2008 is a funny number, it’s one that has been a huge part of this blog and yet for a blog focused on the bright future of financial services, it’s also a number with a massive set of negative connotations when it comes to this industry. It was the year we all came to the realization that there were a great many indecencies that had become systemic throughout the financial system.
But for some individuals this realization of these indecencies came years before the collapse. Individuals like Brew Johnson, Co-Founder and CEO of PeerStreet. Brew Johnson was in real estate law by chance back in the mid-2000’s, which is when he happened upon the dismal reality that our housing market was built on a house of cards through his deep research and desire to figure out what was going on. He knew something needed to change, and he had a plan for how to do it.
When the time was right he brought in Brett Crosby, Co-Founder and COO of PeerStreet to take his tech background from building Google Analytics to help revolutionize the housing market with a new approach to financing the mortgage markets.
I had the pleasure of sitting down with Brett a few months ago, and recently had the privilege of sitting down with both Brew and Brett to chat the future of financial services. Together they are taking the number 2008 and instilling new life into it. Call it the rebirth of the financial services industry, I am hugely bullish on the market opportunity and the social good that can come from this organization.
CL: Brew, as you know Brett and I have spoken in the past, but I would love to hear more about your background and why you became so enamored with advancing the mortgage markets with a marketplace solution?
BJ: Before PeerStreet I practiced law. I was in law school from 1998 to 2001 during the dot-com boom and even helped my brother fund an internet business, but by the time I graduated in 2001, the dot-com boom had crashed.
The law firm I was going to work for was a top 25 international law firm at the time, but it had laid almost everyone off and the only two departments left were in real estate and labor. They asked me to choose one and I chose real estate. It was very serendipitous -- 2001 was right before the housing market started going crazy, and I practiced real estate law from 2001 to early 2006, essentially working within the belly of the beast.
I ended up leaving that firm to go to one of the top real estate firms on the west coast. They represented banks, home builders, and so on. In my spare time I was reading blogs and doing research on all the housing market dynamics that were playing out, but the more I learned, the less the housing market made sense to me. It became obvious that the whole market was a house of cards.
A lot of what we're doing at PeerStreet is informed by what I learned during that time as a real estate attorney within the securitization market.
CL: To that point, when did you decide that the time was prudent to launch PeerStreet?
BJ: I actually left the real estate world for a while to help my brother build and sell a technology company to TripAdvisor. It was that transition from real estate into the tech space that piqued my interest.
At the time, LendingClub and Prosper came into the market to service the personal loan space, and I thought, "if you could apply this to the real estate markets, it would be very valuable in bringing the type of transparency and risk mitigation the industry needed, particularly in preventing another housing crisis from happening. I created a mock business model similar to PeerStreet in 2008, but recognized that market and regulatory conditions didn’t favor startups at that time, even those trying to help solve the problems that seeded the crisis.
Fast forward to 2013, and all the barriers to entry that existed in 2008 had been significantly reduced. After the market crash, government regulation started to favor the startup community, and with the advancements in technology, I felt that it would be a lot easier to create a company like this.
I also believed that we’d finally hit a critical mass in the market for our service. That's when I reached out to Brett to bring him on.
CL: When you speak about critical mass, what specifically do you mean? Are you speaking to the growth of independent mortgage banks, comfort with technology, or something else altogether?
BJ: For me, it was about seeing the movement in marketplace lending, and the growing comfort in investing in this asset class through a new type of platform. This sudden shift in comfort coinciding with easing regulation led to a huge boom for private lending.
The housing class has always had hard money loans and short term bridge loans, but these loans really boomed after 2008 because banks had completely disappeared from the mortgage lending space. The reason we believe it’s so important to build a tech-enabled platform like this is because there are more independent lenders now than ever, and they're scattered around the country, leading to a significant amount of fragmentation in the market. In the past, this created a powerful but fragmented asset class that was inaccessible for most people and very difficult to invest in.
What PeerStreet does is use technology to make sense of this fragmentation, and then layer a whole level of positives onto it. Our business is powerful because we take this mass fragmentation and add curation, intelligent underwriting, and homogenization of the asset class to make real estate easier to invest in than ever and in ways not possible before.
CL: Have you taken learnings from early pioneers of marketplace lending like LendingClub and Prosper that have cast a wider net by trying to market to end customers and investors, which has proved a bit more challenging than perhaps first thought? Or was the idea always to partner with lenders to obtain loans?
BC: In other spaces like consumer credit, auto loans, and student loans, the location of the lender is not important so it’s possible to lend from a central position. In the mortgage and real estate development space, however, having local knowledge matters a great deal. The only people that really know what's going on in each market are those that are closest to the community. If you try and do it from a central position, like a LendingClub for real estate, it just doesn't work very well. From a startup perspective, it’s also more capital efficient partnering with local lenders to provide efficient and cheap deal flow.
BJ: I know it sounds strange since Brett has such a strong technology background, but for us, it's always been about utilizing technology to enhance the old school, boots-on-the-ground model. That local knowledge is important.
We also have the view that acting as an intermediary in this space is safer for our investors because we can diversify across regions without compromising on quality. Starting with a larger funnel of deals also gives you the ability to curate the deal flow and help your investors diversify their investments more effectively. No matter how you slice it, this is a better way for the end investor to interact with this asset class.
CL: In what way is PeerStreet able to utilize technology to actually promote lending at the local level?
BJ: Since we partner with and provide capital to local lenders who lend to small businesses, who in turn lend to other small businesses or real estate entrepreneurs in their communities, we’re enabling our investors to support the value chain of local economies. Essentially, we are investing in communities and helping to promote the up-cycling of housing stock in those areas.
US housing stock is the oldest it’s ever been with most homes being built before 1970. By reinvesting in communities we can help promote long term prosperity in neighborhoods rather than watch them erode over time. A modern platform that brings lending back to being a hyper-local business and promotes long term social impact is a powerful thing.
CL: One of the most exciting elements of seeing businesses like PeerStreet come to fruition is that there finally seems to be brands that people will be able to trust again. What is your viewpoint on this?
BJ: I think it's happening. We see a lot of innovative companies finding ways to make this industry more transparent. This type of transparency helps reduce systemic risk in our financial system and can hopefully prevent the next financial crisis.
Think about it: banks take your deposit, make a loan with it and essentially lever up your deposit with more risk to make more money -- without returning any of that value to you. And these mortgages end up getting sold multiple times into every bond and pension fund you can think of. By the time that loan’s interest payments get back to you in the form of your retirement or bond investments, at a minimum 50% and sometimes up to 90% of the value has been stripped out.
Having an everyday consumer subsidize the bank on the front end and then re-subsidize Wall Street on the backend seems insane to me.
CL: I am a big believer in marketplace lending, though there is still skepticism with the beckoning question of "Well what do you do in a market downturn? What do you say to that, and how are you trying to manage the business to survive a catastrophic market collapse?
BC: The reality is many of the new business models may go out of business because they are simply taking too much risk on their loans. We're positioning PeerStreet for the ups and downs of the American economy.
BJ: We structured our loans and bankruptcy identity from day one. We have a trustee that's a major financial institution. With mortgages or real estate debt, there should be a recorded document that’s a public record and held by a trust. If a borrower were to disappear tomorrow, the assets are still there. They're held there for the benefit of the investors and themselves. Counterparty risk is an extremely important thing. We were very careful in how we structured things and took as many steps as possible to protect the end investor.
In a catastrophic environment, loans are going to default. Even in a regular environment loans are going to go bad. But we’ve run many tests to show that if you are diversified across our portfolio of loans and it’s a situation like 2008, on a relative basis you should still be in a much better place than in other types of asset classes.
Real estate loans can be the best risk-adjusted investment out there unless you start applying too much leverage, which is what the banks did leading up to 2008.
CL: PeerStreet is expanding into new investment offerings such as buy-to-rent loans, so how does the team manage investment selection to ensure a level of quality is maintained on the platform?
BJ: We think every type of real estate loan will go through a platform like ours eventually, so we are taking a very measured approach to how we decide to move into each of those asset classes. Many of the processes across asset classes are similar with the loan to value ratio being central to each one. The only major difference between each of the offerings is the underwriting process, which requires bringing in the right people who understand that specific credit and know how to write that type of loan.
With expansion into new real estate asset classes and continued growth of the team, PeerStreet is positioning itself to be an industry leader of marketplace lending in the mortgage space. The approach is both measured and built to withstand the test of time and recognizes the shortcomings of those that came before it.
This is a team that has the poise and vision to deliver on a very simple mission at its core: To provide a transparent platform to open up access to the real estate asset class across the U.S. for investors while helping to invest into our communities with good debt.
Brew and Brett, thank you for your commitment to helping to improve the housing markets and thank you for instilling Simple.Innovative.Change into the mortgage lending space. Stay tuned…