Real-estate crowdfunding is a house of cards. PeerStreet’s bankruptcy reveals why.

Burry’s “long” was PeerStreet, a real-estate-crowdfunding website that allowed qualified investors to buy a piece of a mortgage on a residential property, usually a rental. Crowdfunding had popped up in the wake of the financial crisis that made Burry’s name, offering the promise of private-equity-style returns to smaller investors.

“What happened in the crisis is there was practically no underwriting,” Burry was quoted as saying at the time. “It’s important for the next-generation alternative lending model that there be controls in place. There’s somebody at the door checking for excess credit risk.”

Just eight years and $121.9 million in funding later, including from the Silicon Valley behemoth Andreessen Horowitz, Burry’s optimism was proved wrong. PeerStreet and its affiliates filed for Chapter 11 bankruptcy protection on June 26 after its lending business dropped to $5.4 million in mortgage originations, down from $695 million in 2021.

I feel that I’m savvy, but I feel duped by what they’re trying to do here. Braun Mincher, a PeerStreet investor

PeerStreet blamed its collapse on plummeting demand amid rising rates. But the bankruptcy documents show the empty promises of real-estate crowdfunding, which rose from the ashes of the global financial crisis, to “democratize” real-estate investing and give the little guy a chance at the spoils previously enjoyed only by the fabulously wealthy. With the help of hundreds of millions in venture capital, this pocket of investing morphed into a $14 billion industry by 2022, anchored by major companies such as Yieldstreet, CrowdStreet, and, for a time, Fundrise.

Insider pored over hundreds of court filings, spoke with bankruptcy and crowdfunding experts, and interviewed six PeerStreet investors and one former employee to find out what went wrong. We found that most of the company’s loans were “nonperforming,” indicating that the majority of PeerStreet’s investors loaned money to borrowers who’ve stopped paying them back. 

More importantly, many PeerStreet investors who thought they were purchasing a slice of a loan in a property have learned that they did no such thing, at least according to the company. PeerStreet has told a Delaware federal bankruptcy-court judge that it sold financial instruments that acted as fractions of mortgages instead of mortgages themselves, giving the company the right to sell the loans in bankruptcy.

The question of ownership is before Judge Laurie Selber Silverstein. Depending on how she rules, many PeerStreet investors stand to lose much of their investment — raising questions about the viability of the real-estate-crowdfunding business model for Main Street investors.

PeerStreet CEO Brew Johnson told Insider he’s “unable to comment at this time.”

A ruling in favor of PeerStreet “will break people’s trust in the crowdfunding platforms as a whole,” Braun Mincher, a PeerStreet investor, told Insider.

Like many PeerStreet investors who spoke with Insider, Mincher has a strong résumé. He’s a tech entrepreneur who has successfully exited multiple businesses and has experience as both a buyer of real estate and a direct lender to real-estate projects. He is a founding shareholder of a $250 million community bank and served as the head of the committee of creditors in another Delaware bankruptcy case. He even wrote a book on personal finance.

Yet the extent of the prospective losses stemming from PeerStreet’s bankruptcy has taken even sophisticated investors such as him by surprise. 

“I feel that I’m savvy, but I feel duped by what they’re trying to do here,” Mincher said, echoing language filed in letters to the court, including one from a noteholder who said they felt like the “victim of an investing scam.”

Crowdfunding took hold in the age of social media, with the pioneer LendingClub getting its start on Facebook in 2007. The concept is simple: Instead of requiring someone with a business plan — be it a startup, a product, or a real-estate investment — to go to a bank or large investor for cash to get their idea off the ground, the investment can be collectively funded by small investors. 

The most well-known version is reward crowdfunding, most commonly seen on Kickstarter, where someone with an idea for a gadget asks for startup money and then provides these early investors with a reward, usually the product itself, once it’s created.

Another form of crowdfunding, equity crowdfunding, works a bit like the stock market without the onerous and expensive process of initial public offerings. An asset, be it a company, a piece of real estate, or even an expensive artwork, is split into shares. Small-time investors can then purchase a share of the asset and split the spoils.

In the case of PeerStreet, investors purchase a note that operates like a mortgage tied to (in most cases) a residential investment property. As long as the property owner can pay the mortgage, the investor gets a monthly payout proportional to their share.

Launched in 2013, PeerStreet quickly grew a stellar reputation among the burgeoning crowdfunding community, but the quality of deals on the platform noticeably declined as its popularity grew, said Ian Ippolito, the founder of the Real Estate Crowdfunding Review, a website that researches real-estate crowdfunding platforms.

According to Ippolito, it’s a common story: A crowdfunding company grows in popularity to the point where deals are fully funded in 30 minutes or less, prompting it to increase the number of deals on the platform. Skyrocketing demand for deals comes with “a temptation to reduce the underwriting,” he said. 

PeerStreet didn’t respond to requests for comment, but its executives have made no bones about its ambition to function as a “two-sided marketplace,” instead of as an investment manager. Marketplaces, which merely connect buyers to sellers, do better as more volume flows through them, which means the incentive is for more investments, not necessarily high-quality ones. This is true for many real-estate crowdfunders, whether they sell notes attached to debt or shares of an equity investment.

“If you get up to a cruising altitude with a whole bunch of developers up there, it’s impossible for them to do the due diligence,” said John McNellis, a principal and cofounder of the development group McNellis Partners and an author of a best-selling book on real-estate development.

He said the up-for-grabs investment pitch of many crowdfunding companies was: “This is up on our website. It may or may not suck as an investment. Make your own decision.”

Perhaps not coincidentally, the rise in demand for deals often coincides with capital infusions from venture capitalists, further fueling the cycle and leading to even more deterioration in the underwriting standards, industry insiders including a former crowdfunding founder said.

Burry was an early PeerStreet investor and vouched for the company’s credit quality in 2015, when it was still in startup mode. By 2016, the Silicon Valley venture-capital firm Andreessen Horowitz was also backing the company. By 2019, PeerStreet had raised $121.9 million in venture funding and surpassed $3 billion in total loans funded. (It had hit the $2 billion benchmark only a year earlier after five years in business.) The company’s meteoric growth continued amid the pandemic, but loan volume collapsed as interest rates rose.

The collapse has revealed deeper issues, including a massive number of loans in or near default. A mind-boggling 54% of the company’s loans were more than 30 days delinquent as of the bankruptcy, a fact pulled from court documents that drew gasps from industry insiders when discussing PeerStreet with Insider.

Ippolito and McNellis said crowdfunding companies were never in line to get the best deals anyway because those tended to be reserved for the banks or institutional investors, which have higher underwriting standards. The focus on quantity exacerbated the situation, resulting in a flood of low-quality deals.

“They call it democratizing real estate. I call it shearing sheep,” McNellis added, explaining his view that the crowdfunding industry was regularly taking advantage of Main Street investors.

PeerStreet’s bankruptcy is also testing a fundamental principle of crowdfunding: It gives small investors a chance to own assets, whether it’s a piece of a company or a mortgage loan.

Bankruptcy filings show that the El Segundo, California, company is arguing that it controls the loans and should therefore be allowed to sell them at auction to pay off its creditors. PeerStreet’s lawyers have pointed to language in the investment agreement that says the notes sold on its platform are unsecured. Instead of a fraction of a mortgage backed by real estate, they’re a financial instrument that acts as a fraction of a mortgage secured by nothing.

More than 50 investors have sent letters to the judge, the vast majority saying they believe they’re secured investors. They have also argued that they should have a right to decide what happens to their investments. The investors who spoke with Insider said they wanted to ride the loans to term in hopes that they could recoup their investments. 

The site’s users have cited the company’s marketing, such as a post on the company’s website that says the notes PeerStreet offers are first-lien loans “sitting at the safest part of the capital stack.” The post adds: “This position is the least risky because these investors will be the first in line to get paid, and take priority to junior debt and equity in the event of default or foreclosure.” In conversations with Insider, some investors also cited a Burry quote in a press release from 2015 that said: “PeerStreet’s notes are backed by real estate.”

Burry declined to comment for our story, but bankruptcy filings show that he, too, has a lot to lose. In addition to his investment in the company, he was a user of the site with over $600,000 in investments and about $9,000 in cash in his PeerStreet account.

The largest investor on PeerStreet’s platform, Pacific Funding Trust, which owned just under one-quarter of the notes on the platform, has also filed an objection to PeerStreet’s effort to sell the loans, claiming that the notes it purchased were actually pieces of the loans. 

In an August 4 hearing, the bankruptcy judge halted PeerStreet’s plan to sell until the question of ownership was resolved, noting both the Pacific Funding objection and the letters from smaller investors. Silverstein, the judge, said the case was extraordinarily complex and that the dispute would take time to figure out.

One of PeerStreet’s lawyers tried to push the sale forward, arguing that the judge could authorize the sale before figuring out ownership. The judge disagreed.

“If you don’t own them, you can’t sell them,” Silverstein said.

The PeerStreet investors who spoke with Insider said the outcome of this case could determine whether they stick with real-estate crowdfunding. The next hearing on the question of ownership has been scheduled for Wednesday.

“If they allow PeerStreet to confiscate my investment that they promised wouldn’t be confiscated, I don’t see why anyone would crowdfund anything ever again,” Sean Quinn, a PeerStreet investor and retired labor-relations executive, said.

Doug Lyon, an engineering professor at Fairfield University and an investor on many crowdfunding platforms, told Insider he planned to continue investing on other platforms but not PeerStreet, even if it successfully emerged from bankruptcy.

“This is where money goes to die,” Lyon said of the site.

Real-estate crowdfunding tends to be restricted to investors with at least $1 million in net worth, not including their home, or $200,000 a year in income. As a result, some investors have hundreds of thousands of dollars on the line, according to the bankruptcy court letters.

According to Ippolito, unsecured instruments are common in the debt-crowdfunding world, which PeerStreet helped pioneer. One of the largest crowdfunding platforms, Yieldstreet, uses a similar form of note that’s not directly tied to the underlying loan, Ippolito found in an analysis of the company’s investment agreement.

Patch of Land operated with a similar note structure before it paused originations in 2020 and let the loans run to term as it moved away from crowdfunding, according to CEO Jason Fritton. The company was eventually sold, and the platform wound down.

To be sure, platforms that offer equity instead of debt tend to provide investors with a true piece of the asset, instead of a note. They do this by creating an entity known as a special-purpose vehicle to buy the property. Then investors receive shares in the actual entity proportional to the amount of money they invested and therefore should have more autonomy in the case of bankruptcy.

Of course, equity holders are often the first to get wiped out in a bankruptcy.

If they allow PeerStreet to confiscate my investment that they promised wouldn’t be confiscated, I don’t see why anyone would crowdfund anything ever again. Sean Quinn, a PeerStreet investor

PeerStreet investors also take issue with the company’s past representations about how it would handle a bankruptcy if one ever needed to be filed. In a post on its website, PeerStreet wrote that its investments were held in a “bankruptcy-remote entity” and that in the “unlikely event PeerStreet no longer remains in business,” a third party would come in to manage the investments “and ensure that investors continue to receive interest and principal payments.”

Instead, the company froze all payments to investors and lobbied the court to let it sell the loans to satisfy its debts. While some of that money could make its way back to investors, the amount is unclear, bankruptcy experts said. 

The company has argued that it would sell the loans in tranches of similarly performing loans and then pass the proceeds to noteholders after calculating each investor’s holding to limit losses. 

But investors said the company could just as easily put the proceeds of any sale into one big pot to pay off its debts in order of seniority. In that case, the platform’s noteholders would be below the hedge-fund company Magnetar Capital, which is owed $27 million, lawyers, and even real-estate brokers, bankruptcy experts said. 

Kirk Brett, the chair of Adler & Stachenfeld’s bankruptcy group, which is not involved in the PeerStreet bankruptcy, said the question of distributions could play out in various ways, including the big-pot scenario investors said they feared. 

“I don’t think that has been addressed in cases before, and you can tell that because there’s not a lot of case-law citations on the issue in the filings,” Brett said. 

The real-estate-crowdfunding industry is littered with allegations of faulty controls. 

In 2018, the Securities and Exchange Commission accused the CEO and founder of iFunding and another corporate officer of misappropriating more than $1.17 million in investor funds and making fraudulent statements to investors. In 2021, the two men were ordered to fork over more than $2 million in fines and restitution after admitting to the SEC’s allegations.

More recently, CrowdStreet has come under scrutiny after it raised $53.8 million for two deals that never closed, prompting an investigation in Delaware bankruptcy court. In July, the fiduciary tapped to review the matter said the money had been “misappropriated,” with much of it transferred to entities connected to the CEO of the developer, Nightingale’s Elie Schwartz. 

CrowdStreet has responded by blaming Nightingale and said that it was assessing legal actions against Schwartz and Nightingale. Nightingale has not responded to the allegations, but its lawyer told the court the company was working on a settlement with investors after the fiduciary revealed that the Department of Justice and Securities and Exchange Commission were looking into the matter. 

Meanwhile, the SEC on Tuesday charged Yieldstreet, one of the largest crowdfunding platforms, with $728.5 million raised, with misleading investors. The SEC said the company did not disclose to investors that the borrowers of a $14.5 million project to take apart a ship had previously failed to repay similar loans to Yieldstreet entities. Investors lost millions.

Yieldstreet agreed to pay more than $1.9 million without admitting or denying wrongdoing. In a statement to Insider, the company said it continued “to aggressively pursue recovery for our investors through ongoing litigation and collection efforts both here and abroad.”

Ippolito told Insider that the industry, which used to have hundreds of operators, had been whittled down to roughly 20 platforms over the past decade. 

Some, such as Yieldstreet, have broadened their operations to other alternative assets, including art and private credit, which has become a highly lucrative pocket of commercial real estate as banks retreat from lending. Some operators have consolidated. Others have wound down their operations. Others, such as Fundrise, have moved away from crowdfunding in favor of a model for private real-estate investment trusts, similar to the BREIT later offered by Blackstone.

Fritton, the former Patch of Land CEO, said Fundrise’s fund model was the wave of the future for real-estate crowdfunding. There’s a large appetite from accredited investors to put money into real-estate deals, but a fund structure can offer more protection for both the sponsor and the investors.

A marketplace of individual investments prioritizes the quantity of investments, but a fund requires the sponsor to operate like a more-traditional investment manager, which ideally leads to tighter underwriting standards. 

Funds are also better able to weather the inevitable but random operating expenses that pop up when you’re dealing with physical investments, such as a broken elevator or water heater or repairs after flooding. Instead of requiring each individual property to keep enough money on hand to deal with these eventualities, a fund can hold a much-larger amount of cash across all its properties that can be used whenever these issues arise. This means there’s much less chance that the sponsor will have to go back to investors to ask for more capital to complete a necessary repair. 

Funds can also protect individual investors from getting wiped out if a single investment goes south, Fritton said. If investors pour all their money into the one deal that fails, they lose it all, but if they pour it into a fund, one deal failing won’t make their entire investment evaporate. “No matter how well you underwrite,” Fritton said, some deals fail.

Fritton gave the example of one deal that looked perfect on paper: The sponsor was the CEO of a publicly traded company with a large amount of experience and fantastic credit. It was the company’s first payment default.

“He never paid us a dime on that loan,” Fritton said.