April 18, 2016

View from LendIt – Innovation in CRE Finance Still in the Early Innings

I just returned from LendIt, the biggest marketplace lending conference on the planet where over 3,500 attendees gathered in San Francisco to discuss all forms of alternative lending, from unsecured consumer to small business and commercial real estate. The general tone of the conference was “cautious optimism” as capital providers paused to reflect on how recent changes in the capital markets will affect the growth rate – but not the viability – of the marketplace lending business model.

Clearly, this signal has been heard before. Lenders who rely on capital markets for funding are naturally subject to the whims of those markets.

That said, this new crop of lenders is creating a lot of positive advancements. Consumer and small business alternative lenders are being validated by partnerships formed with large and small banks that recognize the value of online origination platforms. As banks close thousands of branches per year, the customer acquisition capacity wrought from these networks must move online if these loans have any hope of staying in the banking system.

While not considered marketplace lenders, the “buy to rent” lenders including Colony American Homes, B2R, and FirstKey, all owned by big private equity firms, are generating significant lending volume. They have emerged as a wholesale funding source for many of the “fix and flip” marketplace lenders like PatchofLand, LendingHome, and RealtyShares, who, in turn, finance small investors’ house flipping ventures.

However, innovation in commercial real estate finance is not clearly evident yet. Of the three parts of the loan production process: origination, underwriting and funding, the most noticeable advances have been on the funding side, where the platforms have made “passive” real estate debt investing accessible to accredited investors. However, these investors have expressed more interest in short term, high-yield debt, leaving longer term real estate lending where it has always been.

CRE lending remains too idiosyncratic to scale at the pace currently occurring in other asset classes. The two leaders in this space – Realty Mogul and Money360 – together closed about $200MM of loans in 2015 – about .4% of the $500B originated across the US CRE industry.

For the time being, traditional lenders including banks, insurance companies, REITs, GSEs and CMBS conduits dominate commercial real estate finance. So-called marketplace lenders are hard at work creating technology to remove friction from the antiquated loan production process, but there is still considerable work to be done.

Providing access to a broader universe of investors is a start, but if the deals don’t perform these investors won’t stick around. As technology starts to drive costs out of the system, marketplace lenders will be better positioned to compete for better quality deals, which will naturally attract a broader range of institutional investors and partnership opportunities with traditional lenders.

— David Roover