[Editor's Note: This is a guest post from Kenyon Meadows, a practicing oncologist and self-described “alternative investments enthusiast.” He is the author of Alternative Financial Medicine: High-yield investing in a low yield world and blogs at AlternativeFinancialMedicine.com. Although this is not a paid post, he is a paid advertiser on this site. While I do have some investments that would be considered “alternative,” at least 85% of my portfolio is invested in boring old index funds. In this post, Dr. Meadows explains why that isn't the case for him and details his experience with real estate crowdfunding. Some links in the post are WCI affiliate links (meaning if you sign-up for an account through the link I get paid.)
As a full time practicing physician with a strong interest in alternative assets, podcasts have been an indispensable tool in cutting my learning curve with BiggerPockets.com leading the way in the arena of real estate. I had the honor to be a guest on Episode 219 where the hosts and I focused on some of the more passive investing strategies suitable for time-constrained professionals including things like turnkey single family rentals, private mortgage lending, and real estate crowdfunding.
Of these three arenas, real estate crowdfunding (RECF) certainly elicited the most follow up questions from listeners. I have been an early adopter in this asset class having participated in my first deal in 2013 and many wanted to know what platforms I have used and what my results have been.
Real Estate Crowdfunding
As a brief introduction, this asset class represents the largest sector of equity crowdfunding that has emerged after the 2012 JOBS act.
Some of you are probably familiar with sites like Indiegogo and Kickstarter. These are known as rewards-based crowdfunding whereby people could make small monetary contributions in exchange for early or special access to various items like independent movies, books, music, and consumer products.
A key restriction was that contributors were not allowed to participate in any financial return or have an ownership stake in the product. The JOBS Act lifted this restriction and ushered in a wave of new online platforms offering a wide spectrum of new crowdsourced opportunities with a clear expectation of profit for the investor. It is now possible to take relatively small amounts of money and purchase a small stake in a Silicon Valley startup, loan money to an established small business, and — yes — participate in real estate deals.
Real Estate Flipping – Debt Investing
Remember the plethora of “Flip This House” shows on HGTV that were wildly popular particularly before the 2008 financial crisis? What many of us may not know is that when a real estate entrepreneur needs money for a house flip project, they don't go to a bank but commonly to a private network of high net worth individuals (read: You!) for financing.
In a traditional private mortgage investment, typically one investor would provide a short term, high interest rate loan commonly in the 8%-15% range for 6 to 18 months. This is usually an adequate time frame to acquire, renovate and ultimately sell the property at a profit sufficient to both service the loan and provide enough return to make it worth the entrepreneur's efforts.
Obviously the number of people who can write the high five-figure to mid six-figure checks needed for the initial acquisition of even a modestly priced property is limited; even among physicians. Herein is where the real disruptive capacity of RECF comes to the fore.
The online platforms function essentially as brokers between the real estate entrepreneurs, also known as sponsors; and the crowd of investors willing to fund their deals. With investment minimums ranging from $50,000 to as little as $100, private mortgage lending is steadily becoming more convenient and accessible to a much wider pool of individuals.
Besides debt, there are abundant equity or fractional ownership opportunities with multiyear investment timeframes. Additionally, some platforms have developed specific niches around different property types or geographic regions.
I am going to highlight three platforms that have distinct profiles in terms of the types of deals they offer and meet the following criteria:
- The platform has been in existence for a minimum of 3 years
- I have been investing on it for at least 2 years
- I have had at least 1 successful exit on a deal
We will start with Realtyshares.com which I consider a sort of jack of all trades in RECF in that they offer a wide variety of deals including single and multifamily residential as well as commercial projects.
They offer first as well as second position debt and also plenty of equity opportunities. Depending on the type of project and deal size, their investment minimums vary greatly and while their website banner says the minimum is $5000, in actuality they have projects you can participate in for as little as $2,000 and ranging up to $30,000. This is been my number one site by volume and they have an ample diversity of offerings that can suit a number of investing styles.
Check out an in depth interview with the CEO to learn more about the backstory of the company and their selection criteria for deals.
[Editor's Note: If you are interested in investing with RealtyShares, go through this link and use promotional code “PARTNER100” to earn an extra $100 with your first investment.]
Patch of Land
Next up is PatchofLand.com and from the beginning they have been focused exclusively on single family residential properties with first position debt for fix and flip projects.
Accordingly, these are all short 6 to 18 months duration loans with typical interest rate in the 9 to 12% range. The minimum investment is $5,000. Patch of Land is a particular favorite of mine because, when it comes to crowdfunding, I only do first position loans. First position is synonymous with the senior debt which means that legally we have top priority in getting paid back; even if the property has to be foreclosed upon and sold to accomplish this.
For now both Realtyshares and Patch of Land are limited to accredited investors. According to the SEC that means you either earn more than $200,000 annually as an individual, $300,000 as a married couple, or have a net worth of 1 million dollars minus the value of your primary home. While this is not an issue for many members of the WCI community, only about 4% of the general population meet this criteria.
The vast majority of RECF sites currently have the accredited investor limitation, however one exception that I know of and have used is called Groundfloor.com.
Their mission has always been to cater to the non-accredited investor with residential fix and flip projects using both first and second position debt with an investment minimum at an unbelievable $10 to participate! They advertise average returns of 10% since their founding in 2013. A BIG non-financial restriction for Groundfloor however is that you must be a resident of these 9 states to invest: CA, IL, MD, MA, TX, VA, WA, GA, DC.
It is a long and complicated regulatory issue as to why this is the case, but I know they are working to get a 50 state exemption so check back for updates.
How I Evaluate a Deal
When I'm going on a site looking for a debt deal there are some pretty standard elements presented to you in the user interface. Besides the standard array of pictures, you will see the overall loan size which in this case is $147,000 with an interest rate is 10.25% and 12 month term. You will also be presented with the after repair value or ARV percentage which ideally should be below 65% to 70%. There's a graph indicating what percentage of the loan has been funded and from my experience most projects will fund anywhere from a few days to a week from the time they are listed.
The platforms also provide an abundance of electronic documentation allowing investors to perform a thorough “digital due diligence” prior to committing any money. Items typically included are the developer’s track record of past projects, renovation scope of work, and some form of price analysis such as an appraisal or market comparable. On the more long term equity projects, the capital structures can get complex including components like preferred equity and mezzanine debt.
I have certainly seen many projects get funded in a matter of hours; particularly if it's in a hot geographic location or the interest rate offered is very attractive. Of course this sometimes makes it impossible to go through all of the due diligence documents and highlights one of the fundamental limitations about real estate crowdfunding – you have to trust the platforms underwriting processes. When it’s all said and done, you must have confidence that all of the deals listed have been scrutinized thoroughly. The platforms certainly have the incentive to do this because if too many deals fail to perform, investor confidence and capital would be quickly lost with very little chance of earning it back.
Thus far I think my experience validates solid underwriting. Out of the 35 projects I participated in I've had 17 successful exits, 15 are current and performing as expected while 3 are in some stage of the foreclosure process. My overall returns have averaged a very satisfactory 11% annually for 3 years. With the foreclosures I'm getting regular email updates from the platforms; and in all cases they are confident that my original capital will be returned after taking possession and a subsequent liquidation sale. These relatively few negative experiences reinforce my original decision to stick with first position debt as ultimately this is the safest place to be in the capital stack when inevitably some deals don’t perform as expected.
This dovetails into the important and recurring theme regarding investment styles and risk tolerance. Due to my early adoption I am by default on some of the larger, more-established platforms in the industry that trace their origin from late 2012 to early 2013. Consequently many of them have completed several debt projects and have strong relationships with both repeat sponsors and their investor network. Anytime I see a new debt deal with a sponsor with which I have had a successful exit; I give that project priority-even if the interest offered is a little lower. Many new platforms and sponsors have proliferated over the past 2 years in particular, but I have not seen a compelling reason to migrate away from the more established players.
As mentioned, I am relatively conservative when it comes to RECF by limiting my investments to first position debt. It follows then that the platforms that offer these types of deals exclusively have a higher priority. Keep in mind that unless you invest with your IRA, there is no particularly favorable tax treatment for the interest earned on a private mortgage. Equity returns by contrast, can be shielded by the expenses associated with ownership as well as depreciation resulting significant tax savings. If this is important to you and the longer investment timeframes are not an issue, there are certainly sites that skew heavily towards these offerings. If your preference is to deploy larger chunks of capital per project, you will likely favor equity as well as the investment minimums are routinely 3-5 times that of a debt offering.
In summary, real estate crowdfunding represents an exciting and emerging asset class that is bringing an unprecedented level of access to the retail investor by leveraging the power of the internet. It deserves a serious look for any accredited investor looking to gain alternative exposure to either high yield, short term secured debt or fractional ownership of income property.
[Editor's Note: WCI has an affiliate relationship with the following crowdfunding sites. If you choose to invest with them, please go through these links as it helps support the site and sometimes gets you a special deal:
- Invest with RealtyShares! Use promotional code “PARTNER100” to earn $100 with your first investment.
- Invest with RealtyMogul!
- Invest with FundRise!
- Invest with Equity Multiple! Management fee on your first investment waived when using this link.]
What do you think? Have you invested with any of these crowdfunded companies? Why or why not? What has your experience been like? Any tips for someone considering these investments? Comment below!