Investing in P2P Real Estate Platforms/REAMERGE – a historical overview and comparison with other asset classes

Introduction:

How do you determine if investing in REAMERGE is a “good investment”? In simple terms, it comes down to value. An asset’s value depends mostly on risk and underlying cash flows it produces. With that definition, the best way to assess an asset’s value would be to find a comparable asset with similar risk profile to determine yield/ROI. One can also flip the script and look at it from the other side: compare similarly priced assets and determine the risk associated with the asset. Before delving into a proper comparison of an investment on REAMERGE, let us look deeper into two important topics: diversification and historical returns of popular assets – stocks, bonds and real estate.

Diversification:

At a basic level, diversification helps with risk mitigation, specifically idiosyncratic risk (i.e. Risk that is specific to an asset or a small group of assets). This is more than just investing in different stocks – which hopefully you are investing via ETFs – for example, real estate may be doing well when stocks are not in a bear market.

Institutions such as Harvard have performed very well when it comes to diversification of their portfolios. These institutions go beyond assets such as stocks and bonds.

harvard endowment
Now they invest in P2P lending platforms as well. Always ahead of the curve there Harvard…

Modern concept of crowd funding (in equities) and crowd lending (REAMERGE, Lending Club, Prosper etc.) are changing the field of non-traditional investments by democratizing the opportunities. If properly included in the portfolio, investors can achieve higher risk adjusted returns than traditional stocks and bond portfolio while lowering volatility.

Why is that?, because private equity and private lending has traditionally had no correlation with the broader capital market on a local level. What an investor invests in REAMERGE are loans given to cash flowing businesses with real estate. Such private deals are now finally available to retail investors.

Enough talk, let’s jump to facts

Asset classes and historical returns

Stocks:

Below is the historical performance of the S&P 500 (S&P 500 is the prominent stock market index based on the market cap of 500 companies whose stock is listed on NYSE and NASDAQ)

stock returns morning star

SP500-historical-returns

These are some salient features we can deduce:

  • 10 year average return is about 8%. The S&P 500 index 60 year average is around 7%. It should be noted that we currently are in an unprecedented back to back bull markets which has boosted average return from 7% historically to last ten year average to close to 8% (Of course, no one can predict when a correction will happen; if you do, wall street is waiting for you!).
  •  Volatility – this deserves and will get a post of its own, in the context of volatility drag on your returns. Bottom line is, over the past 20 years we have suffered notable oscillations in the market with an average reversal of a bull market 4-5 years.

BONDS:

From here, we see a comparison of S&P500 and Barclays Capital US Aggregate Bond Index

bond returns
Bonds vs S&P 500
100% Bond allocation? yikes
100% Bond allocation? yikes

We deduce

  • Bonds are more stable investments, but equity markets have been crushing the bond index for 20 years now. Also, overall yields of the bonds have been coming down the past 20 years. The domestic bond market, as gauged by the Barclays Aggregate U.S. Bond Index, had an average annual return of 4.62%. To be accurate if you went for 100% bond allocation you received a 5.5% return (90 year data per Vanguard).
  • Still there is volatility! (see below)

stocks and bond volatility

For further comparison of stock vs bonds see Boglehead page

Real Estate:

Finally! Investment in hard assets!

For simplicity we will delve into residential real estate. Looking at the first graph it’s obvious that besides the housing boom starting in the 2000 prices have been flat. By comparison, as stated before, stocks have been outperforming bond market – what’s the connection? Consider real estate like a bond: Interest rates low -> housing demand goes up; reverse with high interest rates. The fixed income instrument “likeness” comes from monthly rent check you can collect as the owner.

stocks vs realestate
Have home prices really kept up with inflation (minus mid-2000 bubble)? Not really

Unlike stocks (highly liquid, relative ease of use via online brokerage firms), real estate traditionally has taken lots of hands on work. If you are an owner you have to deal with midnight tenant phone calls, fixtures etc. Even if you get a manager, you have to have regular oversight. Then there is the issue of vacancy – every month you do not have a tenant, you are losing money, and paying expenses in upkeep as well as bills. Still, real estate provides a measure of “control”.

It should be noted though that stocks can increase in “real” value – a company does well, has more sales / growth, the stock goes up. Barring house price appreciation, most of the growth in real estate is from leverage. For example, you brought a property for $ 200,000 and put down $50,000 as down payment.

If inflation is 3%, then your house goes up in “value” (simply due to more money printed) to $206,000. Just by math, your return now is $6,000/$50,000 cash on cash – a 12% return!

Real estate crowdfunding portals are making real estate more accessible and less of a headache that it traditionally has been, thus making this class more attractive. Still, many investors consider their house or residence as a great investment which we disagree with and we will discuss it in another blog post or a series of posts.

MICROLENDING/REAMERGE

 Fixed income assets like CD’s (Certificate of Deposit) are the most comparable of the above asset classes. After all, in stocks, you are purchasing equity not debt. CDs can pay interest income monthly. Most CDs, however, require a minimum deposit much larger than what you can invest with on REAMERGE.  For example, current highest yield by CIT Bank yields 1.14% with a minimum deposit of $25,000. That being said, the CD is backed by the credit of the USA government (FDIC insured up to $250,000), the lowest risk in the land! One should then think, does investing in REAMERGE “x” times worth the risk (“x” being the investment return)? If it is then it’s a great value (going back to original concept).

In REAMERGE, an investor is investing in business loans. Comparison to CD’s is straightforward, but let’s up the ante and compare typical loans with high yield corporate bond or better known as junk bonds.

Why do this?

Because crowd lending a loan at REAMERGE is, in some ways, another U.S. fixed-income asset class investment but beyond this, junk bonds have been sometimes able to generate returns comparable to the REAMERGE loans (and for that matter consumer loans at Lending Club and Prosper – we will have another blog post comparing REAMERGE loans to consumer loans down the road).

Projected returns: REAMERGE investors invest in loans producing annual returns comparable to other P2P lending sites, while Junk bonds returned 7.45% in 2013.

Default rates: REAMERGE board members and underwriting team bring years of lending experience with an internal default rate of less than 0.25%. Per JP Morgan, default rate for Junk bonds was 0.7%. These are comparable, albeit corporate bond volume is in billions and thus is very impressive (per JP Morgan High Yield Research that is a 6 year low). By contrast, Prosper and Lending Club claim a default rate of 5%. A notable other direct lender (another topic in blog post later) Avant Credit that focuses on near prime borrowers has a default rate of 15%.

 Maturity and Cash flow: Junk bonds usually pay semi-annually with return of principal at maturity. REAMERGE loans will make monthly payments of both the interest and principal per amortization schedule up to the loan term. The maturity date for these high yield junk bonds are 5-10 years while REAMERGE loans are 3-5 years in term length.

Liquidity: Investing at REAMERGE is via private placements, which have NO liquidity and notes cannot be traded. Junk bonds are highly liquid with a public market.

 Interest Rate Risk: Given the length of maturity, there is higher susceptibility to interest rate changes in the junk bond asset class. Specifically, with an anticipated Federal Reserve interest rate hike policy, there may be more volatility ahead in the junk bond markets.

bond rate hikes

Collateral: Junk bonds are unsecured debt obligation (mostly). Specifically, 80% are unsecured (reset are secured by property, equipment etc.). Although per JP Morgan research default recovery is 54% which is excellent given a stronger review process on corporate bankruptcy and seniority of bond holders in the capital stack. REAMERGE on the other hand has almost exclusively cash flow positive businesses secured by a first or second (mezzanine) lien. Additionally there may be equipment or inventory liens as well as a personal guarantee with two guarantors.

 Conclusion:

There is no right answer or strategy to investment, and an investor has many asset classes to choose from based on their knowledge, comfort level, life circumstances, risk appetite etc. One aspect still holds true: Diversification.

REAMERGE investment is best compared to fixed income assets like CD’s and Bonds where it provides the higher yields of the two, where the loan is secured by the underlying asset (property, equipment, inventory etc.). In the end it’s about value vs risk – is investing in high yield business loans secured by real estate riskier than bonds, CDs?

REAMERGE provides a low volatile, low risk,fixed income investment opportunity. What do you believe? Please leave comments or email us at info@reamerge.com if you have any questions!

stocks vs bonds vs P2P vs savings account
stocks vs bonds vs P2P vs savings account

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