Founded in 2013, Groundfloor is an Atlanta-based company that allows non-accredited and accredited investors to participate in short-term, high-yielding loans that are collateralized by real estate. These loans are typically taken out by real estate entrepreneurs, known to some as “flippers,” who are looking for sources of flexible capital that many banks can’t or won’t provide. Many aspects of this company, which was started by CEO Brian Dally and Nick Bhargava, EVP Regulatory Affairs, go against conventional wisdom. That’s why The FR’s Gregg Schoenberg was happy to sit down with Dally to learn more about his investment and entrepreneurial philosophy, as well as the company’s overarching mission.

Note: Groudfloor is an advertising client of The FR. This Interview has been edited for content, length and clarity.

FR:    Brian, it’s good see you. So tell me, what’s the Groundfloor elevator pitch?

BD:    It’s great to see you as well, Gregg. In a nutshell, the best performing investments — and by performing I mean highest yield with the lowest risk — haven't been going to the 96%, 97% or 98% of Americans who don't meet the standard of an accredited investor.

FR:    You mean private investments.

BD:    Yes. People who have looked at these markets know that all the alpha that's accessible is in these private offerings that haven't been open to the rest of us. Fortunately, that's changing, and Groundfloor is doing its part by opening up private markets to everyone.

Clay Christensen’s influence

FR:    On your Linkedin profile, you say, "As an internet ideologue and community organizer at heart, I enjoy attacking entrenched industry incumbents from a position of weakness." Describe how Groundfloor plays into that ethos.

BD:    Well, I first learned about disruptive technology in the mid-90s when I was at Harvard Business School. I had the good fortune of having Clay Christensen as my innovation professor. He was actually in the middle of writing the book on disruptive technologies that later made him famous.

FR:    Which idea within The Innovator's Dilemma are you specifically pointing to?

BD:    This idea that a community of people see unique value in a technology that delivers and that does one job really, really well. As someone who cares deeply about internet values, openness, access and democracy, I look for opportunities, first with Republic Wireless, and now through Groundfloor, where we can use technology to deliver value without the other stuff that comes with it.

FR:    Unlike other real estate tech entrepreneurs, you don’t have a real estate background. What led you and Nick to say, "Lets democratize access to real estate investments"?

BD:    I saw an analogy to Republic Wireless. In that industry, we saw how “Big Cell” created the impression that it controlled access to wireless communications. But we realized that with the right technology and knowhow, you could put a wireless network and all the necessary infrastructure in place to empower consumers.

FR:    Who was playing the role of Big Cell?

BD:    Wall Street and the big banks. We observed that people who should be participating in the markets weren’t because, let's face it, investing is boring, and people don't want to spend their time on something where they feel like the game is rigged and where they won’t be successful.

FR:    To be clear, you’re talking about the equity market?

BD:    Yes, the public markets. We talked to many people who had this false choice in their mind where on one hand, they can leave their money in the bank earning nothing, or they could turn it over to somebody who will overcharge them and take away their control.

FR:    Your inspiration was to show them a third way.

BD:    Yes. Indifference is the biggest competitor for any new idea. So it's important to focus on something that matters to people. As someone who has been investing since the age of 15, I knew that the barriers to saving and investing like the big boys had become an insidious problem. So we built our company to address the barriers.

FR:    I’ve sensed that control is a big theme motivating how you’ve built Groundfloor.

BD:    Yes, and it’s not about us. It’s all about the people we’re serving. I mean, if I told you, Gregg, that the only way you can buy into the stock market is by investing in a mutual fund, that you can't buy Amazon or Google directly, you’d laugh in my face.

FR:    I understand your point. Although I wouldn’t laugh in your face, Brian.

BD    Ha, I appreciate that. Look, when it comes to private market investments, Wall Street has told people you can’t have direct access. You aren’t allowed. That's a fundamentally un-American idea.

Why residential real estate

FR:    It seems clear to me that real estate became the vehicle through which you believed you could ultimately provide upside to the non-accredited investor.

BD:    Today, yes. But five years ago, it wasn’t obvious. However, the more we thought about it, the more we came back to the fact that 60% of American households are investors in the single-family housing asset class because they own a house. As a result, most people are over-concentrated. To us, the most efficient way to address this imbalance was with the short-term debt product that we created.

FR:    A product that has Groundfloor loaning money to individual real estate developers who are looking to flip homes, right? But you’ve structured it in a way where you do the loan and then syndicate it on a fractionalized basis.

BD:    That’s correct. Our current product checks all of the boxes I just mentioned.

FR:    In all 50 states, right?

BD:    Yes. In January, we qualified under Tier II Regulation A, which allows us to accept investors from all 50 states.

FR:    Do accredited investors also utilize your platform?

BD:    Yes. Accredited investors use Groundfloor because when you use our platform, you get all the benefits of the platforms that cater to accredited investors, plus all the benefits that come with being fully disclosed via the SEC.

FR:    What are the benefits?

BD:    We look like a public company in that we have audited financials that we file regularly. We also have performance reports that we file regularly. No other operator in our space submits to that level of scrutiny.

FR:    Let’s talk about your secret sauce, which is your real estate-based, payment-dependent note vehicle. Did you come up with this structure?

BD:    We invented it, yes. The technical term for it is “limited recourse obligation,” or LRO.

FR:    Can you walk me through how it works?

BD:    From a legal and technical perspective, investors are lending money to Groundfloor by purchasing an LRO. Its aim is to provide an unmatched combination of disclosure, product performance and accessibility.

FR:    If you sell me an LRO, I’m still buying exposure to a specific loan, right?

BD:    Yes. Unlike some platforms out there who buy their loans from originators, we originate 100% of our loans. We do this to ensure consistency and quality control across grades. The SEC reviews every series of LROs to ensure that our disclosures comply with our overall offering. This is how we’re able to offer investors fine-grained control over their exposure across risk grades, geographies and borrowers — there’s no limit, actually.

FR:    Do I get to choose how much I want to put into each loan?

BD:    That’s right. If we offer ten loans on a given week, you may choose to invest in a couple of them, or you may want to concentrate your investment on one loan.

FR:    If I’m an investor, am I taking Groundfloor credit and platform risk when I invest on your platform?

BD:    Yes, you are, because at the end of the day, these are Groundfloor obligations. Our investor agreement and the LRO do specify that any repayment or recovery in the ordinary course of business flows pro rata to the holders of a given series of LROs.  

FR:    Is this a major investment consideration?

BD:    Look, some people talk about this issue of platform risk, and there are a lot of ways of dealing with it. We’re well aware that some other platforms out there tout the fact that they have put bankruptcy remote structures in place.

FR:    So why not put one in place as well?

BD:    To be honest, no one has actually put one through a bankruptcy court yet. So while everybody can claim that they have bankruptcy remote protection, none of these structures have been tested. Any contract can be invalidated by a bankruptcy court, depending on the circumstances and nature of the contract.

FR:    Has anyone ever said to you, "Brian, just raise a bunch more cash and stick it on the balance sheet”?

BD:    I have had a few of my peers scratch their heads and tell me we're doing it totally wrong. I enjoy those moments, because every founding team has a different motivating purpose and vision. If I were trying to reinvent the way that real estate was funded, where I was trying to build a really big and badass real estate finance company, sure, I would have done this in a different manner.

FR:    But that’s not your driving motivator.

BD:    Right; fundamentally, we are centered on the investor, the suppliers of capital. And meanwhile we’re exploring what that can mean for the users of capital, the entrepreneurs, the builders and borrowers. People have really misunderstood what we're up to, but that's okay with me.

Capital markets philosophy

FR:    Before I turn to the borrower side of the platform, I want to ask you about your theory on capital markets, because I know you’re passionate about it.

BD:    My theory is that if in 2008, our capital markets had been structured more like our internet protocol and less like the way they are, people could’ve been spared a lot of pain.

FR:    Because no one entity would have put so much stress on the system?

BD:    Basically, yes. No one point on that network would have been too big to fail. Failure is part of what happens on the web all the time; not every packet reaches you, and yet the web works just fine.

FR:    So you’re saying that decentralization leads to greater durability.

BD:    Yes, but it’s not just durability. We think capital markets really matter to the price of capital, to who gets the capital, and to the terms on which they get the capital.

FR:    Can you give me a practical example of how your theory plays out at Groundfloor?

BD:    We're the only nationwide vendor that I know of that allows our borrower to take a loan and not make monthly payments during the term of the loan. Do you know why that is?

FR:    Because when they have a liquidity event, they pay you back.

BD:    Of course. But the reason why loans in our space aren’t structured that way is because institutions are supplying the capital to most of the lenders in our space.

FR:    And they've got guidelines.

BD:    Yes. They have guidelines that say you have to have a personal guarantee. Personal guarantees don't even matter. They just cause people a lot of heartache.

FR:    I take it that Groundfloor has more freedom to be creative.

BD:    Yes. Given our sources of retail capital, we’ve been freed up to actually build products that make more sense for the borrower. Meanwhile, the cabal behaves in a lemming-like fashion.

FR:    Cabal being institutional capital?

BD:    Right. And they’re all sourcing their capital from similar places. So when a downturn comes, their liquidity will dry up first because it’s more centralized. Or to put it another way, we actually think that individual decision-makers, broadly dispersed, will make better decisions than the high priests of finance.

FR:    Do you have any institutional credit partners?

BD:    Last year, we announced our first institutional partner, Direct Access Capital in Dallas, as a buyer of whole loan credit. They have an appetite to buy up to $100 million of our credit. Fortunately, we've made a lot of progress on our roadmap and haven’t actually had to use that overflow very much. But it's good to know it's there.

Residential renovators or developers?

FR:    Let’s turn to your borrowers. By the way, do we call them residential renovators or developers?

BD:    Some people call them house flippers, but some of our customers don't like to be called that because they actually go in and do a lot of development work. These aren't like weekend hobbyists who go to a seminar and then buy a house to flip it in two weeks.

FR:    These are professionals who do it full-time.

BD:    Yes. In fact, I think of them as real estate entrepreneurs who are operating at the low end of the real estate spectrum.

FR:    By that you mean single-family houses?

BD:    Yes. It’s where real estate entrepreneurs like Sean Conlon of The Deed got their start. Many people just stay there for their whole career.

FR:    How many markets are you currently serving?

BD:    We’re in 24 today, which is mostly a function of where we choose to do business. For example, we don’t do business in California because we don’t like that market. In other markets, we have opted out because of legal issues pertaining to foreclosure.

FR:    Is your competition other online platforms, or is it the local bank near the entrepreneur's home?

BD:    Before the 2008 liquidity crisis, real estate entrepreneurs borrowed for 65% to 80% of their projects. Today that number is growing, but it's still only at 35%. So in reality, our biggest competition is equity, people who are afraid to be taken advantage of and worried by a personal guarantee.

FR:    As you know, Brian, hard money lenders historically haven’t had a great reputation.

BD:    Absolutely.

FR:    Which makes it harder for reputable, professional lenders.

BD:    That's starting to change. If you and I go 50-50 on a house flip where you're the money and I'm the labor, I’m doing pretty well if we sell at a good price. But if I borrowed money from Groundfloor instead of partnering with you, I might make 50 percent more money and not have to sign a personal guarantee.

FR:    But you could be foreclosed upon.

BD:    Yes. Groundfloor accepts a lien on the property if I don’t pay. However, we aren’t looking to foreclose on the property. For some hard money lenders, foreclosure is a win. But for us, that’s a loss.

FR:    Because you’re not a loan-to-own type of model, or like one of these lenders who puts up a billboard on the interstate.

BD:    Right. Our core message is that we try to give you a better deal because we have a wider pool of capital sources and a better structure. We also try to give the borrower a lot of control. You can choose to put more money in or less money in. It's up to you. You can pay a higher rate if you put less money in, you can pay a lower rate if you don't.

FR:    And how does Groundfloor make money?

BD:    We earn an origination fee on every loan we make, which the borrower pays. That’s basically it. But I’ll tell you, there are a couple platforms out there who buy loans from other originators and then turn around and sell them to individual investors. There's a reason that the average yield on those loans is 7% or 8%.

FR:    Because the platform is locking in a spread?

BD:    A huge one. Platforms like this go to local players who originate credit at 12%, 13%, 14% or 15% and then they turn around and give 80% of it to the retail investor. They are masquerading as though they're radical democratizers of an industry, but they're not. With us, we will never take a spread on the investments that we offer. The rate our investors earn is the rate that the borrower pays.

FR:    Given the localized nature of your market, I’m interested in your best method for attracting new borrowers.

BD:    It’s real simple. We rely on human beings.

FR:    Oh come on, Brian. Humans are so expensive.

BD:    They are, but they're worth it. It turns out that humans, for all this tech, make a big difference in our market. They can make a connection with another person that tech can’t begin to approach. Plus, character is an incredibly important aspect of lending. Fortunately, our model scales enough to enable us to invest in people. I’m not saying, of course, that we don’t want our folks to become more efficient and effective thanks to technology. We do, but the human factor, which includes our new broker referral program, is central to acquiring new customers.

FR:    Given your glimpse into the economy, where are you most bullish in terms of housing?

BD:    We like the Southeast generally, and that’s not just because we’re headquartered in Atlanta. We think the demographics tell us that the Southeast has a long way to grow. Given that, we’re planning to go more deeply into some of these markets and are looking for partners at every level.

Roadmap

FR:    So now that you have completed a capital raise from your investors, what’s next?

BD:    There's a real appetite for non-bank lending in new construction, and some of our customers are leading us there.

FR:    What about products that are aren’t as short-term in nature?

BD:    Yes, instead of selling the property at the end of project, some of our borrowers are saying that they want to create an income-producing property. As such, a bridge financing product for rental property is definitely under consideration. We're also looking at small-scale commercial as a category.

FR:    Why move into commercial, given your expertise in residential?

BD:    Like I said at the beginning, I was deeply influenced by Christensen. A disruptive technology always starts off in one little corner of the market. It looks small and unimportant, and then it progressively moves into other areas. That's what we’re starting to see in multi-family deals, so we're dipping our toes into that space.

FR:    Well, as you dip, Brian, I wish you and Groundfloor good luck.

BD:    Hey, thanks, Gregg. Yes, real estate finance has a lot of permutations and a lot of niches that could make sense for us. We’re having a lot of fun both executing today and planning for what’s next.