My Latest Thoughts on Crowdfunding Real Estate Part I

My Thoughts on Crowdfunding for Real Estate and an Interview with RealtyShares

Joe Stampone Innovation/Technology 15 Comments

Note: This post was originally published in 2013. Since then, the industry has evolved considerably. My “thoughts on the real estate crowdfunding industry” should be viewed as  a history of the real estate crowdfunding space. See my latest thoughts to understand where the business is today.

It’s been a few months since I’ve shared any thoughts on crowdfunding for real estate. Since then, a number of new crowdfunding start-ups have launched, my company successfully crowdfunded a piece of equity on a retail deal, and I’ve had countless conversations about the impact crowdfunding could have on real estate investment. This is an aspect of the business that really excites me, so I wanted to share some thoughts from those experiences.

I also caught up with Nav Athwal, the Founder and CEO of RealtyShares, who provided some of his insights on crowdfunding. Just scroll down past my rambling thoughts to see his interview.

The Explosion of Real Estate Crowdfunding Platforms
I keep a running Google doc of real estate crowdfunding platforms and it seems like every few weeks there’s a new public launch (or a group the fizzles). While there’s room for multiple platforms, companies should be hyper-focused on vetting both the sponsors and the individual deals they bring on to their platform. As soon as a deal blows up because of fraud or one just happens to go bad because of the market (which is inevitable) and investors lose their money, the platform could be killed. The ongoing fears around crowdfunding is that most amateur investors (both accredited and non-accredited) don’t understand the risks associated with a real estate transaction. As soon as a deal goes bad, these concerns will be brought to the forefront.

With so many crowdfunding sites, companies are taking slightly different approaches. Here are some of the differences I’ve seen between the various platforms:

  • Fundrise: A real estate investor social network that provides sponsors the ability to create investor networks and connect directly with potential investors. Investors on the site can connect with other investors. In real estate investing relationships and credibility are essential, this structure creates social proof because investors can see investments made by people they trust.
  • RealtyMogul: Investors in Realty Mogul deals invest directly into a newly formed entity controlled by Realty Mogul. All interaction between the sponsor and investors is filtered through Realty Mogul.
  • RealCrowd: Real Crowd members invest directly into the sponsors LLC alongside other limited partner investors. So as opposed to Realty Mogul where there’s limited interaction with the investors, the Real Crowd investors and the sponsor communicate directly.

My Experience Crowdfunding a Deal
I have the great pleasure of working for an entrepreneurial real estate investment firm which strives to be at the forefront of the business. We’ve been waiting for the right opportunity to test out one of the crowdfunding platforms and finally found one. Here are a few of my takeaways:

  • Many outsiders view crowdfunding as pooling small amounts of capital from 100’s of retail investors. That’s not necessarily the case. For our deal, we raised $300,000 from 15 different investors (average equity check of $20,000) with the largest equity check being $50,000. The deal was fully funded in a few days with a handful of investors waiting in case someone dropped out.
  • The group of investors were extremely diligent. While we provided an overly detailed deal memo and populated an extensive FAQ section, we still received emails from perspective investors with lots of very good questions. Overall, this set of investors were as sophisticated as almost any high-net-worth individual we’ve deal with.
  • Putting the deal online provided great exposure. Since launching the deal, we’ve received multiple calls from high-net-worth investors who want to take a look at our future deals and from other real estate firms who want to learn more about our experience.

Although we didn’t need to go to outside investors for additional equity we learned a lot about the process and potential of crowdfunding real estate investments.

Those are my thoughts as a bit of an outsider. To provide some real insight, I want to welcome Nav Athwal, founder of RealtyShares:

How does RealtyShares go about vetting sponsors and the deals that are brought onto the platform?

Joe, note that our approach is similar to Realty Mogul’s.  We create a separate LLC entity in which to pool all accredited investors and that single entity becomes an equity investor in the LLC that owns the property or a lender in case of a debt deal.  This greatly reduces the burden to the Sponsor because the Sponsor doesn’t have to manage many small investors and leaves that to us.  Our platform is built to do just that.

Regarding how we vet Sponsors, we have four-step process to ensure that we list only quality investments on our platform.  The process starts with a real estate company applying for access directly through our platform here.  Once the company applies, we do a quick review of the Company to determine whether they are a fit for our platform and our investor community.  We’re looking for quality Sponsors that have a proven track record, intelligent strategy and geographic focus. If we think there is a fit, we then do a background check and credit check on all principals of the Company.  From there we do a deeper dive into the deal to determine if the assumptions being made by the Sponsor (including with respect to rent growth, vacancy, cap rates, expenses, etc.) are reasonable/accurate.  The final step is having our investment committee, comprised of successful real estate professionals and entrepreneurs review the investment prior to listing it on the platform.   Although this vetting process usually means that most investments that come through our platform are rejected, it ensures that only quality investments are listed, which I think is very important to your point about properly vetting sponsors and investments to minimize something going wrong.  The industry is fragile because it is so new and I think all platforms need to make it a priority to properly vet all investments and sponsors.

With so many real estate crowdfunding platforms out there, how does RealtyShares differentiate itself?

We’re focused on complete transparency, lower fees and a range of investment options.  Some crowdfunding platforms focus only on debt product while others focus only on equity product.  At RealtyShares we offer both.  We also offer both residential and commercial real estate investment offerings in various geographies.  Our first 6 investment offerings spanned 4 separate states and thus through our platform, investors get exposure not only to a variety of asset classes but also multiple geographic locations.

Also, user experience is very important to us, which is apparent through our investment platform www.realtyshares.com.  I don’t think other platforms are as laser focused on that which I think is a mistake.  From our seamless and paperless investment process to the dashboard investors are given access to once they have invested, our user’s are informed every step of the way and are offered complete transparency and efficiency.  We’re making investing in real estate from the comfort of your laptop or tablet while sitting on your couch a reality.

Although the above highlights a few ways in which RealtyShares is different than the competition, leading the competition is essentially going to come down to which platform has better investment offerings and where are investors making more money.  It is still too early to tell which platform will perform the best in that regard but I think we are definitely poised to lead the pack there.  We’re conservative with our underwriting and have a huge pipeline of product and thus have the luxury of being very picky.  That is key to investor success.

RealShares is currently crowdfunding capital for class A multifamily deal outside Dallas. What does the typical investor in this deal look like?

Unfortunately we can’t speak about our current deal because this would violate the ban against general solicitation set forth under existing Rule 506(b) of the Securities Act of 1933.  Although the SEC has created a new rule 506(c) under which platforms and sponsors can advertise their offerings, this rule also brings with it additional regulatory burdens.  We’ve made the decision to hold off on using this rule until it has been vetted and tested a bit more in the open market.  Protecting our investors and avoiding legal grey areas is key to our success and thus our reservations on using it immediately.

On average, investors using RealtyShares invest approximately $16,000 per debt or equity investment.  These investors come from various geographies and have differing backgrounds.  We have everything from google and facebook engineers, self-directed IRA holders to retirees using RealtyShares to access and invest in private real estate.  That is why we think it is important to offer investors variety since their risk and return requirements will differ depending on their personality and their stage in life.  Some investors are more risk averse and like the first position debt offerings we offer whereas others want to participate in the upside and thus like taking an equity position.  Some like a mix and thus want to invest in both.  Diversification is our motto at RealtyShares…diversification not only in terms of investing in real estate rather than just in stocks and bonds but also diversification among different real estate assets.

A friend of mine recently made the comment that real estate crowdfunding sites are essentially non-discretionary fund managers with good technology. What do you say to that?

I can’t say that statement is totally incorrect.  It is a good observation.  We pool investors into a single LLC and then continue to manage that LLC throughout the investment hold period.  However, this structure is merely a means to an end.  We do this because not only does it provide investors with a passive position in the asset as well as liability protection, it also greatly reduces the burden on the Sponsor.  You indicated that you used crowdfunding recently but the investors came to you direct rather than being pooled into a separate fund. That most likely reduced efficiency for you and your team.  By creating a separate fund and staying on as the manager, we make the process for both sides more seamless and efficient.

Also, what we are creating with RealtyShares goes far beyond just being a fund.  We are creating a new asset class.  Yes private real estate investing has been around forever and as of 2013 commercial real estate was a 350 Billion dollar market, but never before have investors been able to access private real estate investments for as little as $5,000 through a transparent online platform.  That is what we are creating.  More transparency and much greater access.

What has surprised you most about the real estate crowdfunding space?

How much popularity it has gained in such a short period of time and how misinformed so many industry players are about the concept of crowdfunding for real estate.  I recently attended a Real Estate Symposium hosted by UC Berkeley’s Fisher Center for Real Estate.  During the capital markets panel, crowdfunding as a viable option to raise capital for real estate came up as a discussion topic and everyone on the panel knew or had heard of the concept and some had even thought about using it.  Very exciting.

However, when it came time to explaining how it works or the benefits, the panelists were misinformed not only about the regulatory requirements but also on how big it could really be.  Some said it would only be good for small assets like duplexes and fourplexes while others said it wasn’t a viable way to raise capital.  RealtyShares and some of our competitors have already proved some of these pundits wrong since we have raised capital for large institutional quality assets and will continue to do so.  It wasn’t surprising that the panelists came from very traditional backgrounds with a vested interest in seeing things stay the same.  But it was very interesting and surprising nonetheless.

Where do you see crowdfunding for real estate in 5 years?

In five years, crowdfunding for real estate can easily be a $1B dollar industry.  Taking example from the P2P lending market via platforms like Prosper and Lending Club, this prediction seems very reasonable.  After only being in existence for a little over 5 years, Lending club is already doing $1B in loan originations a year and prosper is not too far behind.  Real Estate is a much larger asset class than consumer loans and I think we will see an even greater growth trajectory for Crowdfunding platforms like RealtyShares.

Also, in the next year we’ll see crowdfunding for real estate open up to nonaccredited investors made possible through the crowdfund exemption set forth in the Jobs Act.  Although many “experts” and “pundits” are skeptical on how the final rules will look and whether this exemption will be too burdensome to be viable, I believe it will be a very important step towards providing nonaccredited investors, a class of investors historically excluded from being able to participate in alternative asset classes like real estate, with access to new investment opportunities.

I want to thank Nav for taking the time to share his thoughts. What do you think?

  • Jessica Sala

    Love crowdfunding for new business ventures! Just had a friend that started an independent bookstore that way!

  • Nice Information Posted…

  • Phil

    Nav,
    Does your structure allow for investors to do a 1031 exchange?
    Thanks,
    Phil

  • Curt Smith

    Joe, it’s mid March 2014, what’s new in this space. Any more crowdfunding deals. New sites?

    Terms, we need to know the terms these sites are offering borrowers??

    I got a call from realty shares Pres, we talked, he mentioned 10%, 5 yrs and a few points. For holding SFRs that’s actually on the tight side. If the SFR cash flows at 12% and your cost of buy and fix funds is 10%… True you have 20% of your own cash in each deal which increases the spread but it’s still tight. Meaning one needs to do high cap rate deals or just do high profit margin flips.

  • Thanks Jessica. It’s such an exciting space with implications that transcend the capital markets.

  • Hey Curt,

    I fell way behind on comments and I’m just catching up now. So many exciting developments in the space, but it’s still extremely early. The cost of capital and revenue models will continue to evolve for a while, but there are a series of other benefits to crowdfunding your deals.

    Thanks for reading and commenting.

  • Hi Phil,

    I’d reach out to Nav directly. I don’t think they do at this point, but I’m sure they may down the road.

    Best of luck.

  • kissmychub

    $5000 per shot is just way too high for this to be mainstream. Yes, I understand why it can’t be $25 but as it stands now I have better (and easier) ways to make money with $5k investments.

  • That minimum investment will continue to come down overtime across platforms. In fact, platforms such as Fundrise have had minimums as low as $100.

  • realtysharesinvestor

    We have invested in realtyshares for 4408 midnight pass rd. No updates on delays in project progress. Very long delays for any email follow ups. Realtyshares service quality is going down

  • I’m surprised they’re not giving regular quarterly updates. Anyway, good to hear the project is on schedule.

  • Sunny

    No regular updates. They have finally sent a note that the principal is now being returned back but there is no return to investors. However, they worded it in a way that they have done investors a favor by picking up legal costs in following up with the sponsor and force him to refinance. If they were really transparent, they should have sent details on the legal costs they claim to have incurred. In short, they are too busy in growing the platform and getting more deals than be active in communicating with existing investors.,

  • Thanks Sunny. I’m not surprised to hear that, but I believe the industry will continue to improve.

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  • yes, good to hear about project.