Looking to expand your investment portfolio beyond stocks and bonds? Founded in 2015, YieldStreet gives accredited investors access to alternative assets which were traditionally only available to large institutions.
YieldStreet’s differentiator is the breadth of their investment opportunities. While there is a slew of crowdfunding fintechs, few have gone into niche areas like marine financing and litigation financing.
How Does it Work?
YieldStreet focuses on offering income producing, fixed-income assets that tend to be uncorrelated to the market. If you’re looking for capital growth, look elsewhere.
With the exception of marine financing, YieldStreet doesn’t originate loans themselves. Instead, they work with a network of originators who allow YieldStreet to co-invest with them.
The upside is YS gets access to deal flow from originators who often have decades of experience in niche, high barrier to entry markets like litigation financing.
Who Should Invest?
- Seeking passive income
- Seeking debt backed by tangible assets* (not all asset classes are secured with collateral)
- Looking to diversify from stocks or bonds
- Want to avoid volatility
Who Should Not Invest
- Looking for capital appreciation
- Need liquidity in less than 3 years
- Seeking tax-efficient investments (unless you invest through a self-directed IRA)
The Four Asset Classes
There are currently four types of investments: real estate, litigation funding, marine finance, and commercial loans.
Each asset class comes with a unique cash flow structure, risk profile, and downside protection. It’s important to understand their characteristics to pick one that fits your investment needs.
The real estate loans on YS are similar to ones found on PeerStreet, Fund That Flip and Groundfloor. Investors can fund hard money loans which are backed by the underlying property. In return for lending your money, you collect month interest payments until the loan is due, at which point you get your principal back.
Pros of Real Estate
YS loans are higher quality than many of their competitors (we are looking at you Groundfloor). They feature low LTVs around 60%, high positions in the debt stack and sponsors with long track records.
Originators have skin in the game
We like that on YieldStreet, originators hold on to a significant percentage of their loans.
For example, Avatar Financial Group retained 18% of their debt financing for three luxury condos in Connecticut. Ascend Real Estate Partners held onto 73% of the loan they originated for a Manhattan property.
It's a red flag if the originator sells off an entire loan to investors (which we do see on other platforms).
Cons of Real Estate
There are many investment opportunities, and the few they list sell out quickly.
Most Properties in Judicial-Only States
Many of the listed deals fund properties in New York, which is a judicial foreclosure state. These states force lenders to obtain a judgment to sell the property which can be a lengthy process. Meanwhile, you are on the hook for all operational and legal fees associated with the foreclosure.
How to Vet Real Estate Investments
As a general rule of thumb, choose investments with an LTV of 65% or lower.
Skin in the Game from the Originator
Look for deals where the originator keeps at least 15% of the loan.
High Position in Debt Stack
Look for senior secured positions in the debt stack.
Beyond securing loans with underlying property, borrowers will sometimes use their personal assets as collateral. Personal guarantees widen your investment’s safety net.
Located in Non-Judicial States
Properties located in non-judicial states aren’t subject to as lengthy a foreclosure process
Sponsor Track record
One of the best predictors of a loan’s performance is the quality of the sponsor. Look for experienced sponsors who have ideally been through at least one market cycle (ie they’ve been around since before 2008).
Fund that Flip
Patch of Land
Unlike other investments, litigation funding is not a traditional loan. You front money for someone’s legal costs with the understanding that you will only get repaid if the plaintiff wins his case.
Since the likelihood of default on an individual lawsuit is high, YS packages tens or even hundreds of cases into a portfolio to smooth out the risk.
Types of Litigation Financing
Pre-settlement funding provides cash advances to individuals or companies ahead of a verdict. In exchange, YS gets to share in the upside if the plaintiff wins.
An example of pre-settlement funding is the unfortunate case of a New York woman who was hit by a shopping cart that some kids had recklessly pushed off a building.
The victim was no longer able to work due to her injuries. YS provided her family with emergency funds until she received her settlement.
Loans to Law Firms
Law firms will often take cases on contingency, meaning they work for free until the case is settled. This causes the law firm to accrue expenses while holding the cost until the case is settled. YS provides loans to fund their operations.
Pre-Pay Settled Cases
Sometimes settled cases take a long time to actually pay out, so YS will lend money to the plaintiffs until they receive cash from their case.
These are the best cases to invest in because they’ve already won their judgment.
Don’t expect a consistent monthly payout. You get paid your principal and interest as individual cases in the portfolio settle, so expect lumpy and irregular payments. Yieldstreet says that investors should expect to recoup their full investment with accrued interest in approximately 48 months.
Pros of Litigation Finance
Truly uncorrelated to the market
Invest in a portfolio of settlements rather than specific cases
Cons of Litigation Finance
IRR seems low given the risk profile and when benchmarked against competitors
Some regulatory risk of loan rates being capped
Very illiquid (YS estimates 3 to 4 years before the principal is recouped)
Loss of capital if plaintiff loses the case
YieldStreet’s litigation investments return around 14-20% annually. Though a double-digit return sounds high, we actually find it low when benchmarked against returns from YieldStreet’s peers.
For example, LexShares, also a crowdfunded litigation funding platform, has a median IRR (net of fees and expenses) of 66%.
Burford Capital, a litigation funding firm that is only available to institutional investors, reports an average IRR of 31%.
LawCash, the main originator behind most litigating funding opportunities on YS, has charged its clients interest rates as high as 124%, according to court documents.
At those rates, even if half the cases were dismissed, the average return should be closer to 50%. So either LawCash is pocketing most of the returns, or the majority of cases are being tossed.
We reached out to YieldStreet for insight and will update here with their response.
Regulatory Risks of Litigation Finance
Oh the irony: the field of litigation finance faces legal challenges. A handful of states are starting to regulate the industry. They argue that litigation funders should be subject to usury laws which cap the interest rates that can be charged.
LawCash says they don’t require the borrower to pay them back if they fail to get a settlement, thus their investment shouldn’t be treated as a loan.
But in 2015, the Colorado State Supreme Court unanimously decided that lawsuit funding is subject to the state's existing consumer lending law, which means funders have to observe the interest rate ceiling. Five other states passed legislation to place constraints on lawsuit funders.
In addition, federal prosecutors are looking into the industry, according to the New York Times. Specifically, they are investigating whether litigation financing companies are giving kickbacks to lawyers who recommend their clients.
What Does This Mean for Investors?
The vast majority of states don’t cap litigation finance rates. There are also no federal laws about litigation financing. But as an investor, you should be aware that there is regulatory risk in this investment class.
YieldStreet acknowledges that "usury laws may affect the credit investments."
They warn that if a borrower wins a claim against the lender for violating a state’s usury law, not only would the investors not receive the anticipated full value of its “loan”, but could further have to pay fines and other penalties.
Litigation Finance Competitors
While we rarely hear about it, seaborne trade is a twelve trillion dollar industry that underpins the global economy. Ninety percent of everything we touch comes on a ship.
Yieldstreet launched this asset class in 2018, after 14 months of due diligence.
Marine financing is headed by internally George Cambanis. He founded the global shipping practice at Deloitte Greece, where he was a founding partner and former CEO.
These loans fund the acquisition or construction of massive commercial vessels that carry anything from produce to sneakers to oil.
Pros of Marine Finance
Experienced management team
Investment is secured by scrap value of vessels
In-house loan origination
Cons of Marine Finance
Highly correlated to the market
The biggest risk is how heavily correlated with global macro conditions marine financing is. For example, if there’s a slowdown in demand for bananas and oranges, then there will be less need for reefer vessels, which are refrigerated cargo ships made for transporting perishables.
Difficult to evaluate the loans’ merits due to the highly specialized nature of the asset
What is the Draw of Marine Finance?
Milind Mehere, YieldStreet’s CEO, explains why he thinks this asset class is good for investors.
Investors benefit from capital inefficiencies in marine financing
After 2008, banks who traditionally provided financing for vessels, moved out of the market. Smaller players like specialty finance companies, hedge funds, and PE firms took over the space.
Without deep-pocketed competition, there is more room for lenders to command higher interest.
It offers collateral, downside protection
If the borrower defaults, the vessels can be deconstructed to its raw materials (mostly steel), which can be sold to recoup principal.
How to Vet Marine Finance Investments
Time charter financing
Vessels can be chartered for specific voyages (spot charters), or they can be under contract for 1-5 years (time charters). Because they are long-term contracts, time charters are less exposed to short-term supply/demand fluctuations.
Sufficient Cash Reserves
Make sure the investment has sufficient cash reserves to “smooth” out any temporary cash flow problems, which happens if the vessel isn’t being chartered enough.
Residual Value Insurance (RSI)
Sometimes YieldStreet is able to secure an investment grade insurance policy on the principal invested.
Commercial financing includes working capital loans, cash flow loans, merchant cash advances etc, to private businesses.
Past YieldStreet offerings include a loan for ridesharing fleet expansion (which is currently in default) and a portfolio of loans to small businesses.
Pros of Commercial Financing
Low correlation to equity markets (though the loans are vulnerable to recessions)
Short duration (typically 3-12 months)
Loan portfolios are diversified across merchants and industries
For example, a short term financing portfolio bundles advances from over 1,000 different merchants across 10 industries. The largest advance represents only 1.2% of the total portfolio.
Underserved, fragmented market provides an opportunity for high returns
Many companies can’t get loans from banks because they don’t have a long credit history or they don’t have enough assets to use as collateral.
Cons of Commercial Financing
High Default Rate
There’s not much data on the loss rates of working capital loans, but YieldStreet’s data suggests it is a high risk, high reward industry.
Quicksilver Capital, an originator on the YS platform, reports a 22% default rate with 7% actual loss.
Complex workouts and restructuring in bankruptcy
Commercial and industrial loans often go through a complex bankruptcy process.
Borrowers often invoke many claims against the lender including lender liability claims and defenses, in an effort to delay or prevent foreclosure.
Collateral is not guaranteed
Advances are often repaid from expected future earnings or accounts receivable which may not materialize
Borrowers are businesses that are deemed not credit-worthy by banks
Types of Commercial Loans
Merchant Cash Advance
Merchant Cash Advances aren’t technically loans. Small businesses get a cash advance which they pay back by forking over a percentage of their daily sales.
MCAs give small businesses quick access to funds via a simple approval process since they don’t need collateral, just proof of sales. MCAs tend to be short-term (typically 3-12 months) because borrowers typically use them for an immediate and temporary business need.
These loans have high default rates. According to the Coleman Report, a research firm focused on SBA lending, MCAs have estimated default rates from 5% to 15%. In contrast, the default rate of SBA-backed loans is estimated at 2%.
Imagine you run a small accounting firm. You have a $15,000 outstanding invoice for your biggest client, but that client has 30 days to pay her fee. Meanwhile, you need to pay your employees now.
You could take out an invoice factoring advance. Basically YieldStreet will give you cash now. In exchange, YS will collect the $15,000 invoice when it is due, plus an additional fee. If your customer decides not to pay and the bill goes to collections, it is YieldStreet's loss.
Purchase Order Financing
Purchase order financing provides businesses capital so they buy from their suppliers to fulfill orders from customers. For example, take a merchant who sells custom wedding gowns. If she uses purchase order financing, the lender pays her fabric supplier directly. Upon delivering the dress it to her client, she’ll pay back the lender with the proceeds.
Commercial Loan Competitors
YieldStreet’s fees are in line with the fees charged by other crowdfunding sites.
Sometimes YieldStreet charges the originator a flat listing fee (there isn’t a listing fee for the snapshot above).
It’s the "YieldStreet Fee" above: it typically varies from 1% to 4%.
Annual Flat Expenses
There’s an annual flat fee to fund setting up the SPV or BPDN structure for the investment. It's typically approximately $100.
Conflicts of Interest
An article in Bloomberg points out that many deals on YieldStreet come from originators that were funded by YieldStreet’s co-founders.
Of the 110 offerings on its website, 61 were sourced by firms operated by the founders. Dennis Shields, one of YieldStreet’s three founders, founded litigation firm LawCash in 2000. LawCash originated 44 deals on the platform.
Shields along with Weisz, also a founder at YieldStreet, also founded Soli Capital, a specialty finance firm, in 2002. That’s the originator behind the livery cars loan and various other commercial financing deals like this receivables funding opportunity.
It is standard practice for originators to take a cut of the profit. After all, they do the work of sourcing and underwriting deals.
Typically, funds are incentivized to push for lower originators’ fees, since that means more profit for the fund itself. However, since two out of three of YieldStreet’s co-founders are also the originators behind many investments, there’s a risk that they’ll reward their own origination firms with a larger share of the profits.
YieldStreet counters that they don’t allow founders who double as originators to influence whether their deals are accepted onto the platform.
We still think YieldStreet should provide more clarity on the originators’ fee for each investment. As investors, you don’t want to be in a situation where you are assuming most of the risk, but not reaping a meaningful percentage of the reward.
Building a Greater Pipeline of Originators
To be clear, we don’t think there YieldStreet is some nefarious plot to funnel money back to originators. A more realistic way of looking at the situation is that the founders are leveraging their deep background in niche financing by opening their deal flow to investors.
In 2018, YieldStreet raised a $100M credit facility that will allow them to fund over $1 billion in originations. We think this should drastically expand their pipeline of originators.
Meanwhile, if this potential conflict of interest bothers you, you should avoid deals originated by either LawCash or Soli Capital. You can find originator for any given deal by scrolling to the bottom of the detailed investment page.
The Legal Details
What Happens If a Loan Defaults?
Most investments are backed by real estate, marine vessels, etc. In the event that a default does occur, these assets are sold to recover investors’ principals.
Because they aren’t the originators of the loan, Yieldstreet doesn’t directly take legal action against the borrower. Instead, they work with the originator who is responsible for handling foreclosure or liquidation processes.
Secured Doesn’t Mean Riskless
Don’t get lulled into a sense of false comfort just because your investment is secured by real assets. You can still lose money.
The proceeds from the selling the assets may not cover the entire principal.
Even if the collateral covers the full principal, substantial delays can eat into what investors recoup.
For example, if the borrower files for bankruptcy, it can take years before you get your collateral. Meanwhile, investors are on the hook for any costs and fees associated with the liquidation, which can include legal and collections fees.
Not all loans on YieldStreet are in the first lien position. If your debt is junior to other secured debt, you are a lower priority on the totem pole.
What Happens if YieldStreet Goes Bankrupt?
For each investment it offers, YieldStreet creates either a special purpose vehicle (SPV) or a Borrower Payment Dependent Notes (BPDN) to hold the investment. These are bankruptcy remote entities so that if YieldStreet ever goes out of business, your investment won’t get sucked into time-consuming bankruptcy proceedings.
In either a BPDN or SPV, if anything were to happen to YieldStreet, a new manager, such as the originator or a bank, would be appointed for the SPV and take over management responsibilities.
Investors have participated in 110 deals, valued at $560 million, since YieldStreet launched in May 2015. Keeping its standards high, YieldStreet has declined $1.5 billion worth of loans.
The site counts 100,000 active investors. The average investor has money in four deals at any given time. YieldStreet has had an average IRR of 12.63%.
As of January 2019, they haven’t lost any principal. They have three deals in default, putting YS at industry leading 3% default rate. Two defaults were early real estate loans. YS was able to recoup all principal and most outstanding interest for those.
The third default is the ride sharing service loan. The originator is currently in the process of selling off vehicles (which were collateral), and YieldStreet says they "remain positive on the outcome."
On most crowdfunding platforms, your cash sits idle before you start putting it towards investments. YieldStreet solves this problem by letting investors park their cash in their “Wallet”, a high yield savings account that pays a 2.0% interest rate.
Funds are held in Evolve Bank & Trust, an FDIC insured bank.
Notably, the YieldStreet Wallet is open to non-accredited investors, perhaps in anticipation of offering investments to those of us who aren’t in the six-figure club.
On the whole, investors seem happy with YS, with most saying they would continue to invest with them.
The two most common complaints are:
Their investments fill up quickly
Payments and communication can be erratic
Have you had a positive or negative experience with YieldStreet, share it with the community and win the chance to get $500.
All investment proceeds are treated as interest income. This means they are taxed at ordinary income rates.
If your investment is housed in a SPV, you’ll get a K-1 form that will state interest income. If your investment is housed in a BPDN, you’ll get a Form 1099. Investing via a self-directed IRA will shield your proceeds from taxes, but YieldStreet only works with certain custodians.
Non-Accredited Investors Next?
Currently, you have to be an accredited investor to participate, but the CEO says they plan to launch to non-accredited investors in 2019.
Coincidentally, we noticed that YieldStreet filed papers with the SEC to create a multi-asset fund in December 2018. The fund will be structured as a regulated investment company, or "RIC," which can be open to non-accredited investors.
We are impressed with YieldStreet’s dedication to quality over quantity as evidenced by their 0% principal loss to date and 3% default rate as of January 2019. For comparison, two other “best in class” crowdfunding platforms PeerStreet and Fund That Flip have 3% and 2% default rates respectively (as of January 2019).
We are especially impressed that they’ve grown in-house expertise in difficult to access markets like marine finance.
We do have concerns that:
Their litigation financing returns seem low for the asset class when benchmarked against competitors
The originators behind many of YieldStreet’s investments are owned by YieldStreet’s co-founders, which presents a conflict of interest.
We anticipate that this conflict of interest won't be as big an issue when YieldStreet expands its network of originators.
The $100M credit facility they raised in 2018 should help them do this [internal link]. By growing their investor base, having ready capital to co-invest, and rewarding the best players, YieldStreet positions itself to attract more and better originators.
Hopefully, this results in more competitive and sought after deals passed onto investors.