By Rupert Taylor on Thursday 11 August 2016
PeerStreet – the marketplace for investing in US real estate loans – blasted through $100m in ‘funded loan investments’ last week. After a formal launch in October 2015 the signs are good that their innovative model is well conceived to disrupt the large and fragmented private lender market for US residential bridge funding.
A significant part of the magic in this model could prove to be the way that PeerStreet partners with existing originators in the market it is seeking to disrupt. PeerStreet itself does not originate loans. Instead it provides a secondary market for private lenders. This will allow the model to achieve significant scale in a manner that respects the reality that good real estate lending relies on local knowledge.
And the prize for scale could prove significant. PeerStreet is sourcing loans from the residential bridging space. These loans tend to be for a 6-24 month term allowing properties to undergo improvements before being sold, or having a tenant installed – ‘fix & flip’ of ‘fix and let’ in US parlance. According to management the annual market opportunity runs to $65billion and this is a space presently occupied by a fragmented collection of private lenders.
After being screened by the platform this huge origination opportunity can be provided to investors as 6-12% returning, first lien, maximum 75% LTV loans, diversified geographically far beyond their locality. PeerStreet uses algorithms, back testing, third-party valuations, and manual oversight to ensure that only suitable loans make it to the platform. This is exactly the kind of tech-enabled screening that is boasted by all good marketplace models. However the quality of the loans still relies heavily of the assessment of the originator, and even more so on the inclination of the originator to post good loans onto the PeerStreet platform.
And it is PeerStreet’s solution to the potential for negative selection bias that really got my AltFi Data blood pumping. A simplistic analysis of this approach would identify the potential for a variation of an agent/principal conflict. What motivates the originators to share the good loans? Surely the originators will keep the good loans for themselves, and pass on the ones that look less good? How does the system create the right incentives to align the originator with the PeerStreet platform investor?
It is to this challenge that PeerStreet has two brilliant answers. Firstly the platform shares its screening technology with originators. Not only does this help originators source and price good loans, but it also allows PeerStreet to contextualize the loans that then get put forward to the platform. If PeerStreet are seeing an analysis of all of an originators lending opportunities they can readily identify if their investors are being offered the duds. But even more powerful is the motivation that PeerStreet can create by offering originators a shop window from which to advertise their own lending track record. For the originator their cost of funding is invariably tied to their own lending track record. PeerStreet provides them with a platform from which to advertise that, allowing them to create a virtuous circle for their own business, and a tasty carrot to incentivize them to share good loans with on platform investors. So the PeerStreet platform allows them to originate more loans, earning more arrangement fees, and overtime reducing their own cost of funding to improve the spread they make when acting as principal. This is a potentially powerful alignment of interests that could unlock the huge opportunity in this space represents
This use of disclosure to create alignment, and access to a huge asset class with undoubted investor appeal, makes PeerStreet one to watch. With a list of backers including Dr. Michael Burry of ‘The Big Short’ / Scion Capital fame, and founders with both real estate expertise and Google pedigree, perhaps this should come as no surprise.