Groundfloor believes capital markets, in particular real estate capital markets, are often inefficient, complex, and costly because a small number of large institutions have too much control over the flow of capital. This limits entrepreneurs’ access to capital, as well as individual investors’ access to investment opportunities. This view is consistent with the macro thesis behind many online and crowdfunding investing startups borne out of the JOBS Act of 2012.

In addition, the decade-long lack of single family homes (SFH) since the financial crisis has created an opportunity for real estate developers to renovate and resell existing homes, as well as develop new homes.

Groundfloor’s solution is a marketplace for hard money borrowers and lenders. Developers (“borrower” customers) submit a project application to Groundfloor. Groundfloor underwrites and funds the loan to the borrower, then packages these loans into Limited Recourse Obligation securities (“LROs” or “loan”). Each loan is for a specific project — a single property and its developer. The interest rate on the loan is based on Groundfloor’s proprietary credit scoring model and grading algorithm that results in an A through G rating of the project. The loans are made available to investors (“lender” customers) on Groundfloor’s website where they can invest as little as $10 per LRO. Lenders can invest through an individual, business, or IRA account. At the end of the loan term, the borrower repays the principal and interest to the lenders that invested in that specific loan.

Groundfloor LROs can be purchased by accredited and non-accredited investors. Loans typically have a term between 6 months to 5 years and are available in amounts from $15,000 to $2 million, with a 2019 average loan size of $177,371. Based on the 43 loans listed on the company’s website as of June 5, 2020, interest rates can range from 7.5% to 13%. In addition, 90% were “deferred” payment loans which means both the principal and interest are returned as a balloon payment at the end of the loan term, rather than through monthly payments.

There are two items mentioned in the Notable Risks section of the Series B Offering Circular which may raise the eyebrows for some lender customers. First is that much of the information provided by the borrower in the application process is self-reported and not independently verified. Second is that borrowers may use funds to pay off existing loans or to “offset” cash or equity in the project. Given that 84% of the 43 loans on Groundfloor’s website are either “purchase and renovate” or “refinance and rehab,” the entire loan amount may be disbursed upfront, but it is unclear how much of the loan proceeds or borrower equity will stay in the project. While the loan is backed by real estate, it may be for 100-200% of current property value (LTV is not provided) so a reasonable lender would want to know that sufficient funds to complete the project, and absorb unexpected costs, are retained in the project.

The takeaway is that the onus is on the lender customer to perform the due diligence needed to understand the specifics of a given project and loan, and it can get complex. But, the information provided about a given project is often sparse, leaving many questions unanswered.

Since lenders invest in loans individually, a lender would need to repeat the loan selection and diligence process 20-30 times to create a diversified portfolio of loans, then repeat the process again as loans are repaid in order to roll the proceeds into new loans. Some lenders may not mind that, while for others it could be too much of a workload and time commitment.

Recently, the company started offering Groundfloor Notes which “are guaranteed by a pool of loans that we have originated, but have not yet sold as direct loan investments (LROs) on our platform.” This gives lenders the opportunity to invest in a single security that offers lower risk through diversification. These notes offer lower interest rates of 4% to 8% and are only available to accredited investors. While this may be a good investment opportunity, it is less differentiated in the accredited investor market where a wide range of similar investment options and returns are available, and it misses the opportunity to tap into non-accredited investors which is central to Groundfloor’s marketing message.

Groundfloor’s market size is determined by the amount of loans borrowers take out. The company offers up to a $69 billion market size estimate based on the total amount of private, non-bank single family home construction loans in the US. That estimate likely includes loans that are not part of Groundfloor’s target market as the company does not provide loans to homeowners or for owner-occupied projects. Groundfloor only provides loans that are commercial in nature, meaning loans to professional developers, contractors, or investors that intend to sell the property after completion of the project.

Attom Data Solutions, a real estate data provider, provides a different market size estimate of $32.5 billion based on the number of “financed flips” in 2019. Groundfloor earns revenue based on loan origination and servicing fees that average 4% and 3.5% of loan value, respectively. Thus, Groundfloor’s revenue opportunity is approximately $2.7 billion based on Attom’s data. 

Part of Groundfloor’s belief is that real estate capital markets are “concentrated” in the hands of “powerful intermediaries,” implying a low level of competition. There is credence to that perspective when looking at traditional banks like Wells Fargo and US Bancorp that follow conservative underwriting practices for construction loans. However, based on estimates from the American Association of Private Lenders there are as many as 8,300 private, hard money lenders in the US. Even if a large portion are small or inactive players, it suggests there are low barriers to entry and many alternative providers of hard money loans.

Looking beyond the headline loan value numbers to the level of activity in the market, Attom Data Solutions provides several interesting insights in its 2019 U.S. Home Flipping Report. Attom notes that in 2019 house flipping reached an 8-year high with 245,864 single family homes and condos flipped, making up 6.2% of all homes sold in 2019. However, 2019 also marked an 8-year low in “profit” for flippers at an average of $62,900 per flip (Note: This is “profit” before accounting for the cost of renovations) with a median post-flip sale price of $217,900. According to Attom’s Chief Product Officer margins are declining because “The cost of buying properties continued to rise faster than gains on resale.” It seems the strong US housing market, record-low interest rates, and 15-year low in foreclosure filings is making it difficult for the increasingly large number of flippers to find the same low-priced, high-return values that existed in recent years.

There is a question as to whether the coronavirus pandemic will result in a drop in home prices and trigger an increase in foreclosures or other sources of new fix-and-flip supply. Right now, the industry is not expecting a significant impact on home prices. As of May 4, 2020, Redfin expected only a 2% reduction in home prices. Similarly, Zillow initially projected 2-3% price declines, but on June 4th revised their estimate to a 1.8% decline. Surprisingly, on June 5th, Redfin reported that prices actually increased 7% for the week ending May 31st as housing demand continued to outstrip new listing supply.

Groundfloor competes in the real estate hard money lending market. As noted in The Market section above, there are up to 8,300 private, non-bank hard money lenders in the US. However, Groundfloor’s most direct competitors are fellow upstarts that leverage an online or crowdfunding strategy. The most relevant of these competitors are PeerStreet, LendingHome, and Fund That Flip.

Compared to these company’s, Groundfloor has two key advantages. First, its LROs are available to non-accredited and accredited investors alike, whereas all three of the competitors only offer investments to accredited investors. Second, Groundfloor lenders can invest as little as $10 at a time. PeerStreet comes closest with a $100 minimum, while Fund That Flip and LendingHome have minimums of $5,000 and $50,000, respectively. A company’s minimum investment can be viewed as an indicator of their target customer, with Groundfloor and PeerStreet more focused on individual investors, and LendingHome more focused on institutional investors.

There are also a couple of advantages that these competitors have over Groundfloor. PeerStreet and LendingHome boast $3.5 billion and $5 billion in loan originations, respectively, compared to $250 million in loan originations for Groundfloor. The second advantage is the performance of their loan portfolios. As of December 2019, Fund That Flips reported 6.1% of loans as past due or in foreclosure. The comparable number for PeerStreet is 7.5%. Both are high compared to 1-2% industry standards, but are still meaningfully lower than the 14.5% that Groundfloor reported for the same period. This raises questions about Groundfloor’s ability to scale their business while maintaining the level of portfolio quality and performance needed to attract and retain lenders.

The above comparison is based on competitors offering effectively the same investment products — hard money loans. However, if acquiring real estate investor/lender customers is the business’s goal, other competitors trying to attract these same customers with alternative investment options should be considered.

For example, two potential competitors are Fundrise and Concreit. Like Groundfloor, both offer online real estate investments to non-accredited investors with low minimums of $500 for Fundrise and $1 for Concreit. In addition, Fundrise and Concreit both offer easy-to-use websites and apps, an investment product with diversification built-in that deliver attractive yields, and both allow investors to deposit and withdraw funds on a schedule independent of the underlying real estate assets. Fundrise has over $1 billion in assets under management and 100,000 active investors, while Concreit just finished up a private beta and is preparing its public launch.

Groundfloor was founded in 2013 by CEO Brian Dally and EVP Regulatory Affairs Nick Bhargava. The company is based in Atlanta, Georgia and has 50 employees. As of February 27, 2020, the company has raised $22.5 million in equity and $21.7 million in debt.

The company has originated over $250 million in loans across more than 1,500 projects. The company reports that it has more than 75,000 “registered” users. This refers to users that have created an account on Groundfloor’s site. The company has approximately 11,000 “active” users, or lender customers that have invested some amount on Groundfloor’s site. The average active lender invests $6-9 thousand dollars in their first year. A Groundfloor cohort analysis of 2016 customers found that after 3 years retained, active lenders had portfolios averaging $16,223.

The company produces revenue through loan origination fees and loan servicing fees that it charges borrowers. In 2018, the company produced $2.9 million in net revenue, which it grew to $6.4 million in 2019. Based on Q4 2019 net revenue, the company exited the year with an $8.4 million annual run-rate. The company holds loans during the interim period between underwriting and selling to lenders, but the company’s strategy is not based on holding LROs long-term. Thus, the company’s revenue is not expected to be affected, positively or negatively, by loan performance. Groundfloor does not charge fees to, or generate revenue from, lenders that invest on the company’s platform.

Like many early-stage companies, Groundfloor is not profitable. However, it narrowed its losses from $6.1 million to $3.8 million from 2018 to 2019. The company provided cashflow breakeven projections, which seem reasonable overall. Management did not provide a time frame for reaching cashflow breakeven. However, based on their recent increases in revenue run-rate, the potential cash influx from the Series B, and a monthly burn-rate of $200-250k, it is reasonable to believe breakeven could be achieved with this funding round. While nothing is guaranteed in the world of start-ups and private investments, it is definitely a benefit to Series B investors to know that the company has line-of-sight to achieving cashflow breakeven and from there (hopefully) becoming a self-funding enterprise.

As of December 31, 2019, the Series B Offering circular shows that 14.5% of Groundfloor’s loans to developers were either in a state of workout (6.0%) or fundamental default (8.5%). This is an increase from 11.7% in 2018, when fundamental defaults were only 2.3%. Groundfloor CEO, Brian Dally, acknowledged that “at anytime 15%, or up to 20%,” of the company’s portfolio could be in default. He explained that the company “declares defaults strategically based on its strategic asset management approach.” However, investors should be aware that industry standards would expect a default rate of less than 1% for fix-and-flips and less than 2% for new construction. As noted in The Competition section above, Groundfloor’s direct competitors also have elevated rates of workouts and defaults, but they are still half that of Groundfloor’s.

To provide a measurable sense of comfort, Dally noted that Groundfloor’s “loss rate” is only 0.7% of lender principal across the company’s portfolio (Note: This does not account for potentially forgone interest payments to lenders). Groundfloor’s audited financials include an allowance for loan losses. In 2018, the company reserved 1.3% of the value of loans for potential losses. In 2019, the reserve rate increased to 3.7% of loan values.

Groundfloor is offering up to $10 million worth of Series B Preferred Equity at a $72.8 million pre-money value as a part of a Reg A campaign on SeedInvest. Shares are offered at a price of $18.23 with a minimum $984 commitment per investor. Depending on the total size of the raise, proceeds will be used to fund loans to borrowers, develop new investment products, acquire customers, invest in software and technology, expand markets, and other general corporate purposes.

There are a couple key benefits to the Series B Preferred.

• Liquidation preference: In an exit or liquidation scenario, all Series B stockholders will be repaid the original $18.23 per share purchase price before any payment is made to Series A, Series Seed, or Common stockholders. This provides nice downside protection to Series B investors. Note that the Series B is a convertible preferred, not participating preferred. That means the Series B receives either the original principle (liquidation preference) or it converts into common stock and receives its pro-rata share of proceeds, but not both.
• Eligible for dividends: While the company states that it currently has no plans to pay dividends, in the event that it did declare dividends, holders of Series B Preferred would be eligible to receive a pro rata portion of any dividends.

While the company doubled revenue in 2019 from $2.9 million to $6.4 million they also doubled debt on the balance sheet from $10.2 million to $21.7 million. Bear in mind that debt must be paid off before equity in an exit scenario. In addition, Series B investors may experience dilution via conversion of convertible debt to equity, anti-dilution protection afforded to the Series Seed and Series A, or issuance of additional equity in the future. Dilution is an expected part of any early stage investment, however, more attention is warranted here given the complex capital structure.

KingsCrowd rates Groundfloor’s Series B Preferred as a Deal to Watch.

Groundfloor’s co-founders and early supporters have been successful at creating a unique investment product, building a business around it, assembling a management team, and raising capital from investors. Companies and management teams are often evaluated based on past performance, but investments are made based on the future — expectations of future results and future returns. With Groundfloor there are a number of open questions and areas of concern that need to be addressed before committing new investment dollars.

After more than seven years, the company has only 11,000 active lender customers. The company explains they have taken a conservative approach to growth which has allowed them to survive (longer than many startups). That is a fair point, but it is also reasonable to question whether they have found product-market fit yet, or if the market is just smaller than expected. After all, Groundfloor requires lenders to act like stock pickers — and do their own research — at a time when ETFs, REIT funds, robo-advisors, and auto-invest options are enjoying popularity.

Based on the company’s forecast, they need to grow active users 125% and loan originations 133% in order to achieve cashflow breakeven. Ordinarily these would not be considered significant hurdles. Yet from 2018 to 2019 when the company grew revenue 120% year-over-year, debt also increased 113% to $21.7M, workouts and defaults increased to 14.5% of loan value, and “loans to developers” carried on their balance sheet increased 90% to $73.9 million. These are potential clues that the company is having difficulty with one or more aspects of its business model.

Groundfloor is not alone in discovering challenges scaling an online hard money lending business, and it might be why the market is fragmented across 8,300 providers. Several companies in this space have had difficulty with loan default rates and investor complaints. Other sites have struggled to offer enough loan volume to appeal to a broad range of investors. It seems there may be some inherent market forces in this space that makes it challenging to achieve the trifecta of high quality, high yield, and high volume.

Assuming product and business model issues get resolved, there is still a question about competition and differentiation. There are dozens of online or crowdfunding real estate start-ups, so being early to offer an investment option to non-accredited investors with low minimums alone is not likely to be the long-term differentiator needed to become a market share leader. Traditional real estate funds and investors have also keyed in on the SFH opportunity, so competition may heat up rather than cool off.

Ultimately, any investor wants to realize a return commensurate with the risk they take. Investors looking for deals related to real estate (but not specifically real estate itself) might find Groundfloor to be an attractive option, and the Series B Preferred offers some downside protection. However, there are still meaningful risks surrounding the business’s growth and success that should be considered. For that reason, this is a Deal to Watch until investors get more answers.