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.

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