Investing in the People, Not the Product
Investors see the exciting pictures of real property online and assume that is what they are investing in, but really it is the fine print of the crowdfunding company’s Private Placement Memorandum (PPM) and the people running the company that they are investing in. Reading the PPM is monumental to understanding the investment. An investor has to be savvy enough to request, read and understand the company’s PPM, or dig through the company’s website to find where they are hiding the information about the true nature of the investment.
The actual investment is typically referred to as Borrower Payment Dependent Notes. This Note is dependent on the borrower making their payment on the loan for the investor to receive returns and their principal back in full. The crowdfunding company is the one that is collateralized by the asset in the case of default and/or foreclosure. This leaves the investor vulnerable to losing their entire principal investment because they are simply relying on the good faith of the crowdfunding company and not the tangible asset to fall back on in case of default and/or foreclosure.
Lack of Experience Where it Counts
Many traditional and private lending institutions have endured decades of market fluctuations and troublesome borrowers, which means they have extensive experience not only as a loan servicer, but also as an asset manager and coordinator for default resolution. To achieve recourse on a portfolio of defaulted loans, this experience is invaluable. For example, many of the traditional and private lenders that offer direct investments in the collateral to private investors have been around since pre-2008. They are more conservative in who they lend to and what regions they lend and will be less likely to overextend their servicing portfolio to any one borrower or investment type. They are also more likely to have contingency plans and funds in place for the next real estate correction in order to secure the investments on behalf of their investors. With these risk mitigation strategies in place when the market does correct, traditional and private lending institutions will be better equipped to continue as “business as usual”. The private investors investments are collateralized by real property, so they do not stand to lose their entire investment due to default and/or foreclosure.
Crowdfunding companies formed well after the most recent market correction and are driven mostly by the volume of loans they can produce. The focus on quantity of loans will inevitably dilute the quality the investments available to their investors. These companies are in as many regions and work with as many borrowers as they can, with what seems to be little regard as to whether they will be able to manage their book of business if the real estate market was to experience a correction. This will put investors in a less favorable and more vulnerable position in a market correction.
To be continued….
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