How I Analyzed My First Real Estate Crowdfunding Investment

I made my first investment into real estate in October 2018, after nearly six months of research and learning about the space. I didn’t buy a house, apartment building, storage facility, or office park like a traditional real estate investor. Instead, I turned my attention to an emerging model called “real estate crowdfunding.” This is the lab report describing my experience.

Hypotheses

• Crowdstreet provides a user friendly method to access large commercial real estate transactions.
• Real estate crowdfunding is a passive, efficient way of adding commercial real estate exposure to a portfolio.
• Real estate crowdfunding investments benefit from the expertise of experienced sponsors.
• My first real estate crowdfunding investment in a core-plus multifamily property in the the American heartland will produce cash flows from 6%-10% annually with an 11%+ IRR over a 10 year hold period.

Background

What is real estate crowdfunding?

The basic idea with real estate crowdfunding is that a sponsor (the company managing the real estate investment) finds a property they’d like to acquire. They then raise some portion of the equity capital from a group of accredited investors (learn what that means here) and close the deal. In exchange for their investment, the equity investor (most of the time) receives regular cash distributions and participates in the upside in the event the property is sold or refinanced. 

The returns for real estate crowdfunding can be compelling, but so can the risks. Starting investing in real estate on your own, especially with a full time job, is a daunting undertaking. I want to focus on my day-to-day work, which I am good at and which pays the bills, and instead put the responsibility of managing my real estate investments on a seasoned professional. Crowdfunding is perfect for this. 

If this is your first time hearing about real estate crowdfunding, I’d suggest you check out one of the excellent articles below (since i haven’t written my own introduction yet):

• A Beginners Guide To Real Estate Crowdfunding from Financial Samurai
• Ultimate Real Estate Crowdfunding Guide for Beginners from Crowd101
• A Beginner’s Guide to Real Estate Crowdfunding by Fortune Builders

Real estate risk profiles

Commercial real estate investments are broadly categorized into four risk levels. They are listed below with brief explanations, from least risky to most risky.

Core

Core investments are usually class A properties in class A neighborhoods. These are the cream of the crop. As such, they are harder to find and offer lower yields, but are often considered the safest investment. Clash flow from core investments should be immediate.

Core plus

Core plus investments are usually class B properties in class A neighborhoods. These properties may require a bit of work to get up to modern specs or need some help renting up. However, core plus properties are in great neighborhoods and should benefit from positive demographic and economic trends. Core plus investments should also cash flow from day one.

Value add

Value add properties need some work. Often, they’re older, class C type properties that need complete renovations of the units and common areas. They may also have high vacancy rates. These types of opportunities require an experienced sponsor who is capable at renovations and quickly renting out empty units. There is significantly more risk here since your investment depends on not only achieving market rents post-renovation, but on filling the units quickly. May not cash flow for several months.

Opportunitistic

Opportunistic investments are the riskiest types of real estate investments. The sponsor is responsible for developing the property from the ground up, renting it out, and ongoing management, leaving a lot more potential sources of failure. As a trade-off for the risk, opportunistic investments often offer significantly higher returns to investors.

Since we are almost a decade into the recovery from the housing crisis, I’m of the opinion that we are late in the economic cycle. Accordingly, I do not feel comfortable taking on highly speculative investments to possibly knock it out of the park. I’d rather take a long-term, defensive approach to my first investment. That’s why, for this first one, I’ll stick to core and core-plus offerings.

Because they are widely sought after and difficult to source, crowdfunding platforms tend to have far fewer core and core plus offerings. That means I’ve effectively narrowed my options down just with this one investment criterion.

Property type

Commercial real estate offers investments in a dizzying variety of different building types. Each has its own idiosyncrasies, strengths, and weaknesses. I’ve listed the broad categories below.

• Multifamily: Apartment complexes with 5-500+ units. Often located in major metropolitan areas near highways, schools, and businesses. Short-term leases (typically 12 months) with many tenants.
• Office: Office buildings and office parks in urban or suburban areas. Can be one tenant or many, but typically on a long-term lease.
• Retail: Strip malls, shopping centers, regional malls, and the like. Several tenants with an anchor such as a grocery store or department store. Long term leases. Highly sensitive to trends in consumption and the overall economy.
• Industrial: Manufacturing and warehousing spaces. Typically found in areas outlying large metro areas. Massive buildings with high ceilings, specialized equipment, and shipping bays. Can be sensitive to certain segments of the macroeconomy. Longer leases for fewer tenants.
• Hotels / hospitality: Hotel, motel, Holiday Inn! If you sleep there when you travel, it probably falls under this category. Characterized by short stays, high turnover, high nightly rates, and seasonality. Can be susceptible to macroeconomic shocks if people travel less or a location goes out of favor.
• Specialty: Pretty much everything else! Some more esoteric property types here, including self-storage, mobile home parks, car washes, theme parks, bowling alleys, marinas, theaters, funeral homes, community centers, assisted living facilities, and churches. Each has its own quirks, but I like self-storage, mobile home parks, and assisted living facilities, so we will dig into those more in depth in future articles.

Why multifamily?

For my first investment, I chose to focus on multifamily properties for several reasons:

• Fewer people are owning homes now than they used to
• The cost to build new apartments is often significantly higher than buying existing supply
• A large number of tenants makes your cash flow more resilient against vacancies
• The sponsor can implement several methods to force appreciation on the property since its value derives from cash flow and not comparable sales
• Multifamily is less susceptible to downturns in the market. People need somewhere to live and you can always lower rents to keep units occupied
• An investor can quickly achieve economies of scale, especially for property management

In the future, I may diversify my portfolio with exposures to warehouses, self-storage, mobile-home parks, and assisted living facilities. But for now, we’ll keep things simple by only considering multifamily apartment buildings. 

Experimental Procedure

In real estate, there are myriad factors to consider in choosing where to invest. You must consider macro factors such as how the broader economy is performing, job migration, and demographic trends. You must also weigh seemingly micro details such as the deal’s structure, the manager’s experience, and the profile of the property. Since there are a TON of offerings on Crowdstreet at any one time, I will focus on some basic investment criteria first before examining the property. 

Narrowing down the options

Based on our discussion so far, we know I am looking for a core or core plus investment in a multifamily property. But what other criteria should be satisfied?

• Liquidity: Since I feel that we are in the late stages of an economic expansion, it stands to reason that shorter real estate investments of 1-5 years might have exactly the wrong timing if the economy turns. As such, I will consider long-dated investments of 7-10 years or longer. I do not need this money any time soon and as such, I am fine with foregoing liquidity for the right asset
• Returns: Since I am considering only those investments which are the least liquid, I should be compensated (the so-called liquidity premium). Conversely, since I am looking for a core or core-plus asset, I must acknowledge that returns are unlikely to be the high-teens, low-twenties IRRs that many of the more risky projects can offer. Therefore, I will focus on deals expected to produce 10-14% IRRs over their life, with a heavy emphasis on the cash yield component of the return.

That should narrow things down a lot. With this target investment profile in mind, I set out scouring the listings on CrowdStreet. With only a handful left to analyze, I will now focus on the one I chose and detail the reasons why it stood out to me among the others. Later in the report, I will share reasons why I passed on the others.

And then there was one

If you’ve read this far, then you really must want to know which deal I picked. 

My first real estate investment was in the Royale at CityPlace, managed by Block Real Estate Services. The Royale is a 334,000 square foot, 344-unit luxury apartment complex in the affluent Kansas City, KS suburb of Overland Park. 

This investment is a core asset. The targeted investor IRR is 10.9% with a 2.4x equity multiple over a projected 10 year hold period. The Royale is also targeting an average cash yield of 8% over the life of the deal. Distributions are expected to begin the month after closing.

Let’s dive into the reasons why I picked this deal out of all the others. 

Location, location, location

This is a trope for a reason. The location of a property is inextricably linked to its value. 

Overland Park, Kansas is an affluent suburb of Kansas City with a median household income of $78,602 per City-Data.com. Over 60% of the population has a college degree or higher. Its unemployment percentage is significantly below the state average and the area benefits from the presence of several large and diverse employers. This makes our investment less susceptible to the fate of one particular company. 

The median home value is $319,000 and median rents are $1,618 per month according to Zillow estimates. Housing prices are up 8.3% in the last year and projected to rise 4.4% more in the coming year. A 5% mortgage on said $319,000 house comes out to about $1,712 per month. In the last decade, home ownership rates in Kansas City have dropped 6.3%. Despite that, Kansas City is still one off the most affordable places to rent in the US.

The combination of these dynamics makes it advantageous to rent rather than buy. If housing prices continue to climb at these rates, housing affordability will decrease and drive more people to rent. We can also reasonably imply that the relative rent affordability of the area provides significant rent growth upside. 

Overland Park has experienced steady population growth averaging 1.38% per year for the last five years. Average occupancy in the area is an encouraging 94% and it’s expected that demand will outpace supply in Overland Park by 7,000 units in 2020. 

Overall, the Overland Park area presents a compelling combination of strong demographics, consistent growth, solid employment prospects, and favorable renting dynamics. 

Deal structure

The first thing that jumped out to me about the Royale was that there is no sponsor promote structure. The project returns are equal to those delivered to the investor. I have never seen another deal on any crowdfunding platform with that kind of structure. This would typically worry me, but given how much money the sponsor is putting into the deal themselves, I believe their interests still align well to deliver the best possible returns to their investors. 

Other fees on the project are reasonable. The construction management fee is 2% which is lower than the usual 5%. The acquisition fee is a flat $250,000, which is small as a percentage of the total investment. Property management costs 2.875% of the effective gross revenue per year, which is also below the usual 4-8% other projects charge. The asset management fee is 0.125% of effective gross revenue, which, again, is much lower than other deals. Overall, the structure of this deal is extremely investor friendly. 

The sponsor is investing $23.5mm of its own capital in the deal, which represents 70.2% of the total equity. Of the entire $79.3mm deal size, only 57.7% is coming from debt. This is a great thing because it means this property is far less levered than similar complexes and thus a lot less risky. The typical multifamily deal on crowdfunding platforms is about 70% debt. What’s more, the debt they are taking on has outstanding terms, including a low 4.28% rate and over 10 years of interest only payments.

First year cash flows are projected to be 6.8% and are projected by the pro-forma to rise steadily til 10% by the end of the investment. Obviously, one must take the pro-forma projections with a slight grain of salt, but given the demographics of the area, I am believe rent growth should remain positive. 

Property analysis

The Royale is located near the intersection of two major highways, offering direct access to downtown Kansas City. The property is part of a much larger development project called the CityPlace Urban Project, which will provide high-end multifamily, retail, and office properties.

Initially, I was concerned that the addition of several competing high-end apartment buildings would present difficult competition for the Royale. On a call with the sponsor I was relieved to hear that they are involved with the remainder of the project and its currently believed those future developments will proceed at an extremely slow pace and thus not flood the market with new supply.

The Royale’s current rents are slightly below the Overland Park average, at $1,512 per month, which should give them room to raise rents steadily over the life of the investment while still providing relative value to residents. The unit mix is good, with 220 one bedroom units out of the 344 units and 90 two bedroom units.

The Royale was completed earlier this year, so investors don’t have to worry about severe maintenance issues for several years. The kitchens come equipped with stainless steel appliances and white quartz counter tops. All units also come with a washer/dryer combo and central heating and air conditioning. Other in unit amenities include Nest thermostats, wood plank flooring, walk-in closets, bedroom ceiling fans, 9-11 foot ceilings, and covered balconies.

As a luxury apartment complex, the Royale delivers extensive amenities to its residents. The resident lounge is outfitted with pool tables, a business center with Wi-Fi, a media lounge, coffee bar, and a craft/building room. Exterior amenities include private cabanas, a saltwater heated pool, spa, fire pit, putting green, and a grilling area. 

The Royale also offers residents an array of luxury services. These include valet trash/recycling, a full-service concierge, package handling system, and dry cleaning pick-up and drop-off. 

Seems like a pretty great place to live if you ask me! 

Comparative analysis

CrowdStreet provided a list of 17 large multifamily properties in the greater Kansas City MSA that have sold since May 2014. Of those, the average per-unit acquisition price was around $156,000. The three most recent comps averaged a sales price of $166,000 per unit.

The Royale is being acquired for about $225,000 per unit, which is high but not totally out of the realm of its comps. It is a newer development with higher level amenities and as such, should command a bit of a premium over other properties. While the deal may be a bit overpriced, I find the relative risk profile, cash flow, sponsor, and property characteristics more than compensate.

Rent comps provided by the sponsor show rent levels slightly higher than the Overland Park average. Their comps also average a 12.3% vacancy rate, much higher than the Royale. The property is positioning itself toward the top of the market, but not outside reach of the same quality tenant and the comparable properties.

Most important: The sponsor

By far, the most important factor to consider in evaluating a real estate crowdfunding investment is the sponsor. Through the life of the deal, nothing will have a greater impact on the success of the investment. The sponsor is responsible for managing the property (or hiring a property manager), setting rent rates, completing needed construction and repairs, paying down the loan, maintaining occupancy, and much more.

Block Real Estate Services is about as blue-chip as sponsors come. They’ve been in the space for 70 years and manage 38 million square feet of retail, office, industrial, and multifamily properties. They’re also based in Kansas City, meaning they’ve got the deep local knowledge and network necessary to identify the best investments.

Block has leased, bought, sold, and managed properties in 212 cities in 38 states. I think you’d be hard pressed to find a sponsor with this depth and breadth of experience anywhere else.

Their portfolio of properties bought since 2011 is performing consistently. Their historical performance is in line with the expectations for this property. I would have preferred a track record going back through the previous recession, but what they did provide still looks promising.

On the investor conference call, the sponsor was incredibly knowledgeable about all aspects of the project and answered all questions to my satisfaction. I’m confident they will do right by their investors and deliver the kinds of returns they advertise.

Results

Since this is an ongoing investment, I will continue updating this section as new payments and information comes in. Last update: December 18, 2018.

I will add a realized IRR on the investment once it is complete, but in the meantime, it wouldn’t be a meaningful number. 

Thus far, all my interactions with the sponsor, Block, have been straightforward, professional, and helpful. They really seem to value their relationships with their investors and act quickly to ensure all investor queries are addressed.

Why I passed

I looked through roughly 25 deals before I settled on one. As an investor, it is important to be as selective as possible in screening prospective investments, as there can often be risks you won’t see unless you look very closely.

In order to protect those who did invest in the deals I passed on, I will not share specifics on the deals. I will, however, share some broad results I was able to glean from looking at so many deals. Here are the main factors that caused me to say no to so many deals.

Beware of oversized fees

One of the most confusing things about real estate crowdfunding is the fee structure. A sponsor may charge construction management fees, asset management fees, property management fees, several tiers of a promote (incentive) fee, and others. You must read through the OM to find these fees and ensure you are comfortable with paying them.

Be careful to check whether the management fee is charged on the total deal size or on the size of the invested equity. The former may lead to a much larger amount actually paid to the sponsor, so you should plan accordingly. 

Sometimes, you get what you pay for with fees. Some sponsors with pristine track records may charge more. As a prudent investor it is up to you to weight the relative merits of a manager per each dollar of fees you’ll pay them. 

Trust, but verify – The OM is meant to sell you the deal

Remember, the offering document is created to sell you the deal. The pro-forma, investment analysis, and discussion of the area the property is in will paint the best picture possible. That is not to say these documents are illegitimate. The data in them is (most likely) truthful, but you should still spend the time to verify some of the numbers you are seeing in the report. 

For example, if the OM reports that the neighborhood is experiencing strong job growth, go to city-data.com and find out for yourself.

If the property map shows a Starbucks and a Whole Foods within walking distance of the property, go to Google Street view and take the virtual walk to and from the property. Are there sketchy buildings or large highways along the route? Try to experience the property as much like a resident as possible.

Doing little things like this will not only confirm the data you find in the OM, it will allow you to ask thoughtful questions of the sponsor before investing and give you a greater sense of comfort that you really understand what you’ve invested in.

The sponsor is barely invested in the deal

As an investor, it is important for me to know that sponsor’s interests align with mine. The promote fee structure is often touted as one way of ensuring this, but there are other ways to align investors with sponsors. My favorite is to ensure the sponsor invests a significant amount in the same part of the waterfall as investors.

I passed on several deals because the sponsor was taking almost none of the equity in the deal. This implies that they are putting very little of their own capital to work and will instead live off the management fees and promote they receive on the back end. The danger here is that if a property is under-performing and it does not look likely the sponsor will ever earn a promote, they may be less motivated to maximize the property’s return. A large co-investment by the sponsor means that they are rewarded for maximizing return through the life of the deal, not just through their fees..

Time from closing to first payment is greater than six months

I am a cash flow investor. My real estate investments are cash flow vehicle first and an appreciation vehicle second. As such, I do not like deals which make you wait over 6 months to receive your first distribution. Ideally, I want to see deals that provide cash flow from month one. I saw several deals which made investors wait a year or more before their first distribution. One “core-plus” deal I looked at didn’t expect to pay anything until 2021!

Past performance is not indicative of future results

Since the OM exists to sell the deal, the pro-forma financial projections contained therein may be a bit optimistic to say the least. Do some independent research to verify whether the rent growth, occupancy, and cost assumptions the sponsor is making are reasonable. Remember, just because an area has seen 6% rent growth for the last two years does not mean that will continue into the future.

Discussion

It is still much too early in the life of this investment for me to make sweeping inferences about its ultimate performance. I have, however, gleaned a few things from the results so far. 

• A good sponsor is responsive and attentive to investor needs.
• Investing through an LLC may provide you some level of anonymity and protection, but you may have to pay self-employment taxes on the income from the investment if your LLC isn’t structured correctly. Speak with your CPA or financial adviser before making any real estate crowdfunding investments.
• Conducting due diligence on a potential investment with a sponsor you’ve never met, a property you’ve never visited, and on a new platform is a scary thing. But doing said due diligence in a thorough, systematic way will give you a degree of comfort and agency over your investments in a way stocks and bonds likely never will.

Be sure to come back later for future updates on the performance of this investment or sign up for our mailing list to be notified of updates!