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Regulation, Risk and Return – the US AltFi Real Estate Market

Real estate crowdfunding is not your typical crowdfunding sector. Whilst the US alternative equity world has been altered by the release of Title IV, the real estate industry remains relatively untouched. We caught up with Ben Miller - CEO of FundRise, AdaPia d'Errico - Chief Marketing Officer of Patch of Land and Marshall Saunders - Co-founder of SaundersDailey, to discuss the regulatory changes going on and what the main dangers were to the sector.

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Ben Miller struck a noticeably cautious tone on the effect of Title IV:

"While we're looking into it, we haven't determined if it is economic or feasible for real estate. Real estate deals require certainty of closing, something that isn't present in best efforts offerings subject to lengthy, uncertain regulatory reviews...with Regulation A, as well as under the new A+, it takes months to get cleared by the regulators. When we did our first Reg A offering in 2012, it took us over 6 months. Once cleared, a company can then start the fundraising process, which is likely to be another multi-week, if not multi-month, undertaking (not including the 21 day public review period required by Regulation A+). Rarely can a real estate company wait 6 months."

Having done three successful regulation A offerings in the last four years, Mr. Miller did, however, emphasise the importance of the bill to the wider industry, noting:

"Many middle-sized companies will now have access to up to $50 million from the true public, which creates a potentially viable alternative to private equity. There are many medium-sized businesses...that will soon be able to access a new source. We applaud the Commission for developing a comprehensive and workable set of regulations."

Title IV – and the opening up of crowdfunding to non-accredited investors - has been widely lauded as a huge growth opportunity for the market. By restricting themselves to accredited investors - who make up a mere 3% of the US population - and institutional investors, it could be argued that real estate crowdfunders are committing themselves to remain small time platforms. AdaPia, however, highlighted the extent of the opportunity already available in the space - "there's so much opportunity in the accredited investor base already" - without requiring the hassle of A+. This week, her company closed a $930,000 commercial loan in under 7 hours. For this reason, AdaPia argues that "for us, it [Reg A+] doesn't make sense". She highlighted her company's ability and readiness to scale:

"The scale is absolutely there. It's systemic. The real estate lending segment is following the same path as consumer or small business lending. Achieving scale is about putting together efficient processes and using data, human experience and historical information to build credit and risk models that can be applied across the markets we are lending in."

Moreover, AdaPia described the areas that Patch of Land could expand into without A+:

"There are RIAs (registered investor advisors) who are beginning to enter the picture. Working with them is going to be a way to expand the investor base at scale.”

“(Expanding into institutional capital.) We do work with some large institutions already. Institutional provides a lot of firepower, especially when it can commit $100 million in funds, and that makes it possible to originate that much -- quickly. There are many tiers of institutional capital: from family offices, to trusts, private equity, and hedge funds. There are a lot of opportunities in that accredited space as well as the institutional space, for a firm to be able to fund and scale volume quite significantly."

The caution over using the new regulation does not mean that companies, such as Patch of Land have no intention of reaching a wider audience. AdaPia emphasised that, whilst this wouldn't be done through the JOBS act, there is still potential to become a full retail investor. The alternative is to file an S11 and become fully regulated, the direction that Lending Club have gone. Whilst noting that this would require a lot of money, time and personnel: for AdaPia, the benefits outweigh the costs. For the time being, this doesn’t seem to be on the cards though.

Next, we discussed the danger of underwriting costs - and the problems that can arise from moving real estate online and away from the local population. Marshall provided some excellent insight into the issue:

"When you make broad generalisations of an area, especially when it comes to income-producing real estate, there can be huge variances on a block-by-block, street-by-street basis. Real estate ventures are much more successful when you’re investing with people who have already established themselves professionally in the local market. Sometimes when real estate is broken down broadly by zip codes or metroplexes, you'll get an average crime rate or an average rental rate that doesn't hold true on a street-to-street basis. If you don't understand the small differences in a particular area, there is always the chance that you’ll make uninformed investment decisions."

He continued by shedding some light on the dangers of industry participants that aren't specialists in real estate:

"We are finding a few businesses out there who are very gifted on the technology side. They are easily able to get their website up and looking flashy, but they aren't as experienced in the real estate or investment angles of the business. For investors, the quality of the deal is what’s important and in some cases, it’s possible that investors are getting lost in brand firepower and valuation.”

“Back in 2005, 2006, 2007, people were putting their money into projects that didn’t have a strong grasp of local markets. People rushed into investments that promised 20% returns with an 18 month turnarounds and unfortunately, investments didn’t always end as they had anticipated. Making money in real estate is slow and steady and it takes a long-term eye to identify long-term investments that will yield. I’d say that the most you're going to get is 5-7% on a yearly basis."

Importantly, Marshall was clear that this problem was not down to malicious behaviour:

"I’ve gone out to several other sites and I don't think that they're lying and I don't think that they're being disingenuous to their investors. However, I do think that the predictions of what their investments are going to yield are very optimistic."

This is why, according to Marshall, SaundersDailey is perfectly placed to provide a profitable, yet responsible, service to the citizens of Minnesota. With over 75 years worth of real estate experience in his 4-man leadership team, he believes that they can provide a truly professional and knowledgeable account of the area. Mr. Saunders highlighted the importance of being local when describing his plans for growth:

"Eventually we would like to be a Mid-Western company. We would like to see an eventual expansion to Indianapolis, Kansas City, Des Moines.”

However, Marshall expressed his caution over expanding any further and provided his insight into the regional variation into the US:

“On the coasts, you can make tons of money, but the market is so boom and bust with prices either spiking or plummeting. We're looking for people who like to have and hold real estate for long-term, solid investments. Expanding to the markets in either New York or Los Angeles would be such a core shift in the type of investment and the type of investor that we're working with that I don't see that on the horizon in my business life."

It may seem that companies, such as Patch of Land or FundRise, are taking substantial risk for their potentially higher return – particularly FundRise, who are reportedly in discussion with Renren about an expansion into the Chinese P2P market. AdaPia was quick to explain her company’s appreciation of the risk however:

"One must be very careful about believing anyone who says they can fully underwrite online, with only data and algorithms. Real estate, by its very nature, is a tangible, fixed asset that needs to be evaluated with traditional methods such as appraisals. It's a matter of synergistically combining human experience and the plethora of available data in a way that makes sense in order to assess, evaluate, and correctly price an asset or loan. Risk mitigation is important -- If you are evaluating a property in a risky” neighbourhood, you may not be able to remove all risks, however, you can put a price on it. As my CFO likes to say, there are no bad deals, only incorrectly priced deals.”

It should also be noted - as Marshall did - that equity crowdfunding has the potential to reduce risk in real estate:

"Crowdfunding brings the people that own the risk closer to the risk. They can drive by that apartment building that they own a percent of, they can see whether people are loitering outside and they can see whether the management company is keeping it up."


“A person living in the UK who has invested in Minnesota can go online, look at our wi-fi cameras and watch their investment and the neighbourhood that surrounds it, in real time. Even if they're not physically in the area, they can still feel connected to what they own a part of.”

To close things up, we touched upon where the industry is at the moment and where it was heading:

“I think that we are going to see a lot of frenetic activity in crowdfunding.  In the next five years I think that it will become a real industry, not just a fad but a genuine industry.”

It is clear that the crowfunding real estate market is a unique sector - and regional differences within this sector are strikingly large. Whilst recent regulatory developments have not effected real estate in the same way that they have elsewhere, there is no doubt that growth potential is high, and opportunities are vast, but risks are also significant.

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