It’s not just lenders and investors who benefit

By Brew Johnson, CEO and Co-Founder, PeerStreet

Historically, private lenders thrived by having strong relationships with local borrowers and the ability to fill a niche within the broader lending market. By choosing to operate in a space where traditional lenders couldn’t or wouldn’t compete, these private lenders were able to capture market share in their own backyard.

While these lenders could fill this niche, several obstacles to their growth remained due to the highly localized and fragmented nature of the private lending market. By way of example, capital sources were primarily limited to their personal capital, money from friends and family, and in very limited cases, banking relationships. Since raising money to fund loans can be time consuming or overly burdensome, as the ongoing management of these capital sources create large amounts of administrative workloads, the private lending market has remained a fragmented niche or cottage industry, dominated by small, local lenders.

Following the financial crisis of 2008, things started to change and private lending expanded significantly, driven by two main factors. First, banks became even more unwilling or, unable, to lend. This drove an influx of borrowers to private lenders, who happily filled the void. At the same time, investors struggling to find yield in traditional asset classes, began looking for alternatives so more money started entering the private lending market.

These two trends — the growing private lending market and expanding investor appetite — brought forth many new entrants which further expanded the market, including online lenders and lenders backed by hedge funds and Wall Street.

The Future of Private Lending

Many people ask if I believe the expansion of private lending will continue, or was it merely a temporary product of the financial crisis. My answer is unequivocal: not only will private lending continue to expand, but can eventually replace traditional bank lending. Here are some of the reasons why:

The Aging Housing Stock

Long-term trends, especially for fix and flip, are extremely positive: The U.S. housing stock is older than it’s ever been, with the average American home being almost 40 years old. At the same time, homeownership rates are near all-time lows and rental rates are at all-time highs. These stats indicate there is a need for more and better housing options for homebuyers.

Fixing up aging housing stock can be a much more efficient use of capital than new development, which may be more expensive, take longer to convert to new housing, and in many cases, have a larger drain on the environment.

Capital and Credit

While the percentage of homes flipped is near all-time highs from 3.1 percent of all single-family residences in 2015 to 5.7 percent in 2016, only 31.5 percent of flips are financed. This tells me that there is a lot of opportunity for private lenders to extend credit in fix and flip.

So, where do you go to get the capital? Let’s face it. Banks are bloated and hamstrung by legacy systems, infrastructure and regulation. Private lenders are more efficient and faster than banks, provide higher quality customer service, and make loans that make sense in their respective markets.

Technology

The biggest opportunity in private lending will come from the widespread adoption of technology. The industry is increasingly populated by fintech companies looking to create new models of operation, but this doesn’t mean traditional private lenders will be left behind. Not at all. While individual lenders that apply technology may see incremental benefits to their businesses, a sea change can occur, by creating a platform that empowers any lender to seamlessly connect with any investor, anywhere in the world.

A Rising Tide Lifts all Boats

Think of the way the New York Stock Exchange creates value for companies and investors by creating a platform that connects investors wanting to invest capital with companies who need capital. A similar platform for the private lending space will transform the industry for the benefit of lenders and investors, as well as borrowers and even communities.

By creating a platform that allows investors to invest small amounts of money in a wide variety of loans, originated by a wide variety of lenders, in a wide variety of geographies, investors have an entirely new type of exposure and a level of diversification that wasn’t previously possible. Greater diversification should translate to lower risk and, over time, lower the return requirements that investors demand.

For lenders, the ability to access investor capital via a technology platform, makes more funds immediately available, and over time, should allow them to access more capital at a lower cost. Here’s how I see this unfolding: The opportunity to participate in high yield, highly diversified loans drive investors to commit more capital to the platform, which in turn allows the lenders who can participate to make more loans and expand their businesses. It’s a snowball effect that builds on itself; more investors join the platform who make more capital available for loans, which attracts more investors, and because a technology platform can connect lenders with virtually unlimited investors, the snowball effect can continue indefinitely.

The number and types of investors lenders can access via a technology platform like such is potentially unlimited. Yet, the most advantageous characteristic of this model is that lenders need only transact with a single counterparty rather than each investor individually. This cuts down the administrative burdens of accessing those investors and their capital tremendously. This ability to do more with less (more loans with less time and effort spent on capital raising, administration and investor relations) can be transformative to private lenders.

But it’s not just lenders and investors who benefit. The benefits of increasing capital to the system flows through to borrowers, who can increase the number of investments they can afford, and to indirect participants like communities where these fix and flip projects occur. Fix and flip borrowers hire local contractors, subcontractors and laborers. This creates local jobs and support for local businesses while buying supplies. At the end of the rehab process, they deliver a finished property, which has the potential to improve the value of neighborhoods. In other words, technology has the ability to create a better deal for everyone and transform private lending.

Potential Market Risks

While we believe the future of private lending is bright, it’s important to be cognizant of potential risks: inexperienced borrowers may level up too quickly or simply get in over their heads, lack of proper due diligence could miss costly renovation needs, failure to surface other risks or properly address legal requirements could also lead to major issues. Further, in rapidly expanding markets, these risks can be exacerbated with many new players entering the space and chasing opportunities. There’s also market risk. Like in all markets, the housing market ebbs and flows, and the next slowdown will mean an increase in defaults.

However, by leveraging the breadth of knowledge that exists among private lenders, implementing technology and applying best practices with responsible safeguards, it’s possible to reduce these risks and grow the private lending landscape well into the future. We look forward to being a part of this process and are excited about private lenders capitalizing on the opportunities presented by newly available technologies.