Crowdfunding and The Capital Stack

By Jeffrey Steele, Contributing Editor

Traditionally, only sophisticated investors, funds and REITs could invest in the multifamily sector. In recent years, crowdfunding has changed that. Crowdfunding enables middle-class investors and other ordinary folks to get in
on investments that were formerly the exclusive province of the one percent.

The impact can’t be understated, said Scott Picken, CEO & founder of South Africa-based crowdfunding platform Wealth Migrate, which is among the world’s largest. Until now, he said, average investors could only invest in over-traded markets with small returns, such as single family homes. “As investors get more educated and also more comfortable with investing through the Internet, the presence of crowd-funding will continue to strengthen in this space, as it makes sense to all investors,” he said. “Housing is something all investors understand.”

Another leader in crowdfunding is Fundrise.com, a four-year-old online real estate investment platform in Washington, D.C. owned by CEO Ben Miller and three other co-founders. Miller defines crowdfunding as the use of the Internet to invest in or raise money for a project, in this case real estate. “Before Fundrise.com, every other platform required you to be a high-net-worth accredited investor,” Miller said, adding that it was Fundrise.com that altered that landscape, allowing anyone to jump in with a minimum investment of $1,000. Miller believes the next year or two will see crowdfunding playing a part in bigger and bigger deals, and becoming a more significant source of capital for the multifamily industry. His prediction is in part a reflection of the growth Miller has seen in his own company, which is 10 times the size it was at the same time last year, and is projected to again grow tenfold over the coming 12 months. He expects the firm to balloon from 30 to more than 60 employees in the next year.

“For real estate companies, it’s just faster and easier to do something online than to do it offline,” he says. “You go to Fundrise.com for the same kinds of benefits you go to Expedia.com for: speed, cost, convenience. Imagine having to go to the airport to buy an airline ticket. This is the same concept.” Worth noting is the recent launch by Fundrise.com of the first online REIT, which the company calls the eREIT. “The investor is getting at the real estate and the real estate trust with almost no cost. There are no broker commissions and no underwriting concessions,” Miller said. “The big difference between this eREIT and others is it is open to everyone, not just high-net-worth investors.” Jilliene Helman, CEO of RealtyMogul.com, a Los Angeles-based online marketplace for real estate investing that connects borrowers and sponsors to capital from accredited and institutional investors, is similarly upbeat about the future of crowdfunding. “You will see more multifamily being done [with crowdfunding] because the entire industry of crowdfunding is growing,” she said.

Comprising the capital stack
Just how big a part of the multifamily capital stack crowdfunding will become in 2016 is open to conjecture, Miller says. Much depends on whether there will be a pullback in the availability of institutional capital in 2016. If such a pullback does occur, Miller predicted, “Crowdfunding would fill the gap.” Miller believes that when crowdfunding does become significant, it will comprise about 30 percent of the stack.

Steve Cinelli, senior fellow for Massolution, a leading research and advisory firm specializing in crowdfunding and crowdsourcing solutions for private, public and social enterprises, reported that while multifamily comprised “a relatively meager part of the 2015 volume,” change is likely to come in 2016 as the platforms’ growing legitimacy motivates greater numbers of investors to participate. “There is a growing challenge, with the platforms desiring to go upmarket in quality and size of project,” he said. “But [they] have the capacity to do only so much. I believe participation in deals not controlled by the platforms will grow. As such, the crowdfunding participation will be only a relatively slim proportion of the total financing. With mezzanine offerings coupled with more equity, the return profile may go up, but the capacity of an investor network and pre-commitments will drive both the type and size of deals a platform engages, and its acumen to potentially serve as the lead on bigger deals. The jury is out on this one.”

A factor in the following categories
Multifamily crowdfunding at Fundrise.com is spread about equally across three uses, with one-third each going to acquisition, development and recapitalization. That’s what Miller and his colleagues are observing in what he terms “a purely market-driven” market. Picken sees crowdfunding being relevant in all three of the categories. Wealth Migrate, he said, allows investors to participate in the development risk and/or focus on the income potential of a longterm
investment. “As we have seen in the peer-to-peer lending space, the financing
space in real estate is growing exponentially,” he added.

Because much of the funding from the real estate crowdfunding platforms has come in the form of senior debt, Cinelli believes the review of LTV, ARV and other metrics will drive the type of deals that are transacted. “Also, since much of the debt would be considered analogous to hard money—high interest rate, shorter maturity—the nature of the investment and sponsor holding period will be a driver,” he said. “Some platforms are now focused on SFR mortgage financing
with the expectation that either they sell the paper to the GSEs or an institutional player. As mentioned in the Real Estate Crowd Funding Industry Report, I believe the SFR market will see most of the activity. But this is being conducted much like analog mortgage originators that are offering the paper.”

Size of sponsors
Cinelli believes that in the year ahead, sponsors will continue to be on the small side. They will be transacting deals that generally remain below $5 million, with most being less than $1 million. Miller observed that at this point, smaller local and regional investors are much likelier to use crowdfunding. A truly national sponsor is likely to be a multi-billion dollar sponsor with a proprietary capital source that the smaller, regional sponsor doesn’t have. “Typically, a regional
sponsor is funded by a national or regional private equity fund,” Miller said. “That is our competition. Most people who have had a private equity provider would prefer an alternative.”

An example from Fundrise.com’s own recent past is an apartment
developer named Pryde + Johnson, with which Fundrise has transacted
two deals in Seattle. One of the deals turned into a ground-up development called
The Keelson, an approximately 100-unit development in the Ballard
neighborhood. Crowdfunding supplied about $8 million of equity in that $32 million development deal, which was completed this past summer. “The other was The Soren, and it is almost the same project, but in lease up,” Miller said. “He had a HUD loan, and he wanted to pull some money out. But HUD has a very, very high prepayment. We were able to recapitalize him, and allow him to pull money out of the deal, which allowed him to retain 100-percent ownership of the property.”

Miller believes crowdfunding is a particularly good fit for check sizes of $5 to $25 million. “That’s still smaller than your Avalon Bay,” he said. “But it’s much larger than the old-fashioned crowdfunding of last year. I think crowdfunding is going to displace private equity [eventually]”. Helman, whose company has supplied crowdfunding exclusively in acquisition and refinancing deals for income-producing properties, as opposed to development transactions, believes crowdfunding can be used for both smaller and larger deals.

“For raising equity capital, we require sponsors have $25 million in
transaction volume under their belt,” Helman said. “But we’ve worked with real estate companies with billions of assets under management, so it’s a wide range.” One of RealtyMogul.com’s recent transactions involved a Fayetteville, N.C., apartment building called Bristol Park Apartments, where RealtyMogul.com provided a $7.5 million bridge loan and $1.5 million in equity. “There, we did debt and equity, which is rare for a crowdfunding
company,” Helman said. “It’s also indicative of the kinds of transactions
we look for, which are diversified, cash-flowing transactions.”

The full impact of the SEC’s recent adoption of Title III rules is
unknown as of yet. But Doug Ellenoff, a member of the New York City law firm Ellenoff Grossman & Schole LLP, reports, “For local real estate projects and
renovations, I believe that the provisions of Title III crowdfunding will
prove to be useful for most communities throughout the country.”