Real estate crowdfunding versus The Lending Club / Prosper. Which is better for you?
Real estate offers higher returns. Consumer loans offer ease of investing, no due diligence, and industry maturity.
June 17, 2015 BY IAN IPPOLITO
Update 6/23/2017: after many years, I'm closing all my positions on Lending Club (and its close cousin: Funding Circle) and am no longer comfortable making new investments with them. You can read more here.
The Lending Club and Prosper are unsecured consumer loan crowd investing sites. Like real estate crowdfunding sites, they enable individual investors to pool resources and make smaller, more affordable investments in a much safer/more diversified manner then they could on their own.
Consumer loans are quite profitable, and have done very well for investors. But they're not quite as profitable as real estate investing. On the other hand, consumer loans require much less knowledge and due diligence to invest in.
Here's the details on the differences:
Despite some overhyping of returns by certain real estate sites, real estate is still more profitable.
According to their site, the Lending Club averages returns between 5.06% and 8.74% (after defaults).
Certain real estate crowd investing sites advertise returns from 10% to 15%+. However, these numbers are somewhat misleading. The industry is too young to give most investments enough time to possibly default. Additionally, sites usually advertise their highest yielding investments, which are also the most risky. These tend to do poorly during unfavorable portions of the business cycle, which those sites have yet to experience.
A much more objective benchmark is the direct real estate index, which has been tracking for decades. It shows that over the long run, core real estate investing returns 9.2%. More aggressive real estate strategies (core plus, value-added, speculative) can be expected to earn a little more (if the additional risk is also handled appropriately).
So, real estate is still more profitable.
Maturity / ease of investing
Crowd investing consumer loans are a much more mature industry, and much easier to invest in. They started in 2006, and have gone on to receive a lot of publicity and create billion-dollar marketplaces. It has consolidated around two, enormous marketplaces. This efficiency makes it very quick to find new investments, and deploy your money. Studies have shown that it takes 100 investments, to safely diversify, and you can do this in a single day on consumer loan sites.
Most crowd investing real estate sites started in 2013-2015. The industry is very young, and the investments are sparse and spread out among 85+ marketplaces (and growing). Deploying your money on real estate sites takes considerable time (days, weeks or more). Also, the weaker sites have not had time to die out, so it takes more time to analyze the marketplaces as well. (If you want to invest in real estate, we provide free tools to make this a lot easier. See our in-depth site reviews, and new investment feeds).
Knowledge required to invest
Crowd investing consumer loan sites can be safely invested in, with virtually no knowledge. An investor simply needs to understand the idea of different credit grades, and perhaps where we are in the current business cycle.
Real estate crowd investing sites require a fairly detailed knowledge of real estate investing. For example, an investor must understand the likely risk/reward of different strategies, terms like LTV and ARV, the impact of the current business cycle, the overall economy etc..
I expect in five years that third-party rating agencies will exist to quickly rate real estate investments, and make it as easy as buying a bond. But for now, these do not exist.
(However, if you're interested in real estate, and want to do it much faster, we have tools that will get you up to speed as quickly as possible. See our investing tutorials).
Due diligence required on each investment
Crowd investing consumer loan sites don't require any due diligence to invest safely. Personally, I've simply set up automatic investing rule based on the loan rating, which runs completely on autopilot. I've gotten 7–9% returns from the lendingclub since 2011.
Crowd investing real estate sites, (at least as they exist today in June 2015), take a lot of due diligence work. Real estate investments depend heavily on local market conditions, and tiny details hidden in 200 page leases, etc.. Often the underwriting on sites is nonexistent or extremely poor. Skipping due diligence can lead to catastrophic results, so blowing it off is not an option.
I believe this will have to change in the future. Either the sites will all improve their underwriting, so they can be trusted as much as The Lending Club's loan grades (and/or the bad sites will die out). Or more likely, third parties will fill the gap and provide investors with objective information. Until then, this is a significant drawback.
What about today, if you want to invest in real estate? I pay my own analyst to evaluate each investment for me, and give him a bonus based on performance. If you'd like to get in on this, I'm happy to share the results if you're willing to split the costs. Just let me know.
Who can invest
The Lending Club and Prosper are currently open to far more investors, although that will change in the near future. They are open to any individual in the US with investable money (other than a few prohibited states).
Real estate crowd investing sites are currently only available to accredited investors (with more than $1 million in assets, or making more than $200,000 a year for the last three years). Once the JOBS ACT is fully implemented by the sites (it was amended in June 2015), they'll be open to any individual in the US with investable money.
Stock market success
The Lending Club went on to IPO in 2015 with a market cap of $6.9 billion, and is growing explosively. Prosper should be IPOing in 2016.
The real estate sites are too young to go public. I expect this will change in another 5 to 6 years.
Potential market size
Real estate is a much larger industry. Unsecured consumer loans are a $35 billion industry. Just to the commercial side of real estate is $15 trillion, which is 45x bigger. If residential is added to this, it's even more.
Both consumer loans and real estate are strong investments. And I believe that in five years, real estate crowdfunding will edge out consumer loans.
But which is right for you right now?
Consumer loans are like the daddy lion in the Lion King: undisputed king of the jungle. Real estate is like the baby lion Simba: small for now, but you know one day he'll eventually be King, and even better than daddy.
In my opinion, if you're a passive investor and not worried about maximizing your returrn to the utmost, then consumer loans are currently the better call. Real estate investing currently requires way more work and effort, than you'd be willing to spend.
If you're a more active investor or concerned with maximizing your return to the utmost, it makes sense to invest in both. If this is your situation, it also makes sense to keep an eye on the real estate crowdfunding industry, and watch it mature. (Please consider signing up for the mailing list below, to be notified of new developments).
Real estate crowdfunding
What's your opinion?
About Ian Ippolito
Ian Ippolito is an investor and serial entrepreneur. He has been interviewed by the Wall Street Journal, Business Week, Forbes, TIME, Fast Company, TechCrunch, CBS News, FOX News and more.
Ian was impressed by the potential of real estate crowdfunding, but frustrated by the lack of quality site reviews and investment analysis. He created The Real Estate Crowdfunding Review to fill that gap.