Brew Johnson, Founder & CEO
Brew is the visionary leader behind PeerStreet. Prior to PeerStreet, he worked as general counsel at VirtualTourist where he oversaw the company’s $85 million sale to Expedia/TripAdvisor and before that, he was a real estate attorney where he advised some of the largest real estate development and investment firms in the country. His experience in technology platforms, real estate and law culminated in the unique concept that is PeerStreet.
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The Last Downturn
As a real estate attorney, I became obsessed with what was driving everything. We had clients were buying industrial properties for five times what they traded for year before because there were going to put up 10,000 condos in that city. A city that had sold a thousand condos over the previous decade. And there were 150,000 condos going in the next city. People were rationalizing things. It was like the pre-crash in the 1920s when the shoeshine boy you know like giving Joe Kennedy stock tips in the run up to the market crash. The run up to the 2007/2008 crash was such an obvious house of cards; the excessive leverage and risk taking in the system was just so apparent to me pretty early on.
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Merging Tech and Real Estate
During the last crisis I did a lot of things; bought foreclosures, bought distressed notes from banks made a lot of hard money loans to other people who were buying foreclosure. Then came along the JOBS Act and there was a sense that there was market acceptance of the idea of crowd funding deals. I reached out to my co-founder Brett Crosby to raise some money for the idea of establishing PeerStreet and then we started building the business.
Applying real estate legal expertise, with this kind of securitization, a knowledge of the big picture of how that system works, and the kind of tech aspect of things gives us the ability to create a stable tech platform.
Why First Position Debt
Allowing people to access investments in smaller amounts more transparently is the way the future goes. Obviously in real estate investing there are a million flavors to real estate investing, from equity investing to preferred equity to mezz debt to all sorts of things. It is imperative that you do your best to establish some level of safety or security for investors and that it is something that you can scale.
Credibility and safety for safety for investors and credibility for that platform. Deciding what asset class is the most appropriate to do this – the long-term ramifications are very massive. Getting this right could potentially transform that securitization market.
We decided that the most appropriate asset for most investors to invest in is real estate debt, and specifically first position lien debt. The reasons are obviously very simple; it's the safest part of the capital stack. If you're doing an equity investment in real estate every single deal is unique and there's not that much consistency. In order to create a sustainable platform that provides value for investors you need consistency, you need homogenization. In our opinion you have to put them in a safer position than other options out there so we specifically, from day one, we decided to focus on first position lien debt. In the event of a downturn in that position the investor is much more protected.
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[In addition to looking at Loan-To-Value ratios, PeerStreet looks at that particular location's maximum historical decline over a 20 year period to add to the underwriting criteria] We look at the historical cycles of the real estate market to determine what is the worst-case scenario in this market. Did a particular market drop 5 percent during the financial crisis or did it drop 50 percent. But to me the real innovation in that is the ability instead of allowing investors to invest in one loan at a time or one investment at a time and putting a large amount of money in a concentrated position, but to spread the risk across a broad pool of loans to be able to minimize risk through diversification.
Partnering with these off line hard money lenders is a very unique thing. The focus of the asset class is short term bridge loans on single family property. They are the fix-and-flip and buy-to-rent type loans.
Historically this is an incredibly localized business and the kinds of interest rates you can get on these loans can range from anywhere from 10 to 20 or even 25 percent annual interest rate on a secured loan that is collateralized by real estate. It is just a really interesting niche market.
Resilience of First Position Loans
Performance of these kinds of loans largely depended on who the lender was and who the originator was. When I became a real estate attorney and was doing these deals I saw banks lending at 3 percent interest or 4 percent interest on commercial properties, and yet there were people making 15 percent return and I knew for a fact that these guys had never taken a loss on a property. It occurred to me that these were just amazing risk adjusted returns.
During the downturn yields to their investors went down to 1 percent and as funds they may have cut their management fees. But their investors didn't take a loss during the crisis, where other people lost everything because they were making risky loans and they weren't structuring loans correctly and they were advancing too much capital. The key thing is to look at people who know what they're doing and have expertise and track records and who understand their markets and their borrowers. I think they will fare well in almost any market.
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At PeerStreet we decided to create this tech platform that connects those local lenders to the capital markets and to investors. The proper way for a crowdfunding platform or marketplace like us to invest is not to be the one out making the loans, it is to be the gatekeeper intermediary. We are the connective tissue between the investor and those kinds of the expert. While we do due diligence on the lender and on the deal, our overlay tends to be a little more conservative than our lenders. For example, in our underwriting guidelines our maximum LTV is generally a little below what the overall market is. We collect a lot of data, and the more data we collect by analyzing what people are doing and which lenders are having great track record, we then adjust the underwriting criteria accordingly.
Investors probably want not only more diversity across loans but also diversity across originator or across the lenders who originate because that potentially reduces risk.
Complete Transformation of Real Estate Finance
I truly believe that that technology is going to completely transform real estate debt and the mortgage finance system. Our long-term vision for the businesses is that PeerStreet can disrupt the entire mortgage securitization market. Instead of going to the bank for a 4 percent loan I might come to somebody like PeerStreet who is able to offer competitive products. But instead of lending to me through deposits it will actually be financed through our network of investors. In the current system, the average person is subsidizing the bank on the front end and then subsidizing the intermediaries on Wall Street to make the loan. I think in the future, instead of having money actually sitting in deposit people can have money and distribute it across these loans actually earning the interest rate off of that versus that interest rate banks charge today, and seeing it distributed out to intermediaries.
CrowdFunding Real Estate is the Future
A lot of people think that crowdfunding is a bunch of mom and pops, just small investors investing, but the reality is we have major institutions that invest alongside in individual investors. We have institutional take out from mortgage REITs and hedge funds. I think this is definitely the future of investing and the future of real estate. it's so powerful that because it provides better investments for investors and also provides better and more efficient capital to borrowers and to real estate sponsors.
I clearly think it's the future.