Real Estate, Real Assets in Online Investing
Although a property can be viewed as an investment, it is also a building made of bricks and mortar where people live, work, or shop. Why does that matter to potential investors? The tangible nature of real estate impacts the type of risk that investors are taking on. Unlike other online investment options like personal loans or small business loans, loans that are backed by real estate have the underlying value of property to fall back on in the case of a default.
When investors invest with LendingHome, they’re lending money to real estate professionals who are buying houses, fixing them up, and reselling them. To mitigate risks for its investors, LendingHome takes a first lien position in each loan. This means that we (and thus our investors) will be the first to be paid back using the underlying collateral (the property) if the loan goes into default.
A core part of LendingHome’s criteria when evaluating potential loans is the amount of the loan compared to the value of the underlying property. This ratio is known as Loan-to-Value, or LTV. LendingHome ensures that borrowers take on some risk by only providing loans that cover a portion of the value of the home. Therefore, if the borrower defaults and the house needs to be sold for less than its full value, investors still have the potential to recover some or all of their investment because the borrower must lose all of his or her equity before an investor loses any of his or her investment.
Knowing that there are recovery options for investors sounds good in theory, but does it also mean that investors have to go chase down borrowers who are late on their payments or manage a foreclosure to get their money back?
For loans on the LendingHome investment platform, a dedicated in-house servicing team jumps into action when a borrower becomes delinquent. This means that investors never have to get involved in chasing down payments. The servicing team is responsible for working with the borrower to get back on track or, if a resolution cannot be reached, moving forward with either a short sale or a foreclosure.
Short sales occur when a property is sold for less than the amount owed. When that happens, investors are paid less than the amount of money they are owed. However, they may have received interest payments throughout the life of the loan, which can lessen the overall impact of the short sale. For example, the first short sale on a LendingHome loan resulted in a loss in principal but an overall positive Internal Rate of Return (IRR) for investors over the loan period after taking the interest paid over the life of the loan into account.
Another tool for investment recovery is a foreclosure. The goal of a foreclosure is to sell the property to a third party for more than the outstanding debt, often at auction, thus paying back investors right away. If that isn’t possible, LendingHome purchases the property and sells it on the open market to get as much value out of the asset as possible to return to investors.
A Foreclosure Example
One of LendingHome’s first foreclosures involved a house in San Diego, California. The home’s original value when purchased by the borrower had been assessed by LendingHome at $333,000, giving the mortgage an initial loan to value ratio (LTV) of 74.85%. During renovations, the borrower turned a garage into a bedroom, pushing the after rehab value up significantly.
Despite the increase in property value, the borrower was overextended and had stopped paying his mortgage on the property due to personal financial difficulties. He owed $314,000 in principal, and the property was sold at foreclosure auction for $381,000. In the end, the investors made more money than they’d originally expected to make due to the high sales price, but the recovery period extended much longer than the term of the note, with no payments at all for nearly a year.
Investors had expected a 9.77% IRR on their investment and ended up with a 12.66% IRR. Of course, in this case the strong IRR was driven by the added value of the renovations—foreclosures won’t always provide such strong returns. But the tangible property that backs up each investment means that investors are able to get back some or most of their capital, even when foreclosures are necessary.
Both foreclosures and short sales are managed by LendingHome’s experienced servicing team with the help of third party vendors. They handle every detail of loss mitigation, from managing monthly payments through to investment recovery, so that investors don’t have to get involved. There are risks in investing in real estate, but LendingHome’s platform allows investors to diversify across many properties, limiting their risk, without ever needing to spend time chasing down payments.