Crowdfunding vs Private Lending
In the post GFC era even highly creditworthy borrowers with worthwhile project proposals continue to find raising funds from Banks difficult, intrusive and time consuming. Property developers and investors therefore sometimes turn to Private Lending (also sometimes known as Asset Lending) as source of funding. In this blog we take a look at the pros and cons of Private Lending, and consider Real Estate Crowdfunding as a viable new source of funding for project sponsors.
Private Lending refers to funding provided to property developers and investors directly by individuals, syndicates or specialised lenders on a bespoke basis (ie negotiated individually), often sourced through specialist finance brokers.
Private Lending does offer certain advantages to other sources of funding;
- Fast turnaround - because Private Lenders do not have to comply with strict underwriting rules and are largely unregulated, they are often able to provide funds at short notice, particularly if the project has an urgent funding requirement.
- Flexible - Private Lenders can be flexible in terms of their security and serviceability requirements (more flexible than Banks for example) due to the individually negotiated nature of the funding.
- High Loan to Valuation - Private Lenders may lend at very high Loan to Valuation ratios beyond the ability of Banks - sometimes up to 100%.
Of course Private Lending also comes with disadvantages;
- Origination Cost - Private Loans often incorporate very high upfront fees in addition to the loan interest rate - establishment Fees of 3% to 5% of the Loan amount are not uncommon. In addition, if introduced by a specialist finance broker, additional brokerage fees of a further 2% to 5% are charged.
- Interest Rate - Private Loans charge very high interest rates - from 15% with much higher rates possible.
- In some cases, Private Lenders may also seek equity participation in the property as part of the overall funding package (sometimes called an "equity kicker").
- Restrictive covenants - Private Loans often include highly restrictive covenants, in particular regarding the ability to deal with the property (ie sell or lease).
Real Estate crowdfunding matches many of the advantages of Private Lending, while overcoming many of the disadvantages;
- One of the key features of Real Estate crowdfunding is the efficiency and short turnaround times required to raise funds - crowdfunding campaigns are often completed in 4 /6 weeks and supporting administration is straightforward and largely automated.
- Crowdfunded loans are structured in accordance with conventional market practice and do not require unusual / restrictive covenants or equity participation - Real Estate Crowdfunding platforms work with the Project Sponsor to develop a structure which meets the needs of both the Project Sponsors and funders.
- Real Estate crowdfunding carries a substantially lower overall cost than Private Lending - upfront fees (deducted from funds raised) are usually 3% to 5%, and ongoing interest is competitively set against conventional market benchmarks (ie taking into account the type of funding required, the risk profile of the project etc)
Real Estate crowdfunding provides a fast, transparent and low cost alternative to Private Lending and should be considered by commercial developers and investors who are finding it difficult to source funding from Banks.
Private Lending still has a place for complicated or highly leveraged funding requirements, however comes at high cost and often with strict restrictions, and should be used only when other avenues have been exhausted.
"Any advice provided on this post is general in nature. Readers are urged to seek their own professional advice before making decisions."
Feb 11. 2016