Beware of Platform Risk - How PeerStreet, a Real Estate Crowdfunding Firm, Went Bankrupt
26:04 Share

Walking the money for the rest of us. This is a personal financial on money, how IT works, how to invest and how to live without worrying about IT. Amy host David stang that as episode four forty, it's titled beware of platform risk in financing business.

A platform is an online space where users transact business or exchange information. The platform can act as an intermediary that connects buyers and sellers for goods, services or investments. A baby is a platform for booking vacation homes from owners of vacation properties.

Amazon is a platform for buying and telling goods. In twenty twenty two, independent sellers on amazon's platform made up sixty percent of sales, selling four point one billion goods that year. Broker firms such as swab fiddy of platforms for buying and selling investment securities.

Other investment related platforms include crowd funding, real state cyp to currency lending and platforms for investing in startups. Social media platforms like instagram or twitter provide a venue for users to interact and often to sell goods or services. Platforms have proliferated over the past decade and a half, and they have become more powerful.

Amazon, for example, is is an absolutely huge platform. Weren't kenyan john size man, are two academics that have studied these platforms. And they came up with the term and twenty eighteen of the platform economy because in their words, digital platforms are becoming dominant economic and social intermediates. We've just become bigger and more powerful in today's abroad. I want to kick off our discussion platform risk with a really state platform I began using in twenty sixteen. I think it's a good example because IT allows us to see the pros and cons of investing platforms in september twenty sixteen while attending fin can, a conference of financial media professionals bloggers, pod casters IT was held in Sandy ago, and I met with bad cosby, one of the co founders of peer street, an online platform for investing in real estate backed loans. These loans are sometimes called hard money launch, because the lower backed by collateral al real estate that can be sold if the bar were default real estate, hard money learns typically last for a few months to a few years, and allow the borrowers to access capital to remodel or upgrade property before selling IT or renting IT and replacing the hard money loan with the traditional mortgage.

The advantage to the bar war for hard money lunch is a quick approval, as these are non traditional lenders now, they generally charge higher interest rates than on a traditional mortgage, but this is really temporary financing, kind of a bridge loan, while the real ship Operator owner upgrades the property or does whatever needs to be done in order to get longer term financing in place or to sell the property, hopefully for a profit for investors on the peer street platform. This was new, an opportunity to build out a portfolio of high yielding real estate loans by investing as little as a thousand dollars in each one. Peer state was founded in twenty thirteen and was one of the first companies to build an online platform for hard money lending.

Potential barriers could get access to capital to to remodel a home to flip IT or directed history also developed relationships with other private lenders originated who could get financing for deals that they sourced. Pit acted as in immediate arranging the loans but also servicing the loans by processing the payments and handling for closure procedures if a barre defaulted. When I met crosby and Sandy eaga, p street had been in business about three years.

The platform has just issued its three hundred loan. The average interest rate across the portfolio was eight and a half percent, and the average loan amount as a percentage of the appraise value of the property was sixty five percent. That's known as a loan to valuation o eight eight percent average loan rate at a time when traditional thirty year mortgage had interest rates of less than four percent.

That's why these hard money launch are temporary because the bar IT is paying up for access to that capital. The average term on peer street for their loan portfolio in twenty sixteen was ten months. And at the time, through december twenty sixteen, peer street had experienced zero losses on the loans IT had originated.

Now that does that mean some of them didn't go into default and there needed to be a workout of a for closure. But because of the sixty five percent loan to that, there was a question on there, a buffer to allow peer street to access that collateral sell IT in the case of the front. So the last is were zero p street was venture capital.

Back in twenty sixteen, IT received its series a funding, and that funding ground was LED by venture capital firm and traces horror ds. During the meeting, cross me encouraged me to give the platform a try. He followed up on a number of email.

I studied the documentation. The offering documents went back and forth with cross me via email with following questions. For example, in reviewing the private placement memorandum, IT mentioned a spread between the original loan and the yield on the note.

Now that term notes pretty important because as individual investors investing on the peer street platform, we were investing in notes tied to the loans. We were not directly funding the loans. Peer street was acting as intermediary. This is an important distinction that i'll get to in a few minutes, and IT was a distinction I didn't really appreciate at the time I invested in peer street in the fall twenty sixteen cross be pointed out that pier streets typical spread was one percent. In other words, the interest ted on the loan issued by peer street was one percent higher, and the interest on the note tied to the loan that individual investors participated in on the platform.

Crosby said that that serving spread reduces yield to an investor slightly, but in in his opinion, he felt there was a fair trade off having a hassle free and diversified investing experience and the diverse diction he referred to was across loans, thousand dollars per loan. The lenders, in other words, the number of different originators on the platform that could be diversified, the ability for investors to diversify the geography, the the term in cross be pointed out that these are benefits to individual investors that really weren't available prior to peer street. He even described that as a touch less investment because if there are default as individual investors, we didn't have to to go arrange for the foreclosure.

Pier street handled all of that. I mentioned peer street and upset one thirty three of the podcast that was released in november twenty sixteen, which was when I invested and I shared details about the a six months note I invested in alone was secured by a rental property capacity in a california. The yield was eight and a half percent, and I had a long to value tio of seventy five percent.

This particular epsom was on ways to invest in a rising interest ate environment. And with interest rates very low and eight, nine percent yield was IT tractive, I focused on some of the risk. What if the bar were default IT and the house head to be sold off and it's sold off for less?

Then the a praise value, I didn't discuss platform risk and I should have, but I didn't really have a full understanding even even after spending all that time reading the documentation. Pier story at the time was only available to accredited investors, those that met certain income or net worth requirement. I continue to invest on po streets platform throughout twenty seventeen.

Pierce re actually spontaneous pisos of money for the rest of us in early twenty seventeen. And by the end of twenty seventeen, my allocation to peer street made up a around two percent of my network. I typically put a thousand dollars in each loan.

I kept the term one year or less. And generally, I tried to put IT with barriers that had decent credit. I would use the automated feature because IT was so much competition to get these loans, and often times they would sell out quickly.

And so by using the automated feature, I could get an allocation and then look at the particular deal and cancel IT. If I didn't want IT in that first year, I had no default throughout twenty seventeen and really throughout twenty eighteen. One house in venture california burnt down due to width res.

Others were they would pay slow, but generally they would catch up. I discussed peer street again in early twenty eighteen in plus episodes one ninety two in one ninety three. This is the premium podcast for plus members. And after that, or be in between these episodes, one of our plus members is an attorney who has expertise in the crowd funding platform space.

He mentioned the bankrupcy risk that these loans on peer story, where mortgage dependent promising notes that in the case of bankrupcy holders of these notes would be unsecured creditors, a peer peer street is who had the collator on the real state backing the loans. But as individual investors, we were unsecured creditors of peer street, a venture capital back firm where we had no financial information to judge its credit worthiness. I'll admit, I didn't really appreciate the bankrupcy risk of peer street back in twenty sixteen and twenty seventeen when I was investing after this member's email, I was much more concerned about IT.

IT was a risk, and I made the decision then not to reinvest my proceeds in pastry. I let the notes mature and ran the portfolio down. And by the summer twenty and nineteen, I had very little money invested on the platform.

That one note in venture california, the house that burnt down that didn't get paid out until twenty twenty one. Since then, i've been much more cognizant ent of this platform risk. And there are are ways that is mitigated many of the platforms.

The investments are set up in special purpose vehicles, or spv, which appeared to have more protection. In the case of bankrupt y, are set up as A A separate legal entity, apart from the crab funding platform. Another way that these platforms handle this is an entity like masterworks that I invest in, that sponges, the podcast that selling art, each work of art is its own security.

Register with the S. C, C. There is protection because if its its own security, IT doesn't potentially get lumped in with other unsecured creditors. In the case of bankrupcy, like we see with these payment contingent notes where the investor only gets paid if payment is received by the platform that then passes IT on to the note holder. My return over the two to three years I invested on the pier street platform was just about seven percent.

The interest started going down a little bit to wear some of my notes for under seven percent yield, but I had no losses and I moved on. I didn't really give a whole lot of thought to pier story. I didn't really talk about that much on the podcast of the plus membership rather than pointing out platform risk, which we did a number times in the whole idea of the how these payment contingent notes are a risk in the case of the platforms bankrupcy.

I disgusted in my book that came out in late two and one thousand. But I was an an active investor on peer street, didn't really keep in touch with bread crosbey. A year ago, he posted on linked in that he was stepping away from his day to day role at the company. He said he was proud of the two sided marketplace that they had built in.

One of his co founders said in one of their weekly meetings in july twenty twenty two that with the stock market down twenty percent, crypto losses in the trillions and and even save bond funds down six percent and more, over ninety eight percent of investors on peer streets platform have seen positive average returns on their investments. Over the course of their relationship with peers story, I actually was surprised that two percent did not see a positive return, given this is collateral backed real estate baked notes. But when there is a to fall, one of the things some of our members found is the workout process for some of these.

The for closures can take a long time. So two of investors do not have a positive return on the platform then that actually surprised me even more so I surprise what happened. Last month, peer street filed for bankrupcy under chapter eleven of the U.

S. Bankrupcy code. As part of that, peer street plans to sell all of its asset, including its mortgage loan assets and its technology platform.

Before we continue, let me pause and share some words from this week. sponsors. Sometimes it's just nice to sit back, relax, maybe even take a nap.

That's not what you want your money to be doing. You wanted to be working hard for you earning interest, generating returns. That's where the Better man, automated investing and savings APP can help. Better man technology gives you advance ed tools that are built to help you maximize returns.

They have diversified portfolios of low cost etf that have been constructed by experts, high yed cash accounts where your money can earn eleven times the national average, and automated investing technology, like automated rebalancing. These tools can help you reach your, your savings in investing goals. Better man is a fiduciary.

That means it's their job to act in your best interest. They will never recommend an investment or give you guidance unless they believe that will help you reach your financial goals. So visit Better, not come to get start, learn more about the highest cash accounts at veteran dot com, investing in all the risk performance not guaranteed cash reserves offer through veteran L, L.

C. And veteran securities. Veteran is not a bank knowing where our money e's going in, how it's being spent, helps us feel more at peace.

Monarch money is a Operated all in one personal finance up IT gives you a comprehensive view of all your accounts, investments, transactions in more you create custom budgets like we do can track your progress toward financial goals and collaborate with your partner and now get an extended thirty day free trial when you go to monarch money. Dot comes last, David. Monarch is the most customizable budgeting APP.

You can change the layout of your dash port, and I have done that can tag go between light and dark mode. I haven't done that, but you can set up automatic rules for transaction. So, you know, I haven't to fix IT each and every time.

And best of all, monarch never sells your data to third parties or shows your ads. After trying monarch myself, I understand why it's a Operated personal finance. P and right now, listeners of this show will get an extended thirty day free trial when you go to monarch.

Money that come less, David, that's M O N A R C H M O N E Y dog comes less, David, for your extended thirty day free trial. David done, who is the chief restructuring officer for peer street, said that rising interest rates reduced demand for mortgages. Peer street found there were fewer borrowers on the platform and fewer institutional investors willing to buy the loans.

Institution of investors that peer street had begun selling loans to over the previous couple of years. Peer street, as a venture capital baked firm, had to grow incredibly fast. And so IT wasn't enough just to take money from individual investors that wanted to invest on the platform and find borrowers that wanted to flip us.

IT sort of went what the term we've used that I didn't make up blitt scaling the idea that you have to get bigger and bigger and bigger even if you're not profitable. And to peer street, sort of evolved into this full scale mortgage services platform, packaging up loan, selling them to institutional investors. And they were still very dependent on venture capital funding, particularly when the market dried up.

The demand for mortgages in twenty twenty one peer street originated close to seven hundred million dollars in mortgage. In twenty and twenty two, IT was three hundred and eighty five million dollars in mortgages, said IT originated, and in twenty twenty three, five point four million dollars, essentially the business collapsed, David dan said. In addition, in two thousand, thousand and two one APP state historic sources of funding venture capital declined markedly.

As result, history was not able to access material funding to mitigate the loss of revenue caused by market conditions. IT had two hundred and eighty one employees in may twenty twenty two, and then had four series of layoffs. And by the time that fall for bankrupcy, IT had only twenty eight employees.

When IT file for bankrupcy, piers three had four point four million and cash on hand, another eighty and half million dollars in its mortgage business. There's fifteen and subsidy areas that filed for bankrupcy. At the same time, participants on the platform had no transparency on peer streets financial condition.

This would have caught an investor off guard because they weren't reporting their financials, which created global venture capital. Funding has dropped over fifty percent in the past year, and that's including big funding in the A I space, about a fifth of venture capital of funding this year is related to artificial intelligence. But companies and there's fifty thousand venture capital back companies currently double the amount in twenty sixteen, and they're finding incredibly difficult to raise capital.

And the whole idea blitz scaling is don't worry about profits, just grow your market share. But if that venture capital funding dries up, then these companies are at risk. And that's basically what happened to peer street, we don't know.

But presumably they were profitable in twenty and twenty one, I would hope, originating seven hundred million dollars in mortgagees. But we don't know which is the essence of platform risk. We don't know, and we have to mitigate against that risk.

So where does that stand with piercy going on a business, the adventure capital firm on recent horowitz that LED that series a round owns twenty one percent of the equity, though more than likely lose their investment. Booter Johnson, one of the other co founders, had a thirteen percent stake. Now in chapter eleven, peer will continue to Operate.

So they're serving the the loans. They're not paying out. You can't liquidity if you're a holder, one of these notes, you can get your money if you have catch on the platform at this point. And there are potentially after ten thousand retAiling investors still on the platform, I went through the claims list on the bankrupcy website. They list individuals by name.

Many them are owed a thousand dollars, but there are definitely those that are owed over one hundred thousand and individual investors that have over a million dollars invested on peer streets platform, which incredibly, is heartening because of the platform risk. If you look and you zoom in on some of these claims of individuals, their categories as general unsecured claims, just like that attorney mention, they would be if piste would bankrupt. Secured creditors are those that, that have a lean on a specific property, but a general unsecured creditor banks lower.

They are last in line to receive payment behind the secured creditors and others that have priority claims, such as the irs. Peer street says that investors on the platform, the question is, is in their FAQ, when will I get my money back? And they say that the fines will only be returned by agreement of the bankrupt core.

The next step is a meeting of creditors, which is a meeting where creditors allowed to basically exam in the data under old to gather information and Better a Better understanding of asset and liabilities and income. And that's really what I couldn't find right now in terms that we know how much cash to have. But what is the state of their business? Presumably, it's not a situation like we saw with black fy where the money was miss out, located or missing. This should be a fairly straight forward business serving mortgage where there's collateral.

So hopefully, the vast majority of client assets can be recovered, unlike in the case of block five, the cyp to currency lenders that file for bankrupcy last fall in november twenty twenty two, where I saw I note that the committee of unsecured creditors basically wants them to just liquidity at this point because of the the costly legal delays and they're saying the credit committee that black fies management should have known they should have known that F, T, X is baLances sheet was IT risk in the fall twenty twenty two when black five put hundred to billions of dollars and lend IT to F T X. This situation of history doesn't anything like that. At least IT does not appear to be gona take time to see how that works out.

What do we learn from this? How do we mitigate platform risk first? Is so important to understand the structure of any investment to to understand, is this is this an unsecured liability? Or is there a special purpose vehicle? Or is IT a security? Or is there something that keeps that investment segregated from the general assets of the platform entity? That's critical and and it's a risk that I didn't fully appreciate up until early twenty eighteen.

Second is understanding, is there some type of insurance, some protection if the entity goes. In the case of commercial banks, we have fd I, C in the U. S.

And other insurance programs and other countries if your broker goes bankrupt topic we discussed an absolute three. There's also security. In fact in the U.

S. A traditional broker bankrupt those those assets don't go in the chapter eleven. There is the liquidation proceeding and there's protection from the securities investor protection act.

In the case of the bankrupts, even even even in that case because typically their securities, they're just transfer to another broker. We as investors should have platform diversification. Just to be sure, even with S P, V, it's important if as investors were investing in private asset platforms, we should have diversity. Now I often get as regarding with the traditional broker.

If you're with vanguard of fadel an swab, should you have multiple brokers in the case of bankrupcy? Because the sipc insurance in the fact that most of the holdings are just in securities where this protection they are, just because of the the legal structure of the security gently, you don't need to have least I don't have more than one broker. But on the private side, that's incredibly important because there's just there's less transparency regarding IT.

And then finally, a different aspect of platform as if you have a business, not have the majority of your business dependent on what platform we have friends that run a retail business and instagram is a big part of their platform, bringing people in. And when that algorithm changes that, that has hurt their business and they have had defined other ways, it's important to have a home base. So in the case of money, further rest device where you have an email list.

And while we were somewhat depending on apple podcast as IT distributes our podcast, IT isn't the main thing. So we're not entirely dependent on and so we've diversified. So it's important not to be so dependent one platform, if you host vacation properties, do L B N B, but also do V R B O or others.

So you're not be holding the one platform in case something happens that we don't anticipate there's platform risk, but we can mitigate IT. And we've clearly learn lesson on platform risk in the last couple years with the bankrupcy related to cyp to currency platforms as well as his most recent crowd funding platform, peer street. Please be careful when you're investing, understand the risk, mitigate the risk, diversify and especially in terms of the type of vehicle use, make sure it's in a special purpose vehicle or it's in a security so that you're protected in case the investing platform goes bankrupt.

That's episode four forty. Thanks for listening. I have loved teaching you about investing on this podcast for over nine years.

Some topics, though, I just Better explained in writing or with the chart. And that's why we have a weekly free email newsletter, the insiders guide. In that newsletter, I share charts, grasp and other materials that can help you Better understand investing. It's some of the most important writing I do each week. So I spent a couple hours on that newsletter on wednesday morning as I tried to share something that will be helpful to you. If you're not on the list, please subscribe, go to money for the rest of us dot com to subscribe to the free insiders guide weekly email news letter everything i've shared with you in this episode ment for general education and not considered your specific risk situation, not provided investment advice, this is simply general education on money investing in the economy. Have a great week.