William Skelley, founder of iFunding, has given considerable thought to crowdfunding real estate, and how this market will grow relative to other innovations. It’s a pleasure to share his thoughts on these investment opportunities and how best to structure a crowdfund business that’s attractive to real estate investors and developers.
Prior to founding iFunding, William was a principal at Rose Park Advisors, a hedge fund founded by Harvard Business School professor Dr. Clayton Christensen. He has also worked at General Electric, Olympus, Bain Capital and as an advisor to several start-ups. He co-leads iFunding with Sohin Shah. Former New York Governor David Patterson serves as Director of Community. Their web site is www.ifunding.co . In this interview:
- About iFunding
- For Investors: Returns, gaining experience, diversifying investments
- Working with Developers: joint venture partnerships, investor accreditation efforts
- Regulatory – how crowdfund sites different in legal structure
- RE crowdfunding in 2014 and beyond
- What was your prior background in real estate and how did that inform your decision on how to go about setting up iFunding?
While the JOBS act is an accelerant to real estate crowdfunding, it had little do with starting iFunding. Prior to downturn in real estate several years ago, I owned a boutique investment bank. When Lehman and others went under, real estate came to a halt. I was thinking of my next steps and came upon a program at Harvard Business School. There, I met Clayton Christensen, who is known for his work on disruptive innovation, and was leading a prominent hedge fund that focused on investing in innovative companies on a global basis. I joined the group, and one investment we made was in CircleUp. It’s now the largest crowdfunding angel investing platform in the US, with a recent $7m cash investment from Google and Union Square Ventures. From these experiences, I realized the same potential for innovation is applicable to real estate.
- Describe iFunding’s differentiating characteristics, in a nutshell.
We focus on institutional quality deals with commensurate returns, scalable investment amounts and asset types, and we operate on a global basis.
- The returns targeted by many of your investments, at least for home refurbishments, are well beyond that aimed for by other sites. On house refurbs, iFunding has offered a preferred return plus an equity upside component that – should the project go well – offer significant double digit yields. This compares to private money loan investments on other sites, in the high single digits to very low double digits. How do you accomplish these returns?
It’s simply unfair to the investors to offer them something akin to private money lending terms for home refurbishment lending. It’s not truly innovative. We feel that our investors deserve returns like they could receive from a Starwood, for example, if they had access, but with lower minimums.
For the real estate operators, we make the returns competitive in part by allowing a higher loan-to-value than some other sites will, based on greater due diligence.
- Do you do debt deals as well as equity deals?
We offer our investors preferred equity deals. We have a partnership with a large family office that provides all the lending we need for our projects.
- Crowdfunding is billed as a way to democratize the investing process, allowing many more investors to get into quality deals. Are you seeing this expansion of involvement?
We’re seeing a range of investor backgrounds. The most active tend to be seasoned real estate investors. We have one investor who has participated in almost every deal; she used to be an institutional investor.
Others have never invested in real estate before, and we’re seeing them increasingly at educational events. We have a rule now that one person cannot invest more than 50% of the deal, in order to provide more access to smaller investors.
- Do you think the newer investors have the experience to understand what they’re getting into from a risk/reward perspective?
We provide as much information as we can about each opportunity on our website. A lot of what we do is educational. We provide a top 10 FAQ for each deal to get investors thinking. In a continuous effort to educate the community on our company and industry, I’m speaking soon at the New York Law School, and in April as part of a Harvard Business School club panel in Manhattan. There is also a very popular crowdfund expo in San Francisco that will cover real estate this year, where we will have a presence.
- How should investors think about getting into real estate deals outside their geographic region? Regional diversification is a way to reduce risk, but how well can investors do their own due diligence if they’re not familiar with the location?
You want to perform a lot of due diligence on the operating partner and ensure that they are completely familiar with the region and asset type.
In addition, we can use technology to improve investors’ ability to make decisions. We ensure that there are high quality photos from around the property, similar to what AirBnB might provide in the domain of vacation rentals. And, we encourage our operating partners to capture video of the property and post it on our site.
- As investors become familiar with real estate via crowdfunding, some also are revisiting REITs and REIT funds. How do they compare with crowdfunding of specific properties?
Every investor will have different interests and there’s room for both in a portfolio. A major downside of REITs is that you’re susceptible to the vicissitudes of the stock market. REIT values can overreact to news over something as loosely-related as emerging markets. Compare that to a retail property investment, like a storefront leased by McDonald’s for 30 years with corporate guarantee, where the income stream and investment value is very reliable.
REITS are, however, very liquid to purchase and sell shares. To make crowdfunding more liquid, we have future plans to establish a secondary trading platform for our investors’ holdings.
- What are other unique aspects of your mode – you mentioned ‘global‘ at the outsetl?
We recently opened an office in Singapore. That office is expanding our presence into 11 countries. This will enable Asian investors to more easily participate in US properties, as well as give US investors access abroad.We also believe in community outreach and development.
A sector that is very close to my heart is affordable housing. iFunding is working on this now with our Director of Community, the former Governor of New York, David Paterson. Many years ago, my grandmother worked in affordable housing in Cambridge, MA, which helped foster my deep interest in this cause.
Working with Developers
- How receptive are real estate operators to working in your model?
They are very receptive and find us easy to work with. We receive 10 to 15 operating partner solicitations per day. For every fifteen, we will perform in-depth research on 1. In the end, we go forward with 1% to 2% of the deals brought to us.
- iFunding serves as a general partner on the deals you facilitate. What are the advantages of being GP?
We serve as a joint venture partner on every single project and have oversight of the funds. If we raise $200K for a single family home, for example, we don’t just send it to a sponsor. We agree to a budget with the developer and capital is distributed based on hitting milestones. We feel this control is very important. In real estate, should a deal ever go bad, it’s extremely difficult to recoup the money through legal action. So we take extra measures to ensure it doesn’t get to that stage.
- What would you say to critiques that iFunding may be adding a layer of management to projects that it doesn’t have a lot of expertise in?
Just because one is not an expert in industrial parks in North Dakota, doesn’t mean that you can give up responsibility to do everything feasible to due diligence investments and protect them. Beyond review of operating partner’s experience and proposal, our research team ensures the reasonableness of the budget and timeframe. We want to make sure our partners are hitting their goals every month. I think some crowdfund sites will become more involved in oversight going forward, to reflect the model we already have.
- Real estate operators have questions about whether they can be sure that each investor is fully accredited. What is iFunding doing about accreditation proof?
There are handful of firms that, for a modest fee per person per year, will verify accreditation. I’m shocked that crowdfund sites are asking for 1099s or letters from lawyers and investors on their sites. Our goal is to create less work for our investors, not more.
- What are the major regulations that apply to crowdfunded real estate?
You should be aware of 506. Rule 506(c) of regulation D allows a private company to solicit accredited investors using social media, Internet and traditional advertising. There’s no limit on how much an accredited investors can commit to deals under this structure.
Title III of the JOBS Act added a section to the Securities Act, which allows for true crowdfunding transactions with non-accredited investors. This is in the public comment period.
There’s also Reg. A and the pending Reg A+. Reg.A allows for $5m in offerings by a platform over any 12 months, without having to file a registration but it’s considered a low threshold with a lot of effort. The proposed Reg A+ would allow a company to offer up to $50 million bit with greater investment protections.
Finally, there’s an S-1, which is what Lending Club used. It’s like an IPO.
- How did you decide on the legal structure for iFunding?
I spoke to many top law firms, but couldn’t find any two that agreed on the best method to structure the company. Some said you had to be a broker-dealer. Others felt you needed no-action letters. The research took six months. Eventually, we became a broker-dealer, operating under regulation 506-d. Through our legal structure, iFunding is permitted to support nearly unlimited offering amounts; a billion overall is permissible.
Some of our competitors make use of the crowdfunding act, which allows them to solicit any and all investors by posting real estate deals and target returns to the general public on their web site. We feel it’s more prudent to keep the specific deals and terms within our secure web site, accessible only after investors have provided profiles and confirmed they are accredited. In the future, when Title III of the JOBS Act is completed, we may reassess the process.
- What does being a broker-dealer enable you to do?
Being a broker-dealer (BD) allows you to charge a commission for introductory services. If a deal is raising $10 million, it requires more effort than a $500,000 deal on our part. Or, if we only do a partial raise, we’d want the financial arrangement to reflect that.
More strategically, my sense is that VC firms much prefer to invest in broker-dealers. It comes down to both the robust regulatory framework already there for brokers, and the economic scale that can be achieved. I think the real estate investors also will be more comfortable with a broker-dealer.
- For the specific properties you offer for investment, describe the legal and operating structure?
We use a master-sub LLC framework for adding investment opportunities. The sub is efficient to set up, and allows us to distinctly protect the assets and guarantees for each investment.
- What kind of changes might we see in RE crowdfunding, and for your company, in 2014?
On a macro level, I think you’ll see more crowdfund platforms become broker-dealers, as the most viable means of scaling the business.In terms of iFunding, we are making the user experience more friendly and robust, especially the education component. Education is key to growing the community. You’ll see an update to our look coming soon, based on feedback from the investors on the site.
- This market reminds me of many startup segments I’ve been in, such as e-commerce and social media. Only a few companies are likely to grow to dominance. How should RE investors look at iFunding in order to gain confidence that you will be one of the major players in several years?
There’s a checklist of components to consider. The crowdfund team should have real estate experience. The way they structure the investments should be scalable, but more importantly protect everyone’s interests. Confidentiality is extremely important. For example, we never turn over the names of investors in a deal to the operating partner. I’ve seen other crowdfund models that have tried more of a social network approach, but that hasn’t been the most effective in terms of sound deal-making.