Crowdfunding house flippers: Risks and rewards
Home prices are rising at a fast clip again, which is bringing house flippers back to the market. Just like during the housing boom, they are buying distressed properties, doing quick rehabs and selling them for a fast profit.
Unlike during the boom, however, some of these flippers can't get mortgages to ply their trade. So they're turning to the crowd, crowdfunding, to be exact.
Chicago-based Ben Walhood used to sell brain surgery equipment; on the side, he flipped a few houses.
"When I had the W2 and a good income, getting a mortgage was relatively straightforward," he said.
But when the flipping profits grew, Walhood, 33, decided to go into it full time. Without the sales job, though, he had no W2, and that's when the money dried up.
"At that point it was essentially impossible to get funding from the big banks," he said.
Walhood turned to San-Francisco-based RealtyShares, one of a growing breed of crowdfunding platforms. Essentially, it is an online marketplace for real estate investing, where individual investors can open a free account and access investments in properties across the country. They need a minimum of $5,000 to invest and must be accredited, which includes either an annual income exceeding $200,000 or a net worth of over $1 million.
Walhood would get his property purchases funded by this "crowd" of investors, who would lend him the money. As with a mortgage, he pays interest on the loan, and the investors get about a 9 percent return. Once each property is sold, the loan and the investors are paid off.
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"This gap has been left by banks that now crowdfunding platforms, like RealtyShares, are able to fill," said Nav Athwal, CEO of RealtyShares. "They are able to provide quicker, more efficient capital that helps meet the needs of these investors who are looking for speed of execution and the ability to be flexible with their terms as well as with the underwriting standards. Banks just aren't meeting that need."
RealtyShares put Walhood through an underwriting process, checking his credit score, his track record with other investments and his personal finances. Once he was cleared, then only the deals themselves had to be underwritten. That sped up the process dramatically. Now, Walhood can get full funding for home purchases in as little as an hour.
It does, however, come at a cost—a far higher interest rate. Investor loans backed by Fannie Mae and Freddie Mac can carry rates in the 4 percent range; Walhood pays around 11 percent, which is how the investors make such a good profit. Some deals can also include an equity share in the property.
"We're certainly paying a higher interest rate through Realty Shares, but the benefits are well worth it. I can work with Realty Shares or other private funders, or I can just not do this," said Walhood.
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Since he can generally flip a house in three months, he is only paying that high rate for a short time, and then the loan is paid off. He does hold some of his properties as rentals, but for those, once he has a renter in place, he can refinance to a commercial loan through a local bank.
RealtyShares' CEO said the company has funded over 100 projects, 70 of them in 2014. It has already done 30 this year. To date, 90 percent of its projects have been fully funded.
As for risk, there is plenty. Home prices are rising now, but history has shown housing can be cruel. If values suddenly began falling, even locally, certain projects could go under. Athwal said he is very picky about what gets listed on the platform, but he admits that like any other investment, it's never a sure thing.
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"So far we've had no defaults, no major issues with any of our projects, and I think that really goes to our underwriting criteria and the strictness with which we adhere to when we are looking at a property," he said, adding that only about 1 out of 10 properties that come through the platform actually get listed.
The market is filling with other real estate crowdfunding platforms, like RealtyMogul, Fundrise, Groundbreaker and PatchofLand, but the vast majority focuses on larger projects, like apartment buildings, restaurants, offices and hotels. This is one of the first focusing on the single-family flip market.