This is an in-depth review of another relatively new “alternative investment” platform called Yieldstreet. Like many other new financial tech companies,
Yieldstreet is a crowd-funding platform that allows investors to pool together resources to invest. Most of these companies (like Fundrise, which I reviewed here) are focused on real estate investments. Yieldstreet also offers crowd-funded real estate investments, but has a few other unique tricks up its sleeve as well. I’m fairly excited about investing with Yieldstreet, because they offer highly collateralized investments, that are uniquely diversified. Both aspects are very important to help reduce investment risk, and increase potential returns.
Highly Collateralized Investments
Yieldstreet offers two main types of investments: bridge loans made to real estate developers, and litigation financing loans.
Real Estate BRIDGE LOANS
Yieldstreet’s “bridge” loans are short-term loans to real estate developers who are either in the process of obtaining traditional financing from a bank, or are planning to sell the property again in the near future. When you invest in one of Yieldstreet’s real estate loans, you become a lender to the developer. In return for your loan, the borrower gives you a lien on the property that allows you to foreclose and sell the property to get repaid if the developer becomes insolvent for some reason.
A property lien provides a big safety net for the lender, but the actual benefit provided by that lien depends on two things: (1) who gets paid back first if there are multiple lenders, and (2) the value of the property compared to the total amount of loans taken out on the property. The loans offered on Yieldstreet are usually for “first” level mortgages, which means if there is a foreclosure, you will be the first to get paid back. “Mezzanine” or “second-tier” lienholders will only be repaid with the leftovers after the first lienholders are fully repaid (some of Yieldstreet’s more recent offerings have fallen into this category, so always check the offering materials carefully).
“Collateral” is the total property value, minus all loans that have been taken out on that property. For instance, if a property is worth $5 million, and a developer buys the property with $1 million in cash and takes out a loan for the remaining $4 million, the property has $1 million in “collateral.” The loans all need to be repaid if the borrower stops making payments, and therefore are not considered as part of the property’s “collateral.” Another way of saying this is that the property carries a loan to value (“LTV”) ratio of 80% (the loan amount, $4 million, is 80% of the $5 million total value of the property).
Lots of companies (like RealtyShares and PeerStreet) allow you to lend money backed by real estate, but I haven’t found any other platforms that offer loans that are as highly collateralized as Yieldstreet’s. Most other investments I’ve seen (like the one pictured here from PeerStreet) carry LTV ratios of around 75% or more, but Yieldstreet’s loans generally have a 50% LTV ratio.
Using our example above, a 50% LTV ratio would mean that the developer has already put down $2.5 million of cash to buy the $5 million property, and only needs to borrow the remaining 50%, or $2.5 million. As the lender, that gives you a bigger margin of safety, because even if the value of the property goes down for some reason, you’re much more likely to be able to sell it for 50% of the original appraisal value than 80% of the appraisal value (which is what you would need to sell it for if the developer had put only $1 million down in cash on the property). Lending money on a property with a lower LTV ratio should be safer, because it positions the developer to take any potential loss, rather than the lender.
This is where Yieldstreet gets really interesting for me. Yieldstreet allows investors to buy portfolios of loans made to litigation plaintiffs. Lawsuits sometimes take years to resolve, but the plaintiff may have been injured, or have other current needs for part of the funds he or she will likely win at trial or through a settlement. These advances are made by LawCash, who then bundles loan portfolios to investors on Yieldstreet. These loans are paid back directly from any judgment or settlement the plaintiff obtains. It’s a win for both the plaintiff and the lender, because the plaintiff gets money they need for current expenses (money they could not obtain through any “traditional” loan), while the investor collects a substantial interest payment.
Although all loans carry some level of risk, these loans are backed or “collateralized” just like real estate loans. Instead of offering a lien on a piece of real property as collateral, the plaintiff-borrowers offer “collateral” in the form of an injury that is legally recognized. In our legal system, a “cause of action” or legal right due to an injury is just as “real” as a lien that allows you to foreclose on a property. As an attorney, I see legal rights that are “worth” millions of dollars all the time. You should definitely do your own research as to how strong you feel this collateral to be. But my personal opinion is that if the loans are structured correctly, and the underwriting is solid, a lien on a cause of action is every bit as valuable (if not more so) than the collateral provided by real property.
Just like in real estate lending, the value of a lien is only as strong as your position in the pecking order of lenders, and the amount of the loan compared to the total value of the legal right. Only one loan is made to each plaintiff, so you are always in the “first” lien position as a lender (along with the plaintiff’s attorneys, who take a percentage of the total recovery as their legal fees). Also, each plaintiff is only allowed to borrow about 10% of the expected value of the settlement. Just like with property, an appraiser determines how much the lawsuit is likely worth, and that sets the maximum loan amount. Law Cash employs a team of attorneys to perform due diligence on each case to ensure it is being fairly appraised.
Are These Loans Safe?
As you can see, both the real estate loans and litigation financing loans allow investors to lend money to borrowers who offer significant collateral in return. If anything goes wrong with a real estate deal, and the borrower is unable to make payments, that collateral should be enough to cover the original loan principal. The litigation advances are backed by collateral as well, but you only get paid if the underlying case is successful. However, about 90% of the underlying lawsuits settle before trial (and should be able to repay the lender since only a fraction of the value was borrowed), and of the remaining 10% that go to trial, about half are successful. Because no single lawsuit accounts for much of the overall portfolio value, you’re likely to see returns even if some of the lawsuits are unsuccessful.
No investment is truly “safe.” Even government-backed bonds carry some level of risk. Yieldstreet loans are considerably more risky than bonds, but on a spectrum of loan types, I feel they are much more safe than a non-recourse loan based solely on an individual’s credit score (like Prosper or LendingClub loans), or even a recourse loan that is less highly collateralized. The collateral offered in return for these loans is a “tangible” asset that should provide at least partial recovery of your initial investment
Yieldstreet Investments Are Uniquely Diversified
Stocks and other traditional types of investments tend to move in harmony. In other words, if the share price of large corporations drops, the price of small companies will usually drop as well. Or if international equities have a banner year, U.S. companies will usually be up to some degree as well. If you’re trying to retire or live a financially independent life based on income from investments, this correlation in volatility can be frustrating. Traditionally, investors would buy bonds to hedge against a market downturn, but bond returns are extremely low right now. Yieldstreet’s alternative investments, although more risky than bonds, offer significantly higher returns that are minimally, or even negatively correlated to the overall market.
DIVERSIFY THROUGH REAL ESTATE
Real estate is a great way to diversify from the standard stocks and bonds portfolio. Although we’ve seen some situations where stocks and real estate both lose value at the same time (the 2008 economic crisis is one example), real estate tends to be less correlated to the stock market.
Yieldstreet’s real estate loans are usually for a term of 12-24 months. These short-term loans are typically “bridge” loans made to a developer who needs funds quickly to close on a good deal. This short time period allows both the developer, and you as the lender, to better assess the strength of the market, and the potential for better returns elsewhere (although anticipating future market conditions—even a year out—is difficult to say the least).
Diversify Through LITIGATION FINANCING
Yieldstreet’s litigation financing investments are potentially even less correlated to the overall market than real estate. The company that originates the loans and sells them to Yieldstreet reports that during the 2008 economic crisis, they actually saw an uptick in business (which is unsurprising given that many people were squeezed for money during that time).
When you make a personal loan to someone, the loan is usually based on that person’s credit score, which is basically an analysis of how reliable that person is expected to be financially. If there is a major market event, you could expect more people to lose their jobs and become financially insolvent. But when you finance litigation through Yieldstreet, you basically take the credit-worthiness of the borrower out of the equation.
Once a case settles, or there is a monetary judgment from trial, the money the plaintiff borrowed (plus interest) is repaid directly from the lawyer’s trust account, before it’s distributed to the plaintiff. Rather than the plaintiff’s credit score (which is basically irrelevant under this model), the major variable becomes whether the lender analyzed the lawsuit’s chances of success correctly before making a loan. As long as they don’t start lending on meritless cases, there should be very little correlation to the market.
There’s No Free Lunch
To be honest, Yieldstreet is one of my favorite alternative investment platforms right now, because it allows investors to loan money on highly-collateralized loans, that are minimally correlated to the overall market—both factors that should improve returns and minimize risk over time. However, the investments are far from risk-free, and there are several important downsides to keep in mind before rushing to invest:
- One of the biggest downsides is that Yieldstreet is only available to accredited investors. To qualify as an accredited investor, you need to have earned at least $200,000 per year ($300,000 if married) over the past two years, or have a net worth (excluding your primary residence) of at least $1 million. This unfortunately puts these lending opportunities out of reach for many investors. Yieldstreet is apparently working to offer investments to non-accredited investors as well, but there’s no word on exactly when that will happen, or what types of investments will be made available.
- Also, the minimum investment in each offering is generally $5,000 to $20,000. As a general rule, diversification is the best way to keep risks down. I like to limit my investments in alternatives to around 10-20% of my overall portfolio, and it’s an even better idea to split up that 10-20% among many different “alternative” holdings. So, depending on the overall size of a portfolio, $20,000 might be too much to invest in a single loan offering. You’ll have to analyze for yourself whether your portfolio is properly diversified, and whether you can risk a single investment of that size.
- Yieldstreet pays around 9% on real estate loans, and 13% on the litigation financing. These returns are solid, but it takes a while to deploy your investments, which brings down overall returns. It took them about four days to transfer money out of my bank account after I made an investment, and several more days for the money to show up in my Yieldstreet account and start earning interest. Many of their real estate loans seem to be paid off early as well, so the turnaround time can cut into returns. Also, you cannot reinvest interest and principal payments until you meet the minimum investment amount, so you lose out on some compounding of your earnings. I suggest linking your Yieldstreet account to a high-yielding savings account, so at least you can earn some interest between investments.
- Yieldstreet has only been around since 2015. Although they have been very successful so far, their long-term performance has yet to be tested.
- The real estate loans pay on a monthly basis, but returns on the litigation financing loans are on an “event basis.” This means that you receive payments only when a case settles, or wins at trial. The investments are structured with cases in various levels of completion, but payments will still be erratic, and some cases may take longer to settle than anticipated.
- There was only one open investment opportunity at the time I published this article. The litigation financing investments sell out very quickly, so when one is released, plan on investing immediately. (Update: most of the offerings sell out within minutes, so plan on sitting at your computer and refreshing the webpage like crazy to try to get a shot at a new offering.)
- As with any lending opportunity that you don’t procure yourself, you need to trust that the underwriting was done well. For instance, with the litigation financing investments, you’re relying on the loan procurement company to make sure that an individual loan is not overweight in the portfolio, and that the underlying cases are valued appropriately. The company that procures the loans has a long track record of successful financing, but you are of course relying on their due diligence.
If you can get past the risks and downsides, Yieldstreet offers some significant benefits over many of the other options available to investors. First, the types of offerings are somewhat unique, and appear to have little correlation to the overall market. Also, the investments are highly collateralized. I’m testing out the waters with Yieldstreet, and I created another post here to track my progress. I’ll continue to update that post with the performance of my Yieldstreet investments. Leave a comment below and let me know what you think about Yieldstreet, or if you have other ideas for solid alternative investments.