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What is Real Estate Crowdfunding?
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224 Charles Clinton, Co-Founder & CEO, EquityMultiple
From Law Firm to CFRE
Charles started his real estate career as an attorney working at a firm called Simpson Thacher in midtown Manhattan mostly for big private equity clients like Blackstone, KKR, Carlyle and others. All the real estate giants. He worked on huge, multibillion dollar transactions and found that his actual exposure to real estate investing was pretty limited and opaque and during the day and oftentimes late to the night he’d be working on these big real estate deals, but when it came to investing his own money, he always found that a difficult thing to do. Maybe he would find a friend doing a small deal or looking at buying part of a brownstone or some such thing, and it just seemed like such a weird mismatch to him. So when the JOBS Act passed in 2012 Charles was immediately interested. He started reading through it and especially as the first companies like Fundrise got into the space, was interested to see where it could go. It seemed like this was the path really for solving the mismatch.
Entrepreneurship
Despite having taken the safe route and going to law school and becoming a lawyer, Charles has always had a little entrepreneurial spirit in his heart; a willingness to bet on himself and see what happens. He also had a real conviction that CFRE was going to be a major disruptive industry that would change the way that individuals invest in real estate. If you look at kind of the big picture of the real estate industry you have professional investors and endowment funds investing 10 to 20 percent of their total assets into real estate and then you look at your average individual high net worth investor much less your non-high network investor. And they're averaging under 3 percent of their net worth into real estate outside of their home. There's just such a big systemic imbalance here. Charles thought that if he could be just a part of correcting that imbalance there's really a tremendous opportunity there.
Leaders of The Crowd
Conversations with Crowdfunding Visionaries and How Real Estate Stole the Show
Discover how laws that gave us crowdfunding were solely meant to finance small companies and yet inadvertently opened the doors to allow you to invest in real estate like never before.
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Transformation
The process starts with the information that's presented about the deal that the investor is going into. For one of the deals on the EquityMultiple platform, for example, you can sign in and you're going to see long web page filled with an overview of the deal, pictures, a description, the business plan, the financials, information about comparable properties, about the markets, about the condition of the property. In short, information to let you as the investor know exactly what you're putting your money into and make an informed decision.
How to Fund Your Deals
7 Steps to Raising Equity Online
Vs. Non-Traded REITs
You can contrast that with the typical non-trading REIT where the sales process has largely been people sitting in a warehouse cold calling and trying to sell a product over the phone where you don't know exactly what you're investing in you're just investing in REIT number 472 maybe it has a particular strategy but you have no idea what the properties are. Furthermore, information about the fees which tend to always be extremely high as high as 10 to 15 percent annually is buried in tiny fine print and really it's about pushing a product on people and trying to trick your way in versus presenting something laying out all the facts and letting people make their own decisions.
Plus, when you invest in one of these non-traded REITs, you don't know what the assets are in the portfolio. The investor may know some of the prior investments but won’t know any of the ones that the future dollars, including your investment, are going to be spent on. Sometimes it's even difficult to get real good data on the existing portfolio. That's just really the exact opposite of what EquityMultiple is trying to do and what most of the good crowdfunding businesses are trying to do.
EquityMultiple
That how EquityMultiple tried to get out on the right foot and differentiate themselves from the start. Charles says that “the big challenge that you think you're going to have at the beginning are not the ones that you end up having.” He believes that it is important to do and see what works and see how the industry evolves to know what your investors, your customers actually want.
Investment Strategy
What they have found is that they are placing more of a premium on shorter duration investments and investments that have a bigger percentage of their total return being paid out along the way in the form of dividend distributions rather than having most of it be kind of back ended. And that's a little bit of a change from the partner's backgrounds where they would really look at the longer-term value add hold for five years and it's okay if there's no cash flow upfront.
Some of that is what they have seen investors want and some of it is given where the market is they don't want to bank on that asset level appreciation as much; they really want to make sure that the business plan is something that can work right now. That it doesn't rely on a 5 percent year over year growth or anything like that. Their returns on equity investments and preferred equity investments are targeted at somewhere between a 13 and a 20 percent total annualized return and somewhere in the high single digits to low double digits being paid out currently along the way.
Returns
To illustrate this, a deal on the platform right outside of Mempis had a 7 percent current pay to investors starting in the first quarter after the investment closed. Then investors had payment priority ahead of all the other investors in the deal. This is just for equity multiple investors. Once the deal is refinanced or sold they get their principal back, and they'll also get another 7 percent return annualized on top of that for a total 14 percent annualized return. Maybe if the deal does fantastically the equity holders will make more, but the goal really is to really increase the chance of getting to that nice strong low teens or mid-teens returns.
Cap on Upside, Downside Protection
In short, EquityMultiple investors i.e. the preferred equity investors, are capped at a 7% pref plus 7% if the deal goes well, whereas the [common] equity investors who sit on top of that in the capital stack have more upside but also a higher risk of non-recovery of principle. The sponsor and their investors generally take the common equity slug in the deal.
This structure comes out of the institutional world where it's very common there to see these kinds of different tranches of investors. EquityMultiple thought that this was not just a good fit for the institutional side but also a good fit for individual investors because it checks a lot of the boxes that they believe investors are looking for to deliver a nice return. They are still getting a good portion of that return on a current basis, but there is also some real protection in the event that the investment doesn't perform as well as the sponsors is projecting.
While in some ways the background structure of their deals might be a little more complicated on an investment when it’s done as preferred equity there is something that's also very understandable about fixed rate returns; that the investor gets paid after lenders and before the equity investors and EquityMultiple finds that they are dealing with smart people and they have found that it is something they have been able to communicate effectively.
Challenges
The Future
Charles sees a real spike in demand likely from investors over the next few years and suspects with that we're going to see further consolidation in the industry. We'll probably see some of the bigger players in the real estate or the asset management world looking to come into the space either directly or possibly through an acquisition of one of the existing businesses. We've already seen sort of more specialization right. Fundrise has now gone into the REIT space. They're really raising money for their own non-trading REIT albeit in a new way. There are platforms like Peerstreet that are very honed in on single family kind of fix and flip lending and really concentrating on growing that space. We’ll probably continue to see that and continue to see the good platforms grow stronger and deeper and, in Charles’s view, there's really room for several different variants of this business model that offer different value props to investors so as you look out as an investor your options are only going to continue to improve.
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