I have been following GROUNDFLOOR, a real estate crowdfunding company for a couple of years now and what was most interesting to me was that they have always focused on the retail investor. Previously, investing was only available under a special exemption in Georgia, but it was clear that they wanted to open access to everyone to invest in real estate crowdfunding and this week they made it official. I had a chance to catch up with Brian Dally, Co-Founder and CEO to learn more about this announcement and his company.
Going through SEC registration is an expensive and onerous process. Due to the immense interest from institutional capital, both new marketplace lenders and real estate crowdfunding platforms haven’t had to seek retail capital. Which has left investors like me with just two options: Lending Club and Prosper. It is nice to see another company focus on the retail investor.
When I asked Brian about the focus on retail capital he said that they believe that the performance of a capital market is really dependent on the source of capital in the market. They set out to build the largest breadth of product that would end up creating the fastest, cheapest and best source of capital. GROUNDFLOOR was purposely built to serve retail investors. Brian also noted that they had several opportunities to partner with institutional money, but turned them all down. At this stage they want to focus on the retail investor, where no one else is focused.
Not only are they the first real estate crowdfunding to achieve SEC qualification, but they have approached this in a completely different way to Lending Club and Prosper. They are doing an amended Tier 1 Regulation A offering, often referred to as Regulation A+. The process GROUNDFLOOR took is not the same as the one Lending Club and Prosper took, which was through an S-1 filing. The advantage of the S-1 is the ability to sell an unlimited amount of securities, but that comes at a very high legal and regulatory cost. The advantage of a Tier 1 Regulation A+ offering is a lower cost, lower reporting requirement method to reach non-accredited investors, but it is limited to an offering of up to $20 million. GROUNDFLOOR is groundbreaking. They are the first company that we are aware of to utilize Regulation A+ since it became operable through the JOBS Act on June 19, 2015.
To date, they have originated over $2 million on their platform across 42 projects. Loans are fractionalized, with the minimum investment being just $10. With this announcement, lending will open up in California, Illinois, Maryland, Massachusetts, Texas, Virginia, Washington, Georgia and the District of Columbia. GROUNDFLOOR uses a similar note structure to Lending Club and Prosper called a borrower payment dependent note. However, their loans are much shorter and they are secured by real estate.
A typical loan through GROUNDFLOOR is six months to one year in length, with a loan amount of $50,000 to $100,000 per loan. Loans are typically made to developers for fix and flips projects for single family residential projects. Since these are relatively short loans, the end result is usually a sale of the home. Borrowers are charged an origination fee of 2.5% and servicing fees of 1.5% upon repayment. While investors do not pay any fees, they are subject to formation costs for the offering that can range from 2-5%+. Average annualized yields for the investment is over 12%.
When it comes to expansion, Brian mentioned that they are working on other states, but there is a regulatory burden of both compliance and disclosure. They set out to find the states that had the most exciting real estate markets and where they felt there was a big enough base. There were several other factors including size, nature of the real estate market and state laws. Just like Lending Club and Prosper, they have to comply with state and federal laws. The states chosen were ones they felt they could collaborate successfully with.
Brian had several interesting things to say about their growth. Since they were in a pilot, they didn’t emphasize growth and instead focused on the quality of the lending volume. However, that is not to say they haven’t been lending more. When they first started, they did 1 or 2 projects per month and late last year, this increased to between 5 and 7. This pilot was deliberate so they could go through a full cycle. Now they have had $800k repaid on the platform.
In November, they introduced GROUNDFLOOR 2.0, which lowered the minimum investment from $100 to $10. They introduced a grading algorithm and added other features as well. While some real estate crowdfunding companies have been focused on growth, GROUNDFLOOR has focused on product development. They want to understand the consumer and build the right experience before they scale.
Investing in real estate crowdfunding is something that has been previously off-limits to retail investors and it is great to see that retail investors will now have direct access. As the company continues to grow, it will become easier to invest in hundreds of properties. More importantly, it will be easy to be diversified with a relatively small investment. It will be interesting to see if any other real estate crowdfunding sites follow suit.