On September 28, 2015 in NYC, at Wall Street’s third annual Crowdfinance Conference, financial veterans and industry leaders gathered to provide participants with the resources necessary to capitalize in a financial services industry that continues to innovate and rapidly transform the financial landscape.
The conference featured a powerful lineup of keynote presentations and interactive panel discussions including "Opportunities in Real Estate" which I was proud to have moderated. The real estate panel focused on the growth path of each company, changes to business models, plus challenges and realizations that have led to their leadership position and future opportunities.
Before the panel discussion took place, I sat down to chat with Tony Zerucha (managing editor of Bankless Times) to expand upon several key topics (Read the original interview here). In this unabridged version of the interview, we revisit the topics discussed and questions asked to provide you with more insight towards Patch of Land's current and future initiatives, as well as a real estate marketplace lending industry outlook as a whole.
a) POL seems very purposeful about being very transparent. Is this one of the keys to growing the industry beyond its current awareness level?
Transparency is paramount in growing awareness about our company, earning customer trust, and building credibility for the industry at large. Both in finance and real estate, transparency is a relatively new concept. For example, in an informal conversation after my most recent REFCEN (Real Estate Crowdfunding Education & Networking) Meetup in Boston, several people agreed that just openly talking about real estate finance is foreign to many people. Can you believe that? Maybe it’s because I’m a borderline Millennial, (I’m technically Gen X), but to me, in today’s day and age of limitless opportunity, there’s no reason to be proprietary or secretive, except perhaps where intellectual property or trade secrets need protection. Making a decent investment return - whether you’re an investor or borrowing developer - is everyone’s expectation.
Honesty, integrity, and educational and informational empowerment of the crowd are required to meaningfully and sustainably unlock the trillions of dollars of latent potential returns in real estate. Thanks to the availability of information, and more companies’ commitment to making that information available, we are seeing a substantial shift in the way dollars are invested. Also, by taking a stance on transparency, we are also opening up lines of communication to receive information, which is the ‘source’ of crowdsourcing - an invaluable wealth of information that we can learn from, and that our systems can consume. This is a new age of business, and a new age of finance with its foundations built on open communication and information sharing. To us, that’s the essence of transparency.
b) Where does regulation fit into this? How much government regulation do we need? Can the industry police itself?
Not much regulatory guidance exists at the moment that specifically mandates or prohibits transparency or disclosures of certain information. For example, private placement offerings to accredited investors under Regulation D do not specifically require a private placement memorandum (PPM for short, but basically a document that discloses certain risks about an investment), but most platforms have one anyway as a matter of good practice. The banking and lending industries have been historically non-transparent, in contrast to what some are now terming "sunlight banking" (or marketplace lending). Generally, platforms can be as transparent as they like. The FTC doesn't speak on transparency specifically, but does regulate "unfair or deceptive trade practices."
Government regulations, while maybe helpful, are notoriously slow in being written and implemented. The best thing the industry can do is police itself, though that does involve collaboration amongst companies that could be considered competitors. There are a number of good critics, analysts, and attorneys that blog about the industry that are not afraid to stir the pot, so we're hopeful.
b) Your company recently published an article that touched on concerns about Groundfloor’s recent move having a negative impact on the industry. Can you comment on this?
We get lots of inquires from non-accredited investors everyday asking “when will I be able to invest?” and we have been honest in telling them that the regulatory environment today makes the prospect of selling to the crowd unlikely in the near future, in our specific industry. Our company believes in being very straightforward and honest, especially because our industry, still in its infancy, involves the sale of securities. The industry cannot afford to create confusion, false hype, or false hope. At the end of the day, that’s what transparency and investor protection are all about—being truthful, being real, and not misleading investors.
That said, Groundfloor made a bold move and we commend them on making the effort. They were likely attempting a to be the first to have a continuous filing (in the style of Prosper and Lending Club), and may have gotten into regulatory complications with the SEC. The approved filing may be an immensely scaled and whittled down version of their initial draft. And that’s ok—they took a risk, which is what entrepreneurship is all about, and it didn’t work out. You win some and you lose some. They may have tried to salvage that original filing into the resulting Reg A+, so that they could make some headlines about of being the first to get approval to be able to sell to non-accredited investors. We felt that it was important to inform the crowd that this was not the non-accredited investor revolution they were hoping it would be, and that they should not expect a wave of more filings like this in the future, at least with respect to real estate marketplace lending.
c) Can you discuss the motivation behind the move to require underlying collateral? Many in the industry have commented on this.
I think you mean our move from selling unsecured (or very indirectly secured) notes to directly secured notes. The marketplace lending industry in the U.S. evolved largely from Prosper and Lending Club's pioneering of an instrument called the Borrower Payment Dependent Note. A majority of marketplace lenders today use that instrument. However, because Prosper and Lending Club focus on unsecured consumer debt, there was never a thought to evolve that product into a secured instrument since there is no asset or collateral to secure against. The beauty of real estate lending (as well as b2b marketplace lending in some ways) is that there is an actual tangible asset to recover against at the end of the day. We've always taken first lien positions in all properties from day one. Our recent move just allows us to offer that first-lien security interest to our investors. The concept isn't new, but no one lending against collateral thought to apply the concept of secured lending to the marketplace lending industry or the borrower payment dependent note instrument. Everyone thought that the evolution of the borrower payment dependent note was done. It took us over a year to figure out how to properly structure our new model, but we are pleased to be able to offer investors this much more protective product. It lets our investors sleep better at night and moves the marketplace lending industry forward in a significant way. We also published a template of our structure so that the industry may advance and move forward and had a number of inquiries from GCs and outside counsel of other platforms on how to engineer this structure. We are confident that our best-in-class structure will soon be adopted by all the leading asset-based marketplace lenders and the industry as a whole, and are already focusing on other major initiatives to move the industry forward.
d) Data provision, contingency plans to protect investors in the case of failure, and stating many of you invest in POL opportunities are some of the ways you create transparency. What are some others?
One key way we’ve provided transparency to date is the level of information we place on each project at the time we post it for funding. Using this as a baseline, we are continuing to add to the detail and depth of information we provide. It’s very important that investors are given the information and tools to make an informed decision. Given the level of risk inherent in the loans - something we’ve never tried to hide - we believe that the basic tenet of transparency begins with providing information to a prospective investor. In a growing age of empowerment through access to knowledge, people are becoming more active in their money management beyond the use of robo-advisors. We take that information availability very seriously, which is the reason our FAQ section of the site is so robust. We’ve also taken the time to add helpful information on the site. I’ve come across other sites that are very ‘hard sell’. They are one big sign-up form because they are ‘maybe’ assuming that people will jump right in! Well, people don’t just jump right in. People need to take time to get to know the company, the value, and lastly, the proposition. The other way we create transparency is by keeping open lines of communication with customers, regulators, media, and competitors. We don't shy away from participating in group discussions or online forums, or hosting our RECFEN Meetups. Also, we make ourselves, the executives, always available to answer questions; Jason, our CEO, regularly gives people his email or phone number during interviews, including live radio broadcasts, and we also promote transparency at large by publishing articles on media sites to open discussions for the industry and our peers.
2. Growing the industry
a) As someone focused on promoting POL and the RECF industry, what are some of the strategies you employ? What works? What are skeptics common concerns and how do you address them?
Strategies for raising awareness, like any good marketing strategy, change constantly. The days of picking a few channels, developing a single strategy, making creative assets, deploying and sitting back are over! Reaching people is easier than ever due to the proliferation of media, devices, technology and the Web. However, this plethora of channels makes it far more difficult to get their attention. Another complexity is the very distinct audiences that we need to reach - investors on one side, and borrowers/developers on the other side. However, one strategy that I’ve always believed in, is reaching people through events and conferences and I give major props to organizers like Crowdnetic for bringing thought leaders together for an event like Crowdfinance in NYC. Even though most people will glance at their email 30-40 times an hour (this is a researched statistic) even during a conference, they still made the effort to show up, and to learn, and to meet people - and that’s the key. Along with transparency, which is a building block of trust, we are operating in industries (finance and real estate) that are heavily dependent upon relationship building, which can only meaningfully happen in person.
We’ve addressed certain concerns about credibility and viability by simply putting our heads down and working hard. Patch of Land has consistently funded over $10MM in loans for the past two months, and over $50MM so far this year. Concerns about ‘will they still be around’ for many RECF platforms were allayed with venture funding rounds and the contingency-plan trustee agreements we’ve pioneered and put into place. Working hard and proving the business model often silences the skeptics. Also, a key to addressing concerns is to really listen to those concerns, evaluate them, and implement changes where possible, to help improve the overall company. Without feedback, we wouldn’t have a comprehensive understanding of what is working and what isn’t. So we always ask for feedback - and implement it where and when possible. We’ve created an interactive help desk, and even an ideas page, where we invite customers and visitors to tell us what they want: https://patchofland.com/ideas.
b) What strategies have you brought with you from previous experience?
Overall, I’ve always believed strongly in building relationships, networking, and being honest and humble in communications. We’re still fragile as an industry, and under massive pressure to ‘grow’ and scale. I’m an entrepreneur at heart, and was independent for 7 years after working in banking and at a hedge fund in Switzerland. My experience developing intellectual properties and franchises through brand licensing, and then simultaneously taking those to market through digital media, online communities and social strategies has given me a broad understanding of how to deal with complexity in a quickly evolving world of reaching the customer. Thinking strategically and in constellations is necessary in a complex and newly forming industry like this one. Moving swiftly, adapting to every new twist and turn with agility, and iterating marketing tactics like tech iterates software and systems, are also key components to my strategies.
3. Adapting to a down cycle
a) Real estate, given its cyclical nature, may be the first crowdfunding sector to be tested by a downward cycle. How is POL preparing for that? How do you see it affecting the industry?
We get this question a lot, and we believe that having a well rounded product set - and by this I mean real estate financing products - will help us move through the cycles, since different forms of financing will be in demand at different times. Many real estate professionals will say that there is plenty of money to be made during a downturn, just as traders and hedge funds are able to make money during cyclical market corrections; it’s a matter of diversification, some timing, and deep understanding of where the market is moving. We’ll go through each cycle, and each local market cycle, by being close to the customers - both investors, and borrowers, who are experienced, knowledgeable and themselves understand their local market, demand, and trends.
Specifically, we are looking at products that are in demand, or will be in demand in a market we have identified as strategically opportunistic. The geographic diversification of markets allows us to pinpoint ones with the most potential, and at the right risk and price for the products we are offering. We are already diversifying from fix and flips into multifamily and commercial, and into longer-term products, so we are diversifying geographically, by asset type and along the yield curve.
b) Some sites are mostly staffed by tech types with little actual real estate experience. The POL team has plenty of real estate experience. What does that add, and can a site staffed by technological-heavy personnel survive?
We’ve certainly grown to include executives and staff at all levels who have a lot of real estate experience. This is very important because without that basic - and even advanced - understanding of real estate such as how the markets move, how people operate in the industry, and most importantly, how to underwrite, a company may be biting off more than it can chew, which could result in some bad deals. We are also a team of entrepreneurs, innovators and technologists as well as finance and financial markets expertise. Having the right mix of people is the key to long-term success. The benefit to having a team that isn’t predominantly from real estate, is that there is no legacy thinking, or legacy systems with a new ‘face’ or to put it another way, with a website, but no clue as to what it means to be participating in a revolution in the way real estate is financed. Many real estate people have underestimated also the regulatory, legal, compliance, and marketing aspects of growing a company in this space. So it comes back to having a well-rounded team with specializations and complimentary skill sets.
4. Managing growth
a) Have there been any challenges POL has faced as you have grown?
POL has faced many challenges that a lot of start-ups face! A few key challenges have been: trying to grow on a very constrained, bootstrapped budget; raising that first significant round of capital; staffing and key hires; the see-saw of too much/too little capital vs. too much/too little deal flow; managing expectations of investors, customers, industry. I feel like we’ve faced each one valiantly and with heart. We have a great team with awesome attitude, and it shows in our results.
b) How do you maintain strict underwriting as your geographical footprint expands?
Our underwriting, like many of our processes and systems, begins with human expertise and experience. We take that, and develop technology to enhance and create efficiencies so that as we move into new markets or new products, we can modify and adjust parameters before we offer loans in a given market and on the fly, which gives us a baseline to compare to what our underwriting and market teams know. Our underwriting is overseen by very experienced underwriters and a credit committee. We’ve built technology that consumes bluechip data sources, aggregates and performs predictive and trend analysis and is then passed through our custom pricing and risk models. These trained models take geography into account and compare segmented trends and other analysis to our risk thresholds and provide multifactor market reports and numeric scores. Internally, our staff can investigate each market from the perspective of each of our data sources, compared to our current portfolio performance, and use our scenario development tools to model possible events in each new market. We also make considerable strides to show this level of market intelligence to Investors as well.
5. Can you share briefly what you will be talking about in New York?
I’m excited about moderating the real estate panel in New York at Crowdfinance 2015. RECF is expected to top $2.5B in 2015 and outlets like Bloomberg are beginning to talk about RECF, which shows that awareness is growing, so I’m also going to skip over the basics of ‘what’ it is, and dive right into some meatier discussions. With a few years behind the industry now and these companies now established as leaders, I’m going to focus on the growth path of each company, changes to business models, challenges and realizations that have led to their leadership position, and looking forward towards future opportunities.