When I found out RealtyShares was closing its doors to new investors on Nov 7, 2018, I was shocked and saddened. Given they are based in San Francisco, I had met multiple people from RealtyShares since mid-2016 and developed some good relationships.
I feel terrible for the people who will no longer have jobs as we enter the holidays. In a way, I feel like I've lost a job and colleagues as well since they were a business partner.
On Wednesday, October 24, I had lunch with their CMO at Townhall restaurant. She told me they had just revamped their website and rebranded the company's name with a new color scheme and logo. I even got a new shirt.
Further, I was told they would be launching a second fund, with a minimum $25,000 investment (vs. $250,000 for their first), to be more accessible to more investors. Their second fund would act like an index fund for all the deals they vetted onto their platform.
Obviously, the new fund is no longer launching. All that will remain will be an asset management and operations team who will be responsible for servicing existing investors and their approximately $400 million of assets under management until scheduled completion.
RealtyShare wrote in their e-mail, “This transition will have no impact on the underlying real estate investments. Investments will continue to be managed and distributions will continue to be made. Investors will continue to receive asset management updates and year-end tax information.“
What Went Wrong At RealtyShares
I expected consolidation in the space, I just didn't expect RealtyShares would be one of them so soon given they had raised $27 million in Series C round in September 2017 and had so much demand. That's a lot of cash to go through in 13 months. I’m hopeful they still have a cash cushion left for the transition.
In retrospect, it looks like RealtyShares expanded too quickly (personnel, got in and out of residential at a high price etc) without an equal amount of supply.
Ever since I joined their platform in 2016, most of their deals were quickly filled. This was part of the reason why I invested in the Domestic Equity fund instead because the fund would always get first dibs on the best deals. I didn't have time to log in every day to check.
But if you consistently have excess demand, your customer acquisition cost (CAC) will start to go higher because your new customers will just be sitting there without deploying any or as much capital. Hence, finding that supply and demand balance is key.
Further, they probably didn't have the technology optimized to scale quickly. RealtyShares ran a people intensive business to review, finalize, and manage deals. Their growth was more linear, rather than hyperbolic as venture capitalists like to see. I suspect part of the over-expansion was due to VCs always pushing more aggressively for growth.
I truly believe the vast majority of RealtyShares employees had no idea their next round of funding wouldn't come through until it was pulled last minute. I truly appreciate my time working with Kristina, Brian, Amy, and Alyssa. I wish them all the very best. I'm sure our paths will cross again.
For Investors On The RealtyShares Platform
Like many investors, I followed up to get more details about what will happen to our investments on the RealtyShares platform, despite their reassurances in the initial e-mail. After all, I invested $810,000 on the platform (not in the company).
This was one person's response:
Please rest assured that your investment in the DME Fund will be taken care of. We are in the process of transitioning all of our active investments to a fund administrator, who will handle distributions. We will certainly keep you posted as we continue to firm up the transition plan.
We are focused on making the transition as seamless as possible and the asset management fees we charge should cover this until maturity.
It's important to remind ourselves that we are not investors in RealtyShares, the business that could no longer raise money to keep expanding. We are investors in individual real estate investments. RealtyShares, at the end of the day, was a marketplace to match investors with sponsors of real estate projects around the country.
According to RealtyShares, RealtyShares created an LLC for each investment as a subsidiary of RealtyShares to invest in equity and preferred equity deals. Investors in RealtyShares (Cross Creek, Blue Mountain, Union Square Ventures, Menlo Ventures, General Catalyst, 500 Startups, etc), the company, have no claim against these LLCs during a wind down. The fund administrator, NES Financial, will be paid to manage and operate these specific investments and the DME fund until scheduled completion.
It is up to the sponsors to do their jobs and provide investors with the best return possible. They can't just disappear because RealtyShares was often just one of several investment sources for their respective deals. Further, sponsors always invested some their own money in their deals because investors wanted to see skin in the game.
The sponsor's incentive is aligned with RealtyShares platform investors to do the best they can to make their deals work. If their deals perform poorly, they'll make less money or lose money, hurt their reputation, and have a tougher time raising capital in the future.
In the meantime, I recommend everybody write down in detail each deal they own and the contact information of each sponsor for your records. This is extremely important given the governing oversight of RealtyShares may be diminished. For existing investors, nothing should really change except for not being able to invest in new deals.
Log in to RS, click on “Documents” then “Investment Documents” – you can download the full package for the active investments right there to keep handy. Here's a link where I have gathered all the sponsor and deal profiles of the RealtyShares DME Fund and one individual investment I made in Conshy, PA. There are a total of 18 deals I've recorded, which may help some of you.
If you calculate a 1% – 1.25% average asset management fee on $400 million in assets under management, RealtyShares should earn roughly $4 – $5 million a year to keep a team of people to manage their existing assets until their respective target exits. By going from ~100 employees down to ~15 employees and cutting all new customer acquisition efforts, they should have a sustainable business that should last. They just can't grow like the VCs wanted. I'm assuming they'll also downsize to a smaller office space to further reduce expenses.
I'm still a believer in the real estate crowdfunding space because it allows us to arbitrage real estate profits around the country. As someone who is sitting in expensive San Francisco, I want to use my expensive SF money to buy inexpensive heartland real estate property with lower valuations and higher cap rates.
Not having to source and manage these properties while earning a higher income is a core thesis of my Buy Utility, Rent Luxury strategy (BURL). I want to own assets that provide collateral and produce the highest amount of passive income.
Based on public funding knowledge and what I've observed in the real estate crowdfunding space, here are a couple RealtyShares alternatives. All companies are private, so I do not have knowledge of their financials.
1) Fundrise. I've worked with Fundrise since 2016, and they've consistently impressed me with their innovation. They were founded in 2012 and are the pioneers of the eREIT product. They've not only raised $55 million from venture capital, but they also found a way to directly raise capital through their “Internet Public Offerings” directly from investors on their platform (past 9 months).
More recently, they were the first ones to launch an Opportunity Fund in the real estate crowdfunding space to take advantage of new tax laws.
Fundrise is open to non-accredited investors (e.g. everyone), unlike RealtyShares. Further, their business model of creating tailored funds like the Heartland eREIT is attractive to someone who wants to diversify into real estate, but who doesn't want to pick and choose individual investments on the platform, despite these investments also being carefully vetted first.
Check out their Form 1-Semi Annual Report filed with the SEC. The first several pages has details of their progress. In September 2018, they surpassed $400 million in assets under management under the Sponsored Programs, and I hope they keep on going.
You can check out my latest Fundrise overview here. Fundrise is my favorite real estate crowdfunding platform for all investors.
2) CrowdStreet: After a tremendous amount of research and meeting with the people at CrowdStreet, I believe CrowdStreet is an excellent real estate crowdfunding platform. It focuses on deals in 18-hour cities and also moved its HQ to Austin, Texas.
Post-pandemic, lower-cost areas of the country are seeing tremendous demand because more employees can now work from home. CrowdStreet has a healthy pipeline of individual deals and funds, such as a Build-To-Rent Fund focused on single family rentals.
Here is my latest CrowdStreet review. CrowdStreet is for accredited investors only.
RealtyMogul was also founded in 2012 and offers accredited investors a way to invest in debt or equity commercial real estate offerings. They also have a couple eREITs for non-accredited investors. So far, they have distributed over $100M, have 220K members, and have funded over $3B in property deals.
I spoke to their CEO, Jilliene Helman at length on Nov 9 and she mentioned how she wants to build a multi-decade long business not a flip. Instead of growth at all cost, she's focused on growth at a reasonable pace to ensure long-term profitability.
Her firm is extremely focused on the underwriting process, uses technology to automate more cumbersome areas of the business, and has higher origination fees for sponsors to account for the costs of doing business. They also focus on investments larger than $1M.
Realty Mogul has a smaller team at ~55 people. They also stopped investing in hotels and single family flips in 2015 because they viewed them as more risky and/or cumbersome to manage. 65% of their deals are in bread and butter multi-unit residential property.
Given they have higher barriers for whom they do business with, it feels like they really are focused on hitting singles and doubles instead of home runs, which is more in line with how I like to operate my own business. Here is my latest RealtyMogul overview post for more details.
Needless to say, please only invest if you have thoroughly done your due diligence and know what the contingency plans are. I would take your time understanding the platform and asking other people about their experiences.
The Future Of Real Estate Crowdfunding
Long term, there will likely only be a handful of winners in the real estate crowdfunding space. It's the company that gets its technology and supply/demand matching right that will emerge victorious.
As news of RealtyShares' closing spreads, investors will take pause and reevaluate their alternative investment strategies and do more due diligence on respective real estate crowdfunding platforms like I am right now.
Further, I expect real estate crowdfunding platforms to do work to improve their balance sheets, increase their supply of deals, tighten up their underwriting standards, improve their technology, and improve their messaging. All of these things are good for platform investors long term.
I'm confident RealtyShares will do the right thing and see existing investments through to scheduled completion. They've got ongoing asset management revenue of $4M+, an asset management team, and a fund administrator in place. I have faith that the co-CEOs, Alexis de Belloy and Ed Forst will do the right thing. If not, trouble awaits for their careers.
Please remember that real people who tried really hard to make something successful have lost their jobs. Some have families to support while all had hopes for a brighter future.
Some Learning Points
We must learn from every unfortunate situation if we are to improve. Here are some takeaways from RealtyShares' demise:
1) We often hear advice to just start and pivot later. This works if you want to build a lifestyle business, but if you plan to build a VC-backed company heavily relying on technology to scale, it's worth spending more time getting the technology right first before aggressively launch. Going back to try and fix or optimize your foundation is really costly.
2) Taking VC money means you no longer have full control of your company. Never look down on a fully bootstrapped company that is cash flow positive because they are the masters of their own destiny.
3) Limit alternative investments to no more than 10% of your net worth. Further, diversify your 10% as well. Alternative investments are usually not as liquid as old fashion stocks and bonds. The rewards can be much higher, but so can the uncertainty and headache. Related: Just Say No To Angel Investing
4) Recognize real estate is late cycle as we enter 2019. Inventory is rising, interest rates are rising, and prices are flatlining or going down. Expensive coastal city real estate is already softening. If things get really bad, eventually, less expensive real estate markets will also take a hit, despite long term demographic shifts toward lower cost areas of the country. It usually takes 3-5 years for the real estate market to work its way through a down cycle.
5) You must forecast the health of the real estate market when your equity investments plan to exit. Based on your forecast, you must adjust your IRR expectations accordingly. Don't believe any of the advertised IRR rates. They are almost always blue sky scenarios, and we know rain and thunder showers inevitably come.
6) Nothing is ever as rosy as it seems. There were a couple small red flags in 2018 that I observed, namely the one month dearth of deals on RS's platform during the summer and a couple personnel departures, but nothing which would make me suspect they were burning through so much cash that they wouldn't last through the year. All guidance they gave pointed to continued growth and success.
With Financial Samurai, maybe from the outside, it may seem like writing all these articles, managing the forum, doing podcasts, responding to requests, and building business relationships looks easy. But I assure you that sometimes it is extremely difficult to keep things going smoothly, especially if you've got a little one to take care of as well.
This week I had multiple nights where I only slept 3-4 hours because my wife fell seriously ill with food poisoning for 36 hours, our babysitter canceled on us last minute (we had planned 2 or 3 days for 3 hours each day), my boy now has the same sickness, and the RealtyShares news hit. At one point I felt like the last man standing facing a 1,000 person army. But I kept fighting because that's the only thing I could do.
7) Stay humble as an investor. It's sometimes easy to think we are the best investors in the world thanks to such a wonderful bull market. But bad things happen all the time, especially when we least expect it. Certainly don't take delight in the suffering of others because you might also meet an unfortunate circumstance one day. Try to be humble in everything you do no matter how much success you have.
8) Keep taking calculated risks. Once we accept that bad things will always happen, we will become better investors because we'll take into consideration exogenous variables during our due diligence process. Those who keep taking calculated risks should be rewarded over time. We've just got to take the hits, learn from our mistakes, and keep on going.
9) Salvage what you have. A $400 million investment portfolio that generates $4M – $5M a year in fees is significant. I suspect the portfolio could easily be sold to a competitor or money manager for $5M. After five years, the acquirer would earn a healthy IRR return while also having a potential new set of accredited investors to do more business with. Meanwhile, investors in RealtyShares, the company, would recoup some of their $60M+.
I hope this article has been helpful. It’s been a very difficult week for me, and I appreciate your patience and understanding. I will update this post with more information as it comes in. If you discover any more useful information, please share here or in the FS Forum. Thanks.
Ranking The Best Passive Income Investments – A look at all the passive income options out there ranked by risk, liquidity, return, and more.
Real Estate Crowdfunding Learning Center – A collection of important real estate crowdfunding pages I put together to learn about the various nuances of the space.
Career Advice For Startup Employees: Sleep With One Eye Open – It's tough getting rich working for startups since most don't hit it big.
Example Of What A Bad Real Estate Crowdfunding Loss Looks Like – Here's a post I wrote in Oct, 2017 about a deal the RS DME fund made which I did not like.
Update 5/13/2019: They hired a fund administrator named Assure and announced they have sold most, if not all of their assets to IIRR Management Services. During my latest retirement income streams analysis, I also got about $50,000 of capital returned out of $800,000 invested in the DME fund as the Austin Multifamily property paid off.
Here is the letter sent out to platform investors:
RealtyShares was founded with a mission to connect capital to opportunity. With your support, we built one of the top online real estate investment platforms, with over $870 million invested across more than 1,100 projects.
In November 2018, we shared that we had ceased adding new investors and offerings to the platform due to our inability to secure additional capital. Since then, our resources have been focused on servicing existing investors, managing assets and actively exploring long-term solutions to ensure that investments are managed to their terms.
Today, we are pleased to announce that we have contracted with IIRR Management Services, LLC to manage the remaining investments and investors on the RealtyShares platform, and to purchase certain assets of RealtyShares and its subsidiaries. IIRR is a joint venture formed through a partnership between RREAF, a leading real estate sponsor and developer based in Texas, and iintoo, a global real estate investment platform. Both firms have significant real estate and asset management experience and are deeply committed to looking after the RealtyShares platform investments and investors. Both RREAF and iintoo will also offer new investments through their respective platforms. You can find details for these organizations below.
IIRR Management Services, LLC will leverage current RealtyShares staff and partners (including Assure Services, our Fund Administrator) to continue servicing investors and assets through the RealtyShares platform. They will augment existing Asset Management and Investor Services teams with additional real estate professionals to manage the portfolio, communicate updates, and provide timely distributions. This contract management transition does not change your rights in or the structure of the underlying real estate investments. You can continue to reach us at email@example.com.
RealtyShares has experienced tremendous change over the last few months and we recognize that the transition has been challenging, both for us and our investors. We apologize to those of you who may have experienced delays in distributions or reduced levels of communication, as we have been working with limited resources since our announcement in November. We are very confident that IIRR Management Services will bring unparalleled experience and expertise in managing the RealtyShares investment portfolio for the benefit of our investors.
We thank you again for your support.
Update October 2, 2021: The RealtyShares investments are still slowly being worked out. The pandemic derailed a lot of original plans for hospitality and office in particular. But things are recovering, thankfully. The DME fund has paid out 52% of capital so far. It probably has another two years to go.