This article will profile a successful real estate crowdfunding investment. Real estate crowdfunding started in 2012 and is therefore a relatively new investment alternative. However, real estate has been one of the longest investment classes in history.
In October 2016, I decided to invest $10,000 in my first real estate crowdfunding investment. It was a “Class A,” 30,265 sqft, two-story office building in Conshohocken, Pennsylvania. Conshy, as the city is commonly known, is located 25 miles northwest of downtown Philadelphia. I even wrote a detailed post about the project to get the community's advice before investing.
The building was purchased at 70% occupancy. There was a value add plan to lease it up and bring the rents to market rates. The sponsor, Haverford Properties, planned to hold onto the property for five years. The goal was to hopefully sell it for 40% more.
Instead, the sponsor decided to sell the equity portion of the deal for a 22.7% premium in 4Q2019 after three years and call it a day. Below shows a deposit I received of $12,271.84 from IRM, the new servicing manager that took over from RealtyShares in 2019.
Lessons Learned From A Successful Real Estate Crowdfunding Investment
My first reaction to getting my capital back plus a net 22.7% gain was that of happiness and relief. RealtyShares decided to close its doors to new investors in November 2018 and sell its book of business to a new operator, IRM.
The transition period was filled with uncertainty, but I had faith either a competitor would buy RealtyShares or an experienced operator would purchase the existing assets, earn its fee, and wind them down. After all, an individual LLC was created for each investment and would continue going no matter the fate of the real estate platform.
My next reaction after getting my capital back was inspired out of greed. 22.7% over three years is only about a 7% compound annual growth rate. A 7% return in 2018 was fantastic given the S&P 500 closed down 6.24%. But a 7% return in 2019 when the S&P 500 closed up 31% is dismal.
Then I remembered the sponsor had promised to pay out annual distributions from its Net Operating Income of 8.4% a year. If this was true, then my total return over three years would be closer to 48%, for an attractive and steady 14% Internal Rate Of Return (IRR).
Here are some important lessons I've learned from this real estate crowdfunding exit that should help us better evaluate future investments.
1. Never Get Mesmerized By Blue Sky Real Estate Scenarios
The sponsor that gets me worried is one that tries to sell their deal too hard. One way to attract capital to their deal is to provide a Blue Sky Scenario that makes their potential returns sound amazing. Just know that a Blue Sky Scenario is highly unlikely to happen. I'd assign it a 10% chance of coming true.
As an investor, your goal is to look at multiple scenarios, including a Downside Scenario, a Realistic Base Case Scenario, and a Blue Sky Scenario. If a sponsor does not give at least two different return scenarios in its marketing and research material, I would move on or at least question them further.
A good rule is to take whatever the sponsor's forecast is and cut it by 30% to calculate your expected return. Of course, a sponsor who has a history of overpromising and underdelivering will hurt their future capital raising needs. Therefore, it's up to the investor to stick with only repeat sponsors with a long track record of delivering or surpassing on their promises.
One more thing, the sponsor described the Conshy office building as Class A. But if you look at it below, it looks more like Class B to me. In my mind, Class A office buildings are those ultra-modern skyscraper or iconic type office buildings in major cities such as the TransAmerica building in San Francisco or the Chrysler Building in NYC.
Also, you never know when there might be a recession around the corner. So it's good to have those bear case scenarios before investing in real estate.
2. Skin In The Game Matters In Real Estate
Below are the sources of financing for the Conshy, PA real estate deal. Out of a total of $5,927,433 in financing, only $267,433 or 4.5% came from the sponsor. That is not a lot of skin in the game.
Instead, I think we investors should expect the sponsor to have at least 10% of their capital in the deal. After all, banks usually require homeowners to put down at least 10% for a primary residence and 30% for a rental property investment.
Notice how the sponsor writes “(16.4%) (1)” next to Sponsor Equity to make the amount seem bigger than it really is. Sure, the sponsor's equity is indeed 16.4% of total equity raised. However, their skin in the game is really only 4.5% of total capital.
If you plan to take more risk as an equity investor, you want the sponsor to feel as much pain as possible if things go wrong. I have seen several deals go south for equity investors because the sponsor had very little equity invested.
3. Understand The Capital Structure
The Conshy, PA deal was composed of 73% debt ($4,300,000) and 27% equity ($1,627,433). If the sponsor was a complete failure at adding value to the property and ended up selling the office building for only $4,300,000, equity investors would lose 100% of their capital even though the property value declined by only 27%.
The reason why equity investors lose 100% is because equity is LAST to get repaid in the capital structure. See below the priority in repayment in the capital structure, also known as the capital stack.
I don't know what the terms were for debt investors in the Conshy, PA deal, but I can imagine it would be something like 7-8% a year for five years. The target equity return in the deal was more than double.
Let's say the sponsor did a fantastic job and Conshy, PA became the new Amazon headquarters on the east coast. The commercial office building rises in value to $10 million in five years. In this scenario, debt investors would still only get 7-8% a year in interest payments and 100% return of capital in five years.
But equity investors would get roughly: $10 million sale – $4.5 million debt = $5.5 million equity. I've excluded selling costs in the equation for simplicity. The equity return would therefore be 238% or a 27% IRR over five years.
The more bullish you are on the property, the more equity risk you should be willing to take. However, to make an appropriate investment, you must analyze the capital structure.
See: Deciding Between A Debt Or Equity Real Estate Investment
4. Real Estate Marketplace Platform Risk
Because RealtyShares closed its doors to new investors at the end of 2018, there was a lot of uncertainty regarding what would happen to the existing deals. Would some shady sponsors try and take advantage of the closure and not follow their operating agreement? Would investor's money disappear into a black hole?
For about five months, there was not a lot of clarity as to what was going on as RealtyShares sought a buyer. In the end, a company by the name of IRM was created to manage the existing book of business through to completion.
IRM would earn the remaining fees and investors would feel more confident that someone was at the helm to make sure sponsors kept doing what they were supposed to be doing.
New Management
Once IRM took over, it would take them another three months or so to get familiar with all the deals, the interface, and the sponsors. Only then did updates start coming out again. Further, there were many examples where payments took longer than usual to pay out.
I was never really worried my money would disappear. The operation of RealtyShares and the individual real estate investments I made were in separate LLCs. Besides, sponsors wouldn't want to risk committing fraud in such a public setting.
As a real estate crowdfunding investor, you've got to spend time researching each platform. You must understand each business model and making sure it has enough capital.
It was my understanding that RealtyShares had a closing dinner to celebrate a new round of funding. However, the investors got cold feet and pulled their investment last minute.
If you are very worried about platform risk, CrowdStreet has a unique business model. CrowdStreet connects the investor directly with the sponsor. In other words, if you invest in one of their deals, you will be investing on the sponsor's platform. This could be lower risk or higher risk, depending on the sponsor.
5. The Investment Truly Is Passive
During the three years of investing in this Conshy office building, I received quarterly updates on the progress of the building. After all, the sponsor's goal was to increase the occupancy and rent per square foot in order to one day sell the building at a higher price.
Below is a sample of a quarterly update. Passivity is one of the best reasons for owning a triple-net property.
After reading the first couple of updates, I stopped reading them because I started feeling the stress of being a landlord again. Instead of following along, I just let the sponsor do their job and earn their fee. I couldn't get out of the deal anyway, even if I wanted to.
I reminded myself that the reason why I sold one of my key rental properties in 2017 was so that I could focus my attention on my family and not have to think about the work that is involved in real estate.
In the end, the deal provided a ~40% total return net of fees after three years. The return would have been closer to 48%, but the sponsor didn’t pay out distributions from NOI for a couple quarters. During this time period all I had to do was file a K-1 each year.
Diversifying My Real Estate Holdings Further
By 2023, I should be getting back at least all my remaining ~$410,000 in capital. I've received about $400,000 back so far. It is currently invested in 14 remaining commercial and multifamily real estate assets across the country (equity fund).
One deal in Austin that has already closed was a home run. A student housing deal in Arizona that closed was a turd. The sponsor sold the property below its purchase price.
Out of the remaining 14 deals, supposedly 9 of them are on track to hit their average IRR of 16.7%. Meanwhile the rest are below plan thanks to COVID. But the two that are below plan have aggressive IRR targets of 19.8% and 20%, respectively. So hopefully, even if they return half those figures I'll be happy.
Although investing $800,000 may sound like a lot, it's actually much less than the $2,745,000 in exposure I had in just one San Francisco rental property with an $815,000 mortgage.
The way I see it, I significantly diversified my real estate holdings. I've also so far boosted overall returns, paid down debt, and created 100% passive income.
When I sold my SF rental property in 2017, I was at my wit's end dealing with rowdy tenants and figuring things out as a first-time dad. Being able to reduce stress and buy back my time has been huge.
Real Estate Crowdfunding Returns
According to my dashboard when this deal was paid out, I've received $281,340.39 in capital back so far. $165,445 of the capital came on February 5, 2020 from the equity fund I'm invested in. And $12,271.84 from the Conshy deal on February 11, 2020.
Although the chart above says “earnings exclude principal,” I don't think it's right given a couple deals have closed. But I won't really know the 4Q201 details until an overall fund report comes out in 2Q2020. When I get the details, I may write about the other investments as well.
My plan going forward is to reinvest at least $500,000 in capital across at least two real estate crowdfunding platforms. I will continue to focus on the heartland where valuations are lower and cap rates are higher. The potential growth is also higher due to migration trends.
I also plan to go from 100% equity investments to 70% equity investments. The remaining exposure will be 30% debt investments to lower my risk profile.
Latest Private Real Estate Returns
Below is my latest private real estate investing dashboard. It shows $810,000 of capital invested and $624,270 paid out.
Because I will have at least $500,000 to invest, the ideal real estate investment for me would be another “best of the best” fund that shoots out just one K-1 each year.
I like the idea of having a management committee pick what it thinks are the best investment on their platform. I don't mind paying an extra fee. In the past, there have been times when I've seen an attractive deal and couldn't get in in time because I was too slow and demand was too great.
Best Real Estate Crowdfunding Platforms
Based on my research, my favorite platforms are Fundrise for its eREITs, and CrowdStreet for its 18-hour-city-focused real estate deals. Both platforms are free to sign up and explore.
If you're trying to decide between Fundrise or CrowdStreet, have a read of my post that compares the two. For most people, investing in a diversified fund through Fundrise is likely the best way to go. It's more simple and less risky. But the returns will likely be lower.
To round out my 100% passive real estate holdings, I am also an investor of the following publicly-traded REITs: O and OHI.
2020 is the year where I'm going to be predominantly focused on real estate investing. Stocks had their time in 2019. With interest rates plummeting, coronavirus fears rising, and an increased interest in tangible assets that provide steady income, I believe real estate will outperform again as it did in 2018.
I ended up buying a new forever home in mid-2020 for my family. This was one of the best lifestyle investments ever as we got locked down for 1.5 years.
Just make sure to do your due diligence and invest in a risk-appropriate manner. Just like the stock market, there are certainly investment losers. If you can't take the risk, online savings accounts are paying a boring 1% risk-free. But my bet is in real estate.
Readers, any other lessons you've learned from a successful real estate crowdfunding investment? What do you think about real estate investing this year compared to stocks and other asset classes?
Unfortunately my experience with Crowdfunding is mixed. Did 5 deals with RS, 1 ended up a total loss which negated most of my other gains. With Peer Street, did 6 small deals, (10K each) and 3 performed and 3 are in foreclosure. I’m hoping to be able to recover the money on those at some point. I need to research Fundrise and RealtyMogul a little closer but I don’t know that I like the lack of control in this type of investment….
Surprising about PeerStreet since they are mainly loans no? How were the foreclosed properties rated? Any hints that in retrospect now look like red flags?
I’m going to stick with funds for diversification, more peace of mind, and hopefully better overall returns.
Yes, all loans, mostly for cash out refinance to fix and flip. Multi-family in two of the three that have defaulted. When I did the research, all of the borrowers had history with Peer Street and no bad records that I could find. Perhaps the lower credit scores of around 650-675 should have been a red flag but otherwise not much else. Lesson learned for certain.
Peer Street is certainly easier to contact than RS but if I do this again, it has to be with a platform that has a lot more transparency and much easier to contact on a regular basis. With RS, I’m just praying to get the last two closed this year and get my principal back….
Conshohocken is northWEST (not northEAST) of Philadelphia. Source: I’ve lived in Conshy since 2003.
Thanks. How’s the economy there?
Hi Sam,
I have a question. We heard from a friend on Cash Value Life Insurance, it seems that we can take loans from it if we need cash and any gains grow tax free. This sounds good to us, do you have any insights into it specially any negative aspects? It seems that you have to watch for fees etc. other than that anything else?
We both max out 401K, cannot contribute to Roth due to income limit, have done some traditional to roth conversion, don’t have any debts to pay off. We pay too much taxes, so looking for any tax free investments.
Thanks
Rene
This article just reinforces my belief that directly owning investment properties has now been made obsolete by real estate crowdfunding. I wrote about this on my blog months ago, and my opinion has not changed. Why manage your investments yourself when you can relax and collect a passive income from a professionally managed portfolio of properties. And as Sam showed in this article, it is very possible to mitigate the risk of real estate crowdfunding if you know what metrics to look at. I’d say direct investment property ownership is far riskier than real estate crowdfunding.
Great article as always, Sam.
Sincerely,
ARB–Angry Retail Banker
You can leverage and there are large tax benefits investing yourself in real estate vs crowdfunding. I don’t see how crowdfunding is any different from a REIT if you look at realty mogul and Fundrise for instance.
the private investments are much less volatile than the publicly traded REITs. Check out O, for example. Closed down just as much as the S&P 500’s 12% correction recently.
Also see: Fundrise Investment Performance 2014 – 2019
Another great article. Thank you! How did you manage having to file only one K-1? My biggest fear about investing with CS is having to file multiple forms for various states. I like Fundrise because you just receive 1099s.
Yes, 1099s is one benefit of investing with Fundrise.
I invested in a domestic equity real estate fund that promised a one k-1 per year out of the 18 deals, and that’s what I got.
Then I got 1 K-1 for this conshy deal. They are pretty straightforward to file. But if I had to file more than five or six of them it would go kind of annoying.
Hence why I want to focus on a fund with one K-1.
Got it. I don’t think they are offering such deals anymore, unless I’m mistaken?
Fundrise has their eREITs which are essentially real estate funds by geography or investment type.
CrowdStreet also has a fund, but I think they send more than one K-1 for the fund.
Just like, Xrayvsn, I have been investing in syndicated deals for about 13 years now. It started with investing in a single asset and I’ve done fine. However, the sponsor came out with an value add and income fund, which I have been investing since 2016 and since then, I have deployed money with other sponsors with the same strategy. It’s almost like buying into an index fund, so hopefully it irons out the returns and cash flows. The area I invest with are hotels, MultiFamily and just started senior homes, but these are development deals, but investing in a portfolio of 5 developments.
I almost invested with RS, just to diversify, but did not commit-I’m glad.
I read one of your crown funding articles a few years ago and decided to go for it. But it turns out real estate crowd funding is illegal in Ohio (any idea why?). I currently own 3 cash flowing rentals, and am considering buying more, but I have to confess I love the passive returns generated from stocks. Rental properties are anything but passive.
Any advice for people in my situation? REIT’s and fundrise seem to be the only options, and they’re more correlated to the stock market than I would like.
REITs have been doing fantastic. I think they will continue to do well in this uncertain and lower interest-rate environment. Fundrise offers good regional exposure and the returns have been very steady ~9%-10%.
I really like the stability of real estate, especially during two back to back 3% declines in the S&P 500.
I had considered RealtyShares when it was still around, and had fiddled with PeerStreet, but decided to only go with Fundrise because I think they do a better job than I can of managing risk, both Macro and Micro. Much of their writing is about managing risk, and that plays out in their preference toward debt rather than equity, even in the growth ereits. For those that feel burned by bad deals, I’d suggest taking a look at fundrise.
Very insightful post! Glad to hear most of your REC investments are in good shape. Makes sense to diversify across platforms and to look at the equity bond mix and realistic vs blue sky performance estimates before diving into a bunch of deals. Looking forward to hearing how more of your deals pan out. Thanks
Sam-you recently had a post where your wife reviewed a book. I can’t remember the name of the book and can’t find the post. Can you tell me the name of the book? Thanks
See the post: The Courage To Be Disliked: Change Your Life Because You Can
I’ve been reading for years and just wanted to say thank you for this website. It’s challenged my thinking and helped give me the courage to make some of my financial/life moves over the last couple of years.
Great to hear some details from you on a specific investment and congratulations on the solid IRR.
I have joined three RE Crowdfunding platforms (Crowdstreet, RealtyMogul, and ArborCrowd) and have submitted my first indication of interest. I’m looking forward to adding these deals to my investment portfolio over time.
I own RE debt through several private placements and they have returned a consistent 6.5-7% cash yield for years. The debt is in first position with LTVs below 75% so more conservative like you say. Let us know what vehicles you choose to get into this asset.
Again, congrats!
Sam, can you share which private equity funds you are invested in and/or planning to invest in?
The last Kleiner Perkins one that was open in 2019. How about you?
I’m considering the Origin Investments IncomePlus fund, but haven’t looked into it in too much detail yet. Initially, the fees look pretty high to me. I’m looking to try something in this area for the first time.
I’m stuck in two deal at RS that are not doing well. One especially, is doing horrible and in all probability I’ll lose my capital of $35,000. in that particular one. The latest IRM update was that a forensic accountant was hired and found potentially fraudulent credit card transactions by the sponsor. NOT GOOD!
Yikes, sorry to hear. Which deal is that one? Hopefully there is progress made.
I have one loss I want to write about, an Arizona Student Housing project. But I’m waiting to get more details. It has to do with being an equity investor and the project selling for less than expected. Taylor Fitzpatrick LLC was the sponsor.
It was the SE Michigan (Detroit area) housing fund. It was speculative with huge upside potential and these were fix and flip homes priced at an ave. of $30k at cost.
Sponsor screwed the pooch!
I’m waiting for the Corey Place property as well that supposed to be due later this year (but they stopped distributing $ to investor since last year). Fingers crossed, hope I get back my principal…
I have similar experiences, as do many others that are active on RS-focused forums. When I look at the timing of when the deals “stopped performing”, they are suspiciously around the same time that RS closed its doors. Now, maybe these deals were only artificially performing before that time (RS shell game), but I and others in RS forums suspect that many sponsors saw this as an opportunity to bail on their commitments. From what we can see from IRM, which is VERY little, they seem to be monitoring the deals but not actively managing them. Meaning, if a payment comes in, they’ll process it appropriately (maybe – has anyone else experienced that at least 30% of updates need to be followed up with a correction…? What does this say about internal IRM ops?), but there’s little or nothing done to hold sponsors/deals accountable. “We sent a letter…”
I have a small position in Fundrise and want to build it out over the years.
I started out investing in real estate with Crowdfunding and it was on Realtyshares as well because it seemed like the most popular platform.
I did 3 deals and they were all debt, I belive at 9.5% interest. All three did exactly as promised and I was completely out when RS went under (that would have been an incredibly stressful time for me if I still had investments with them).
I have since gone to private real estate syndications and haven’t looked back. Found a few syndicators I am comfortable with and diversified among them (typically class B multifamily apartments). I try to invest in properties with no state income tax so I simplify my returns.
Right now I am about 55% in real estate of my overall portfolio.
Would you mind sharing the syndicators that you had good experience with, if you’re comfortable sharing? :)
From May 2017 I have invested in a syndicator called 37th parallel (I think I 6 deals with them that havent gone full cycle yet though). Met the principals in person as well and I like their investing strategy (again Multifamily, Class B apartments, typically in the 15-30 million range).
Last year I put money in the MLG IV fund which is a fund with properties all over the US. I chose the parallel fund which does not require me filing annual K-1’s to the states that are not income tax free.
And rounding up the main syndicators I have invested with is my investment with Origin Investments, specifically the Income Plus fund. I love the idea behind this fund as it is an open ended “forever hold” type fund so you can park your money in it and leave it for cash flow (versus others where when they exit you have to keep finding new places to put in). The fund just started 1 year ago and the goal is to get 6% preferred rate of return. I interviewed the main principal (Michael Episcope) on my blog which had a lot of tidbits if you are interested in it further.
Thanks!