Updated May 23, 2021. Prosper and P2P is going through a difficult time now due to interest rate compression. Proper screwed investors by overstating returns for several quarters in the past. But they are trying to do better now going forward. That said, P2P lending is still my worst-ranked passive income source.
If you are focused on building passive income for financial freedom, I'd much rather focus on buying dividend value stocks and real estate crowdfunding instead.
How Prosper Screwed Investors
Prosper Marketplace Inc., one of the largest U.S. online-lending platforms, notified the majority of the investors that buy its loans that it had overstated their annual returns due to a system error, a spokeswoman said.
The error has been fixed, according to spokeswoman Sarah Cain. Some of the investors that were affected saw their annual returns fall in half, but in most cases returns fell less than 2 percentage points, Cain said. The issue has been going for “several quarters,” she said.
As a four year investor in Prosper's P2P loans, this is absolutely UNACCEPTABLE in my opinion. With the 10-year yield at under 2 percent, a 2 percentage point overstatement is huge. Several quarters means at least three quarters of overstatement, but probably over a year. During this time, Prosper was able to attract new investor money under false pretense. Prosper screwed investors bad.
The most important aspect in all investments is trust. If we cannot trust Prosper to properly state the returns, how can we trust Prosper with our money? I've been gradually pulling my money out of Prosper for the past couple of years, and now plan to pull 100% of my money out due to this latest snafu.
According to the Prosper spokeswoman, the glitch didn’t affect the cash that investors received, tax documents, expected future returns, or any other information the startup provided to loan buyers. In a small number of cases, returns were understated, Cain said.
Trust Is Gone In The P2P Industry
With a rising interest rate environment, borrowers are getting squeezed with higher rates. You'd think that Prosper would be able to charge more, earn a higher spread, and allow investors to earn more as well. But with the return errors, the investor is not seeing any benefits of a rising interest rate environment. Instead, it looks like there are increased defaults / charge offs from borrowers that are hurting returns.
Online consumer loans’ total returns were 3.95 percent in 2016, compared with 6.93 percent the year before, according to Orchard Platform, a technology and data provider to the industry. Prospered screwed up.
My biggest fear with P2P investing is that borrowers get squeezed so much that there's a cascade of defaults. It looks like this cascade has begun. When borrowers default, investors get nothing. There are no workout agreements. Prosper screwed up.
Owning a real asset is the main reason why I much prefer real estate crowdfunding through platforms like Fundrise than P2P lending. If the economy goes into difficult times, at least there's a real asset that can be worked out in the form of lowering rents, delaying debt repayments, etc. Whereas with P2P lending, once the borrower defaults, your money simply disappears.
What The Hell Happened
I distinctly remember meeting with Ron Suber, Prosper's CEO at the Four Seasons in late 2015. He was about 30 minutes late to our meeting because he had double booked. When he finally had time for me, Ron was enthusiastic about the business because he had raised a lot of money, valuing Prosper at close to $1.8B. He even inquired whether I wanted a business development job. I politely declined.
Then the world fell apart for them. The entire industry within the next 12 months as private company valuations got slashed. Lending Club went through a scandal where their ousted CEO was found overstating the books in early years. Prosper saw large institutional investor outflow.
Prosper slashed its workforce by about 25% in 2016 as funding for loans grew pricier. The company posted $118.7 million of losses for 2016, according to a filing. Unfortunately for Prosper employees, I don't think they're ever going to IPO or see a lucrative acquisition. Senior management were probably able to cash out some of their holdings of course, as that's the way things go in the startup industry.
At the end of the day, a financial institution can only operate well if there is trust. When Prosper screwed investors, their trust was lost. It may take too long for Prosper to regain their trust for Prosper to ever be profitable and survive on its own.
Look Elsewhere For Investment Income
Prosper screwed investors and it's hard to trust them going forward. Therefore, ikf you're looking at alternative ways to make money, I'd spend some time focusing on real estate syndication deals instead. The returns are greater (8% – 15% historically) and you're investing in a real asset.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. Fundrise is free to look. I've personally invested $810,000 in real estate crowdfunding since 2016.
Prosper Screwed Investors is a FS original post.