Recently crowdfunding thought leader Anthony Zeoli published a thought-provoking piece entitled “Why You May Want to Reconsider How “Secure” You Feel About Your Real Estate Crowdfunding Investment.” Patch of Land sincerely appreciates the learned issues that Zeoli points out in his article; this piece intends to respond to his points, provide clarification on the nature of Patch of Land’s current and future offerings; and call for greater collaboration amongst the RECF platforms and its surrounding community for more feedback and suggestions. If the RECF industry–not just portals, but investors, borrowers, advisors, ancillary service companies, and leading law firms in the space–works together, we can collectively influence and manage its evolution.
As General Counsel of Patch of Land, I can speak to our company’s dedication to transparency, customer service, and compliance. To that end, I encourage potential and current investors to read our FAQs (a newer, more comprehensive version to be published within days); recent 3-part blog series on scaling, underwriting, and default scenarios; and our Q&A articles.
With regard to compliance, the challenge with the RECF industry—and any startup in a novel yet highly regulated space—is that fine balancing act between compliance, cost, and clarity. For companies that strive to be as compliant as possible—or even overly compliant—it’s all too easy to rack up significant legal bills to research how regulations written prior to the existence of your industry might apply. Unfortunately, most RECF startups don’t have an unlimited legal budget. Even those platforms who have raised a significant amount through Series A funding know that just one legal project can cost upwards of a million dollars, and may easily become obsolete by a regulator’s issuing of just one paper on guidance.
With that in mind, Patch of Land wishes to see the RECF community grow and flourish. Zeoli has done the community a service by publicly raising awareness around weaknesses that platforms should rectify; the RECF industry must welcome and encourage crowdsourced concerns to push the industry as a whole to work towards greater transparency and to build the foundations upon which the industry will flourish.
Having said that, we’d like our informed investors to have greater clarity as to the nature of our notes, as well as our future plans to further protect their investments.
Real Estate Crowdfunding Offerings V1.0
We let our investors know that currently its notes are not guaranteed through our Private Placement Memorandum. Investors risk the loss of their entire investment, and are indirectly collateralized via the underlying loan to a borrower. It works like this: Patch of Land receives a high number of loan applications and, after undergoing a robust and thorough underwriting and due diligence process, funds the best applications with its own internal revolving line of credit—a process we commonly describe as “prefunding.” This means that we must believe in a deal enough to put our own skin in the game. Each of these borrower loans is secured by a first lien position on the rehabilitation property, personal guarantees of one or more individuals if possible, and—going forward—other creative mechanisms that ensure the security of this underlying loan.
Patch of Land then publishes the rehabilitation project on its website and issues Borrower Payment Dependent Notes (“BPDNs”) to investors similar to the notes Lending Club and Prosper issue. BPDNs are simply this: investors gets paid when Patch of Land gets paid. These notes are unsecured, fully amortized credit obligations by Patch of Land to each of the investors of the project. They are not directly collateralized, thus the success of the investment is wholly dependent on the success of the borrower. Therefore, Patch of Land’s duty to pay arises only when the borrower makes payments on the note, which, generally, is done in equal monthly installments and a final balloon payment. A borrower may, however, elect to prepay the loan at no penalty. Investors should be aware that because they are not receiving a secured interest in the property, if the borrower defaults on the loan the investor has no recourse against Patch of Land or the borrower. Patch of Land, however, has a fiduciary duty to take actions to collect money and pay it to investors. Further, Patch of Land has a continued business interest in protecting its own credibility and track record.
To be clear, investors’ names are not directly on the corresponding property title.
Patch of Land, in effect, serves as the administrator on each investment, providing clear, effective and unified direction for all issues that may arise regarding the investment property. As so to not overwhelm borrowers with phone calls by numerous investors, Patch of Land currently retains the sole right to recourse in order to best protect investor funds.
As Zeoli explains in his article, sometimes an individual developer will personally guarantee the underlying project loan. To be clear, this does not mean that an investment is “guaranteed.” Instead, a personal guarantee is a legal document in which an individual becomes a guarantor of the loan. The personal guarantee is indirectly—not directly—tied to the corresponding BPDNs that are issued to investors. When able, Patch of Land requires personal guarantees to enable multiple avenues to collect on a debt in which the foreclosure or resale of the collateral does not satisfy the debt. In some states, lenders may concurrently go after the personal guarantee and foreclosure, whereas in other states, a lender can only go after the personal guarantee after a foreclosure.
One question we are frequently asked is what happens in the unlikely event of Patch of Land’s failure. Patch of Land has contracted with and transferred over our loan servicing functions to one of the largest national loan servicers that manages over $3 billion in loans. Loan servicing is the process by which a company collects interest, principal and escrow payments from a borrower. In the unlikely event that Patch of Land were to declare bankruptcy, this vendor would continue servicing these loans and would take on the additional responsibility of making disbursements directly to investors based on their pro rata share of the company.
Patch of Land Offerings v 2.0
Patch of Land has devoted significant time and resources over the past two months to do a complete review and restructuring of legal documents for both borrowers and investors. This includes the restructuring of our notes so that they are directly secured. There are a number of ways to achieve this goal, and we are creating a corporate and note structure to be rolled out in coming months that we feel will give investors greater confidence in their investment.
Patch of Land is creating a new series limited liability company structure that will be a special purpose vehicle (“SPV”) designed to be bankruptcy remote. Additionally, we contemplate that there will be certain provisions in the governing documentation to decrease the likelihood of the SPV becoming a bankruptcy debtor. Note that despite these provisions designed to promote bankruptcy remoteness, recent case law has taught us that there can be no assurance that any SPV will be bankruptcy-proof. Patch of Land is committed to instilling the maximum about of protection for our investors and ensuring that the company has the proper control mechanisms. The point here is that, while structured to be bankruptcy remote, other factors such as corporate governance may not necessarily ensure that the SPV is bankruptcy proof.
Possible risks are outlined in our new Private Placement Memorandum, which we anticipate will debut before the end of the year. We are excited to unveil this new note structure soon.
Documentation of Collateral
Patch of Land is committed to transparency as much as it is committed to privacy rights and compliance. Early on, our founders decided not to publish notes (or rather, the loan documents) openly on our platform because we had no scalable way to redact sensitive personal information, such as the guarantor’s social security number, residential address, and banking information. As our business has grown, the decision over whether to publish the underlying loan documents is one that has been increasingly discussed. Patch of Land is currently considering the publication of draft loan documents, which seems to be a middle ground between transparency to investors and privacy of our borrowers and guarantors.
Additionally, in keeping with Patch of Land’s philosophy of working hyper-locally, we work with outside counsel in each state to draft our loan closing documents–even in those states that do not require an attorney for closing. In that process, we conduct an extensive interview and vetting process to ensure that the attorney has extensive experience in handling our specific type of transaction. We require that our outside counsel be members of their respective State Bar and carry legal malpractice insurance.
On the topic of balancing privacy with transparency, Patch of Land does not publish a personal guarantor’s FICO credit score on our website. Although we do perform exhaustive background and due diligence research on each borrower and guarantor and do review a guarantor’s credit score and history, federal laws such as the Fair Credit Reporting Act and Gramm-Leach-Bliley Act indicate that open publication of this sensitive personal financial information may not be permissible. We continue to work with outside counsel to research ways to provide optimal transparency while protecting the privacy of our borrowers.
We (and Third Party Appraisers) Watch Over The Borrower
Patch of Land works to fully protect investor funds through various methods of control and oversight. For every project, we commission an independent third party full walk-through appraisal by a certified licensed appraiser familiar with the local market. Each appraisal report contains an “As Is” and a “Subject To” value in order to provide Patch of Land and its investors with the most accurate property values. On large renovation projects where a disbursement schedule is needed, we may commission the appraiser or other independent third party to do a field inspection confirming work completed before each disbursement. In addition, a title run down is performed prior to each disbursement of funds. The developer requirements are unique to each property and can be found in the specific property’s write up on the portal. As part of our commitment to transparency, we post project updates and photos as work is completed in order to give our investors the most up-to-date information and progress about the property underlying their loan.
We’d Love To Hear Your Thoughts
“If you want to go quickly, go alone. If you want to go far, go together.” -African Proverb
As I mentioned in Zeoli’s article, “it is extremely important that each portal be fully transparent and take the time to educate its investors about its offerings. If investors misunderstand the nature of their investment, this will be problematic for the real estate crowdfunding industry as a whole–not just that particular platform. At PatchofLand, we believe in taking an ally approach–not a competitor approach–when interacting with other platforms because when one platform takes a risk, they take that risk on behalf of the entire real estate crowdfunding industry.”
The RECF industry is growing and maturing quickly, but the industry is still young and many existing regulations were not written in anticipation of the RECF industry. As we wait for the regulators to catch up and issue more clarification and guidance, we encourage the RECF industry to help us grow and mature to make the RECF industry the best it can be. To that end, we thank our investors for trusting in our company and our team as we continue to work towards a structure that lowers investment risk for our investors, and we continue to invite feedback as to how we can become better. We also encourage the CEOs and General Counsels of other RECF portals to reach out to us to work together on coming up with a system and structure that best protects our investors and, thereby, the industry.
We’d love to hear your thoughts. Our Executive Team works hard everyday to raise the bar on transparency, compliance, and customer service.
Amy Wan is Patch of Land’s General Counsel. She leads corporate strategy and tactical legal initiatives. Amy brings extensive experience in legal innovation and rethinking the delivery of legal services. In 2014, she was named one of the top ten women to watch in legal technology by the American Bar Association Journal. Prior to joining Patch of Land, Amy worked in enforcement and compliance at the U.S. Department of Commerce, where she represented the United States at the WTO and participated in free trade agreement negotiations on regulatory coherence and technical barriers to trade. Amy also spent time at the U.S. Department of State and U.S. Department of Transportation. She was one of only 3.6% of over 9000 applicants appointed to the prestigious Presidential Management Fellows program. Amy holds an LL.M. in Public International Law from the London School of Economics and Political Science, a JD from the University of Southern California Gould School of Law, and a BA in Biological Sciences from the University of Southern California.