Monthly Archives: January 2014

Real estate crowdfund differentiators: benefits/risks to investors

“No one comes here anymore; it’s too crowded.” – Yogi Berra

RE Crowdfunding is becoming more accepted

After 6 months of researching crowdfunding sites of many kinds, I’m coming to the conclusion that real estate crowdfunding is very likely to deepen its roots and spread its branches. The main benefit of providing a broader set of investors access to this asset category, with relatively low minimum investments ranging from $100 to $10,000, is compelling.  The precautions taken by the RE crowdfund web sites suggests to me that – while there could well be hitches along the way, as with any new and sophisticated service, especially if the economy turns downward – the steps the sites are taking to protect investors and developers are sufficient for the regulators to keep this market as a viable investment path. You’d expect though, that of the dozen RE crowdfund (I’ll abbreviate them as “CFs” in this post) sites available now, a few will emerge as market leaders.

Differences among crowdfund sites – and impact to the investors

Some differences among the sites are fairly obvious, such as the states they do business in, the property types emphasized, whether they offer equity and/or debt deals, and how the user interface displays property details for evaluation. Other differences are less obvious, however, it’s these that are likely to make a difference in managing your risks.  Some questions to investigate with each site include:

  1. Does the crowdfund company participate in the deal? Crowdfund sites may be thought of as ‘neutral’ platforms, however their role can vary from “broker” that receives a fee to promote the deal, to “general partner”/investor. The CFs with greater involvement claim this to be an advantage for investors, ensuring more “skin in the game” from an organization they have contact with, should something go wrong.
  2. How are forecasted returns calculated? Inspect carefully whether the loan-to-value on the debt portion of any small property financing is based on current property value, or after repair value (ARV). This might be in the fine print.
  3. If offering debt deals (investor makes loans), how are guarantees structured? The majority of debt-issuing crowdfund companies hold the guarantees – first lien on property, any personal guarantees – themselves. So, should the website/crowdfunder become unavailable, it will be difficult to take action to ensure repayment is made.
  4. How is due diligence performed? Most CFs assess the strength of each individual property and deal (though always reminding participants that due diligence is ultimately up to the investor). At least one site says they concentrate on due dilligence at the developer level, upfront, then rely on that developer to propose robust deals with appropriate prudence.
  5. What fees are charged, and to whom? Most CFs charge fees to the developers as opposed to explicitly to the investors. Look closely at any deal’s operating agreement to understand how the developer and/or general partner is compensated. Some receive a promote fee before equity returns are split up. Others contain a transaction fee that takes effect when the first repayment to investors is made. Much of the time the fees are one time, but on a multi-year, complex commercial deal, you’ll also see management fees.
  6. Are the terms the same for the crowdfund investors as they are for any private/direct investors? I am hearing several sites say “yes, they are the same, for now…” (in the operating agreement), but it’s preferable to understand what advantages any private investors may be given.
  7. How are accredited investors checked? Some sites rely on checkboxes for the investor to assert their situation. Increasingly, they are seeking documentation to be sent to prove income and/or assets. At least one site asked for such proof to be renewed every 3 months should you want to invest on one of their deals.  While this may be legally prudent, I find it cumbersome especially if it involves an affidavit from one’s lawyers about assets. On the other hand, developers are duly concerned about what happens if their deal investors weren’t all accredited.
  8. How much real estate experience does the team have and with what types of properties? Further, how sophisticated is their board and support team, including their legal counsel?  Should you speak to executives at these firms, you may pick up nuances about how well versed each is in terms of what can happen to a syndicated real estate deal, and how the contracts are structured vs. traditional “off-line” deals.

Your returns may vary…

Finally, shop regularly across sites to check returns. Crowdfunders are evolving in terms of what is considered “fair” and “attractive” returns to investors vs. rates to the RE developers. For example, on simple house flips, I’ve seen target returns ranging from 8% annual interest for 3-9 months, to 13% returns with premature repayment penalties, to 10% preferred equity plus a 50/50 split of further profits.

What is crowdfunding for real estate?

““I am a firm believer in the people. If given the truth, they can be depended upon to meet any [situation]. The great point is to bring them the real facts, and beer.” – Abraham Lincoln

Crowdfunding – the involvement of a broad audience in financially supporting a project – has caught on wildly in markets ranging from consumer loans, to global micro-finance, startup support and the arts. It’s now the focus of nearly a dozen crowdfund websites for real estate investing, with the primary benefit being a low dollar minimum, typically $1,000 to $10,000 to hold your very own slice of an income- and equity-generating property.

Exactly how does real estate crowdfunding work, and what are the benefits and risks? This post will give you an introduction, with future posts diving into the details including my crowdfunded deal experiences, and interviews with crowdfund CEOs, developers and legal/financial experts.

Crowdfunding Examples

Crowdfunding has become an increasingly acceptance mode of business in a variety of markets. For consumer lending, Prosper and LendingClub allow individuals to back loans for home purchase, debt consolidation, education, etc, at interest rates of 5-15% (this is after accounting for write-downs). Google is a backer of LendingClub while the huge hedge fund Blackrock invests in Prosper. This sector was on pace to fund $2bn to $3bn in loans in 2013. Elsewhere,

  • Circle Up and and Grow VC provide access to early-stage venture capital deals;
  • Mosaic funds large-scale solar panel installations in return for an interest rate backed by those projects’ profits.
  • Kickstarter and Indiegogo crowdfund projects ranging from new technology and business ideas, to charities and musical/artistic creations. Kickstarter has raised nearly $400m so far.

RE Crowdfund Sites

In real estate, crowdfunding websites I’ve researched include: FundRise, Patch of Land, PRIMARQ, RealCrowd, RealtyShares, and Realty Mogul, and I’ve invested through several of these so far. There are another half-dozen companies in beta or beyond.

This hyper-growth was kicked-off by the Jumpstart Our Business Startups (JOBS) Act, which in 2013 first allowed companies to promote their private securities offerings to accredited investors. Accredited investors have minimum income requirements in the six figures or minimum liquid assets of a million of more.  Next, rules have been proposed for unaccredited investors to participate in crowdfunding, though with limits on invested amounts. While there’s debate over whether the law properly balances ease of access to opportunities for investors and offerers, against investor protections, so far over $2bn has been raised through this process. Read more at VentureBeat.

What are the benefits for real estate investors? To begin with,

  • Far more individuals are likely to gain access to a range of RE deal opportunities, without having to know the ‘right people’.
  • Returns are attractive on paper, ranging from 8-13% on a home refurbishment loan, to 12-20% internal rate of return on a commercial/rental property. This certainly beats average bond/stock returns, and compared to non-real estate crowdfund, investments are both better rewarded on average and better secured, via the property and developer guarantees.
  • Minimum investments for accredited individuals are relatively low, range from $1000 to $10K on many sites.
  • The crowdfund sites provide much of the due diligence, easing somewhat the need for the investor to be fully versed in real estate.
  • In sum, more individuals can incorporate real estate into their financial portfolio, without having to resort to the volatility and lack of transparency in REITs.

Risks are ever-present and need to be carefully evaluated by anyone getting involved. At a high level, these include:

  • The traditional risks with real estate remain: that these are ‘living’ properties, whose profits are affected by their developers, tenants, trends in the economy, issues in the neighborhood, etc.  Your principal investment is by no means guaranteed and, in the end, you can only look to yourself and your lawyer for responsibility to be comfortable with the due diligence.
  • Your capital is locked up in a deal from 6 months to 6 years or more. You choose the types of deals to be involved with, and all else being equal, longer lockups usually target higher return rate.
  • With some crowdfund sites and deals, the site operator has a stake in the deal or facilitates distribution of interest payments. If the site were to go out of business – far from rare in the web startup world – you need to ask what happens to your investment. (In many deals, though, you strike an arrangement directly with the RE developer and have no obligations from the website itself)..
  • There are multiple parties involved in a deal, much like a traditional RE syndication.  While the developer usually is the sole operating member of the deal’s corporate structure, in a worst case all the parties may tangle in voting or legal proceedings.

With all these considerations and more, real estate crowdfunding can be attractive in a number of situations: allocating a modest portion of savings to real estate; gaining access to a diversified set of properties, geographically and by property type; and learning more about real estate investing while preparing to serve as prime lender on your own deals.

There will be much more to follow as we look at individual crowdfund sites and the risk-reward considerations. Meanwhile, I recommend the real estate community discussions at Bigger Pockets to get a flavor of investors’ thinking.

Welcome to the Heartland real estate investing blog

“Be humble, for you are made of earth. Be noble, for you are made of stars.” – A proverb

Welcome, visitors.  This is the kick-off of a blog dedicated to small-scale real estate investors, getting involved with one or a few homes, rentals or small commercial properties. I will share my findings from live deals, interviews with experts, and number-crunching research, and I look forward to your opinions and questions.

In addition to the terms and outcomes of various investment opportunities, there are several subjects that will have special coverage. First and foremost is “crowdfunding“: where a broad community of investors put in relatively small $ amount each and gain access to a wide range deals in which to partipcate. As of this writing, the start of 2014, there are nearly a dozen web sites taking off in this market, and it has the potential to democratize RE investing just as crowd-funding has made consumer loans, startups and the arts more accessible to invest in.

Another special topic I’ll cover is the most effective use of online data sources to identify property buyers and investors and evaluate risks. Additional topics include: the potential for hedging one’s real estate investments, for example to offset some of the potential declines in the property markets by holding other types of financial assets; as well as devices/technologies that will make properties more ‘green’ or ‘smarter.’

As the quote at the top of this post suggests, there are few financial/business pursuits like real estate, which combine the grounding of earth & construction; the complexities of legal terms and financial analysis; and the aspirations of improving the community as well as one’s own prosperity.  I look forward to sharing experiences.

– Scott