Is the Real Estate Crowdfunding Market Getting Too Crowded?

The real estate crowdfunding market is only a few years old, but it has taken off. Its broad appeal lies in its ability to provide individual investors access to commercial and residential properties through an online platform, even if they only have modest amounts to invest. This market was made possible by the JOBS [Jumpstart Our Business Startups] Act, which allowed the raising of capital through securities crowdfunding for the first time.

One of the largest real estate crowdfunding companies around is RealtyMogul. Knowledge@Wharton recently sat down with Timothy Li, its chief information officer, to talk about his company’s business model, opportunities for investors and property owners, and whether there’s a shake-up coming. What follows is an edited version of that conversation.

Knowledge@Wharton: Real estate crowd funding has taken off in the last few years. What’s the attraction?

Timothy Li: We essentially democratize the way you invest in real estate. Three years ago, before the JOBS Act, it was not possible for somebody to go online and pitch in $5,000, $10,000, $20,000 into a real, commercial property deal. After the JOBS Act, it was easier for us to raise equity money online to facilitate many commercial real estate transactions. We made it easy, we made it transparent. And individuals can invest in actual properties, as opposed to a pool of properties within a [fund].

Knowledge@Wharton: How does RealtyMogul work?

Li: RealtyMogul is an online platform that caters to passive and active investors. A retail investor — a passive investor — goes online and chooses from a variety of different property types. We have multifamily, student housing, office space, retail centers for people to choose from.

It’s really easy to invest. You can pitch in as little as $5,000, and you own a real piece of real estate. We make the process very easy and fast and transparent. You can go online, make an investment, track your portfolio performance, and we send you all the paperwork you will need, and we take care of all the back end process on top of it all. We pull all the investors together behind an LLC, and we negotiate on your behalf with all the rights a real property owner would have. So, it protects the crowd and also gives us control over the property’s performance.

Knowledge@Wharton: Tell me about the technology on your platform and how that democratizes the real estate market, in your view?

“We essentially democratize the way you invest in real estate.”

Li: The technology that we use is fascinating. There are tons of data out there on commercial real estate — anything from tracking rental performance, to sales records and things of that nature. We pull all that data together and make the best decisions we can possibly make [on which properties to take on].

Data aside, we have some of the best commercial real estate underwriters in the country working for RealtyMogul. Our chief credit officer has tons of experience at JPMorgan Chase. We have tons of people at RealtyMogul.com that have many, many years of real estate and finance experience.

The technology combines Big Data, marketing — online marketing technology — and a really fascinating crowdfunding platform technology that we built in-house. It allows us to get the crowd together, distribute the funds, manage the assets and keep track of all the transactions. And you can log in anytime and look at your portfolio performance and track it online.

Knowledge@Wharton: For property owners, what is the advantage of going to a real estate crowdfunding site, versus a traditional lender?

Li: The property owners, or the sponsors, have a great advantage when they come to RealtyMogul…. We do a full stack of financing. What that really means is that we will raise the equity portion of the commercial deal on … the property owner’s behalf. And we will also give you access to debt. So you come to us with a small percentage of the equity, maybe 2%. And we will raise the additional 98%. Part of that is equity that we will raise from the crowd, and the other part is debt — we will hook you up with an institutional buyer. So, you get the whole service in one stop.

Knowledge@Wharton: For investors, what kind of return could they reasonably expect, as well as what kind of risks are they undertaking in terms of the default rates of the properties?

Li: Most of our deals are equity deals. There are preferred equity deals and also JV [joint venture] equity deals. These equity deals are essentially down payments [similar to what you would see in a] home mortgage. High risk, but it does have the potential to give you a high return. Typically and historically, we’ve seen [returns] averaging 6% to 12%, maybe even higher on our equity deals. And these deals tend to be 2- to 3-year holds.

And on the out, on the exit, the owner can choose to either sell the property, or refinance our deal out, so to speak. The other component of an equity investment is that you also get a cash-on-cash return. And what that means is, the rent that you would collect on this property, you also get a distribution on a quarterly basis, as a cash-flowing return on the investment.

“It’s really easy to invest. You can pitch in as little as $5,000, and you own a real piece of real estate.”

Knowledge@Wharton: What kind of properties do you invest in?

Li: Anything that is not single-family homes. So, we’re talking about hundreds of units of multi-family apartments, retail centers, office space, senior housing, student housing or even storage units. So we invest in commercial real estate types of properties.

Knowledge@Wharton: How are you different from a REIT?

Li: The biggest difference is RealtyMogul.com offers full transparency. You know exactly which property you’re going to be investing in. So you see the property. We’ll give you all the details about the property, the performance, and the management team.

A REIT is more of a blind pool of funds, right? You put your money in, you don’t necessarily know which property and what kind of property it’s going into. And it’s hard to get your money out in a REIT. With RealtyMogul.com, you know exactly what it is that you’re investing in. You are a true owner of that property, and you get your money out in two, three years.

Knowledge@Wharton: The real estate crowd funding market is getting very, very crowded. How are you standing out?

Li: The way we stand out is by building trust, transparency and developing a special relationship with our investors. These retail investors come to us with their hard-earned money. These are doctors, software engineers, partners of their firms — and we want to take care of their investments. One of our guiding principles is investor protection. Everything we do is around investor protection. I believe the only way that we’re going to stand out is by protecting our investors, making the right investment, providing the right returns for our investors, and not betting on things we don’t believe in.

Knowledge@Wharton: Do you see a shakeout coming?

Li: I really don’t see a shakeout. In many ways, this industry is brand new. We have only been around for two and a half years, and so have many of our competitors. We’re just in the early innings of this game. Truth be told, all of the legislation is still being developed and vetted out by the SEC and Congress.

There’s a new piece of legislation [coming that] will allow non-accredited investors to start investing in these crowdfunding platforms. So, everything is brand new to us, and we are constantly analyzing what’s coming down the pike, as far as regulations go. And I really don’t see a shakeout anytime soon. It’s just fascinating to see how the industry is just starting to take off.

“We have only been around for two and a half years, and so have many of our competitors. We’re just in the early innings of this game.”

Knowledge@Wharton: Most of the deals that you guys have done are on the equity financing side, versus debt. Is there a reason for that?

Li: Yes, absolutely. It’s easy to get a mortgage. Let’s just use the single-family home as an example. You can waltz into any big bank, like Wells Fargo or Chase, and get a mortgage if you have the down payment. But it’s hard to get a down payment. You have to save for that 20%, if you will. A lot of the sponsors — or property owners — don’t have that kind of cash lying around. They’re spread pretty thin, or they don’t want to use their cash. So that’s where we come in. And that’s why you see a lot of equity deals, a lot of down payment deals, if you will.

They come in with 2%, we come in with 18%. Both of us go to the bank with our 20% and we buy the property and get the mortgage. So you see a lot more equity deals than debt deals. And … equity deals typically, on average, do give you a better return. You are the true owner of the property, you get, again, cash-on-cash rent money. And also on the out, if the property performs — say you bought it for $1 million, you sold it for $1.5 million — you get the additional profit distributed proportionally.

Knowledge@Wharton: Can you talk about some of the tax implications of real estate crowdfunding?

Li: RealtyMogul just launched a brand new product: a 1031 Exchange platform. There are a whole lot of benefits in a 1031 Exchange…. If you have a [gain from selling a piece of] property and you want to reinvest that money to avoid a capital gains tax, you can roll that into a Delaware Statutory Trust, or a DST 1031 property. That means you can take the profit, spread them into one or multiple properties, and keep on growing your money without paying capital gains tax right off the bat.

Even on a common equity or JV equity deal, you could depreciate a property, just like you would [after] buying a single-family investment home, on your tax returns…. On top of it all, it’s just good having a portion of your investments in commercial real estate.

Knowledge@Wharton: So what’s next for your company?

Li: We’re growing really fast. We closed our Series B funding in July of 2015 of $35 million. In total, we raised close to $42 million in the past two years. We’re poised to grow. We have over 70 employees nationwide. We have offices in San Francisco and New York, Los Angeles, Atlanta and Houston. We’re growing. We are putting more and more properties and products on our platform. We’ve been attracting hundreds, if not thousands of investors, on a monthly basis. So far, there are 73,000 members at RealtyMogul.com constantly looking for deals and making investments.

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