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:
- 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.
I had the pleasure of interviewing Adam Hooper, the CEO of RealCrowd, one of the prominent real estate crowdfunding sites. Adam has spent the last ten years working with a spectrum of real estate professionals including operators, lenders, investors, developers and institutional clients. Prior to RealCrowd, he founded two national platforms for brokerage, consulting and joint venture equity investments.
As investors and developers look for education about crowdfunding, I’m pleased to be able to share in-depth thoughts from an executive at the forefront. In this interview:
About RealCrowd and crowdfunding
- When and how did RealCrowd start?
We initially came up with the idea around late 2011 when we were continually working on transactions that were beyond where most real estate operators could efficiently and effectively syndicate, yet were too small for institutions to get involved. At the same time, we had friends and family reaching out to us regularly with smaller amounts – $15k-$50k – that they wanted to invest directly in commercial real estate. Unfortunately, there really weren’t any options for them. So we had the “ah-ha” moment of realizing both sides of this equation existed, we just had to build the platform for them to exist together.
- What exactly has changed with the JOBS act to permit sites like yours to exist?
The biggest change is of course lifting the ban on general solicitations. Real estate has been syndicated for decades if not centuries, but the basic mechanics haven’t changed over that same time. Investor networks have been historically limited to growth by the fact that one could only solicit investors they had a pre-existing business relationship with. That is no longer the case, and issuers can offer their investment opportunities to anybody and everybody – a major shift in how operators can access capital and how investors can access opportunities.
- Can you share any information about the amount of activity on your site, such as # of deals? It looks like your offerings are consistently being over-subscribed, so that must feel good.
We have done 6 deals so far, totaling over $62M of total asset value. And yes, it feels great that we’ve come that far in only a few months of being live with the platform!
RealCrowd’s benefits and differentiators
- What differentiates you from other real estate crowd-funding sites?
We take a very different approach in that we are not forming individual investment entities for each deal. That is, we don’t create a “Crowd Shares III, LLC” type of entity in order to control investors’ money being placed in “123 Main Street, LLC” for the property. We feel that is a terribly inefficient approach (having to replicate all of the diligence, accounting, reporting etc. that is already being completed at the asset level) that adds unnecessary complexity and uncertainty to the investments – if that platform implodes, unwinding those deals will be a nightmare. Another is our product focus. We came from an institutional background (with a combined 20 yrs and nearly $3B of transactional experience) and want to bring deals of that caliber to Main Street investors that traditionally would never have the opportunity to participate in those assets.
- Some crowdfund sites invest in their own deals and/or serve as general partner. One might justify that this provides more skin in the game and better control. What are your thoughts on this approach?
Why should investors have to pay another layer of fees, overhead and risk additional complexity to roll dice on the hope that Crowdfunding Co. will be in business for the life of their investment? We reduce that risk and provide the opportunity for direct investment in real estate, not investing in a fund manager.
For investors: requirements, risks & rewards
- A low minimum investment level should encourage new investors to include real estate in their portfolio. Your minimums range from $5-10K, correct?
Minimums on the platform are set by the real estate operator, remember these are their offerings on the website, not ours. Offerings have ranged from $10k to $50k minimum investments.
- What is the typical range of investment amounts you might see on, say, apartments with several hundred thousand in equity up for investment?
Average investments have been in the $35k-$40k range, but keep in mind that’s a spread from the $10k investors up to six figure(+) investors.
- Do you offer debt and equity deals?
Right now our focus has been on equity deals as that’s our background and expertise. We also feel the debt markets are so aggressive right now at historically low rates, that to provide an attractive return to investors you have to go way outside on the risk spectrum (hard money loans, major rehabs, house flips etc). This will likely change in the future and we do have our eye on debt opportunities as the markets shift.
- For equity deals, if the deal goes insolvent and the assets need to be liquidated then would you have a significant number of physically-separate individuals, and their lawyers, who have to agree on next steps?
While I am unable to give legal advise, typically in real estate deals there is a managing member of an LLC, or a general partner of a limited partnership, that would control the unwinding of the assets. Every deal may be structured differently depending on the circumstances however.
- What could you advise someone like me, familiar with east coast 4-family units, about investing, say, in apartments on the west coast? Is diversification a good thing for me, or taking me out of my zone of expertise? Is it better to be in travelling distance to the property, “just in case”?
I think the biggest benefit of platforms like ours that are emerging is to provide the ability to diversify. Yes, one can diversify somewhat locally, but to build a truly diversified portfolio, one can now take advantage of this new reach to look at other asset types (office, retail, industrial, multifamily etc) and geographies. The benefit of investing with best in class operators is that they are the ones doing the “on the ground” work at the assets – passive investors don’t need to be just down the road to handle the day to day maintenance or hassles that can come along with property ownership.
- Do you get a sense that the majority of investors are experienced enough to understand the opportunities and risks? For example, I think I see more multi-year commercial deals involving equity with 16-20% IRR being funded more quickly than, say, house refurbishments with a 1-year maturity and a secured loan. And one web commentator noted that investors won’t really know how real estate works until one of their deals encounters challenges. …On the other hand, I’m told that crowdfund investors ask as sophisticated questions as traditional, direct RE investors. What are your thoughts on participants’ understanding?
Education is a big part of our mission. E-books, regular blog posts and eventually seminars are all in our roadmap. Real estate is a fundamentally simple asset class to learn – tenants pay rent, expenses are paid from that cash flow, the remainder is distributed to investors. Granted, that’s a VERY simplified view, but you get the point. I do think the crowd is smart however, and would agree that questions we see coming through on specific deals are sophisticated.
- I like one of the benefits you promise: “[Online,] investors will be able to track the many benefits of owning real estate, including net cash-flow distributions (distributed quarterly), adjustments in net operating income through changes in the property tenancy and potential growth of their investment through property appreciation.” Is this information now available on your Portfolio dashboard?
For real estate developers and promoters
- I’m colleagues with smaller developers, typically refurbing houses, 4-families, or small apartment buildings, interested in getting better terms than from a typical hard money lender, through crowdfunding. It appears that your site focuses on larger developers, however. Do you have a sense of whether the effort and costs of getting involved with crowdfunding are worth it to the smaller RE developer?
Absolutely. This is the most revolutionary change in the real estate capital markets in generations.
- How do you perform due diligence? I understand you focus foremost on the developers. Your site says that “typical sponsors will have been involved as a principal in a minimum of $50 million of real estate, bought and/or sold at least 10 transactions.”
Our level of diligence is heavily focused at the operator level. We feel this is ultra critical and we strive to have a platform with best in class operators. We also feel that it is impossible for anybody to be an expert in all asset classes in every market across the country. Therefore we cannot believe that some of the platforms in the space are recommending what is a good deal or a bad deal. That isn’t our position as a platform to make. Now, we do know how to find and attract operating partners that are experts in specific product categories in specific markets across the country. The best operators tend to do the best deals over time.
- I read that “RealCrowd will charge a nominal fee to the operating partner for its services to arrange for the investments to be made.” Is there anything else that we should be aware of in terms of fees?
We do charge an up front flat access fee to the operators to utilize our set of tools / a fee to them with each deal. At this time, we do not charge any asset management fees nor do we participate in the upside of the deals. We also take a firm approach that platforms should not be taking any economics from the investors.
- Investors need to be accredited to participate, correct? And that requires them, or jointly with a spouse, to have income of several hundred thousand or liquid assets of $1m. What steps do you have to take at the outset, and over time, to demonstrate one’s accredited status.
Everybody that participates in a 506(c) offering must be accredited. To start, we have our users fill out a self accreditation worksheet as part of their signup process. We then speak with them to determine they are in fact a real person! When time comes to invest in an opportunity, we will take the necessary steps to verify that they are in fact accredited. We take this very seriously and have even seen investors that we are unable to verify based on the documentation provided showing up on other platforms with testimonials about how easy it was to invest! Those are some of the things that cause concern for us a bit about the space.
- Some web commentators have voiced concern that you, or other sites, act like a ‘broker’, or promoter of investments and that this role is restricted of crowdfund sites by the JOBS act. Are these the correct words to use or is there a misunderstanding here?
There is a misunderstanding. There is an exemption to registration as a broker/dealer in the JOBS Act that we fall under. Our approach is again different than other platforms in that we are not an issuer selling our own securities, but we provide a SaaS platform of tools for operators to run their own offerings in an online environment. We are best described as a ‘platform’ right now. Technically we are approaching it as a true marketplace as well, which by definition includes multiple sellers (operators) and multiple buyers. Other companies are only offering investments in their own securities which doesn’t seem like a true marketplace to us.
- What are future strategic plans for RealCrowd?
Eventually we will look into adding debt opportunities and may eventually look international as well.
- What are improvements being made to your process and site?
We just hired an amazing Director of User Experience (he was a Lead Designer at Salesforce.com and we managed to court him to eventually join our team!) and will be rolling out major improvements shortly. Our goal is to continually innovate and provide both operators and investors with the best experience possible. We are also always looking for feedback in how we can better the experience as well.
- It seems to me that the future of crowdfunding will be about balancing careful due diligence and presentation of offerings against growth rates. The first crowdfunder to have deals go bad could tarnish the entire field. How do you feel about that risk, and what is RealCrowd doing to be as transparent and prudent as possible?
We agree completely. Real estate investing, as with all investing, carries with it an inherent risk. Deals will go bad, the market will sour, people can and will eventually lose money. This gets to the earlier point that I brought up – we are not in the business of recommending investments for individuals. We want to make sure that we have the best real estate operators in the industry on our platform, companies that have been through multiple market cycles and take a very proactive role in operating the real estate. Those are the companies people want to invest with, and they are the ones that have the local market intelligence and experience to be a steward of their investors’ capital. Our platform is about access to invest directly with real estate experts.
Disclaimer: This blogger, Scott Lichtman, has made a real estate investment through the RealCrowd site. I am not otherwise involved with the company.