Proliferation of syndicated real estate investment opportunities

[VagabondMD]

I have seen a rapid proliferation of syndicated real estate investment platforms, and I am starting to grow concerned. I have invested with RealtyShares and Peer Street and have signed up (but not invested) with Realty Mogul and FundRise. It seems like I am getting multiple emails daily urging to invest in one platform or another. For the income oriented investor, the yields on the opportunities are quite attractive, in the 7-10% range, for short term offerings (8-12 months).

I spoke with a couple of friends who are involved in commercial real estate as a career and asked why there are so many opportunities for someone like myself to plop down some cash and passively earn a pretty good return. They do not understand why a credible, successful real estate developer does not get his or her own line of credit and leave the VagabondMD (and the like) out of the transaction. It makes no sense to them, and it makes little sense to me.

Is the public only being offered precarious deals? From over-leveraged operators? What gives?

I would be interested in hearing from anyone else who has participated in these syndicated real estate opportunities, any good or bad experiences, and any opinions why a successful real estate firm would offer me an 8% return on my investment since they presumably can get financing from a bank (or other lender) for much less.

[YYjames]

1. Not so easy to get lines of credit or bank financing for projects again and again. They are tight after 2008 fiasco.

2. Economy rolls in credit cycle. Currently in a very happy credit cycle and 2008 is a distant memory. Will come back to bite overleveraged players.

3. High yield investment that you are mentioning is hard money lending - while great, it depends on the "flip". No flip, your money is gone. Currently there are buyers so you get your interest and a balloon payment at term, but tulip mania may not last (I can't predict it ofcourse, but high yields in low yield general environment is not sustainable).

4. These are private platforms - data is sketchy and bad deals go under the rug. I do know of some deals going south on couple of platforms. Note that they haven't been through bad economic cycle. Another example is LendingClub - look at the troubles they are going through. Oh and the 12% returns WCI claims? Psh whatever. More like sub 7% on an amortizing loan.

5. Goal is always "sticky" capital. A regular joe like you is likely to stick it out vs. hedge funds. I promise you getting 8%, while great, the platform makes 2-3% and the borrower is making 8-9%+ net from your borrowed money.

 

[Zaphod]

Ive never liked these investments as they can be tax painful (p2p stuff) and dont like being the hard money lender at 1/3-1/2 of what you could get if you cut out the middleman and just did some hard money lending yourself.

I think there will be a reckoning of course as people pile into the space in search of easy money (both platforms and investors), while the earlier ones may do fine, those in at the end probably less so. The P2P lending space is already feeling the pinch with LC and now Prosper running into issues. Even if it was a good market in the early days and there was money to be made, the essence of capitalism means that eventually gets whittled down to more standard returns (risk/liquidity adjusted) as competition for less and less profit matures.

For 4-8% returns (tax equivalent) I'd just go with a muni bond fund/portfolio, not risk free, but much simpler and much less risky. Your return will vary depending on location and tax rate of course.

[The White Coat Investor]

Part of the reason for the rapid proliferation is the JOBS act. You simply couldn't do it before. So it's now the wild west until the weak companies get shaken out of the market and things start consolidating. Hard to pick now which ones will win but it seems reasonable to choose by volume.

As far as why go after your money instead of a bank's, it basically comes down to a cost of capital.

So far my experience is reasonably positive, but I've only had one complete trip (a 1 year debt investment paying 9%.)

[YYjames]

Actually cost of capital is cheaper with the banks. It is just limited due to banking laws post Dodd Frank.

[Zaphod]

Wild west is a good term for a lot of the new finance paradigms out there right now. Eventually as things become more set and regulated, better players will win and things will hopefully be a little more respectable and safe feeling.

[NJDoc]

I was considering getting involved with one of these platforms, but by the time I checked out the current offering it had sold out...in literally a few hours.

That reminded me of the crazy real estate years, prior to the crash when everyone and their brother was an expert in real estate. I am steering away from the little players and stay with the big respected names. You may not get 12% cash on cash with a large syndicator, more like 7%, but the project IRR's are solid usually over 14% and the likelihood of failure is lower in my opinion.

 

 

 

[Jim]

My problem with these sites is that they make it almost impossible to do your due diligence on the person or corporation you're investing in. As YYjames said, bad deals (i.e., defaults) are probably swept under the rug so as not to scare off new investment.  I've seen some of them brag about how much has been returned to investors, but try to get them to talk about who got burned and you'll hear crickets.  Too much risk, not enough return.

 

[PenguinMD]

Saw this posted over at BiggerPockets which also mentioned the current state of RE crowdfunding.
Worth a read.

https://dealflow.com/seriesd/real-estate-crowdfunding-jumped-shark/

I also started in P2P and then discovered Crowdfunding (both startup and real estate).

Liked the initial P2P returns but those are getting harder to clear double digits now. Also if it's a taxable account the extra tax headache plus getting taxed at marginal rate I ended up at the same if I just bought a state exempt muni plus no tax work!

For RE crowdfunding, I have investments in RealtyShares, RealCrowd and Fundrise. I have an old Fundrise investment when they still did individual. Now Fundrise as well as RealtyMogul are now pushing eREITS which should be interesting to watch.

It's a bit telling if major platforms are pivoting their strategy. The eREITS sounds scarily like a bundle of mortgage back securities -- they are giving themselves their own grading and projected returns... Hmmmm...

For me I stopped doing debt as it's not tax favorable. Equity is better but you do have paperwork so you want to pick your locations carefully plus the buy-ins are much higher so you want to do your due dillegence.

It is true that there is some selection bias, the most successful sponsors aren't on these platforms cause they don't need to find investors so you are kind of left with the b-team sponsors trying to grow their client base.

It's akin to doctors who accept HMO plans. Typically these are the fresh docs who need the volume. The more established and seasoned doctors only go PPO or in some cases CASH ONLY.

So the whole industry is ripe for consolidation as there's too many players and not enough deal flow. There's way more email and solicitations from the platforms to close deals then before so when that happens my "spidy senses" start going off .

Also don't count your return until you get it in the bank. I've seen very high projections but reality it's much lower.

Also this site attempts to capture all of the RE crowdfunding platforms which is just crazy right now.

http://www.therealestatecrowdfundingreview.com/top-100-sites-ranked-and-reviewed

As always it pays to do your homework. There's really no free ride, where you can just blindly pick from a menu and expect a 20+% return .

[Jim]

Many thanks for the thoughtful review & links, Penguin

[YYjames]

I know the lopito guy who made that "matrix" comparison for RE websites. Realize that everyone has an agenda - he does too. Won't go into details.

Investments in alternatives (I will consider CFE as alternative) should be run like a business. "Hard" to realize double digit returns because platforms are pushing Reg A+ investors and thus can manipulate yields lower + general competition + more efficiency + oversupply of money.

I will just say that if you can work hard and do due diligence, there are plenty of double digit RE returns out there. Can't do it click button, ACH debit the account way.

[PenguinMD]

A word about IRR, now that I'm deep in around a dozen or so CRE deals.

When looking at IRR you should keep in mind timeframe. Like I had a really good IRR for a 6mo project but in reality the actual net was not that sizable and the opportunity to re-invest for the next 6mo to hit that IRR wasn't there. Still a good a return but just realize what you get at the end of the day.

That's why looking at the multiple will help ground you on what is the real dollar return on capital to you.

What I found with IRR with a CoC component is that the IRR is calc against your slowly reducing principals. So if you invested 10K with a CoC of 10% and IRR of 15% then each year your principal amount keeps going down 10% (since you're getting it back) and then at the end you get the big cash payout (cross your fingers) which hits the PROJECTED IRR.

Most important its PROJECTED, so you want to also look at the preferred hurdle rate plus the splits at different tiers. The preferred equity rate is how much you get before the sponsor will get (pay you first). Also the capital stack is worth looking at as when I got a mortgage on my house they wanted around 20% so I had skin in the game, you want to see something similar with the sponsor. Are they in 10% or 15% do they have significant "skin in the game" that they would care if the deal goes south, you want to have your interest aligned.

I've seen double digit million dollars deals where he sponsor is only putting in 50k but asking for 4m in outside money and the rest loans. So in that case I don't think it's enough skin in there.

Granted when things are good, things are good and everyobe gets paid but you want to think worst case cause these are just projection they may never sell or refininance in 5yrs and then you're stuck.

This also depends on what you view as your betting amount if you don't lose sleep with any $25k investment (high roller in the house), then sure you can spread a bunch of bets on the roulette table and see how it goes. Outside of that, unfortunately need to do your home work and dig into the details.

[Jim]

Sounds like Penguin knows this stuff waaaay better than me  8O He's using terms I don't even understand!  :roll:

[PenguinMD]

Lol!

Same technique as when talking to patient families right!? Makes it sounds like we really knows what's going on, when in reality no idea!

Remember there's a fine line between knowing what you are doing and those THINKING they know what they are doing! Remains to be seen where I actually fall!

All this being said, at the end of the day it's about the outcomes so check back in 5 years and I'll let you know!

[NJDoc]

YYjames wrote:

A word about IRR, now that I’m deep in around a dozen or so CRE deals.

Click to expand...

Penguin,

All good points. While were are referencing a metric of performance such as IRR, it may be worthwhile to remind everyone that this is just one measurement. As Penguin mentions, multiple is another, Cash on Cash (CoC) is another. A key understanding of IRR is that the actual calculation assumes that the proceeds are reinvested at the same rate as the project IRR. If you use that money for other expenses, then you will not achieve the projected IRR. This is a major point in my opinion. To achieve the projected IRR the cash flow HAS to be reinvested at that same rate. Not easy to do as I can tell you from personal experience. Some syndicators will occasionally offer a modified IRR calculation , which assumes proceeds are reinvested at the cost of capital. I have found this to be quite a rare disclosure.

Hurdle rates and preferred returns are also key. Always take a look at the waterfalls involved with a project...more terms... but important.