Let's take a look at what a real estate crowdfunding loss looks like. When you invest in real estate crowdfunding, you have to expect there will be losses given there are no guarantees.
I recently published The Worst Landlord Horror Story Ever, a story about a reader who bought a Las Vegas residential property several years before the bottom fell out in 2008-2009. He went through hell dealing with maintenance issues and suspect tenants.
Eventually, the complex started accepting Section 8 housing where the government would subsidize 80% of the rent to lower income earners.
His housing complex of 157 units turned into a drug infested war zone. Only after buying two more units at the bottom of the market did the reader finally break even after 13 years.
A Potential Real Estate Crowdfunding Loss
So it is with complete surprise that I got an e-mail from on real estate crowdfunding company the very next week notifying me my real estate crowdfunding fund invested in a 168-unit garden-style apartment complex in Las Vegas! This was also after I decided to invest another $250,000 in the fund, bringing my total up to $500,000. It was as if the real estate gods were mocking me.
I was informed that the property had been originally constructed in 2001 as an affordable housing development, but that recently the property had been purchased by the now-seller under a “qualified contract” that released the property from its affordability requirements. Although technically a market rate property, residents in occupancy during the conversion maintain protected below market rents for a period of up to three years, so that only about a third of the units had rolled over to market rate units.
This was a preferred equity deal, though, so is more like a loan than a true equity position. The sponsor contributed over $3 million for the common equity position, so that at least provides some degree of “cushion” to the preferred equity position. Additionally, the sponsor was to set aside 28 months of preferred current payments in an account controlled by the crowdfunding platform.
Still, my heart sank when I read that not only was this a Las Vegas apartment complex, it was also an affordable housing development. I’ve got nothing against affordable housing from a social good perspective. Rocketing housing costs are making it difficult for everyday people to live.
But as an investor who is hell bent on staying financially free due to his investments, I worry about investing in an affordable housing complex for all the reasons my landlord horror story mentioned. In addition, in order to reach the project’s targeted internal rate of return (IRR) the sponsor is relying on turning the remaining units (2/3 of the total) into market rate housing.
It remains to be seen whether the tenants will simply accept the rent increase, move voluntarily, or be evicted with potential buyouts.
Some of the features of this investment included:
Demonstrated rent increases. Approx. 33% of the units had now been moved to market rates, and where the units had already been renovated, the new market rents were nearly 25% more than the earlier “affordable unit” lease rates.
Property was acquired at a discount to market. The property was acquired off-market, having been sourced through a relationship of the sponsor. The property sold at an effective price of $108k per unit, apparently well below comparable assets of a similar vintage. The offering information also indicated that the purchase price was about 15% below comparable properties, both on a per unit basis and on a per square foot basis.
One thing to note from my landlord horror story is that an institutional investor picked up those units during the financial crisis for roughly $60K/unit, but I’m not sure if these units are like for like since the newly acquired apartments are newer.
Strong Submarket. The property was located in a submarket of Las Vegas for which REIS reported a mean vacancy rate of 3.2% in Q1’17 across all property classes per REIS, and average vacancy is expected to decrease to 2.6% by 2021.
Sponsor’s Common Equity Cushion. The sponsor’s $3.5 million common equity contribution meant that its own money would be at risk before the preferred equity investment would be affected.
Reserve for Preferred Payments. 28 months’ worth of preferred current payments were to be reserved for in an account controlled by the crowdfunding platform.
Decent Estimated Population Growth. ESRI forecast population growth of 6% over the next 5 years for the area within a 3-mile radius of the property, translating to over 8,000 new residents in the near vicinity.
Access to Local Amenities. The property was located in close proximity to numerous amenities and employers, with Las Vegas strip located just 3.5 miles away.
Setting Low Expectations For This Potential Real Estate Crowdfunding Loss
Perhaps I'm being too pessimistic on the deal given the Sponsor is putting up $3.5 million of their own capital before investors lose money. It just totally caught me off guard regarding the timing of the deal given my post. Further, just because I'm not a Las Vegas real estate expert doesn't mean the Sponsor isn't either. The catalyst is very clear: a “qualified contract” that releases the Property from its affordability requirements by October 2019.
But given the risk involved, I'm disappointed the target IRR is only 13%. A target IRR of 18% seems more appropriate. For reference, a 13% IRR is lower than all the previous target IRRs for projects in the fund that aren't investing in affordable housing.
But here’s one thing that concerns me. The seller is selling the property for an approx. $6.5 million gain relative to its own purchase price just two years ago! I’d be selling too if I could make an almost 60% return on my money in two years. Yes, the sellers had to spend money renovating some of the units, but they couldn’t have spent that much since two-thirds of the units are still below market rate units.
Tough Deal To Invest In
I personally would not have invested in this deal because I'm trying to stay away from coastal boom bust cities like Las Vegas, the #1 city that got crushed during the housing crisis. The other cities that got hit the most were Phoenix, Fort Lauderdale, Miami, West Palm Beach, and Tampa. Further, it doesn't sit right with me to convert below market rate units. Nobody wants to experience a real estate crowdfunding loss.
I'll be happy if this project just gives us our money back (0%) return in three years. That said, it still looks like there is roughly 50% more upside before the Las Vegas property market gets back to its 2007 peak. San Francisco, on the other hand, is ~25% above its previous peak, which is one of the reasons why I was happy to sell.
Now you know the downside of investing in a fund. You can do all your research, but once you hand over your money, it's up to the investment committee or fund manager to decide how to best invest your money. Sometimes their investments won't align well with your beliefs, and you've got to be OK with it. Instead, it may be best to spend the effort to choose your own real estate crowdfunding investments.
My problem is that I've been hands on with all my investments my entire life. Therefore, it's hard for me not to watch where every dollar goes. But as a 40-year old father who has better things to do than pick every single investment, I need to outsource my investing to others who do have time and expertise.
The more I can let go, the more I can focus on enjoying life to the fullest. And who knows? This Las Vegas investment might very well return 40% after three years as targeted and prove me wrong. I'll be sure to let y'all know if it does! And if it's a big bust, I'll be sure to let you know too. At least this is only one of potentially 10 – 15 investments within the fund.
Update: Based on feedback from many readers, it seems like investing in Las Vegas isn't as bad as I initially feared. The Raiders are moving to Vegas, employment is growing, and there continues to be a migration to low cost cities and states with no state income taxes. But the Raiders sure are sucking under John Gruden, despite his $100M contract!
Update 2022: The deal actually ended up being a home-run, with a double-digit IRR because Las Vegas blew up, in a good way. Real estate prices in Las Vegas skyrocketed once the pandemic hit in 2020. Who would have guessed? Not me.
Best Real Estate Crowdfunding Platform
If you're looking to buy property as an investment or reinvest your house sale proceeds, take a look at Fundrise, one of the largest real estate crowdfunding platforms today. They allow everyone to invest in mid-market commercial real estate deals across the country that were once only available to institutions or super high net worth individuals.
Fundrise is the pioneer of eREIT funds. They are creating an Opportunity Fund to take advantage of tax-efficient Opportunity Zones. Thanks to technology, it's now much easier to take advantage of lower valuation, higher net rental yield properties across America.