243: Crowd Funding Strategies for Real Estate Investors

SHOW NOTES FOR EPISODE 243: CROWD FUNDING STRATEGIES FOR REAL ESTATE INVESTORS

Even in an uncertain marketplace, real estate crowd funding is attracting a broad cross-section of investors.  But what is the appeal and what kind of returns can investors realistically expect?  In today’s podcast, Adam Hooper, CEO of RealCrowd, discusses the current crowd funding marketplace and what strategies investors can employ for maximum success and returns.

What You Will Learn

• What crowd funding is – it’s advantages and limitations
• Why real estate is such a successful crowd funding asset
• Various crowd funding strategies that can pull in 10-12% yields
• What requirements do real estate managers using crowd funding need to have
• Three hot crowd funding markets
• What is the one thing a crowd funding investor MUST do to be a successful investor
• How investors are diversifying investment dollars through crowd funding over a broad cross section of assets, managers, geographic areas, etc. for the same investment amount as a single deal

About Our Guest

Adam Hooper

Adam Hooper is the founder and CEO of RealCrowd, an online real estate equity marketplace that has brought its members access to $4.5 billion of investment opportunities.  Founded in 2013, RealCrowd is a Y Combinator backed company that has grown to be a leader in the real estate crowdfunding space.  RealCrowd operates as a direct investment marketplace, where investors participate directly in the underlying asset, rather than a platform sponsored entity. This benefits investors by increasing efficiency, transparency and most importantly, reducing fees and layers of middlemen.  Prior to founding RealCrowd, Adam was a partner at a leading real estate capital markets firm where he was involved in over $1 billion of transactions sourcing and structuring joint venture equity investments.  In the commercial real estate business since 2004, he has been involved in launching three prior national platforms for investment sales and brokerage, as well as institutional joint venture equity investments.

More About Adam

• Making the transition into crowd funding was a natural efficient evolution for Adam because of what he was doing before (as a partner in a leading real estate capital markets firm) to help real estate managers to raise capital
• For every commercial real estate transaction out there, you have the debt portion and the equity portion.  His background was in helping real estate managers raise the joint venture equity portion
• Before crowd funding, if it was a syndication, the raise was a very inefficient process that involved country club networks, friends and family in one-on-one type settings
• When the opportunity to launch RealCrowd was presented, he was in his early 30s, married, had three children, had a good salary, benefits
• Sat down with his wife and said, “Hey, I think I’m going to quit and do the start-up thing.”  He just had this gut feeling that it would work
• It was a big transition for him coming from a very conservative, fact-based underwriting position to moving to Palo Alto, right down the street from Stanford, in a community where people’s brains just operate at a different level
• Even though it wasn’t the most rational decision he ever made, he saw it as a great opportunity to have a fundamental impact on how capital markets function.  The perfect storm!

Crowd Funding and the Birth of RealCrowd

• Crowd funding for real estate is relatively new
• Created out of a regulatory change in 2012 called “The Jobs Act”
• Indiegogo, Kickstarter and other donations-based crowdfunding organizations were getting started at this time
• They thought, “Why can’t we do that for real estate?”
• They wanted to take this distribution channel of the Internet (crowdfunding), leverage the new regulatory environment (The Jobs Act) that allows for private deals to be publicly advertised and build a platform around that to give access to this asset class
• That’s the core of what RealCrowd wanted to do – to bring access to both sides of the marketplace – helping investors access institutional quality deal flow all around the country that they didn’t have access to before.  And they wanted to give real estate managers access to syndicate their deals amongst high net worth individuals around the country
• That was the spark that started RealCrowd in 2013
• They were one of the first companies to do this
• They have seen much success over the years with both investors and real estate managers participating in the platform
• Had two family friends from the technology world (also co-founders) who joined him to make it work

Why Real Estate?

• Underwriting commercial real estate assets is a very rational numbers-based approach
• That is what attracted him to real estate when he started his career years before
• It was the financial and fact-based underwriting of commercial real estate that he liked over residential or leasing real estate
• But he also loves the critical relationship-focused aspect of real estate and they try to maintain that through their platform that allows participants to build and grow relationships to a new level

Building a Two-Sided Marketplace

• A two-sided marketplace is one of the most challenging types of companies to build because you have the “chicken and the egg problem”
• If you have a large investor base but no assets for the investors to invest in or if you have tons of assets but no investors, either situation can become a disaster
• The biggest challenge was how do you build both sides of this marketplace in tandem
• The advantage was that Adam had already built a large network and was able to attract real estate managers, to tell the story and get them to understand what RealCrowd was doing and how it impacts their business and how they could access this new pool of capital
• It was harder getting the investors on board.  Fortunately, they were part of a well-known technology accelerator group called Y Combinator, that helps tech start-ups successfully launch.  They were early on in crowdfunding and were able to ride the crowdfunding “press wave” through which they attracted a lot of Silicon Valley type investors who understood the technology and the benefits and saw this as an opportunity to diversify their concentrated portfolios in assets outside of their exposure to tech
• They maintained a lot of discipline on the real estate side to maintain a high caliber group of real estate managers, top tier real estate sponsors
• They educate and emphasize with their investors the importance of selecting the right real estate manager and developing a strong relationship with the manager/steward of their capital
• They have turned away a lot of business that doesn’t meet their high caliber requirements

Minimum Qualifications for Real Estate Principals Using RealCrowd

• Minimum of $50 million in transaction value (as a principal)
• 10 years minimum of principal level experience combined among the company
• One of those principals must have have at least 5 years of experience.  They define “experience” as the principal must have their own personal capital at risk in those deals
• If they were a commercial broker or a VP at a bank who has done many deals but they didn’t have their own money in those deals, they would not count that toward qualification on those deals
• In addition, RealCrowd does thorough background checks on principals (bankruptcies, foreclosures, litigation, reference checks, capital partner reference checks) to make sure that they are who they say they are, they have the track record, have the experience, so that when investors invest with them they know the investors are in good hands
• No minimum project size but the average size is $15-30 million, “sub institutional size,” $5-7 million on the low end, $35-40 million on the high end

When do Real Estate Managers Come to RealCrowd?

• Usually, once the asset is already in escrow, under contract
• Going through due diligence
• Basing their capital offline
• Getting their debt capital structure in place
• RealCrowd helps them along concurrent with the above activities
• That’s on an acquisition

Other Real Estate-Related Areas Covered by Crowd Funding

• They also do a number of re-caps – once they already own the asset or closed with it already on their balance sheet – looking to syndicate some capital that they’ve already closed the asset with
• They do funds (co-mingled real estate funds) anywhere from $25-250 million
  • Raise capital over 12-18 months
  • Deploy that over 3-4 years
  • Will be an evergreen or closed end fund – a pool of assets in that fund instead of a deal-by-deal specific capital raise
• Involved with many different strategies – They can fund from everything from single tenant net lease core assets all the way up to ground-up development
• The main asset classes they do include:
  • Office
  • Industrial
  • Some retail
  • A lot of multifamily
• They don’t do single family residential and land

State of the Asset Markets

• Do deals in 38 different states
• Multifamily is the most active
  • Seen the bifurcation between Class A (new product) and B, B-, C
  • A lot more opportunity in Class B than in Class A
  • Rents are pretty peaky
  • And to develop new product you have to charge very high rents – there’s not much room to grow
  • More downside potential than upside when talking about new Class A product construction
  • More re-positioning/value-add activity going on now in the market with slightly older vintage product – previously mismanaged, requiring capital reinvestment, upgrades, etc.
  • New supply pipeline is looking a bit thin
  • Portland has some new opportunities/dynamics
  • Seattle, San Francisco markets pricing is pretty hot
  • There are some secondary and tertiary market opportunities because there is not as much institutional capital chasing those deals yet – this seems to be where most of the opportunities exist
• Would love to see more industrial
• Investors are a bit skeptical on retail right now – see their podcast: Is Retail Dead? with Eric Hohmann

Investor Decisions Relative to Economic Changes and Risk

• A concern for RealCrowd is an investors ability to make an appropriate risk-adjusted decision based off of their current situation
• Some deals are just inherently bad and investors obviously need to stay away from those deals and other deals are better for some investors than for others
• RealCrowd is focusing a lot of their educational efforts on helping investors to better understand what is the right risk allocation model for themselves. He is trying to help investors learn how to look at the risks they are taking more than just what they are getting in their returns
• He’s not sure if he has seen, at this point in time, a marked shift in behavior by investors relative to their anticipation of market shifts
• He feels that generally real estate should be looked at on a longer term horizon, unless you are looking at a very quick value-add deal with rehab and a quick get out in the next couple of years
• If the projects are capitalized responsibly and you’re working with a sponsor that’s well-capitalized, with a more conservative business plan, whether the correction happens in 2020 or 2024, if the deals are structured correctly and they’re not over-leveraged and you have a prudent manager, you should be able to weather the cycle
• The time to get concerned is when you see projects that are highly-leveraged at 80, 85, 90%.  That’s what was happening before the 2008 crash.  That’s when he’ll see some concern and investor pull-back.  He has not seen that yet
• Maintaining conservative underwriting and conservative debt levels should hopefully position some of these assets so they can ride that out
• Is now the time to do a spec office development?  He thinks it’s a little late in the cycle to do that
• Stay with fundamental real estate.  Multifamily is good because people will always need a place to live
• Acquiring assets at an attractive basis, relative to replacement costs, those are some of the things that investors are starting to pay attention to and looking at overall market trends in terms of where they choose to invest
• They do have some longer-term-hold assets on their platform and he hopes to see more
• The early days of real estate crowd funding was focused more on hard money loans and fix ‘n flip debt that was super short term (6-12 month terms) and some investors in that space saw that as normal
• That’s not typical for most real estate holds.  Real estate is known for being able to ride out cycles for the long term
• He has seen a slight shift in that direction.  He would hope there would be more of an appetite for longer term holds
• Investor expectations for today’s underwriting is not keeping pace with the reality of the deals that are out there
• When people were first investing in 2013-15, there were a lot of great deals where investors could get in and out in 12-18 months with high IRRs.  Those deals are harder to find today
• Today, underwriting has tightened, deals have tightened, hold periods are extended.  Trying to get investors to get a hold of the reality of today’s market is a big part of their “investor education” efforts today

Biggest Mistake Investors Make With Crowd Funding

• Not establishing a direct relationship with the real estate manager
• Some crowd funding platforms operate more in an “aggregator model” where the crowd funding company forms an LLC and the investors are investing in the LLC – not a person, so there’s no direct connection between the investor and the manager.  That comes with an elevated fee and the underlying security isn’t in the real estate itself
• When investors do not know who they are investing with and don’t have that direct connection, that is one of the biggest mistakes he see

Biggest Investor Successes

• What he sees on his platform is investors who are diversifying across direct real estate investments by product type, manager, geographic location, strategy all for less money than before
• Many syndications require $250-500,000 minimum to get into some deal.  Real Crowd has $10-25,000 minimums
• By taking the money they may invest in a single asset deal and take that same amount of money and spread it across 15-20 different deals to build a well-diversified deal of assets to protect them against any specific market or asset challenge

Funds vs. Deals

• You can also invest in funds, as well as individual deals
• Their funds have had 10-12% annual returns
• Average deals are paying high single digit returns with IRRs in the mid-teens.  Some deals IRRs will be in the 20s but they are less frequent in today’s market

What Makes RealCrowd Stand Out?

• Ability to have direct contact with real estate managers
• Fee-free for investors.  They are compensated by the real estate managers
• Excellent investor education to make smart investment decisions
• Providing information that investors want

How Real Estate Managers Use Crowd Funding

• RealCrowd is not a full-replacement for the capital the manager needs (the LP equity).  They seek crowd funding to augment what they are already trying to raise.  They don’t rely on crowd funding to get the deal done
  • For example, if there is a $20 million dollar deal, the funds need come in as follows
    • $13 million loan
    • Manger needs $7 million in equity
      • Typically, 20-40% of equity will come through RealCrowd
      • The rest comes from existing capital sources
        • Friends
        • Family
        • Offline capital
        • Smaller institutional, family office types of groups
        • Or, their own balance sheet
  • Out of 180 deals RealCrowd has done, less than 5 have not closed their deals

Advice for Old Dawg Investors Interested in Crowd Funding

• Just get started
• Crowd funding is just doing what has been done for decades regarding raising capital.  The only difference is that it is an online resource
• Do you want to buy a whole asset and be responsible for running that asset or are you interested in partnering with an experienced real estate manager and having a more passive role?
• If investing as a limited partner is interesting to you, get educated, ask questions, do your due diligence, look at the manager’s track record, team and staff, read PPMs
• Real estate is a great investment to build a good diversified portfolio

What’s Ahead for RealCrowd?

• Continuing help people to make good investment decisions
• Have products coming online in the advisory space to help people assess risk
• Continue to grow – seek out great real estate managers with great projects

Rap-it-Up

• Favorite real estate book: Investing in Real Estate Private Equity: An Insider’s Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding by Sean Cook
• Favorite business book: The E-Myth by Michael E. Gerber
• Most valuable website for success: Google.com
• Favorite app: Fantastical or Spotify
• Favorite quote: “There’s no Plan B because that only detracts from Plan A.” and “Never confuse a vacation with a family trip.”
• If you had to start all over, knowing what you know, and you only had $1,000, what would you do to launch your business? Buy a computer and go on Google to find out what to do. Just get it done!

How Can You Reach Adam

• RealCrowd University – 6-week course to learn crowd funding
• Website: RealCrowd.com
• Email: ahooper@realcrowd.com

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