Member News

Crowdfunding Platforms Preparing for a Potential Market Turn

By Tim Casey | Trepp

When property investor 10 Federal launched a $10 million fund in 2017 to invest in self-storage properties, the Raleigh, North Carolina firm hoped to raise $1 million of equity through crowdfunding platform CrowdStreet. The remainder would have to come from its existing network of high net-worth investors. But it didn’t need to tap them, as it ended up raising the entire $10 million through crowdfunding. It used that capital to fund the purchase of 10 properties.

The company, formed in 2010, is now in the process of launching its second self-storage fund and is aiming to raise $20 million to $30 million, solely through CrowdStreet.

While 10 Federal’s Co-Founder Brad Minsley expects the company to achieve that goal, he’s also realistic. If interest rates increase, the company’s operating expenses and financing costs would rise, while property values and investor returns could decline.

“Something could turn in the market, and we may get nowhere near $20 million,” he said.

“We’re all competing for investor dollars,” said Minsley, who founded the company with his brother, Clifton. Both were previously with Phillips Development and Realty, a Tampa, Florida multifamily developer. If yields generated by his investments decline, “we’ll be less competitive raising investor dollars,” he said.

The Evolution of Crowdfunding

So far, crowdfunders have not had to deal with high interest rates, a recession, or a prolonged downturn in the market. The industry took off soon after President Obama signed the Jumpstart Our Business, or JOBS, Act into law in 2012. A provision in that legislation allowed sponsors to directly market their offerings to individual investors and raise capital in small increments, paving the way for crowdfunding.

At first, most platforms offered equity or debt investments in so-called “fix-and-flip” single-family residential properties. They then turned to commercial properties, making it possible for sponsors to raise capital from a group of investors who previously did not have access to such assets.

Crowdfunding’s relatively short tenure has coincided with a booming real estate market. By the end of October 2018, prices for commercial properties had increased 94.77% from their low point in 2010 and were 25.4% higher than their pre-recession peaks in 2007.

While crowdfunding platforms have become more mainstream, they’re still a tiny player in the overall commercial real estate market. Since inception, they’ve only raised about $3 billion of capital from their “crowds.” Contrast that with the $530 billion of commercial mortgages that the Mortgage Bankers Association estimates were originated that year.

While dozens of crowdfunding platforms got to the starting line, many never took off. This only left a few dominant players, including CrowdStreet, RealtyMogul, Fundrise, and RealCrowd.

“People talked about how this was going to be a low barrier-to-entry market and there was going to be this mass proliferation, but these businesses are quite complicated,” said Charles Clinton, a former real estate attorney who cofounded EquityMultiple, a New York crowdfunder that’s completed 53 deals. “You don’t just have real estate deal work and investment structuring, but you also have regulatory issues, a technology component, and you have to deal with investor dollars.”

For Some, the Ad-Venture Ended

Despite the sector’s young age, it’s already had at least two failures. For instance, iFunding of New York, which focused on debt and preferred equity investments, closed shop in 2017. The SEC filed a complaint against the company in September 2018, alleging it had misappropriated investor funds.

RealtyShares of San Francisco stopped taking new investments in November and laid off most of its staff because it couldn’t secure capital to continue operating what had become a costly enterprise. The company was one of the first platforms to launch and grew to more than 100 employees, making it among the largest crowdfunders. It had raised $58 million of venture capital and claimed to have brought in $870 million from its crowd which was invested in 1,160 deals.

But the company got ahead of itself. It evidently grew too quickly and failed to generate enough deal flow to please its investors.

Nav Athwal, one of RealtyShares’ founders and its Chief Executive until November 2017, noted that venture capital firms expect to see rapid growth from their investments and aim for a liquidity event within seven years.

But “these businesses are much better evaluated over longer durations than a typical (venture capital) timeline,” he said. “If you look at these companies over a longer duration of 10 or 15 years, I think you’ll see ultimate success for the industry, but I don’t think it’s a good marriage with (venture capital).”

Dealing with Rising Interest Rates

Some crowdfunding platforms have evolved from their early days, when they simply served as third-party marketplaces which allowed sponsors to raise money from their crowds of accredited investors (those with a net worth of at least $1 million).

For instance, Fundrise and RealtyMogul have launched non-traded REITs which allow their crowds to invest in diversified portfolios of properties at lower-priced entry points. Meanwhile, CrowdStreet recently launched a fund through which it hopes to raise $25 million from its crowd of accredited investors that it would use to invest in opportunities listed on its site.

RealtyMogul’s REIT offerings are structured as perpetual-life vehicles. Up until recently, these structures were quite unusual in the non-traded REIT space. Perpetual-life vehicles allow firms to weather any potential increase in interest rates.

“It doesn’t mean we want to hold on to everything forever,” said Jilliene Helman, Co-Founder and Chief Executive of the Los Angeles company. “But if we go into a down market, there’s no impetus for us to sell because we don’t have fund life issues.” Meanwhile, the company has been locking in long-term financing against properties its REITs buy.

Hotel specialist AWH Partners of New York has been raising capital through the CrowdStreet platform specifically for small- to middle-market properties it pursues because most of its usual institutional partners typically pass on smaller deals. It tapped crowdfunding for the first time last year, when it raised $2.3 million of equity from 69 investors through CrowdStreet to recapitalize the High Peaks Resort in Lake Placid, New York. It followed that up in December when it raised $4.5 million of equity to help fund its $20 million purchase of the Topnotch Resort in Stowe, Vermont.

Chad Cooley, who co-founded AWH, brushed off concerns of a higher interest-rate environment, which he said is typically an indication of strong economic growth and could deepen the pool of crowdfunding investors. But that could be offset by a movement to other fixed-income investments, which would become more attractive.

A Strict Deal Diet

Crowdfunding platforms, like most real estate investors, are becoming more judicious in what they pursue, in light of the potential for higher rates. Take ArborCrowd for example, which was launched in 2017 by Arbor Commercial Mortgage, a Uniondale, New York apartment specialist. It’s raised roughly $20 million for seven transactions, but has passed on what co-founder Adam Kaufman said was hundreds of deals.

“We choose our deals pretty carefully,” he said, adding that the company only works with sponsors that have proven track records in particular markets. “Where the market’s at today and what’s going on, it’s hard to find quality. We’re looking to build a long-term business that we would like our investors to be happy with and stick around for the long haul.”

RealCrowd, which was founded in 2013 by former Palmer Capital brokers Adam Hooper and Roman Rosario, continues to serve as a marketplace where investors can invest directly in sponsors’ equity offerings. So far, the company has raised about $250 million through 169 deals.

RealCrowd is now preparing for a higher interest-rate and lower return environment by being even pickier about what deals it offers. Additionally, the firm is providing online courses to investors to educate them about the risks associated with real estate investing.

“This has been a really good time to be a real estate investor,” Hooper said. “As that cycle starts to crest, whether we have a slowdown of growth or a slight pullback, I think one of the challenges is trying to help get investor expectations more in line with the reality of the current market.”

This article was originally featured in The Year-End 2018 magazine, which contains research from Trepp and Commercial Real Estate Direct. Download your complimentary copy of the magazine here.

Disclaimer: The information provided is based on information generally available to the public from sources believed to be reliable. 

Compliments of Trepp, a member of the EACCNY