By Dr. James M. Dahle, WCI Founder
It's been a while since we gave an update on our real estate investments. They're really the only “interesting” part of our portfolio because everything else changes so infrequently. As a reminder, here is our asset allocation:
Stocks (60%)
- US Stocks (40%)
- Total Stock Market (25%)
- Small Value (25%)
- International Stocks (20%)
- Total International Stock Market (15%)
- Small International (5%)
Bonds (20%)
- TIPS (10%)
- TSP G Fund (10%)
Real Estate (20%)
- REITs (5%)
- Equity (10%)
- Debt (5%)
Today we're only going to be talking about the last two categories there, for a total of 15% of our portfolio. The rest is covered with what is the equivalent of seven index funds. Also, be aware that I have a financial relationship with essentially every company and link you see in the rest of this post. Some firms I just invest at, others buy ads here at The White Coat Investor, and still others I have an affiliate marketing partnership with. So if you decide to use some of these firms, I do appreciate you going through the links provided here as they help support the site and letting them know where you heard about them.
First, a broad overview of the many different ways one can invest in real estate and why we've chosen to invest as we have. Let's use a slide I'm borrowing from the real estate investing lecture of our online course, Fire Your Financial Advisor.
As you can see, on the left side are options like buying the house down the street and managing it yourself. There is the most opportunity to add (or subtract) value, the most hassle, and the most control. This option is most like a second job. On the far right, you see a REIT mutual fund like Vanguard's excellent REIT Index Fund. Minimal hassle or expertise, maximal liquidity and diversification. So what's the problem there? Well, it's terribly tax-inefficient and has higher correlation with the overall stock market- “real estate flavored stock” if you will. I think you probably give up some potential return for the convenience too.
On this continuum, we lean more right than left, but have investments all the way from syndicated properties to REIT mutual funds. We don't have the time, desire, or expertise to spend much effort on the left side (at least any more). Doesn't mean it's wrong for you, but that's what we do. Pluses and minuses either way. I figure if I'm going to put a lot of effort into a second job/inefficient market investment, it's going to involve websites, where we have significant expertise and not real estate, where we do not.
Equity Real Estate Investments
Let's talk about our equity real estate investments. Remember we lump some of our website investments in here as well, but out of respect for Physician On FIRE and Passive Income MD and what they're trying to accomplish, I'll be leaving many details of those investments out of this post.
Since our last update, we've made some new investments, closed some old ones, and held some others. I'll be discussing all of them here. Be aware that the overall returns will often appear lower than they actually are. These investments are not marked to market on a daily basis. In fact, they might not be marked to market on even an annual basis. So I may be using the value I bought something at 2 or 3 years ago when calculating my returns. With some investments, you never get to know how you're doing until you've actually gone round trip with it, and that round trip may take a decade!
Partnership Office Building
Up until 2017, our partnership office building had been a really great investment for us. Part of that was the screwy way the buy-ins and buy-outs had worked with it. When I bought in, I was able to buy in at what was essentially the prior year's price. I bought some more of this in late 2016 (essentially doubled my investment to $32K or so) But what wasn't made clear to the investors by the board was that we were buying at a projected future price for the investment. Wacky? Of course. Unfair? In many ways. So I complained about it. Now it looks like I'm going to be on a new separate board managing this investment. That's what you get for speaking up. I suspect things like this happen with physician office building type investments all the time. Pay attention to the details because they do matter. The annual appraisal comes up in another month or two so the return is probably a little better than it looks. But my annualized return on this one over 5 years is 13.84% a year.
Indianapolis Apartment Complex
This one was my first crowdfunded syndicated investment. It was purchased through RealtyMogul way back in November 2014. It was trailing the pro-forma (and still is) but is catching up. Some money was held for a while due to a dispute with FHA, but that was finally released to the investors in 2017. It's not clear what my share of the property is worth, making it difficult to calculate my return, but if it is worth exactly what I paid for it ($10K), our annualized return stands at 4.96%. I suspect it is worth quite a bit more as the Net Operating Income increased 13% over the last year, and the value of the property should be increasing along with that. Time will tell.
Salt Lake City Apartment Building
This one was a preferred equity investment on a building in downtown Salt Lake City purchased through Fundrise. Fundrise has been gradually moving from a model where they offer individual investments to accredited investors to running an “eREIT.” Well, the eREIT bought this investment off me this year, almost a year earlier than I expected the investment to end. It promised a 14% return and now that we've gone “full circle” I can report that indeed we made an annualized return of 13.66% for a little over 2 years. It was nice getting those checks like clockwork each quarter and I was kind of disappointed to be bought out early.
My Grocery Store
This one has been fun to own. We've been owners of (a tiny slice of) the land our neighborhood grocery store sits on that we bought through RealtyShares. This $5,000 investment basically pays us $25 a month. Part of that land was sold off (I think it was the old Burger King in the parking lot) this Fall and some of our capital was returned. I haven't seen a current valuation for the property since we bought it a couple of years ago, but assuming it is worth what we paid for it, our return annualizes out to 5.46%. (It promised 6%.) It sounds like we'll be exiting by summer, so with my next update I should be able to give you the total return on this one.
Physician On FIRE
This is an equity investment in a website you all know well. This is by far my highest yielding and highest returning investment in 2017. I enjoyed a 50% yield in 2017 with a total return that annualizes to something like 344%. That's a little squirrelly to calculate as websites are so difficult to value.
That's it for updates on the old equity stuff. Let's move on to the stuff we've bought since last April.
Origin III Fund
I've been realizing the last couple of years that I don't particularly enjoy scouring through a bunch of crowdfunded real estate websites. Nor do I think I'm doing a particularly great job of picking investments and doing due diligence. So I'm moving more toward funds where I pay someone else to do that for me. The nice thing about that approach is that while you still have to do due diligence on the manager, that's it for 5, 10, or more years. And if they buy 10 or 20 investments in the 
fund, it also provides you a fair amount of diversification. This investment with Origin Fund III is the first of these I have done. Instead of giving them all your money up front, they call for capital as they find attractive investments. So while I've committed $100K, I've actually only invested $37K so far. There haven't been any distributions yet, as expected. This is going to be a long-term one, so I'll update you as we go along. It is managed by Michael Episcope who has guest posted here a few times.
Passive Income MD
Another equity investment in a website you know well. We haven't had it long but returns are promising. Cash on cash yield was over 6%. In the first month. Now you know why I like website investing. Granted, it's a little tough for you to reproduce what I'm doing here, but we're talking about my investments today, not yours!
Texas Preferred Equity Investment (Equity Multiple)
I've been watching for an investment with Equity Multiple for a few months and decided to jump on this one. It is a preferred equity deal on an apartment building in Houston. My share of it is $20K. Nothing to report yet on it other than the promised 10% yield and a 15% overall investment return. I like Equity Multiple because they invest some of their money into every deal. The deals are pretty few and far between though, and fill up quickly.
The Future
We'll continue to meet the capital calls for the Origin Fund III. We're also expecting to make an investment with WCI advertiser 37th Parallel Properties at some point this year. These guys are really of the mindset of “Do one thing and do it well.” They do apartment complexes, mostly in Texas. But they may only offer 1 or 2 investments a year, so you'd better be ready when it comes along! We also anticipate adding another site or two to the WCI network this year.
My overall calculated return for the equity real estate portion of the portfolio annualizes out to 26.57% per year for the last 5 years, but as noted above, it's probably higher than that. This year's return was 46.60%, boosted significantly by investments in the two members of The WCI Network. It takes a fair amount of time to get money invested into equity investments, so I'm actually a little underweight there; too bad with those kinds of returns.
Debt Investments
First, let's update you on what's happened with some of our past debt investments. The only round-trip real estate investment I could report on last time was a $2K trial investment that I bought through RealtyShares and ended up with a return slightly higher than promised. We've had two more round trips since.
Fund That Flip New York
We lent some money ($5K) to a home flipper in New York via Fund That Flip. He returned our money 6 weeks later with interest and penalties for early pre-payment. The return annualized out to 14.46%, although it was actually a 2.02% return in just 6 weeks. I've been pretty happy with Fund That Flip. I like their lower Loan to Value ratios and they're rated well.
RealtyShares Greenbriar
This was another $5K hard money loan done through RealtyShares. Our money was returned in a little under 6 months with an annualized return of 8%, as promised.
Let's talk about our current investments.
RealtyShares Lovers Lane
Another $5K hard money loan through RealtyShares. After 6 months, it is paying as promised. Annualized return is 7.32% so far.
RealtyShares BarTree
Similar story. $5K hard money loan. Lower yield. Making 6.74% on it so far per my calculations.
RealtyShares Church's Chicken
This might be the only loan for a retail project that I've done. This is a $10K loan on a Church's Chicken in Alabama somewhere. I'm making 8.21% on it. I've been pretty happy with RealtyShares, from a volume standpoint, a transparency standpoint, and a yield standpoint.
Fund That Flip Jay Road
Another $5K loan through Fund that Flip. Making 6.97% so far (4 months) on it.
Fund That Flip Fox Lane
Ditto. 6.98%.
Fund That Flip 527 East
Ditto. 7.26%.
PeerStreet
I had been watching for a PeerStreet loan for a while and managed to get into this $5K loan. I think it promises 7.5% or so. No payments yet, but I just got into it. I like Peer Street as they seem to have a lot more inventory than many of the sites; there are new loans every business day. They only do debt investments and are highly rated by those who keep track of these sorts of things. One minor annoyance- they don't automatically send the payments to your bank account like the other companies do. Hopefully that'll change soon.
Alpha Flow
As I've been doing these crowdfunded hard money loans over the last two years, I've been running into a problem. They're popular. That seems to be resulting in two things. First, the yields are dropping. Where it used to be easy to find 10% or even 11%, I'm seeing more and more at 8% and now 7%. Second, they're snatched up in seconds. That's part of why it took me forever to get that money invested with PeerStreet. Even with their “auto-invest” feature, I had to stand in line for a month until it was my turn to get an investment that met my criteria. And that line is getting longer all the time. Forget due diligence. There's no more of that going on. It's like what happened with Lending Club and Prosper. You either invest automatically or you are left with the crumbs. So I'm doing two solutions for this last problem. The first is Alpha Flow. Alpha Flow is actually a Registered Investment Advisor (RIA,) so in that respect, I guess I have a financial advisor now. But they basically take my money and spread it out over a whole bunch of loans. Instead of having $5K or $10K per loan at RealtyShares, Fund That Flip or PeerStreet, I have $20K invested in 84 different loans. That service costs 1% of AUM. This is all brand new, and so far I calculate my return at an annualized 4.90%. I'm just auto-reinvesting everything here. I'll be curious to see what the return is on this after a year or so.
Broadmark Real Estate Lending Fund II
Broadmark is my second solution to my problem making individual hard money loans. Like a mutual fund, this is very much set it and forget it. I sent them $75K and they reinvest my earnings in the fund and send me statements every now and then. This fund makes hard money loans in Colorado and Utah. I've only been in this one for a few weeks but my return annualizes out to 5.62% so far by my calculations. Historical returns range from 0.84% to 0.99% per month in this fund. We'll see how this goes over the next few years. I'm actually only locked into it for a year.
So far, I calculate my overall return for the debt portion of my real estate portfolio at an annualized 6.71%. That's a little lower than I'd like to see. I'd prefer to be in the 8-12% range. I think it'll get there though as most of these are brand new investments and the fact that there is a little delay in sending me the distributions has a major impact on the return calculation over such a short time period.
The Future
I'm actually a little overweight on the Debt side (mostly due to the Broadmark minimum investment amount) and a little underweight on the Equity side (mostly due to the Origin capital call process.) So I won't be buying anything on the debt side for a little while as that situation works itself out. I think the additional layer of fees for the Alpha Flow, Broadmark, and perhaps another fund or two is probably worth it to me to avoid the hassle and lack of diversification of picking individual investments myself, but time will tell. Now that I'm invested, I only need to invest a little each year to keep it at 5% of my portfolio.
Lending Club and Prosper
A quick update on my situation at Lending Club and Prosper. Long-term readers will recall that I invested 5% of my portfolio in Peer to Peer Loans for several years but have been gradually exiting. Since Prosper no longer allows you to sell any notes, I'm basically stuck there for a while. I made 5.75% this year at Prosper (5.83% overall since inception). But I'm down to just $259 invested there now across 20 notes, 18 of which are current and 2 of which are in collections.
Lending Club has been a pain in the butt for me this year. I was able to liquidate most of the account (perhaps 80%) within 2 or 3 months a year ago including my entire taxable account, although I sold many of those for a small loss (<5% of face value.) This year I've been trying to sell the rest throughout the year for par value with limited success. I still own about 10% of what I had invested, but am down to about $4,500 spread across 135 notes, of which 121 are current. Due to the IRA custodian's fees, there has been quite a bit of cash drag there during the liquidation process. I've done two partial rollovers to Vanguard so far at $100 a whack but probably won't do another one until it is all liquidated. That date may still be over 2 years away. One thing I noticed though is that it is easier to sell a note under $25 than one over $25, so perhaps when they get paid down to less than $25, they'll be easier to sell. At any rate, my Lending Club return for the year is -5.22%. Overall XIRR since 2012 is still over 8%, 8.09% to be exact, so I guess I can't complain too loudly. I enjoyed double digit returns for 4 years but had a bit of a sour experience toward the end.
WCI Supporters
Here are the links and special deals available through this site's sponsors that are mentioned in the post:
Affiliate deals (meaning I get paid if you sign-up after going through this link):
- RealtyMogul
- FundRise
- Equity Multiple Management fee on your first investment waived when using this link.
- Peer Street
- Lending Club
Other WCI Supporters mentioned in this post
Bear in mind that most of these investments are available to accredited investors only ($1 Million+ in investable assets or $200K+ annual income.) Two great resources I've found to do due diligence include:
Crowd Due Diligence – An outgrowth of the 501 Investing Google Group. Honest reviews from real investors.
The Real Estate Crowdfunding Review – Ian Appolito's site where he reviews and ranks the various crowdfunding companies and funds out there.
Summary
Overall, I'm cautiously optimistic about the real estate (and alternatives) portion of our portfolio. Some of the returns seem a little low this year, but frankly, the Vanguard REIT Index Fund didn't exactly knock it out of the park in 2017 (4.94%) so I can't really complain. And I think the returns I'm reporting are lower than what I'm actually getting, especially on the equity side. I do like that it is easier to diversify platform risk with crowdfunded real estate, which is the main reason I got out of the Peer to Peer Loans. I also like that I have something backing up the loan besides the word of somebody who carries a balance on credit cards. But there is a lot of capital sloshing around in this world and it is finding its way into crowdfunded real estate (particularly the debt side) just like it did into Peer to Peer Loans. Falling yields and slipping financial ratios are the natural consequence of that. So be aware that these are all high risk investments that are likely becoming even higher risk. Not sure that's all that different from the stock, bond, and publicly traded REIT markets these days though.
If you are interested in learning more about real estate, I recommend checking out WCI's No Hype Real Estate Investing course. It will give you the foundation you need to learn about all the different methods of real estate investing.
What do you think? Do you invest in real estate? Where on the continuum do you fall? Have you invested with any of these companies or funds? What was your experience like? Comment below!
Good summary post. I actually invest across the whole spectrum from SFH to REITs. Now concentrating more on syndication and funds. I’m also in the Origin III – I like hiring and leveraging experts to build a commercial RE portfolio for me. Capital calls are a bit of a pain, but I understand the need for it. I’m overweight in equity and I haven’t done much debt except for PeerStreet where two of my four investments are in foreclosure. Going forward, I will only invest in debt funds like Broadmark to get better diversification and less work on my part. Platform wise, I like CrowdStreet and RealCrowd because it is a direct-to-sponsor model and the sponsors are higher quality in my opinion.
Really thorough post on an interesting topic!
I’d really love to learn more about the tax implications of all of these investments, too. I have a pretty solid handle on how much tax you incur from a 403B investment or backdoor Roth, for example, but I do not have a great handle on real estate, because being fresh out of training this is not something I have jumped into (yet). When you discuss these returns how are taxes involved? I imagine that some of these types of investments are more tax efficient than others?
My understanding is that income from debt deals is treated as ordinary income and taxed at your marginal tax rate whereas equity income can be taxed at your ordinary marginal tax rate or capital gains depending on structure and how long you hold the property? I am curious to know how your gains change with the tax loss (or tax benefit through depreciation, etc) seen in these vehicles? I am sure that is a post unto itself, but I think it would be worth the read!
The debt investments are terribly tax-inefficient. The equity investments benefit from depreciation, which shelters the income somewhat. The gains are also deferred until the sale (or indefinitely if exchanged) and get capital gains treatment.
John Templeton said “The only thing that matters is your post tax return.” Would you consider reporting your return after it is taxed? Also, would you consider investing inside of a self directed IRA? Some companies allow it, and others do not. But, the ones that do may give you a higher post tax return.
Take the highest tax bracket and multiply it by my returns of anything in a taxable account and you can figure it out yourself.
Yes, I’ve considered and have used a self-directed IRA. Probably wouldn’t put equity investments in it though, just the debt ones.
Website purchases aside (which I think are misplaced in this real estate summary), it sounds like you’ve made <8% pre-tax return, much of it illiquid, in a year when the US market rose ~28%.
I guess those gains would be impressive if the US market were down.
Should the economy recess, I think these investments are subject to very limited returns. Perhaps loss of principle as well.
That’s the point of diversification!
Diversification is important, yes.
But my point is that it’s not really a great ROI, even worse considering the effort involved and tax complications for individuals.
The post looks more like an advertisement for the site’s sponsorship.
And why are website businesses included in this real estate summary?
Yes, this website is still a for-profit business.
Websites are included because I include them in my real estate allocation.
I’m glad you admit the potential for conflicts of interest. It does read like you’re talking your book.
Counting website businesses in your real estate assets is pretty… it’s a bad idea in my opinion. They’re misclassified I think.
Perhaps rather than “real estate” this section of the portfolio would be called “alternatives.” Then websites and real estate fit nicely.
Okay…do they go better with stocks or bonds?
Yes, diversification works even when you don’t want it to.
Also, note that the debt returns, while they may seem low, are higher than what I was getting on my much safer debt investments. That money never would have been in the stock market.
And, of course, if I’d just put it all in Bitcoin at the beginning of the year I would have come out even more ahead. Unfortunately, you have to invest without knowing future returns.
Good thing no one was suggesting you invest in bitcoin. Wy would you imply that I was suggesting you should? Seems rather disingenuous of you, no?
No, my point was that it’s easy to choose what will outperform in retrospect and there is always something that did better than a diversified portfolio. Congrats on a 28% year, that’s very good.
And the US market rose 21.17% in 2017, not 28%. International stocks were up 28%. I also own all of those and benefitted from their rise.
My mistake, I was recalling my personal account’s performance from the bed this morning.
Is it worth all the effort for something that is such a small portion of your overall portfolio?
That’s a good question.
I ask because the people who I’ve met who have done really well with real estate seem to love doing it as a business and have made a fairly substantial time and money commitment.
If I were to dabble in this area, I would most definitely not be one of these people. I would want no more than 10% of my net worth tied up in real estate; and at that percentage, would it really make a significant difference in the long run? I’ve decided no, but am curious about your thoughts on the matter.
Well, the less you put in, the less hassle it’s worth.
Dual physician income, both W2 employees. Looking to invest in real estate, but have neither the time or experience to physically own investment properties. These syndicated websites are enticing, but the tax implications of owning them personally are horrible. Does anyone here own these investments through a LLC or other structure? If so, can you elaborate? Thanks.
They’re all in LLCs, but you don’t have to set them up. The syndicators do. That doesn’t help the tax situation though.
By tax situation here do you both mean the k-1s and multiple state tax returns, or something else? The k-1 is provided by the manager, so that doesn’t so bad. I agree multiple state returns are annoying, but tax software sorts it out. What am I missing? Serious question.
You’re not missing anything. Worst case scenario, you have to do multiple state returns. If you’re careful with the investments you choose (specifically avoiding equity investments in some states) you can avoid doing even that.
You are well diversified with your investments. Have you thought about investing in a condominium unit? I purchased a one bedroom unit in 2010 and so far so good after three tenants. We’ve made a little improvement a couple years ago but we’ve been very happy with our investment both in value and the business itself.
The only condo I’ve owned has been the one we lived in in medical school, which didn’t turn out well (well, medical school did, but the condo purchase didn’t.)
I definitely agree about the spectrum of real estate options from those that feel like a 2nd job to a more preferable (for me) hands off approach which I know I sacrifice some potential returns for convenience.
I personality have invested in RealtyShares with 3 different platforms with debt offerings. No complaints whatsoever and 2 of them returned capital as well promised interest payments and the third ended up getting a 6 month extension with payments continuing as promised.
I have more recently concentrated almost solely on 37th parallel syndicated offerings. I have read many articles from Dennis Bethel MD who has posted on this site. Have been with them for almost a year and so far has been a great experience. I like the buy and longterm hold they provide. The buy in is a lot higher than crowd funded sites (minimum 50k).
I round up my real estate holdings with the vanguard reit fund and a guest house which I am renting
I have made multiple investments in Realty Shares (including your SLC shopping center), and so far, the equity investments are well below the expected advertised returns, and they also increase the complexity of tax filing. One of my Realty Shares debt investments ($3000j is in foreclosure, an apartment building in Milwaukee, and until I see how that works out, I am not committing more to that platform.
I have also invested in multiple deals (25 plus) in Peer Street, and I currently have one property in foreclosure ($1000), a house in West Palm Beach. As I select the investments on Peer Street, I have the gnawing sense that I am offered the low end deals (high risk, low return), the best example being the 1 month/3% loans, where I take the same risk as the longer term deals, and the platform gobbles up most of the return. It’s a great deal- for Peer Street!
As for other non-conventional investments, I own a share in an imaging center business, for over a dozen years, and it has been a big winner. I am currently getting paid out about 2x my initial investment every year!
I also am invested in a private managed futures fund, which has been a bit disappointing, as I invested at a time when volatility across numerous asset classes has essentially dried up, resulting in negative returns across the board.
Vagabond-
Your imaging center is the type of deal that I’d love to hear more about.
I hear docs in other specialties speaking about their surgery centers, dialysis centers, etc…
I don’t know how to go about getting in on these deals or how to evaluate an offer to join one of these deals.
Any insights?
thanks!
I’ve had that request a lot and would love to get a guest post giving step by step instructions for evaluating one. But I’m not sure it’s quite that simple. It’s not like there are hard and fast rules about what makes one deal good and another bad. As far as getting in on the deals, it’s who you know. If you’re a radiologist, you’re likely to get invited to be in an imaging center. A surgeon, an outpatient surgical center. An Emergency Doc, perhaps a FSED or UC. Nobody has ever invited me to buy into an imaging center.
I’ve owned zero real estate since forever, …….other than what’s passively present in other AAs.
Reits are a dividend proxy and currently compete poorly with rising interest rates. Not interested. No regrets.
My lending club returns have been pathetic – I bought in summer of 2015 for ~5% of my net investments at that time and have had a small negative return (adjusted account value) over those 2.5 years. It has since become ~1.5% of my net investments since I haven’t made any additional contributions. I’ve just been surprised with how easily people get loans, then don’t pay and it gets charged off (with no real consequences other than it my be harder to get another loan?).
That grocery store isn’t yours is it? Its the land that it sits on, unless you are getting profits from operation thats a mislabel.
Also if you claim 5% of your portfolio in P2P and you have 2-3 million portfolio then you really had 100-150K in that? Sounds more like 10K which is nothing. Same goes for your RE investments, those annualized returns on what capital? 500K? would be helpful to know total money in these things. Not the same “risk” if you are putting in 100-200K total in these platforms and funds.
Website profits >>>> RE, which should raise curiosity in a good investor if this is about investing. (business investing > RE)
That’s correct. I own the land.
You’re asking for even more specifics of my personal finances than I’m already revealing? Seriously? When you’re not even using your real name? Think about that for a second.
Keep in mind my portfolio is growing and growing rapidly thanks to new contributions. So what was 5% just a couple of years is a much lower amount than what is 5% now. With the P2PLs, it takes a lot of time to get out of them. So while I had at one point 5% of my portfolio in there, the combined effects of pulling money out and growth of the portfolio has reduced that percentage to less than 0.2%. It will continue to Fall until I am able to fully exit.
I agree that 50% returns on $200K is a lot better than 50% returns on $20K. My AA calls for 5% in real estate debt investments and 10% in real estate equity investments/small businesses. Those are 6 figure amounts given my current portfolio value. They used to be 5 figure amounts. Someday they may be 7 figure amounts.
If you’d like to post every excruciating detail of your financial life on a website somewhere for people to read, feel free to do so. I think I’ve provided more than enough detail for learning purposes and asking for more detail is just financial voyeurism.
Not sure what your last comment is referring to. I couldn’t decipher it. But I don’t think anyone is surprised that I’m better at running websites/investing in websites than I am at real estate.
Don’t want to argue about this, but the way you present it is that you have “substantial” amount in these assets but reality it its a tiny portion and in some your are experimenting not really going full blast so you can post about it or they are site sponsors. Sorry but thats how I see it. Big numbers but in reality they are not that big – not very clear to the novice med student reader who’ll just click links based on your returns which are on small invested capital. That’s why total invested matters – shows your conviction. I don’t want an audited financial here but disclosure in context.
I have 500% return on bitcoin. I didn’t invest 50K in it.
But hey your website so you can blame me for whatever and people will listen to you vs. me.
Last point is: having a real estate business is not the same as investing in real estate. Also investing in businesses will always yield greater than just pure RE investment. There – deciphered it.
I’m reporting as I go along on my experience. I’ve noted amounts invested. I’ve noted returns. What specifically do you think isn’t clear? Which investment do you not know how much I have invested?
unfortunately real doctors think they can outperform the mkts
for RE just buy reits
with the $$$ you earn be happy with 5-10 million at retirement using index funds hassle free
I have “played around” with the crowdfunding and peer-to-peer and such, but in the end, I believe you are correct.
I agree with Ken on this one. Maybe I am just old but what is the advantage of Crowdfunding anyway? I guess you don’t have to be an accredited investor so the initial amount is lower. In years past I have invested in 2 hospital syndications and one surgery center. These types of investments do ok.
Its just a scheme to make money for platforms. None of them have a great explanation for this vs REIT tbh.
I am increasingly of this opinion.
Hard to know exactly until you’ve gone round trip a few times, and that requires 5-10 years.
Different investments. A REIT buys shopping malls and huge apartment complexes. A little crowdfunding investment might be a single house or restaurant. A big publicly traded REIT like the ones in the Vanguard REIT Index Fund doesn’t buy those things. It’s a different asset class.
In addition, REITs get bid up in price so much that their yield falls significantly. I mean, look at it now. The Vanguard fund yields 2.29% (adjusted) right now. And that’s with REITs paying out by law 90% of their returns. It’s pretty darn easy to find a crowdfunded deal offering a better return than that.
That’s the explanation. Do what you like with it. No real estate is mandatory for your portfolio. Nothing mentioned in this post is a mandatory investment.
Uh terrible first example. Many of these websites buy “huge apartment complexes” Those are your multifamily residentials. Single house investments are SO risky its not even worth me spending time explaining here; oh an yields are 7-8% which does look better for individual investment but you are losing diversification. Also they don’t invest in resturaunt but rather shopping strips. Again, RE not the operational business.
I don’t find a single family home to be a terribly risky investment, so go ahead and spend your time explaining just how risky that is. I’m willing to give up some diversification for higher returns.
Not interested in wasting my time. These single family investments are HML loans. The music stops in HML – please see history plastered on biggerpockets if anyone really wants to dig.
Sure last point is valid. Its not just diversification though, its work/expertise in selecting deals. Trusting funds to take your money and then invest is pretty much what this blog does not want you to do in equity market (hedge funds, money managers of funds).
Anyways, no point arguing. To each his own. My points are to emphasize its not all rosy as the posts suggests.
If you think that post was too rosy, you’re not going to like BiggerPockets.
These loans are first lien loans secured by the value of the property. If the borrower stops paying, you foreclose.
Are you trying to argue that the real estate market is anywhere near as efficient as the publicly traded stock market? Really? I find it far easier to believe that a talented real estate manager can add value greater than costs than to believe the same about a stock mutual fund manager.
Sure. Foreclose and get pennies on the dollar.
People can google iFunding. Thanks.
Are you just giving me a hard time or do you really not understand how this works?
Step 1: Loan money 65% of current market value to a house flipper at 8%.
Step 2: Collect mail money every month.
Step 3: House flipper fixes up house, sells it 6-12 months later.
Step 4: You get your money back.
In the event that house flipper doesn’t send mail money, you foreclose on house flipper. Since you only lent 65% of the value, and you’re in first lien position, that extra 35% in value covers the costs and hassle of the foreclosure. Either way, you get your money back.
If you decide to do this through a crowdfunding platform like iFunding, you also introduce platform risk such as what happened to iFunding. There is usually some back-up plan in place. With iFunding, there wasn’t, but it looks like something is coming together.
If you want to avoid those risks, you can do so.
So you’ll rely on LTV? Got it. Most are not low LTVs for the yield you want to get. And to be frank, if the house doesn’t flip there are reasons. Possibly the local market tanked and then it forcloses much worse price. Its not covering foreclosure expense its to get your money back from that equity. Some houses go at 20%-30% of their original equity. You are screwed and not getting all money back.
You don’t have to tell me about RE. I do this as a side gig thank you very much.
Also very comforting to know that ANY of these platforms can go the way of iFunding. And we can count on backup? Got it. You are copy pasting definitions, doesn’t change the risk.
Katie says I should let you have the last word and go work on something that matters, so I’m going to do that. Wise, that one.
I agree with Newbie post came off suggesting all up side with low risk. When you are guaranteed 8-12% returns one would suspect the quality of the loans fall into the high risk junk bond territory. What percent of these loans default there must be data out there why was it not included? So you invest 10k in 10 sites get 10% return on 9/10 one defaults return equals -1%. So I just did a quick search for lending club default rate came up with 5%.
http://www.lendingmemo.com/lending-club-prosper-default-rates/
Your advertisement states returns 4-6%. Law of averages you will loose money if that is the true default rate.
A fair question would be. Out of all the investments you outlined above how many of them were prior to any consideration of advertising these sites on your web site? I am honestly a little disappointed in this post one of the lessons I always teach my residents and students is follow the money/conflicts.
Advisors who pitch whole life get all of first years premium = major conflict?
Readers Invest with sites above Jim gets paid can this really be an honest evaluation of these investing platforms.
Jim you also got way too defensive to newbies comments. Reminds me of the responses you would get from financial advisors from your early posts when you so eloquently explained why the are not needed.
People keep asking “why wasn’t this included, why wasn’t that included.” I’m reporting on my experience. I haven’t had any defaults, so I can’t report on any. I reported on all my defaults with lending club, just search the site. There are half a dozen posts about it. I’m treating these real estate investments the exact same way- I tell you what my experience is as I go along.
I’m not sure why you think this post is an “evaluation” of these sites. Let me quote from the post:
As noted, this post is simply telling you what I’m doing and how it’s going. Nothing more. My experience has been all upside and the risk hasn’t shown up on me with crowdfunded real estate. It showed up on me with Lending Club, and there was a lengthy post discussing that. If you want to try what I’m doing, knock yourself out. If you prefer to invest in some other way, knock yourself out. It really doesn’t bother me. But suggesting I’m somehow screwing you over by telling you about my experience when I make like a 3 figure amount in affiliate commissions in any given year from all of these crowdfunder affiliate deals combined is simply ridiculous. Do your own due diligence. If it seems like a reasonable thing to do, then do it. If not, don’t.
I listed the firms that I have affiliate partnerships with and those who buy ads. The others “I merely invest with.” I list my conflicts of interest and sources of revenue once a year in the state of the blog post.
As far as “too defensive,” people get defensive when they are attacked, especially repeatedly for years.
Constructive criticism is fine. Questions are fine. Pointing out my errors is fine. Trolling is not. Sometimes it’s a fine line.
The goal is high returns and low correlation with the stock portion of my portfolio. If I didn’t think I could get that, I wouldn’t bother. But there are no guarantees. You make your bets and you take your chances.
If you owned REITS in 2008, you know why I am interested in real estate with lower correlation to the overall stock market. The market dropped 50%+ and that Vanguard REIT fund dropped 78%.
I agree re: goals. The next time the Vanguard REIT fund drops 50+%, it might be the case that our investment in the SLC strip mall also drops in value by the same amount, but because it is not subject to mark-to-market accounting, we might never know.
I do agree that diversifying with real estate investments is certainly worthwhile but, overall, an “optional” asset class. Of course, the hard core real estate investors might say the same about investing in the stock market.
Valid point. Again not saying these sites aren’t useful – they do give access to people who don’t have such network to invest in multifamily complex, commercial RE etc. Its just that returns are overstated and there are risks that we don’t know yet fully given the awesome market environment we are in. Also yields are falling.
Just glancing through your thread here, am I correct to infer you are ok real estate investing, just not via website driven syndication, p2pl, etc? So, your preference is to get educated and build a commercial real estate network directly? If so, this is just you putting in money, right? Someone else is doing the deal?
If this is directed at me then answer is NO. thats not what I am saying.
My point is not to pick a fight with WCI (although thats what he thinks), rather its to provide counter arguments to a very rosy, link/for profit sponsors he has driven, post. Very easy to post 26% annualized returns (which I am personally not clear how much money he has invested exactly in each deal – see argument above) and for medstudents and residents or young attendings to click these links and follow the rabit hole (which is the goal here really). All that is still fine –
for profit website afterall – but where is the post and disclosure on major risks? I have to dig and highlight iFunding that went bankrupt leaving investors hanging? and its not just about getting your money back. Good if you did, but you are not guarenteed to get ALL of it back which even if you do is a net negative since you earned nothing or very little on it (compared to your favorite risk free rate).
You can develop expertise in real estate – my preferred way – but you have to run it like a business then. These platforms are good but they have had deals gone bad. You can dig further into some paying out of their own pocket to make investors whole (yes this has happened) – how long can they do that? they are venture backed and money runs out anytime.
Anyways, I am wasting time for no reason. Anyone with rudimentary skills can look and decide for themselves.
You’re not wasting your time.
I agree with you.
Jim Dahle should do more to disclose risks & his personal stakes, given the fact he gets paid to pump these businesses.
Keep it up, I’m reading every response & find you’ve got him totally defensive…he knows you’re right.
Would you like 2000 words of the post to be about risks? How long do you like your posts? The interest of most readers tails off after 1500-2000 words. Suffice to say your entire investment is at risk, just like a stock or bond. The due diligence is all on you. They’re investments for accredited investors only- i.e. investors who should know how to do due diligence and who can afford to lose their entire investment.
I still can’t figure out what personal stake disclosure you two want to see. Specifically what are are you asking for that I’m not giving you? What do you feel like I’m hiding? I feel like I’ve been pretty darn exact in the amounts invested and the returns obtained so please be specific if there is something else you want to know.
So are you going to tell readers how you invest in real estate or just vaguely allude to it? (Amazing given your criticism that I haven’t included enough details and refusal to specify the details you wish to see.)
Sorry Jim, I’m not getting paid for these clicks or the website traffic. Perhaps you’d cut me in on your business, then we could chat.
Be as incredulous as you’d like, I agree with newb and my point stands as stated.
Sure, no problem:
1. Disclose your financial relationships with these site sponsors, when they are mentioned.
2. Cite the risks in the main post, above & below. Be clear about how each investment specifically is at risk.
3. Disclose the nominal terms of your investment therein, for each firm.
4. Identify how you benefit, and in nominal terms from sponsorship by these firms.
1. All were disclosed in the original post. Let me quote:
2. That would require a 15,000+ word post. Go to each individual site and read the risks section of the PPM for that information. Assume your entire investment is at risk but that you cannot lose money above and beyond your investment. That’s the way most are set up.
3. I think I’ve done this. Which one(s) are you wanting that I haven’t done either in this post or a previous one? [Update: I went back and added investment amounts on a few of them where that information wasn’t included. Sorry, I thought I had already done that but it must have been the last real estate update post I did. That’s probably what you two were griping about.]
4. The affiliate agreements don’t permit me to disclose that and I’m not going to disclose what I sell any given ad for. Want to know what my ads cost? Come buy one. Most affiliate agreements are quite public and available to bloggers and podcasters and easy to discover how much they pay. For example, here is where you would get that information on RealtyShares: https://realtyshares.ositracker.com/mysite I quote from that site
That’s a fairly typical affiliate agreement for a crowdfunded real estate site.
I’ll be waiting for your guest post submission that includes these details for each of your real estate investments.
Oh and as far as how much I’ve benefitted in the past from the firms listed in this post, the grand total of ads and affiliate payments wouldn’t account for 1% of the income of WCI, LLC. These are very minor revenue sources for me.
Here is the risk section from one PPM, a debt investment with RealtyShares. Enjoy!
RISK FACTORS
Investing in the Notes involves a high degree of risk. In deciding whether to purchase Notes, you
should carefully consider the following risk factors, which do not include all of the various risks
associated with an investment in the Notes. Any of these or other risks could have a material
adverse effect on the value of the Notes you purchase and could cause you to lose all or part of
your initial purchase price or could adversely affect future payments you expect to receive on the
Notes. Only investors who can bear the loss of their entire purchase price should purchase Notes.
General Investment Risk Factors
The Notes are highly risky and speculative. Only investors who can bear the loss of their
entire purchase price should purchase Notes.
The Notes are highly risky and speculative because payments on the Notes are special,
limited obligations of the Company that depend entirely on a corresponding borrower loan.
Notes are suitable purchases only for investors of adequate financial means. If you cannot afford
to lose all of the money you plan to invest in Notes, you should not purchase Notes.
Changes in Capital Markets and the Economy Generally May Materially and Adversely Affect
the Performance of Underlying Borrower Loans.
Each corresponding borrower loan will be materially affected by conditions in the global
capital markets and the economy generally. Concerns over (among other things) inflation,
energy costs, geopolitical issues, wavering business and consumer confidence, unemployment
levels, and the availability and cost of credit all play a part in the volatility and expectations for
the economy at any one time. Small businesses borrowing at higher-than-average interest rates
may be particularly susceptible to such factors. Such factors may from time to time contribute to
an increased likelihood of borrower defaults.
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A Note May Not Realize Income or Gains from The Corresponding Borrower Loan.
An investment in Notes may decline in value due to a default on the corresponding
borrower loan. Accordingly, a series of Notes may not be able to realize income or gains from
the relevant corresponding borrower loan. Any income realized by an investment in a series of
Notes may not be sufficient to offset the expenses (anticipated or unanticipated) of such
investment.
Risks Related to the Borrower and the Property
A borrower’s typical value-add strategy involves increased risks relative to investments in “core”
stabilized properties.
The value-add strategy generally pursued by a borrower involves greater risk than core or coreplus
approaches, notably by an increased reliance on greater leverage, renovation or development,
and a focus on secondary markets. Much of the increased risk involved with value-add projects
arises from the construction element of such projects. Lesser renovations can include property
enlargement, significant capital improvements (e.g., a new roof or lobby), refinishing of interiors,
or certain structural repairs. More significant redevelopment can include a major overhaul of the
property, or its conversion to a different use (e.g., a warehouse converted to multi-family
apartments). Construction risks include the possibility of higher-than-expected costs (financing,
materials, or labor) and uncertainty about the future economic environment, i.e. whether the market
valuations applicable at the time of the project’s completion will support the costs incurred by the
construction.
Value-add properties may also be located in secondary or tertiary markets, which can be
somewhat riskier than primary markets since, all else being equal, primary markets may be more
desirable for tenants and may be present market participants with less development competition.
The re-tenanting opportunities available in secondary markets can serve to increase cash flow
when existing rents are below current market levels, but also present a risk element since a
borrower may find it to be unexpectedly difficult to find new tenants. Finally, value-add
opportunities rely more heavily on “total return” – as opposed to just current yields – since price
appreciation is a key component of the strategy.
Value-add strategies require significant market expertise. Borrowers must have enough
local market knowledge to acquire and reposition older assets by introducing property upgrades or
operational improvements that are valued in that market region. Borrowers must evaluate local
market information, factoring in the cost of construction and the process, and determining whether
they see a higher and better use than what currently exists. There can be no assurance that a
borrower related to a particular series of Notes will be able create value and execute strategically
on its business plan in a way that enables that borrower to pay interest and principal on the
corresponding borrower loan.
Payments on the Notes depend entirely on payments the Company receives on corresponding
borrower loans. If a borrower fails to make any payments on the corresponding borrower loan
related to your Note, payments on your Note will be correspondingly reduced.
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The Company will only make payments pro rata on a series of Notes after it receives a
borrower’s payment on the corresponding borrower loan. The Company also will retain from the
funds received from the relevant borrower and otherwise available for payment on the Notes any
non-sufficient funds fees and the amounts of any attorneys’ fees or collection fees it, a third-party
servicer or collection agency imposes in connection with collection efforts. Under the terms of
the Notes, if the Company does not receive any or all payments on the corresponding borrower
loan, payments on your Note will be correspondingly reduced in whole or in part. If the relevant
borrower does not make a payment on a specific monthly loan payment date, no payment will be
made on your Note on the corresponding succeeding Note payment date.
The Notes are special, limited obligations of the Company only and, except for the security
interest in the corresponding borrower loan granted to the Indenture Trustee, are not secured
by any collateral or guaranteed or insured by any third party.
While the corresponding borrower loans (or the components thereof) will be secured by a
mortgage, deed of trust, security agreement, or legal title, the Notes themselves are special, limited
obligations of the Company and will not represent an obligation of the borrower or any other party
except the Company. The Notes are not secured by any collateral other than the security interest
in the specific corresponding borrow loan granted to the indenture trustee and are not guaranteed
or insured by any governmental agency or instrumentality or any third party. Investors in the
Notes may look only to the Company for payment of the Notes. Furthermore, if a borrower fails
to make any payments on the corresponding borrower loan, Investors in the related Notes will not
receive any payments on their respective Notes. Investors will not be able to pursue collection
against the borrower and are prohibited from contacting the borrower about the defaulted borrower
loan.
Investors do not themselves have a direct security interest in the corresponding borrower
loan or the right to payment thereunder. The Company has granted to the indenture trustee, for
the benefit of each Investor in a series of Notes, a security interest in the corresponding borrower
loan and the payments and proceeds thereof. The indenture trustee may exercise its legal rights
to the collateral only if an event of default has occurred under the related indenture agreement,
which include our or RealtyShares’ becoming subject to a bankruptcy or similar proceeding. If
an event of default under the Indenture were to occur, the Investors would be dependent on the
indenture trustee’s ability to realize on the collateral and make payments on the Notes in the
manner contemplated by the Indenture.
Despite the Company’s separate legal status and its relationship with the indenture
trustee, there remains a risk that if RealtyShares were to become subject to a bankruptcy or
similar proceeding that a bankruptcy court might determine that the Company’s assets should be
consolidated with those of RealtyShares. In such event, your rights could be uncertain, your
recovery of funds due on the Note may be substantially delayed, and any funds you do recover
may be substantially less than the amounts due or to become due on the Note. In addition,
although the Company will take all actions that it believes are required under applicable law to
perfect the security interest of the indenture trustee in the collateral, if its analysis of the required
actions is incorrect or if it fails timely to take any required action, the indenture trustee’s security
interest may not be effective and holders of the Notes could be required to share the collateral
(and any proceeds thereof) with the Company’s other creditors and/or the creditors of
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RealtyShares.
If the Company deems it necessary to conduct a Protective Advance Offering, issued and
outstanding Notes will be subordinated to any additional securities, Notes, or advances made
pursuant to such Protective Advance Offering, which could result in a total loss of principal or
interest to investors of previously issued Notes.
In the event the Company determines that additional capital is necessary to preserve or restore
the value of a project investment in default, it may obtain such capital by conducting a Protective
Advance Offering. In such event, any additional securities, Notes, or advances made pursuant to
such Protective Advance Offering may rank senior to the Notes series corresponding to the
project investment, and holders of such Notes will be at risk for total loss of their investment.
The Company does not have significant historical performance data about performance on the
corresponding borrower loans. Loss rates on the corresponding borrower loans may increase
and prior to investing you should consider the risk of non-payment and default.
The Company is in the early stages of its development and has a limited operating history.
Only a limited number of borrower loans have been offered through the Company’s platform prior
to this offering. The Company’s management has experience in real estate loans and related loan
syndication, and the Company has made other real estate loans under other formats, but the
performance of previous borrower loans may not be indicative of the future performance of the
Company’s borrower loans relating to corresponding Notes, and the Company does not yet know
what its long-term loan loss experience will be.
If payments on the corresponding borrower loans relating to your Notes become past due or
otherwise in default, it is likely you will not receive the full principal and interest payments that
you expect to receive on your Notes, and you may not recover your original purchase price.
If a corresponding borrower loan becomes past due or is otherwise in default, the Company
may need (in the case of a senior or junior loan) to foreclose on the property underlying the
corresponding borrower loan at a foreclosure sale unless the property is purchased by a third party
bidder at the foreclosure sale, or (in the case of a mezzanine loan) to assert its rights against the
equity interests in the borrower that are the subject of the applicable security agreement, or (in the
case of a participation interest) to depend on the originating lender to pursue such rights as are
applicable. The Company or one of its affiliates may act as manager for the foreclosed real estate
(or of the borrower, in the case of a mezzanine loan), and the costs of foreclosure or effecting such
other security interests will be advanced by Company, but if the Company cannot quickly sell such
property and the property does not produce any significant income, the cost of owning,
maintaining, and selling the property would reduce any proceeds gained through the sale. If the
foreclosed or controlled real estate cannot be sold for net proceeds that can fully return the
outstanding amount of the related Notes, Investors will lose part or all of their investment.
For some non-performing borrower loans, the Company may not be able to recover any of
the unpaid loan balance and, as a result, an Investor who has purchased a corresponding Note may
receive little, if any, of the unpaid principal and interest payable under the Note. Investors must
rely on the collection efforts of the Company or the applicable collection agency to which such
22
corresponding borrower loans are referred. Investors are not permitted to attempt to collect
payments on the corresponding borrower loans in any manner.
Loss rates on the corresponding borrower loans may increase as a result of economic
conditions beyond the Company’s control and beyond the control of the borrower.
Borrower loan loss rates may be significantly affected by economic downturns or general
economic conditions beyond the Company’s control and beyond the control of individual
borrowers. In particular, loss rates on corresponding borrower loans may increase due to factors
such as (among other things) local real estate market conditions, prevailing interest rates, the rate
of unemployment, the level of consumer confidence, the value of the U.S. dollar, energy prices,
changes in consumer spending, the number of personal bankruptcies, disruptions in the credit
markets and other factors.
The success of each borrower loan is dependent on the performance of the borrower and other
third parties over which we have no control.
With respect to a particular property, the borrower is responsible for various management
functions that are essential to the success of the Project, including property marketing and leasing
rates, payment of bills, maintenance of insurance, and property management generally. Poor
management on the part of the borrower could adversely affect the financial performance of the
corresponding borrower loan or expose it to unanticipated operating risks, which could reduce the
property’s cash flow and adversely affect the borrower’s ability to repay the corresponding
borrower loan.
Information supplied by borrowers may be inaccurate or intentionally false.
Borrowers supply a variety of information regarding the current rental income, property
valuations, market data, and other information, some of which is included in the Series Note
Listings. The Company makes an attempt to verify some of this information, but as a practical
matter, cannot verify the majority of it, which may be incomplete, inaccurate or intentionally false.
Borrowers may also misrepresent their intentions for the use of borrower loan proceeds. The
Company does not verify any statements by applicants as to how loan proceeds are to be used. If
a borrower supplies false, misleading or inaccurate information, you may lose all or a portion of
your investment in the Note.
With the exception of loans which have a draw feature coupled with them, when the
Company finances a corresponding borrower loan, its primary assurances that the financing
proceeds will be properly spent by the borrower are the contractual covenants agreed to by the
borrower, along with the borrower’s business history and reputation. Should the proceeds of a
financing be diverted improperly, the borrower might become insolvent, which could cause the
purchasers of the corresponding Notes to lose their entire investment.
Sales proceeds, or projected revenues, from a property could fall short of the amounts
projected.
Where a corresponding borrower loan is on a property being renovated, that property often
does not throw off any current revenues. In these cases, the success of the project generally
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depends on the borrower being able to make a profitable sale following the renovation work, or on
the borrower recapitalizing the property after it has been “stabilized” with new tenants and the
associated rental income. Such projected sales or refinancing events may not bring the proceeds
anticipated, and those proceeds could be inadequate to repay the corresponding borrower loan in
full.
Where a corresponding borrower loan is on a property with existing cash flow, the payment
schedules may be based on projected revenues generated by the property over the term of the
corresponding borrower loan. These projections are based on factors such as expected vacancy
rates, expense rates, and other projected income and expense figures relating to the property. The
actual revenues generated by a property could fall short of projections due to factors such as lowerthan-expected
rental revenues, or greater-than-expected vacancy rates or property management
expenses. In such event, the borrower’s cash flow could be inadequate to repay the corresponding
borrower loan in full.
Warehouse Affiliate’s lender may have superior rights in default. Where the Company has
borrowed money from the Warehouse Affiliate, we will be expected to repay this money promptly
as additional investments are made by Investors. If we are unable to do so, we will continue to
owe money to the Warehouse Affiliate. If we were to default in our obligations to the Warehouse
Affiliate, or if the Warehouse Affiliate were to default in its obligations to its own third-party
lenders, those lenders (the “Warehouse Lenders”) may be able to declare us in default and/or
exercise control over the actions of our third party servicing entities and/or indenture trustees.
Although we would expect the Warehouse Lenders to act in the best interests of all lenders to the
Company, we cannot assure you of what actions they may take. The Warehouse Lenders may
seek to direct payments made by the corresponding borrower to themselves, rather than allowing
them to be paid to all of the Company’s lenders, or they may not cooperate with you in pursuing
your rights in a default.
The Notes are restricted securities, will not be listed on any securities exchange, and no liquid
market for the Notes is expected to develop.
The Notes are not being registered under the Securities Act, but rather are being offered in
reliance on Rule 506 under the “non-public” offering exemption of Section 4(2) of the Securities
Act. The Notes will not be listed on any securities exchange or interdealer quotation system. There
is no trading market for the Notes, and we do not expect that such a trading market will develop
in the foreseeable future, nor do we intend in the near future to offer any features on our platform
to facilitate or accommodate such trading. Although the Notes by their terms are pre-payable at
any time without penalty, there is no obligation on our part to repurchase or otherwise prepay any
Notes at the election of an investor. Therefore, any investment in the Notes will be highly illiquid,
and investors in the Notes may not be able to sell or otherwise dispose of their Notes in the open
market. Accordingly, Investors should be prepared to hold the Notes until they mature.
Insurance against risks faced by a property could become more costly or could become
unavailable altogether.
Real estate properties are typically insured against risk of fire damage and other typically
insured property casualties, but are sometimes not covered by severe weather or natural disaster
24
events such as landslides, earthquakes, or floods. Changes in the conditions affecting the economic
environment in which insurance companies do business could affect the borrower’s ability to
continue insuring the property at a reasonable cost or could result in insurance being unavailable
altogether. Moreover, any hazard losses not then covered by the borrower’s insurance policy
would result in the corresponding borrower loan becoming significantly under-secured, and an
Investor in a Note could sustain a significant reduction, or complete elimination of, the return and
repayment of principal from that Note.
Environmental issues may affect the operation of a borrower property.
If toxic environmental contamination is discovered to exist on a property underlying a
corresponding borrower loan, it might affect the borrower’s ability to repay the corresponding
borrower loan and the Company could suffer from a devaluation of the loan security. To the extent
that the Company is forced to foreclose and/or operate such a property, potential additional
liabilities include reporting requirements, remediation costs, fines, penalties and damages, all of
which would adversely affect the likelihood that Investors would be repaid on the Notes.
Of particular concern may be those properties that are, or have been, the site of
manufacturing, industrial or disposal activity. These environmental risks may give rise to a
diminution in value of the security property or liability for clean-up costs or other remedial actions.
This liability could exceed the value of the real property or the principal balance of the related
mortgage loan. For this reason, the Company may choose not to foreclose on or operate
contaminated property rather than risk incurring liability for remedial actions.
Under the laws of certain states, an owner’s failure to perform remedial actions required
under environmental laws may give rise to a lien on mortgaged property to ensure the
reimbursement of remedial costs. In some states this lien has priority over the lien of an existing
mortgage against the real property. Because the costs of remedial action could be substantial, the
value of a mortgaged property as collateral for a mortgage loan could be adversely affected by the
existence of an environmental condition giving rise to a lien.
The state of law is currently unclear as to whether and under what circumstances clean-up
costs, or the obligation to take remedial actions, can be imposed on a secured lender. If a lender
does become liable for cleanup costs, it may bring an action for contribution against the current
owners or operators, the owners or operators at the time of on-site disposal activity or any other
party who contributed to the environmental hazard, but these persons or entities may be bankrupt
or otherwise judgment-proof. Furthermore, an action against the borrower may be adversely
affected by the limitations on recourse in the loan documents.
The Company has an incentive to fund as many corresponding borrower loans as possible,
which could impair its ability to devote adequate attention and resources to collection of
corresponding borrower loans.
Other than any revenue generated from the management of certain equity investment
opportunities offered from time to time by the Company, substantially all of the Company’s
revenues are derived from origination fees or servicing fees generated through making and
arranging borrower loans and offering related series of Notes. As a result, it has an incentive to
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finance as many projects as possible to maximize the amount of origination fees it is able to
generate. Increased project volume increases the demands on its management resources and its
ability to devote adequate attention and resources to the collection of corresponding borrower
loans. In the event that the Company takes on loan volumes that exceed its ability to service
outstanding corresponding borrower loans, our ability to make timely payments on the Notes will
suffer.
The property valuation models used by the Company in determining whether to make a
corresponding borrower loan may be deficient and may increase the risk of default.
Real estate valuation is an inherently inexact process and depends on numerous factors, all
of which are subject to change. Appraisals or opinions of value may prove to be insufficiently
supported, and the Company’s review of the value of the underlying property in determining
whether to make a corresponding borrower loan and the value of the underlying security may be
based on information that is incorrect or opinions that are overly optimistic. The risk of default in
such situations is increased, and the risk of loss to Investors will be commensurately greater.
The real property security for the corresponding borrower loans may decline in value.
The value of the real property security for each borrower loan will be subject to the risks
generally incident to the ownership of improved and unimproved real estate, including changes in
general or local economic conditions, increases in interest rates for real estate financing, physical
damage that is not covered by insurance, zoning, entitlements, and other risks. Many borrowers
expect to use resale proceeds to repay their borrower loan. A decline in property values could
result in a borrower loan amount being greater than the property value, which could increase the
likelihood of borrower default.
Although real estate assets are generally cyclical in nature, the Company’s operating
history since its inception does not yet span any prolonged down cycles in the real estate market.
Loans ending with large “balloon” payments carry particular risks.
Some of the corresponding borrower loans may be interest-only loans providing for
relatively small monthly payments with a large “balloon” payment of principal due at the end of
the term. Borrowers may be unable to repay such balloon payments out of their own funds and
will be compelled to refinance or sell their property. Fluctuations in real estate values, interest
rates and the unavailability of mortgage funds could adversely affect the ability of borrowers to
refinance their loans at maturity or successfully sell the property for enough money to pay off the
corresponding borrower loan.
Participation interests involve counterparty risk with the originating lender.
In the case where a third-party originating lender holds legal title to the mortgage loan
and is listed as the lender of record, that lender is the only party with a direct contractual
relationship with the borrower. In those situations, the Company would not have a direct claim
against the underlying borrower, but rather only a contractual relationship (via a participation
agreement) with the originating lender.
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If the originating lender files for bankruptcy, the Company’s right to receive payment on
the underlying loan under its participation interest will continue to depend upon (and flow
through) the originating lender. Whether the Company will be entitled to obtain the proceeds of
the underlying loan paid by the borrower, as opposed to merely having the right to assert a claim
in the originating lender’s bankruptcy as a secured or unsecured creditor, will depend on whether
the applicable participation agreement is characterized as (i) a true purchase and sale of an
undivided interest in an underlying loan or (ii) a loan from the Company to the originating
lender. Although the Company will endeavor to have its participation agreements structured such
that a bankruptcy court will likely determine that the participant holds an “ownership interest” in
the underlying loan, because the originating lender maintains record ownership of, and legal title
to, the loan and the right to receive payment from the underlying borrower, any attempts by the
Company to (i) take possession or control of the underlying loan or (ii) receive distributions
directly from the borrower of the underlying loan, will require relief from the bankruptcy court
governing the originating lender’s estate.
The counterparty risk extends to the originating lender’s compliant administration of the
underlying borrower loan. In a participation arrangement, the Company must rely on the
originating lender with respect to it meeting applicable disclosure requirements and complying
with relevant state or federal laws.
Construction and rehabilitation loans carry particular risks.
Construction and rehabilitation loans involve a number of particular risks, involving,
among other things, the timeliness of the project’s completion, the integrity of appraisal values,
whether or not the completed property can be sold for the amount anticipated, and the length of
ultimate sale process.
If construction work is not completed (due to contractor abandonment, unsatisfactory work
performance, or various other factors) and all the borrower loan funds have already been expended,
then in the event of a default the Company may have to invest significant additional funds to
complete the construction work. Any such investment would be recovered by the Company prior
to the Investor being paid back on the Note. If the value of an uncompleted property is materially
less than the amount of the construction loan, even if the work were completed, then upon a default
the Company might need to invest additional funds in order to recoup all or a portion of the
investment. Default risks also exist where it takes a borrower longer than anticipated either to
construct or then resell the property, or if the borrower does not receive sufficient proceeds from
the sale to repay the corresponding borrower loan in full.
Security of the corresponding borrower loans does not remove the risks associated with
foreclosure or seizure of equity interests.
Different property types involve different types of risk in terms of realizing on the collateral
in the event that the borrower defaults. These risks include completion costs in the case of an
incomplete project, partial resale for condominiums and tracts and lease-up (finding tenants) for
multi-family residential, small commercial and industrial properties. The Company may not be
able to sell a foreclosed or controlled commercial property, for example, before expending efforts
to find tenants to make the property more fully leased and more attractive to potential buyers.
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Moreover, foreclosure and similar remedial statutes vary widely from state to state.
Properties underlying defaulted senior loans (or equity interests underlying mezzanine loans) will
need to be foreclosed upon (or seized) in compliance with the laws of the state where such property
is located. Many states require lengthy processing periods or the obtaining of a court decree before
a mortgaged property may be sold or otherwise foreclosed upon. Further, statutory rights to
redemption and the effects of anti-deficiency and other laws may limit the ability for the Company
to timely recover the value of its loan in the event that a borrower defaults on a loan.
A bankruptcy of the borrower will prevent the Company from promptly exercising its remedies.
If the borrower enters bankruptcy, an automatic stay of all proceedings against the
borrower’s property will be granted. This stay will prevent the Company from foreclosing on the
property unless relief from the stay can be obtained from the bankruptcy court, and there is no
guarantee that any such relief will be obtained. Significant legal fees and costs may be incurred
in attempting to obtain relief from a bankruptcy stay from the bankruptcy court and, even if such
relief is ultimately granted, it may take several months or more to obtain. In such event, the
Company will be unable to promptly exercise its foreclosure remedy and realize any proceeds from
a property sale.
In addition, bankruptcy courts have broad powers to permit a sale of the real property free
of the Company’s lien, to compel the Company to accept an amount less than the balance due under
the loan and to permit the borrower to repay the loan over a term which may be substantially longer
than the original term of the loan.
The Notes limit your rights in some important respects.
To protect the Company from having to respond to multiple claims by investors in the
event of an alleged breach or default with respect to a series of Notes, the Subscription Agreement
restricts investors’ rights to pursue remedies individually in connection with such breach or
default.
In addition, the Company may require that any claims against it be resolved through
binding arbitration rather than in the courts. The arbitration process may be less favorable to
investors than court proceedings and may limit your right to engage in discovery proceedings or
to appeal an adverse decision.
“Events of Default” under the Note are limited to narrow circumstances.
Under the Notes, the Company’s bankruptcy or a similar event related to the Company’s
insolvency is deemed to be an Event of Default, upon which the entire outstanding principal
balance of the Notes and all accrued and unpaid interest thereon will become immediately due and
payable. Other acts or omissions by the Company that may represent breaches of contract,
including the Company’s failure to act in good faith in collecting corresponding borrower loans,
do not represent Events of Default under the Notes and do not result in the entire principal balance
becoming due and payable.
The U.S. federal income tax consequences of an investment in the notes are uncertain.
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There are no statutory provisions, regulations, published rulings or judicial decisions that
directly address the characterization of the Notes or instruments similar to the Notes for federal
income tax purposes. However, although the matter is not free from doubt because payments on
the Notes are dependent on payments on the corresponding borrower loan, the Company intends
to treat the Notes as its debt instruments that have original issue discount (“OID”) for U.S. federal
income tax purposes. You should be aware, however, that the U.S. Internal Revenue Service (the
“IRS”) is not bound by the Company’s characterization of the Notes and the IRS or a court may
take a different position with respect to the Notes’ proper characterization. For example, the IRS
could determine that, in substance, each Investor owns a proportionate interest in the
corresponding borrower loan for U.S. federal income tax purposes or, for example, the IRS could
treat the Notes as a different financial instrument (including an equity interest or a derivative
financial instrument). Any different characterization could significantly affect the amount, timing,
and character of income, gain or loss recognized in respect of a Note. For example, if the Notes
are treated as the Company’s equity, (1) the Company would be subject to U.S. federal income tax
on income, including interest, accrued on the corresponding borrower loans but would not be
entitled to deduct interest or OID on the Notes, and (2) payments on the Notes would be treated
by the holder for U.S. federal income tax purposes as dividends (that may be ineligible for reduced
rates of U.S. federal income taxation or the dividends-received deduction) to the extent of the
Company’s earnings and profits as computed for U.S. federal income tax purposes. A different
characterization may significantly reduce the amount available to pay interest on the Notes. You
are strongly advised to consult your own tax advisor regarding the U.S. federal, state, local and
non-U.S. tax consequences of the purchase, ownership, and disposition of the Notes (including
any possible differing treatment of the notes). For a discussion of the U.S. federal income tax
consequences of an investment in the Notes, see “Certain U.S. Federal Income Tax
Considerations.”
The Company’s ability to pay principal and interest on the Notes may be affected by its ability
to match the timing of its income and deductions for U.S. federal income tax purposes.
You should be aware that the Company’s ability to pay principal and interest on a Note
may be affected by its ability, for U.S. federal income tax purposes, to match the timing of income
it receives from a corresponding borrower loan that it holds and the timing of deductions that it
may be entitled to in respect of payments made on the Notes that it issues. For example, if the
Notes are treated as contingent payment debt instruments for U.S. federal income tax purposes but
the corresponding borrower loans are not, there could be a potential mismatch in the timing of the
Company’s income and deductions for U.S. federal income tax purposes, and the Company’s
resulting tax liabilities could affect its ability to make payments on the Notes.
29
Second-lien or mezzanine debt investments, and investments based on unentitled property or
property requiring substantial construction, carry particular risks.
Series of Notes relating to corresponding borrower loans involving second-lien or
mezzanine debt involve increased risk. Mezzanine loans that take the form of subordinated loans
secured by a pledge of the ownership interests of either the entity owning the real property or an
entity that owns (directly or indirectly) the interest in the entity owning the real property. These
types of investments may involve a higher degree of risk than long-term senior mortgage lending
secured by income-producing real property, because in the event of a bankruptcy of the entity
providing the pledge of its ownership interests as security, the assets of the entity may not be
sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt
senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied
only after the senior debt. As a result, we may not recover some or all of our investment. In
addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage
loans, resulting in less equity in the real property and increasing the risk of loss of principal.
Second-lien or mezzanine debt also involves increased risk of value fluctuations based
on the performance of the project, including potential decreases in value through and including
the loss of your entire investment in such Notes. Moreover, borrower loans involving untitled
land (where no zoning has been assigned or no building or development permits obtained) or
loans involving properties requiring substantial construction efforts (including ground-up
developments) contain additional risks relating to the nature of such efforts licensing or
construction efforts. Investors should closely review such investments and take into account the
additional risks involved with Notes relating to such borrower loans.
Risks Related to the Company
The Company does not intend to provide Investors with audited financial statements.
The Company does not intend to make the large expenditures necessary to provide audited
financial statements to Investors. There will be no independent certified public account reviewing
the Company’s finances and Investors will thus not be in a position to independently evaluate the
Company’s financial health in determining whether to purchase the Notes.
The indenture trustee may at any time terminate its relationship with the Company.
To further limit the risk to Investors of any bankruptcy of the Company or of our parent
RealtyShares, the Company has granted to an indenture trustee, for the benefit of each Investor in
a series of Notes, a security interest in the corresponding borrower loan and the payments and
proceeds thereof. The indenture trustee may terminate its relationship with the Company at any
time, however; the Company can thus provide no assurance that the indenture trustee will remain
in place throughout the term of any Note.
If despite the Company’s separate legal status and any relationship with an indenture trustee, a
bankruptcy court were to determine that the Company’s assets should be consolidated with those
of RealtyShares, the the rights of the holders of the Notes could be uncertain, and the recovery,
if any, of an Investor may be substantially delayed and substantially less than the amounts due
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and to become due on the Note.
The Company was formed so that, in the event of a bankruptcy of RealtyShares, the various
borrower loans that we own are expected to be shielded from claims by creditors of RealtyShares,
thereby protecting the interests of Investors in any series of Notes and in the proceeds of the
corresponding borrower loan. To further limit the risk to Investors of any bankruptcy of the
Company or of our parent RealtyShares, we have granted to an indenture trustee, for the benefit of
each Investor in a series of Notes, a security interest in the corresponding borrower loan and the
payments and proceeds thereof. The indenture trustee may terminate its relationship with the
Company at any time, however; the Company can thus provide no assurance that the indenture
trustee will remain in place throughout the term of any Note. In any case, if RealtyShares were to
become subject to a bankruptcy or similar proceeding and it was determined by a bankruptcy court
that the Company’s assets should be consolidated with those of RealtyShares, the rights of
Investors to continue receiving payments on the Notes could be subject to the following risks and
uncertainties:
• Interest on the Notes may not accrue during a bankruptcy proceeding. Accordingly, if Investors
received any recovery on their Notes, any such recovery might be based on the investors’ claims
for principal and interest accrued only up to the date the proceeding commenced.
• Our obligation to continue making payments on the Notes would likely be suspended even if the
funds to make such payments were available. Because a bankruptcy or similar proceeding may
take months or years to complete, even if the suspended payments were resumed, the suspension
might effectively reduce the value of any recovery that a holder of a Note might receive by the
time such recovery occurs.
• If an indenture trustee remains in place, the Notes will be secured only by a pledge to such
indenture trustee of the corresponding borrower loan. Investors do not have a direct security
interest in, or any direct claim to, the corresponding borrower loans.
• Because the terms of the Notes provide that they will be repaid only out of the proceeds of the
corresponding borrower loans, investors might not be entitled to share in the other assets of the
Company available for distribution to general creditors, even though other general creditors
might be entitled to a share of the proceeds of such corresponding borrower loans.
• If a borrower has paid the Company on any corresponding borrower loans before the bankruptcy
proceedings are commenced and those funds are held in the clearing account and have not been
used by the Company to make payments on the Notes, there can be no assurance that the
Company will be able to use such funds to make payments on the Notes.
• If a bankruptcy proceeding commences after the purchase price of Notes has been paid, holders
of the Notes may not be able to obtain a return of the purchase price even if the offering proceeds
have not yet been used to fund a borrower loan.
• Our ability to transfer our obligations to a back-up entity may be limited and subject to the
approval of the bankruptcy court or other presiding authority. The bankruptcy process may delay
or prevent the implementation of back-up services, which may impair the collection of
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corresponding borrower loans to the detriment of the Notes.
If the Company were to enter bankruptcy proceedings, the operation the Company’s activities
with respect to the corresponding borrower loans and the Notes would be interrupted.
If the Company were to enter bankruptcy proceedings or were to cease operations, we
would be required to find other ways to meet obligations regarding the corresponding borrower
loans and the Notes. Such alternatives could result in delays in the disbursement of payments on
your Notes or could require us to pay significant fees to another company that we engage to
perform services for the corresponding borrower loans and the Notes.
In a bankruptcy or similar proceeding of the Company, there may be uncertainty regarding the
rights of an Investor, if any, to access funds sent to the Company.
If the Company became a debtor in a bankruptcy proceeding, the legal right to administer
the Company funds would vest with the bankruptcy trustee or debtor in possession. In that case,
Investors may have to seek a bankruptcy court order lifting the automatic stay and permitting them
to withdraw their funds. Investors may suffer delays in accessing their funds in any Company
account as a result. Moreover, U.S. bankruptcy courts have broad powers and a bankruptcy court
could determine that some or all of such funds were beneficially owned by the Company and
therefore that they became available to the creditors of the Company generally.
The Company has a limited operating history, minimal operating capital, no significant assets
and limited revenue from operations.
The Company has minimal operating capital and for the foreseeable future will be
dependent upon its ability to finance its operations from the servicing fees it realizes on borrower
loans. There can be no assurance that the Company will be able to generate enough servicing
revenue to continue operations. The failure to successfully generate servicing revenue, and the
failure to originate or acquire quality borrower loans and sufficient Investor subscriptions for
Notes, could result in the bankruptcy of the Company or other event which would have a
material adverse effect on the Company and the Investors. The Company has no significant
assets or financial resources, so any such result could materially adversely affect your
investment.
When you subscribe to purchase a Note, you must commit funds toward your purchase, but
the Notes may not be issued until significantly later.
Each funding request for an investment opportunity remains open for some period of time,
and after an Investor has submitted a subscription agreement and remitted funds the Company
must still wait for funds to clear and for the corresponding borrower loan to close before the Notes
are deemed issued. You will not have access to your funds during the period between the time of
your subscription and the time when your Note is issued. Because your funds do not earn interest
prior to the time when the Note is issued, the delay in issuance of your Note will have the effect
of reducing the effective rate of return on your investment.
Borrower prepayments will extinguish or limit your ability to earn additional returns on a
32
Note.
Prepayment by a borrower (where some or all of the principal amount on the corresponding
borrower loan is paid earlier than originally scheduled) can reduce the utility of your investment
for the originally expected investment period. Some borrower loans do not prohibit prepayments,
or prohibit them only for short periods of time. When a prepayment occurs on a corresponding
borrower loan, you will receive your share of such prepayment, but further interest will not accrue
on that prepaid amount following the prepayment date. You may not be able to find a similar rate
of return on another investment and thus may have difficulty satisfactorily reinvesting the prepaid
funds.
Purchasers of Notes will not have the protection of the provisions of the Trust Indenture Act
of 1939.
We have granted to an indenture trustee, for the benefit of each Investor in a series of Notes,
a security interest in the corresponding borrower loan and the payments and proceeds thereof. The
indenture trustee may terminate its relationship with the Company at any time, however; the
Company can thus provide no assurance that the indenture trustee will remain in place throughout
the term of any Note. In any case, because this offering is being made in reliance on an exemption
from registration under the non-public offering exemption of Section 4(2) of the Securities Act, it
is not subject to the Trust Indenture Act of 1939. Consequently, purchasers of Notes will not have
the protection of the Trust Indenture Act of 1939.
The market in which we participate is competitive, and if we do not compete effectively our
operating results could be harmed.
The real estate lending market is competitive and rapidly changing. We expect competition to
persist and intensify in the future, which could harm our ability to acquire attractive real estate
investments.
Our principal competitors include major banking institutions, private equity funds, real estate
investment trusts, as well as other online lending platforms. Competition could result in reduced
volumes, reduced fees or the failure of the RealtyShares Platform to achieve or maintain more
widespread market acceptance, any of which could harm our business. In addition, in the future
we may experience new competition from more established internet companies possessing large,
existing customer bases, substantial financial resources and established distribution channels. If
any of these companies or any major financial institution decided to enter the online lending
business, acquire one of our existing competitors or form a strategic alliance with one of our
competitors, our ability to compete effectively could be significantly compromised and our
operating results could be harmed.
Most of our current or potential competitors have significantly more financial, technical,
marketing and other resources than we do and may be able to devote greater resources to the
development, promotion, sale and support of their platforms and distribution channels. Our
potential competitors may also have longer operating histories, more extensive customer bases,
greater brand recognition and broader customer relationships than we have.
These competitors may be better able to develop new products, to respond quickly to new
33
technologies and to undertake more extensive marketing campaigns. Our industry is driven by
constant innovation. If we are unable to compete with such companies and meet the need for
innovation, the demand for the Company’s products and services may substantially decline.
Risks Related to RealtyShares and the RealtyShares Platform
RealtyShares has a limited operating history. As a company in the early stages of
development, it faces increased risks, uncertainties, expenses and difficulties.
RealtyShares has a limited operating history. RealtyShares only began offering real estate
investments in June 2013.
For RealtyShares to be successful, the volume of financings originated through the
RealtyShares Platform will need to increase, which will require RealtyShares to increase its
facilities, personnel and infrastructure to accommodate the greater obligations and demands on the
RealtyShares Platform. RealtyShares also expects to constantly update its software and website,
expand its customer support services and retain an appropriate number of employees to maintain
the operations of its platform. If RealtyShares is unable to increase the capacity of its platform
and maintain the necessary infrastructure, you may experience delays in receipt of payments on
the Notes and periodic downtime of the RealtyShares Platform’s systems.
RealtyShares will need to raise substantial additional capital to fund its operations, and if it
fails to obtain additional funding, it may be unable to continue operations.
At this early stage in its development, RealtyShares has funded substantially all of its
operations with proceeds from private investment. RealtyShares will require substantial additional
funds to continue the development of the RealtyShares platform. To meet its financing
requirements in the future, it may raise funds through equity offerings, debt financings or strategic
alliances. Raising additional funds may involve agreements or covenants that restrict
RealtyShares’ business activities and options. Additional funding may not be available to it on
favorable terms, or at all. If RealtyShares is unable to obtain additional funds, it may be forced to
reduce or terminate its operations. Any inability for the Company to fund operations could have
a substantial and deleterious effect on the viability and operations of RealtyShares, which may
affect the Company’s ability to continue offering Notes on the RealtyShares Platform.
RealtyShares has incurred net losses in the past and expects to incur net losses in the future.
RealtyShares has incurred net losses in the past and expects to incur net losses in the future.
Its failure to become profitable could impair the operations of the RealtyShares Platform by
limiting its access to working capital to operate the platform. RealtyShares has not been profitable
since its inception, and it may not become profitable. In addition, it expects its operating expenses
to increase in the future as it expands its operations. If the Company’s operating expenses exceed
its expectations, its financial performance could be adversely affected. If its revenue does not
grow to offset these increased expenses, it may never become profitable. In future periods, the
Company may not have any revenue growth, or its revenue could decline.
If RealtyShares were to enter bankruptcy proceedings, the operation of the RealtyShares
34
Platform and the activities with respect to the corresponding borrower loans and the Notes
would be interrupted.
If RealtyShares were to enter bankruptcy proceedings or were to cease operations, we would be
required to find other ways to meet obligations regarding the corresponding borrower loans and
the Notes. Such alternatives could result in delays in the disbursement of payments on your
Notes or could require us to pay significant fees to another company that we engage to perform
services for the corresponding project investments and the Notes.
In a bankruptcy or similar proceeding of RealtyShares, there may be uncertainty regarding
the rights of a holder of a Note, if any, to access funds held by the Company.
If RealtyShares became a debtor in a bankruptcy proceeding, the legal right to administer the
assets of RealtyShares would vest with the bankruptcy trustee or debtor in possession. While the
Company has taken precautions to make itself “bankruptcy remote” from RealtyShares, there can
be no assurance that a bankruptcy court would observe these restrictions in a bankruptcy of
RealtyShares. Moreover, U.S. bankruptcy courts have broad powers and a bankruptcy court
could determine that some or all of such assets were beneficially owned by RealtyShares and
therefore that they should become available to the creditors of RealtyShares generally. In the
event that a bankruptcy court consolidated the assets of the Company with those of RealtyShares,
Investors or the indenture trustee may have to seek a bankruptcy court order lifting the automatic
stay and permitting Investors to realize the returns on their Notes. Investors may suffer delays in
accessing any available returns from their Notes as a result.
We rely on third-party banks and on third-party computer hardware and software. If we are
unable to continue utilizing these services, our business and ability to service the
corresponding borrower loans may be adversely affected.
We rely on third-party and FDIC-insured depository institutions to process our
transactions, including payments of corresponding borrower loans and remittances to holders of
the Notes. Under the ACH rules, if we experience a high rate of reversed transactions (known as
“chargebacks”), we may be subject to sanctions and potentially disqualified from using the system
to process payments. The Company also relies on computer hardware purchased and software
licensed from third parties to operate the platform. This purchased or licensed hardware and
software may be physically located off-site, as is often the case with “cloud services.” This
purchased or licensed hardware and software may not continue to be available on commercially
reasonable terms, or at all. If the Company cannot continue to obtain such services elsewhere, or
if it cannot transition to another processor quickly, our ability to process payments will suffer and
your ability to receive payments on the Notes will be delayed or impaired.
If the security of our investors’ confidential information stored in the RealtyShares Platform’s
systems is breached or otherwise subjected to unauthorized access, your secure information
may be stolen.
The RealtyShares platform generally uses third-party services to store investors’ bank
information and other personally-identifiable sensitive data. Any accidental or willful security
breach or other unauthorized access could cause your information to be stolen and used for
35
criminal purposes, and you would be subject to increased risk of fraud or identity theft. Because
techniques used to obtain unauthorized access or to sabotage systems change frequently and
generally are not recognized until they are launched against a target, the third-party services
utilized by RealtyShares may be unable to anticipate these techniques or to implement adequate
preventative measures. In addition, many states have enacted laws requiring companies to notify
individuals of data security breaches involving their personal data. These mandatory disclosures
regarding a security breach are costly to implement and often lead to widespread negative
publicity, which may cause our investors and borrowers to lose confidence in the effectiveness of
our data security measures. Any security breach, whether actual or perceived, would harm our
reputation, we could lose investors, and the value of your investment in the Notes could be
adversely affected.
Any significant disruption in service on the RealtyShares Platform or in its computer systems
could reduce the attractiveness of the investment platform and result in a loss of users.
If a catastrophic event resulted in a platform outage and physical data loss on the
RealtyShares Platform, the Company’s ability to perform its obligations would be materially and
adversely affected. The satisfactory performance, reliability, and availability of RealtyShares’
technology and its underlying hosting services infrastructure are critical to the Company’s
operations, level of customer service, reputation and ability to attract new users and retain existing
users. RealtyShares’ hosting services infrastructure is provided by a third-party hosting provider
(the “Hosting Provider”). RealtyShares also maintains a backup system. The Hosting Provider
does not guarantee that users’ access to the RealtyShares Platform will be uninterrupted, error-free
or secure. RealtyShares’s operations depend on the Hosting Provider’s ability to protect its and
RealtyShares’ systems in its facilities against damage or interruption from natural disasters, power
or telecommunications failures, air quality, temperature, humidity and other environmental
concerns, computer viruses or other attempts to harm our systems, criminal acts and similar events.
If RealtyShares’s arrangement with the Hosting Provider is terminated, or there is a lapse of service
or damage to its facilities, RealtyShares could experience interruptions in its service as well as
delays and additional expense in arranging new facilities. Any interruptions or delays in
RealtyShares’s service, whether as a result of an error by the Hosting Provider or other third-party
error, RealtyShares’s own error, natural disasters or security breaches, whether accidental or
willful, could harm our ability to perform any services for corresponding borrower loans or
maintain accurate accounts, and could harm RealtyShares’s relationships with its users and
RealtyShares’s reputation. Additionally, in the event of damage or interruption, RealtyShares’s
insurance policies may not adequately compensate the Company for any losses that we may incur.
RealtyShares’s disaster recovery plan has not been tested under actual disaster conditions, and it
may not have sufficient capacity to recover all data and services in the event of an outage at a
facility operated by the Hosting Provider. These factors could prevent the Company from
processing or posting payments on the corresponding borrower loan or the Notes, damage the
RealtyShares’s brand and reputation, divert its employees’ attention, and cause users to abandon
the RealtyShares Platform.
Risks Related to Compliance and Regulation
Non-compliance with laws and regulations may impair our ability to arrange or service
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borrower loans.
Failure to comply with the laws and regulatory requirements applicable to our business may,
among other things, limit our, or a collection agency’s, ability to collect all or part of the
payments on the borrower loans on which the Notes are dependent for payment. In addition, our
non-compliance could subject us to damages, revocation of required licenses or other authorities,
class action lawsuits, administrative enforcement actions, and civil and criminal liability, which
may harm our business and ability to maintain the RealtyShares Platform. In some instances, our
non-compliance may affect the enforceability of the promissory notes and security instruments of
the borrower loans.
If the Company is required to register under the Investment Company Act or became subject
to the SEC’s regulations governing broker-dealers, its ability to conduct its business could be
materially and adversely affected.
The SEC heavily regulates the manner in which “investment companies” and “brokerdealers”
are permitted to conduct their business activities. The Company believe it has conducted
its business in a manner that does not result in it being characterized as an investment company or
broker-dealer, as it does not believe that it engages in any of the activities described under
Section 3(a)(1) of the Investment Company Act of 1940 or any similar provisions under state law,
or in the business of (i) effecting transactions in securities for the account of others as described
under Section 3(a)(4)(A) of the Securities Exchange Act of 1934 (the “Exchange Act”) or any
similar provisions under state law or (ii) buying and selling securities for our own account, through
a broker or otherwise as described under Section 3(a)(5)(A) of the Exchange Act or any similar
provisions under state law. The Company intends to continue to conduct its business in such
manner. If, however, it is deemed to be an investment company or a broker-dealer, it may be
required to institute burdensome compliance requirements and its activities may be restricted,
which would affect its business to a material degree.
The Company has not reviewed our compliance with foreign laws regarding the participation
of non-U.S. residents on the RealtyShares Platform.
Although it is the Company’s current policy not to allow investments from persons not resident
in the U.S., from time to time it may occur that non-U.S. residents may purchase Notes on the
RealtyShares Platform. As we have not reviewed the compliance of these sales with applicable
foreign law, these sales of Notes could result in fines and penalties payable by the Company.
The Company is not subject to the banking regulations of any state or federal regulatory
agency.
The Company is not subject to the periodic examinations to which commercial banks and
other thrift institutions are subject. Consequently, our financing decisions and our decisions
regarding establishing loan loss reserves are not subject to periodic review by any governmental
agency. Moreover, the Company is not subject to regulatory oversight relating to our capital, asset
quality, management or compliance with laws.
Increased regulatory focus could result in additional burdens on our business.
37
The financial industry is becoming more highly regulated. There has been, and may
continue to be, a related increase in regulatory investigations of the trading and other investment
activities of alternative investment funds. Such investigations may impose additional expenses on
us, may require the attention of senior management and may result in fines if we are deemed to
have violated any regulations.
As Internet commerce develops, federal and state governments may adopt new laws to regulate
Internet commerce, which may negatively affect our business.
As Internet commerce continues to evolve, increasing regulation by federal and state
governments becomes more likely. Our business could be negatively affected by the application
of existing laws and regulations or the enactment of new laws applicable to lending. The cost to
comply with such laws or regulations could be significant and would increase our operating
expenses, and we may be required to pass along those costs to our investors in the form of increased
fees. In addition, federal and state governmental or regulatory agencies may decide to impose
taxes on services provided over the Internet. These taxes could discourage the use of the Internet
as a means of commercial financing, which would adversely affect the viability of the RealtyShares
platform.
Laws intended to prohibit money laundering may require the Company to disclose investor
information to regulatory authorities.
The Uniting and Strengthening America By Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the “PATRIOT Act”) requires that financial
institutions establish and maintain compliance programs to guard against money laundering
activities, and r
The 2008 recession was triggered by the real-estate bubble popping, so this had obvious effects on REITS, and then the stock market tumbled after.
The reverse scenario is what we will likely face in the next few years i.e. how will REITs react to stocks crashing. REITS did pretty well during the 2001 dot com crash. Hard to know for sure, but if the next recession isn’t triggered by real estate, REITs should be a good diversifier against the S&P 500.
Maybe. Maybe not. Hard to know how they will perform in the next stock market downturn. But I don’t think it’s a stretch to say there will be a higher correlation with stocks for real estate traded on the stock market vs real estate that isn’t traded on the stock market.
RE Lending Club IRA: I am also in the process of exiting and transferring money from my LC IRA to my Fidelity IRA. Strata (formerly Self-DirectedIRA) charges “only” $25/transfer for LC accounts and Fidelity reimburses these fees.
Fidelity reimburses them huh. That’s nice.
– One of the best option is Fundrise mutual fun (not exactly but take a look at it to see what I mean). Immediate diversification, both debt and equity deals, or both.
– Secondly, I did make a lot of money on lending club, then 1st half of 2017 did do well, barely 1% return. Now that portfolio has stabilized return are back to 8 – 8.7% over past six months. Overall, lending club at least for me has been good investment.
I’ve got a post coming up on the eREITs from Fundrise and RealtyMogul.
Similar story for me with LC. 4 or 5 good years, one mildly bad one.
The fine print in many of these deals says that the borrower dependent note is unsecured. I think that is a very key point. In many of the deals, the investor has the impression that the note is secured, but that is not what the fine print says. Now, the loan is secured by the real estate. However, the actual note you are investing in most of the prospectuses I have read state that it is unsecured. I don’t really know what this means for risk, but I do know that an unsecured asset is not as good as a secured asset. It would be in the investor’s best interest to invest in a project dependent note that is secured by the underlying asset. This kind of reminds me of the prime money markets. The are backed up by commercial paper, but everyone assumed they were secured by something as secure as treasury bills. One objection I have to the industry is that it seems to be implied that the investor is investing in a secured asset, when the fine print says it is unsecured. Usually this is pointed out in the “risk factors” section of the prospectus. Practically speaking, this may not make a difference. But, in a year like 2009 the reason may become apparent. As a famous man once said, “you don’t know who is swimming naked until the tide goes out.” There are only a few people (I am not one of them) who know why it is set up this way. Probably the attorneys that wrote the prospectus would be able to tell us. I would challenge the readers to go back and skip right to the risk factors where this information is revealed in many of these investments. It won’t take long to find or read.
Is it required to fill out a state income tax return in the state in which you partake in these investments? To my understanding the answer is yes. This would be one argument against doing these, unless it were a tax free state. The layer of complexity in doing an extra state tax return may not be worth the hassle of this asset class.
Depends on the state. Some states allow the LLC to file a consolidated return. Other states are tax-free. The debt investments don’t require a state return.
Interested to hear your thoughts on Fundrise eREITs (or similar) which to me seem to hit the sweet spot between effort, diversification, and return.
WLI would beat your returns on “never would have been in the stock market.”
That post is coming.
In the FAQ of one vendor, it says what you are investing in is UNSECURED debt. I wish one of the companies would set it up as secured debt to the investor providing the money. 65 percent LTV is great for the entity that has security in that asset, however that entity is NOT the investor. What if it is like 2009 and the vendor is doing poorly. Can the indentured trustee give the proceeds from the sale of the land to the company, and not the investor? I think that can happen, because the investor is signing up for an interest in an UNSECURED debt instrument. I would question whether or not this is giving the investor a “fair shake” in the deal. It is a fair shake in that this information is disclosed, but I would argue that most investors are interpreting this as a secured debt instrument when it is very clearly an unsecured debt instrument.
Voice of reason. Wise, this one.
C_N: so what would you suggest if someone wanted to get into RE investing today? Are you in favor of owning and managing local property vs syndications of any type?
It’s mostly a question of control. How much control/hassle do you want? If you want more control, go direct and deal with the extra hassle. If you want to minimize hassle, give up some control with syndications. Advantages both ways.
I’m not sure you’re looking at this correctly. And to clarify, we’re talking about debt investments here. My understanding is the LLC investing in the debt is in first lien position. Investors are members of that LLC.
So your emphasis on UNSECURED simply refers to the fact that it isn’t backed up by RealtyShares or Fundrise or whoever. It is still backed up by the property.
How would you recommend the crowdfunder set up the structure that would make you feel better about it? How do you think someone should invest in real estate?
Let me explain it this way. I am sure it can be done. If a lawyer can make a collateralized debt obligation, they can create a secured debt instrument. For example the borrower dependent note could read that it is a secured note by the real estate that it is supporting. By way of example, if the operator defaulted on their debt payment, the investors could go after the asset directly (if the trustee failed to do his job). Currently, the investors cannot go after the asset. Sure, the trustee can go after the asset, but does the trustee have to give the money to the investor? I think the answer is NO because the investor is buying a debt note that is not secured by the asset. The trustee can go after the asset, but the investor does not have access to the underlying real estate asset. When a bank lends a home owner money, the bank can take the home if a payment is not made. That is a secured debt. The bank would not sign up for a loan where they cannot get my house but the trustee can get my house (not the bank). Granted, I may be over thinking it, but it clearly says you are investing in an unsecured debt instrument. Perhaps that is why the yield is so high. The cynic in me believes it is set up this way on purpose in case things get ugly during a recession. After all, the lawyers did not write the borrower dependent note to state that it is secured by the underlying real estate, did they? However, they could have written the note that way, right?
Oh, I see. You want the investors to be able to go directly after the borrower instead of having to go through the LLC. How much yield would you be willing to give up to get that feature?
I just sent you a document where you get a secured note and a 15 percent yield. It is an example of a debt note that is secured by the real estate. It is more beneficial for the investor and less beneficial for the owner. In this case, there is not a vendor. It is direct with the real estate owner. The disadvantage is that if things go south, it is not the vendor taking the man to court, you are asking your attorney to get the job done. A different animal, for sure. However, I would rather take a 15 percent yield that is secured by the asset directly. Take a look…enjoy!
Right. I think that’s great. The downside? You’ve got to go out and find the real estate owner yourself. And if you have to foreclose, you’ve got to arrange that yourself. You’ve also got to make the loan yourself, rather than just loaning $1K, $5K, $10K, or $20K. Nobody is going to come knocking on your door saying, “Hey, I’d like you to loan me money at 15%.” You’ve got to build those relationships yourself. Or hire a fund manager to do it.
Good summary , and of course there are a million ways to invest in real estate.
As I have posted numerous times, I have done SFH, REIT’s , local commercial real estate, syndicated out of state multi family and invested in big private equity real estate (PERE) funds. I still manage the out of state multi family, but these days I prefer the expertise of PERE.
Until recently I have avoided the debt side, now I have a small chunk in a debt fund. However, as WCI pointed out it is horribly tax inefficient. I don’t participate with small players such as crowd funding, only because I was an active investor back in 2007-2008 and I have a bad taste in my mouth from those years when everyone was a real estate investor.
These days my current real estate investments are about 16% of my assets and I intend to grow that 20% ‘ish by retirement. Returns have varied over the years, from a loss on a SFH rehab 10 yrs ago, to over 20% per annum on local commercial real estate. The big funds typically pay around 7-8% preferred returns with IRR’s estimated at 14%+, although I have one paying 10% pref.
It’s all good, off course right now those returns pale in comparison to the broad market. But that will change in time, and the real estate cash will just keep coming in…
PEER STREET WARNING. I put 100K in as proof of concept on a specific property that I “vetted” in April 2016.
8% APR 18 months. LTV approx 65%. Peer Street has first lien. The property was fully funded end of June 2016 but didn’t go live until August 2016. I didn’t put another penny in after or roll the accrued interest into something else on their site. (experiment)This investment matured 01/01/2018. So my balance is approx. 111K. When I went to cash out the entire sum, was told the property is in default and they’re working on getting the money. Never again. Going forward, I’ll stick to what I know. Blue chip dividend paying multinationals, a few preferreds, some real estate etc. I was looking to diversify. Currently my return of capital+ rate of return @PS are sucking wind. I signed up for Equitymultiple.com in 2017 but have yet to invest a dime based on experience @PS.
So….why didn’t you pull out the payments over the previous 14 months? Or did the borrower never make any?
Just pulled out the 11K but the 100K is still in the wind.
Thanks for posting and validating what I’ve been saying.
None of this is “wrong” but the way it’s presented is not something I identify with (“Everythig is awesome” song comes to mind)
Maybe you’re not part of the team? 🙂
https://www.youtube.com/watch?v=StTqXEQ2l-Y
That makes sense. Please keep us updated what happens in the end.
I’ve been thinking about you since yesterday. You invested $100K in a single loan? How much do you have invested total in crowdfunded debt investments and across how many platforms? $100K seems like a huge chunk given the minimums of $2-10K. I would assume if you put that much into a single loan that you have millions invested in these things, but that might not be the case.
The collateral may not belong to the borrower dependent note holder in some of these companies. The prospectus (of some vendors) states that other creditors can claim the collateral on your loan! That would be like the bank lending me money so I can buy my house, but someone else other than the bank can collect my house if I don’t pay my mortgage. Jim, I sent the relevant clause to your email. Don’t get me wrong, I am not really against the concept, but I am making the argument that it is not really a secured loan in the traditional sense. Thus, the return is better because the risk is higher. I think these are reasonable investments for the enterprising investor, as long as it is with a small portion of one’s capital.
Beats me why you’d even consider them when your pal is allowing you to invest alongside him in 15% notes.
Boy, did we beat this one to death. Looking forward to tomorrow morning. Keep em coming! I am afraid to see what tomorrow’s topic is. I can only hope it is as feisty as this one.
The concept of crowdfunded real estate intrigued me after I read a detailed piece by Money Mustache a few years ago. This was my first foray into this type of product. Since I don’t do bonds ( except for 2 individual muni bond issues I bought around 8 years ago), I wanted something less correlated to stock market. Majority of our money is in after tax brokerages. In mid 2016, everything was already looking frothy. I resumed holding my nose and buying indiv stocks from my watchlist later that year. I also keep 6 years of cash for when the artificially propped up market pops but again looking for diversification (in all the wrong places).
Put 100K into single property as proof of concept @ Peer Street. Money actually funded property(money went to work@ 8%) 6.28.16.
Need to report back that all money returned 100K +14K. So I’m looking at Peer Street offerings again as a way to diversify. 8% is pretty good but remember taxed at 28% I think vs. 20% LTCG. Positives for me is that it’s something like a bond position. I feel that if I do a slow steady drip of 10K increments, I won’t get cut off at the knees. So something to consider. I Would invest again.
Thanks for sharing your experience.
WCI, thank you for an interesting article. I find many of the posts against you above to be unfair and borderline annoying.
These articles keep things interesting. Thanks again!
Funny how a little controversy gets all the attention, isn’t it? I ran an article on index funds today (the other 85% of my portfolio) and every one says how important it is, but nobody wants to read it or talk about it. Only 16 comments on that one.
Hence the news media “we” have created. Controversy brings attention and attention is the new economy.
Jim’s consistent up-front disclosure of his conflicts (any post that requires it, and a yearly comprehensive update) far exceeds any other blogger I’ve encountered. He has stated many times before that he is incentivized to run more posts on things that drive traffic to sponsors and/or affiliates. That’s just a fact, so he repeats it lest you think there is something sneaky going on.
In this case, he researches and participates in these alternative investments, and then he can comment on his experience in a post. This is a financial blog, so why not? I don’t do any of these things, but it doesn’t hurt to hear from someone who has. Buyer beware as always.