My first investment into real estate crowdfunding has completed. In April 2015, I invested $5,000 into a fix-and-flip loan at the site Patch of Land. There are more details in my initial update, but here’s a quick recap of the loan details:

• Single-family home in West Sacramento, California
• Loan secured by property, in the first position. Backed by personal guarantee from borrower.
• 6-month expected term (roughly April 15th to October 15th). Fix-and-flip.
• Loan-to-value is 75% per independent 3rd-party appraisal.
• 11% APR interest, paid monthly.
• $5,000 invested.

Here are the initial and final numbers on the property itself:

• Developer Purchase Price: $155,000
• Estimated Remodel Costs: $55,000

• Developer Contribution $31,000 + closing costs + origination fee
• Developer Loan Request: $179,000

• Independent 3rd-party After-Repair-Value: $238,000
• LTV based on Independent ARV: 75%

• Developer estimated selling price: $275,000 to $300,000
• Actual selling price: $300,000

Here are the final numbers for my partial investment:

• 4/20/15 – $5,000 invested.
• Proceeded to collect $45.83 of interest on the 15th of every month (pro-rated on partial months).
• 9/23/15. Loan extension granted.
• Kept collecting $45.83 of interest on the 15th of every month (pro-rated on partial months).
• 3/15/16. Notified that house in under contract for $300,000.
• 3/30/16. Loan was paid in full.

The loan term was supposed to be for 6-months (one of the main reasons I chose it) but the process took longer than expected and the total loan period ended up being nearly 12 months. My total interest payments were $517.91. I also received an additional $75 fee for the loan extension. I thus received a total of $5592.91 over 346 days, for an annualized return of 12.5%. Without the extra $75 penalty fee, my interest payments would be right at the promised 11% APR.

Takeaways from the process:

• Be patient but decisive when selecting your investment. You should be comfortable with the local market situation as well as the numbers like loan-to-value ratio. You should know what you want, ignore anything that doesn’t fit your criteria, and act quickly when you see something that does. This is really the only part of the process where you have control, so use it wisely.
• Understand the contract. Just because there is a “6-month expected term” doesn’t mean you’ll get your money back in 6 months. You should read the terms carefully to see what options are available to the borrower if they can’t make that date. Is an extension automatically granted? Is there an increased interest rate? How long does the extension last?
• Liquidity and more patience. One of the defining features of this type of investment is that it is highly illiquid. If I buy a mutual fund, I can sell the entire thing and get fair market value as cash in my bank account in a few business days. With an investment like this, the borrower could pay it back early, take their sweet time, or even default entirely and they’d have to liquidate the home before I get my principal back. That could take another several months. You should not need this money any time soon.
• Low-maintenance. The good part of having no control is that you don’t have to do anything. I just sat back and had the interest automatically swept to my bank account each month. I received a simply 1099-INT for the interest earned through this loan, and it was quite easy to deal with at tax time.
• Updates. I did not receive constant updates on this loan, but I think the updates were adequate. I was given a couple of photos on the remodel progress and updates on loan extension, house listing, house listing changes, and house being under contract. You do not have any two-way contact with the developer.

I will admit that I was nervous for a little bit on this house. I could track the house listing on real estate sites like Zillow and I questioned some of the cosmetic choices that the developer made, including painting the house an gunmetal-grey stucco. I also questioned the high listing price of $325,000, which I thought they’d never get and would scare off potential buyers. It all ended well as the house was repainted into a neutral beige and the developer agreed to sell at a good price.

Will I invest again? Well, I can’t help but be satisfied with my 12%+ annualized return, but things could also have dragged out a lot longer. I will probably invest again, but at a different real estate site, if only to see how they might handle things differently. I’m in it to make money, but I’m also in it to learn as this is my “experimental money” fund (even Burton Malkiel and Jack Bogle have such accounts).

Account screenshot:

Here’s an update on one of my real estate crowdfunding experiments. In mid-April 2015, I invested $5,000 into a loan for a single family fix-and-flip in West Sacramento, California. The loan was supposed to be for 6-months (one of the main reasons I chose it). (More details in my initial update.) Well, the short version is that the fix part happened, but it has now been 10 months and the house is still on the market. The borrower took the option of a month-to-month extension. The loan is still current. Here’s a screenshot and some more thoughts:

Interest received in a timely manner. So far, I’ve been receiving my $45.83 every month ($550 annualized) on my $5,000 initial investment (11% APR). I enabled the option of having my interest automatically swept to my bank account each month. So far, this investment has required zero maintenance.

Read your contract. Just because there is a “6-month expected term” doesn’t mean you’ll get your money back in 6 months. You should read the terms carefully to see what options are available to the borrower if they can’t make that date. Is an extension automatically granted? Is there an increased interest rate? How long does the extension last?

Liquidity, liquidity, liquidity. One of the defining features of this type of investment is that it is highly illiquid. If I buy a mutual fund, I can sell the entire thing and get fair market value as cash in my bank account in a few business days. With an investment like this, the borrower could pay it back early, take their sweet time, or even default entirely and they’d have to liquidate the home before I get my principal back. You must be prepared for all scenarios.

Be happy with your loan-to-value ratio. I personally believe the house is listed for too high a price, but that part is not under my control. What was under my control was choosing to invest only in a loan where I was comfortable with the collateral. For example, they may be asking ~$320,000 but the loan amount was only for $179,000. As I am (one of the folks) in first position lien on the property, the house would need to sell for under $179,000 in net proceeds for me to lose principal.

In other words, have an adequate cushion so that you don’t lose sleep about it at night. It also helps that I’ve already earned 8.6% of my initial investment back over the last 10 months, cash in hand. Finally, I will repeat that this is a speculative investment using “experimental money” that makes up a very small portion of total assets. (Even Burton Malkiel and Jack Bogle have such “funny money” accounts.)

Tax documents. I received a 1099-INT for the interest earned through this loan. The 2015 form was made available in a timely manner on January 27, 2016. As such, it should be rather easy to add this in at tax time.

Added bonus for new sign-ups. I’ve been a registered member of RealtyMogul for a while, and they recently emailed me that if I referred a friend, we’d both get a $150 Amazon gift card just for completing the registration process (i.e. zero investment required). Here is a screenshot. The restriction is that you must be an accredited investor, which means either a single income of $200,000, joint income of $300,000, or net worth of $1 million excluding primary residence. I’ve registered at a few of these sites, and you may need to send in a scanned W-2 (was allowed to remove SSN) or brokerage statements for verification.

This is a nice carrot if you are already interested in hard money lending or fractional real estate ownership. You must either use this special sign-up link or use the promo code JONATHANP7 during registration. Offer expires 12/31/15.

*The referrer and the referred will each receive a $150 gift card (redeemable at Amazon.com) upon successful completion of the investor registration process at RealtyMogul.com by the referred party. Gift cards will be mailed within 30 business days to the address on file. This promotion is limited to 6 referrals per referral code and is only valid until December 31, 2015.

Original post from mid-2013 below:

Realty Mogul is a new “crowdfunding” start-up that lets you invest in residential investment property for as little as $5,000. You either take a partial ownership position in a property, or you become a lender to (experienced) house flippers. The new thing here is that you can do it completely online with a few mouse clicks (no mortgage brokers, real estate agents, or tenants) and again that low minimum $5,000 investment. (Thanks to reader Johnson for the tip.)

Taking an equity ownership position means that you own a little slice of a single-family home or multi-unit complex while a professional does the buying, fixing up, renting out, and eventual selling. Realty Mogul only has done one deal like this so far (fully funded) and the intended timeframe is 5-7 years. You earn rent while the house hopefully appreciates in value, and cash out when the house sells.

Being a lender looks very similar to the age-old practice of hard money lending, just with smaller chunks. You lend the money to a house flipper who needs a short-term loan (3 months to a year) and doesn’t want to deal with traditional mortgage lenders and their closing costs and long underwriting delays. The loan is backed by a personal guarantee (not too special, you can try to sue and/or hurt their credit score) and more importantly you usually have a first position lien on the property (if they don’t pay, the lender gets the title to the house). Most of the previously funded loans have an annualized interest rate of 8%.

Realty Mogul states that they differentiate themselves from other similar startups like FundRise and Prodigy Network by (1) outsourcing the real estate expertise to vetted professionals and (2) keeping a focus on cashflow, either via rent or interest payments. Right now they’ve only had about 7 investments, but they seem to open a new one up after the last one fully funds.

Currently, the SEC limits this type of investment to accredited investors, which means either a single income of $200,000, joint income of $300,000, or net worth of $1 million excluding primary residence. When I tried the application, the only screening process was to check a few boxes and state that you qualify. Supposedly, the recently passed JOBS Act will allow them to drop this requirement later this year.

If given the option, should I drop $5,000 into this to try it out just like with person-to-person lending? $5,000 is still a lot of money to put into an investment where you are not able to do much due diligence. Getting good returns on a single investment project is all about the skill of that particular rehab team. Will the teams that sign up for capital via Realty Mogul always be the good ones, or those that are having a hard time getting funding from elsewhere? I thought that hard money lending rates were more in the 10%+ range; I don’t know if I’d be happy with 8% but maybe that’s the going rate now. Even if you have collateral, recouping your principal in case of a bad loan can get complicated and time-consuming. At least with P2P lending I can spread $5k over 200 different loans such that even though I am certain to get some defaults, it is unlikely I will get a negative return overall.

More: TechCrunch, LendAcademy, BizJournals, The Verge

While reading back through various transcript notes from the 2015 Berkshire Hathaway Annual Meeting, I recalled the following quote from the Q&A session. A shareholder had asked why Berkshire had never borrowed money to buy stocks (i.e. leverage). Charlie Munger replied:

It’s obviously true. If we’d used the leverage that some others did, Berkshire would have been much bigger … but we would have been sweating at night. And it’s crazy to sweat at night.

This is an important point, as many other similar investors have used leverage to boost their returns (not always, but some with success). Buffett and Munger certainly could have justified such an action, especially given their excellent investment track record.

Munger did not make this jump, but I believe but an individual investor could also apply this quote to paying off their mortgage early. Even I enjoy discussing the details of mortgage payoff vs. retirement savings, and acknowledge that mortgage interest rates are low while stock returns are historically higher. Why use your money to pay off your mortgage when you could invest in stocks instead?

The problem is that if you are putting off paying off your mortgage just so you can invest in stocks, you are using leverage! That is, you are taking borrowed money and then putting it at risk. That may increase your overall returns, but it will also increase your exposure to bad outcomes. For most people – not everyone, but most – paying off your mortgage debt will help you sleep better at night. Based on his biography, Warren Buffett himself bought a house in cash when he got married. Even though he was confident he would have made more money by putting those funds toward his investment partnership, he chose not to have a mortgage.

In addition, many financial advisors are incentivized to maximize the amount of your money that they manage, as they can’t earn any fees off your home equity. Wes Moss, a fee-only advisor and Money Matters radio show host, ignores that and gives blunt advice in his book You Can Retire Sooner Than You Think:

Sooner or later, every homeowner asks the simple question, “Should I pay off my mortgage?” and immediately gets bombarded with a variety of complicated, hedged responses. Here is the simplest possible answer: Yes. If you are anywhere near retirement and can afford to pay off your mortgage, you should.

I view this as an example of how real-world, experience-based advice can differ from theoretical, academic-based advice. Humans are not perfectly rational. I have never regretted paying off my mortgage early, although I do agree with the qualification that mortgage payoff should roughly coincide with retirement date.

* Of course, Warren Buffett quickly added: “…over financial things.” Ba-dum-bum-ching!