Different Approach
Other companies offer different ways to invest in fractionalized mortgage loans. Two of them, LendingHome and PeerStreet, for example, provide loans to fix-and-flip buyers who purchase a property with the intent of fixing it up and reselling it for a profit.
LendingHome is a San Francisco-based direct lender that uses its own capital to originate short-duration, first-lien position loans. It started lending in April 2014, and its investor platform initially was open only to institutional investors who bought all of the original flow of loans. In January, it expanded its platform to include accredited individual investors who can buy fractionalized notes. The minimum investment to get on the platform is $50,000, and there’s a $5,000 per-note minimum.
Matt Humphrey, CEO of LendingHome, says the company lends at a gross interest rate of roughly 11%, and investors have seen returns of between 9% and 10%. “We’ll take 10% of the gross coupon, so if it’s 11% our fee will be 1.1%,” he explains.
He adds that investors should expect to remain for the duration of the one-year loans. For now, LendingHome markets its notes directly to individual investors, though it has plans to engage with financial advisors. “The RIA audience will be big for us in the future,” Humphrey says.
PeerStreet doesn’t originate loans but instead works with originators with proven track records that create and fund the loans, and says it employs advanced algorithms and big data analytics to re-underwrite the original underwriting to ensure loan quality. According to the Manhattan Beach, Calif.-based company, the loans generally are secure first-lien mortgages with short-term durations of six to 24 months and LTV ratios below 75%.
PeerStreet started lending two years ago, and it opened up its investment platform to accredited investors in the U.S. in late October 2015. “We have a variety of investors on our platform from individuals, wealth advisors and family offices to institutions and funds,” says Brett Crosby, co-founder and COO of PeerStreet.
The investment minimum is just $1,000. “With us, you can put $1,000 in 100 loans and get diversification across loans, lenders and geographies,” Crosby says. “And you can do it across different time frames so it resembles your own personal bond laddering.”
PeerStreet takes a 1% servicing spread on the note, so if it’s a 10% loan the company will put it out to investors at 9%. Investors should expect to remain invested during the term of a loan.
“Investors can handpick and curate what they want to invest in—we’re kind of like an E*Trade for this asset class,” he adds. “Or you can use automated investing, which is like a Wealthfront or Betterment for this asset class, where you set up the parameters of the loans and we’ll allocate that accordingly when loans become available that match your criteria.”
PeerStreet borrowers on average pay between 6% and 12% for loans, and Crosby says investors on its platform have reaped average yields north of 8%. According to the company’s website, mortgage-backed securities have had higher Sharpe ratios, meaning they compensate investors better than other fixed-income classes for the amount of risk taken. But given that the company’s platform is so new, it remains to be seen how these investments will do during a recession.
“Defaults are predicated on how conservative the underwriting is,” Crosby says. “We’ve talked to some accounting firms to try to get a benchmark for that, and they recommended having a 50-basis-points loss reserve for their clients in this space. But given our conservative underwriting, we expect our losses to be less than that. In this space, the underwriting and how conservative you are really matters.”
Mac & Mae
Despite the alluring high yields offered by this nascent sector, some investors looking for mortgage-based yield might prefer a wait-and-see approach and instead opt for conventional mortgage-backed securities from Ginnie Mae, Fannie Mae or Freddie Mac or for those issued by private firms. But current average coupons on these products are roughly 3.5% or less.
Another alternative is collateralized mortgage obligations, which are complicated vehicles dishing out similarly low yields. Or there’s the iShares Mortgage Real Estate Capped ETF (REM), tracking an index composed of U.S. real estate investment trusts that hold U.S. residential and commercial mortgages, and which recently sported a distribution yield exceeding 11%.
Naturally, the principals at Income&, LendingHome and PeerStreet believe they’re offering cutting-edge products that meet a genuine market need. “We’ve almost created a new asset class because you can invest in this space in a way you really couldn’t before,” Crosby says.