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ANALYSIS: Top Real Estate Crowdfunding Platform Just Collapsed. What Does This Mean For The Industry?

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RealtyShares, a San Francisco-based startup, is a real estate crowdfunding platform that offers debt and equity investments for apartment buildings, office buildings, malls and so on.

As recent as August, this crowdfunding company was named a “hot startup” by Inc. Magazine.

Since its 2013 inception, Realtyshares says it’s raised more than $870M for more than 1,160 real estate projects. Investors far and wide, left and right, were pouring money into the platform.

Had investors like…

And now, in November?

The very same startup announced it has stopped taking new investments, that it’s laying off most of its employees.

Why? Because they were unable to secure more operating capital.

The easy story to tell here is that real estate crowdfunding—an industry disruptor democratizing access to institutional real estate assets—is little more than fad—much like the whispers around crypto.

(Which is taking a f*cking beating, btw. They’re even calling it a #fraud.)

Sure, it’s an easy, simplistic conclusion to draw. But there might be a little more to it than that.

What’s the story?

On Sept. 14, 2017, Techcrunch reported that Realtyshares had closed a $28M Series C funding round, bringing their total VC investment amount to $105.6M, per Crunchbase.

At the time, then-CEO Nav Athwal (who since left in November 2017) said they had over 120k users on the platform and wanted to “diversify in real estate in a way that hasn’t been possible before.”

At the time, Tyler Christenson, managing director at Cross Creek Advisors, who led the funding round, was super bullish with the boilerplate and jargon out in full force.

“RealtyShares is positioned to become the leading marketplace for sub-institutional debt and equity commercial real estate investment,” he said.

“These commercial investment opportunities in multifamily, retail, industrial, and office properties have historically been limited to large institutions, and RealtyShares has been able to break down many of the barriers investors have faced.”

Now? No more deals. And mass layoffs ahead.

$870M? $105M? $28M? What does it all mean?!

In 2017, when the round closed, Athwal said they had deployed $500M across deals. As of November, Realtyshares says that number’s $870M—a 74% jump in deal flow.

Now, just for clarity, taking investments for deals on the platforms vs. taking investments operating capital are two entirely different things.

As we’ve covered around here, startups raise capital for the purpose of increasing valuations, offering early investors (who take bigger risk by going in early) juicy exit strategies.

Example. See WeWork, right? It was worth $5B, then $10B, before landing at an insane $20B, with whispers then of being too aggressively valued. Guess what: It’s worth $45B.

Take a look at their funding history—and the valuations that followed.

For Uber, back in 2014, when it was “just” worth $17B, early investors made 2,000x return their initial investment. Four years later, Uber’s now rumored to go public at $120B. You do the math on that one.

How does this tie into Realtyshares?

Good question. Here’s how.

You see, with each funding round—Series A, Series B, Series C (hey, can the WealthLAB finance team get on a “Funding Rounds, Explained” piece soon?!), Series D, etc.—startups hope to increase the valuation of the enterprise.

Then ultimately either go public in an IPO or get sold to a private buyer. This is what early investors, angels, VCs and so on want to see. This is how they get their 10x.

“Over the past six months, RealtyShares aggressively pursued a number of financing options to continue growing the business,” RealtyShares wrote in an email to customers.

According to a report by The Real Deal, a Hail Mary, last-ditch effort to find a buyer failed. With no more capital to raise or valuation jumps to squeeze, Realtyshares said “No Mas.”

“Unfortunately, despite our best efforts, we were unable to secure additional capital. As a result, we will not offer new investments or accept new investors on the RealtyShares platform.”

Sooo, is crowdfunding doomed?

That’s the obvious, quick-trigger question. Does this mean the still-young real estate crowdfunding industry is doomed?

No. Real estate crowdfunding is basically pseudo-private/kinda-sorta public syndication of deals—a practice that’s existed forever.

Deals will continue to get syndicated, money will continue to pool, and this will happen offline, online, in whatever line. It’s one of the hottest asset classes for pension funds to protect against inflation, for instance.

Just look at Blackstone’s recent $18B fund. Those are standard practice.

So where did Realtyshares’ money go?

You got $870M worth of deals. You raised over $105M. Where did the money go?

Important point to underscore: The capital invested into Realtyshares, Inc. is to run and scale the business. 

These investors are totally separate from the investors in the real estate offered on the platform. In addition, the $870M is deal volume. 

In theory, the deals you invest in on Realtyshares may be for a fraction of the equity in the total deal. Which then is leveraged with debt. (Mortgage. A loan.)

Like, here’s an example: Deal costs $100M. Down payment is $10M. Realtyshares has a $1M equity offering in said deal; 100 investors invested $10k in that deal. Total deal is technically $100M.

Doesn’t mean that Realtyshares actually had $100M between their hands. Their operating cash comes from that $105M+.

The “transition will have no impact on the underlying real estate investments,” Realtyshares said in same note. In other words, for the crowdfunding investors in the assets listed on Realtyshares, it’s business as usual.

Go ahead. Celebrate. Do a lil’ dance. You still got your money.

So why the smoke?

So the $105.6M? Where did it go? Yeah, here comes the bad news…

RealtyShares makes money when investors invest into the real estate deals on their platform.

In essence, Realtyshares snags a commission at the time of the investment and also over time, designed to be lower than the industry average.

Hence the disruption.

So, most likely, Realtyshares—whose disruptive business model offered investment access at lower fees than its private equity and asset management competitors, just to reiterate—found it couldn’t sustain the growth with its current business model.

When companies plateau…

This is obviously speculation on our behalf, but let’s use this entirely hypothetical example as an illustration.

You have a business that charges a $10 commission of each sale of hardware. Based on the market size, you can reasonably expect to do 100,000 sales every year.

Total market is 1M sales a year. In theory, you have another 90% of the market to get a piece of. But in reality, your plateau comes at 125k sales every year.

Your ceiling, in other words, is $1.25M in revenue every year.

Now, if you’ve raised money with the intention of increasing the value—again, this is a general example, not specific to Realtyshares—and you hit a ceiling in terms of revenue…

There’s only so much upside to justify a valuation to investors before they say…

Is that what happened here?

Who knows? Could be. Looks like it.

It’s what happen to a lot of them. They raise tons of cash, accelerate the growth, grow too fast, and then they die.

In fact, “premature scaling” at one point was (and still may be) the No. 1 startup killer. This basically means when a company grows too fast for its own good,

In fact, premature scaling causes the death of 74% of tech startups.

Or as internet entrepreneur and New York Times bestseller Neil Patel put it:

If you gain more funding than your business warrants at its specific stage, it can produce undesirable side effects. In essence, it can cause you to expand your operations beyond what is manageable. This is premature scaling in its most common and nefarious form, and it is going to destroy your startup.

Back to real estate crowdfunding.

So what’s the rest of the industry saying? Why the sudden Realtyshares collapse?

CEO of Crowdstreet Tore Steen says the Realtyshares situation isn’t an indicator of health or longevity in the industry.

“It’s actually an indicator that the industry is maturing,” Steen says. “In an industry like this—crowdfunding of commercial real estate—you’re going to have certain business models that survive and certain ones that might not.”

Co-founder of competitor EquityMultiple Charles Clinton agreed, saying head count is to blame.

“I think you’ve seen some of the platforms that have managed headcount and spending a bit more judiciously are maybe a bit better situated for the next couple of years of growth,” Clinton told NREI.

And in the meantime?

It’ll create a “temporary crisis for people,” but that the industry will get past this pretty easily, Clinton said. “We’re still in the very early innings of total growth.”

Real Estate Investing

Cap Rate, Explained

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Whenever you’re pitching, shopping, brokering or hunting deals, one of the first terms you’ll come across is the “cap rate.”

Short for capitalization rate, at its most basic form, the cap rate indicates the annual yield on a real estate property.

But that’s not all it’s good for. It can also indicate valuations, feasibility of a deal, and what you should pay for a property. Here’s WealthLAB’s Cap Rate, Explained.

What is a cap rate?

The basic formula of the cap rate is the property’s net operating income (NOI) divided by the purchase price. It basically means the yield (return) of the property without considering debt or anything else. Or, in layman’s terms, it lets you know (an estimate of) your cash flow in advance.

Cap Rate Example

Let’s take a 20-unit property in Atlanta listed for $2 million. The rent roll for the year comes out to $300,000 with operating expenses totaling $100,000.

$200k divided by $2M = 10% = a 10% cap rate. (In everyday lingo, you’ll hear people call that a “10 cap.”)

How can I use it?

Quite a few ways. The most basic one is to compare the cap rate of a property you’re considering investing in vs. the average cap rate for the market. This would let you know whether you’re getting a good deal or not.

Pro forma

You can also use it when projecting income against a property you plan to upgrade. Then it would be a “pro forma cap rate.”

Find your price

You can also use it to find the price you’re willing to pay. But perhaps your strategy says you’ll only buy properties at a 12% cap rate. So now you can use the cap rate to calculate what your offer should be.

Using example above, if NOI is $200k, simply divide by your desired cap rate offer price (12%) = $1.66M = your offer price.

What’s a good cap rate?

It all depends, really.

Depends on the market, the state of the property, the cost of capital. In so-called gateway markets (think New York City, London, Tokyo etc.), the cap rates are lower because of the idea that — just like bonds and other “safe” instruments — investing in big markets is a safe play.

In addition, properties in big markets traditionally trend upwards—thus offsetting the lower cash flow.

In smaller markets, where there are less job, less people, and therefore less rental demand, the value doesn’t trend upwards as much; they remain stagnant.

For that reason, they’re deemed more risky and you’d seek a higher cap rate to get higher cash flow to mitigate that risk.

And valuation?

Yes, cap rates are also used to value properties. Again, going by the average cap rates for a given market, once you recapitalize (refinance), the lender—vs. the free market—will set a value of your property.

So the value would be found like this: NOI divided by cap rate. Let’s use the Atlanta 20-unit as an example. That particular type of property in that particular market has an average cap rate of 8%.

$200k NOI divided by 8% = $2.5M = your property’s value.

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Real Estate Investing

Is The 1% Rule Garbage?

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There’s a lot of “rules of thumb” floating around out there related to real estate. The one I hate the most is the 1% rule.

It’s wrong. It doesn’t work. Period.

Let me explain…

The 1% Rule Explained

Let me take a step back and explain the 1% rule first.

In a nutshell, it says that the monthly rent for your rental property should be at least 1% of the property value. If you can meet this goal then you can make some good money in real estate.

So, if you find a property that rents for $1,000/month and you can negotiate a price of $100,000 then you’re in good shape.

…at least according to the people pushing the 1% rule.

Image result for rules of thumb

Breaking Down the 1% Rule

Let’s say that that you find a property that is $100,000 and rents for $1,000.

We know around 5-10% goes straight to vacancy. So, that leaves you $900.

And 50% of that goes to expenses. Leaving you with $450.

And a 30 year mortgage on an $80,000 loan (I assume 20% was put down) is around $429.

So, that leaves you around $20 – $70 (depending on vacancy) each month.

…not very sexy is it?

The Break Even Ratio

Traditionally, the 1% rule was considered the break even rule. Where you would most likely cover your debt when rents are 1% of your purchase price.

So, what happened?

I don’t know for a fact, but I think a couple of things happened.

Turnkey Real Estate Companies

House, Building, Key, Plan, Turnkey, Catchment

First, I think that turnkey companies started pushing it as a solution. A turnkey company finds a distressed property, rehabs it, puts a tenant in there and sells it to you for at or above market price.

There is definitely some value to what turnkey companies do, but often they based their prices on the 1% rule and not necessarily on market value. That allows them to get higher prices in generally low cost markets.

They justify it with free education. They teach you that if you can get 1% of the value as rent, then the deal is great and you can make a ton of money…

To people on the west coast or other high-cost areas, this seems awesome because the ratios there are closer to 0.5%. So, relatively speaking, they are “great deals” even though they are overpaying.

Inexperienced Gurus

There are a ton of new gurus out there pushing all kinds of different ideas. Some are good and some are not, but the 1% rule keeps popping up, especially with online education.

Often, these are run by people who own a few properties and have done really well since the recession. It makes sense if you think about it. If you bought at 1% back then and rents and prices have almost doubled, then you are way above 1% based on what you purchased it for.

But, that is buying based on speculation that the market will improve, not based on the fundamentals of the deal.

Another common guru you see out there now is someone who’s only been investing for a few years. Even if they are doing great but they haven’t really been around long enough to see and understand the nuances.

They don’t realize that the 1% rule works when there are massive rent growth and appreciation but could never work in a sideways or downward trending market.

What About Using it As a Filter?

People will suggest using the 1% rule as a filter to go through hundreds of deals quickly. Here’s how they suggest you do it:

list all the prices, list all the rents, then calculate the ratios. Anything under 1% toss out and anything over 1% keep and look at deeper. So, a spreadsheet might look like this.

Based on this, you should consider buying the first, third, and fifth property on the list because the ratios are all above 1%.

But, this is missing a HUGE amount of detail. What is most important is not what it’s receiving for rent today, but what it could be receiving after you own it. So, you should based your numbers on potential rent not current rents.

Based on the new spreadsheet, the best potential deals are the 4th and 6th. While others may have potential as well based on the 1% rule, you see some really good ratios on deals you would have previously discarded.

That’s why the 1% rule is kind of silly. It leads you to discard potentially great deals in favor of more marginal deals.

Focus on The Numbers

The rent to price ratio is an important ratio to consider before purchasing anything. Just remember, it is a rule of thumb. Also, remember what it truly means:

The 1% rule is the break even rule not a rule to earn you money.

Rules of thumb are designed as a reality check. Things like the 50% rule to expenses or the 1% rule are there to act as a guide. If you are running the numbers and you’re rent is 1.5% while everyone else is at .75%, then you should think twice.

Or, perhaps your expenses are at 25% and everyone else is running at 50%. Then you should double check.

They are not and should never be used to make a buying decision.

That’s why I give away simple calculators like this one, to point you in the right direction.

This article originally appeared on IdealREI. Follow them on FacebookInstagram and Twitter.

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Real Estate Investing

The No. 1 Strategy To Build A Rental Property Empire

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It’s impossible to buy enough rental property to retire with, right? It simply takes too long to save up, buy property, and a little rent over years

You just need too much money for down payments to keep buying.

Wrong.

It’s true that buying rental property is a very capital intensive process and it’s true that you generally need 20-25% down for your purchases (except your first few which can go FHA or VA).

It’s also true that most people don’t have unlimited funds and can’t keep putting 20-25% down.

But here’s the thing – you don’t have to keep putting money down.

There’s this really simply strategy that allows you to avoid doing all that. You guessed it, it’s called the BRRR strategy and I’m going to go into that in a lot of detail. But first…

A quick story about how I retired using the BRRR real estate method.

BRRR Strategy During the Great Recession

A long time ago I started using the BRRR strategy before anyone ever called it the BRRR strategy.

In a nutshell, it’s a way to buy property that allows you to preserve capital in order to buy more and more properties over time.

I’m going to get into detail on it in a minute, but I want to take you back to 2009 through 2013 during the deepest part of the great recession.

No one had jobs. No one could afford to pay rent. Housing prices dropped like a rock and flat lined like a hospital patient. There was no bounce.

It was just despair everywhere.

They call it the great recession, but in historical terms, it was clearly a depression.

…and I decided to get into real estate.

Everyone said I was crazy, and I was a little crazy. A lot of people had just lost everything, tenants weren’t paying, evictions were happening all over. It was rough.

But, deals could be found everywhere. The other benefit was since no one had work contractors were easy to find and would work for 1/3 what they charge now.

The hard part was finding money to invest and finding banks to lend.

I bought my first 3 family in 2009, then bought a 4 family a few years later in early 2012. This is a picture of the 4 family, sexy isn’t it?

By 2015 I had over 20 units. By 2017 I had around 35, and now in 2018 I’ve moved up to apartment complexes and have over 470.

This is the strategy I used to keep buying more property while continuously putting more money in my pocket.

Here’s how brrr investing works in real estate.

Using the BRRR Strategy to Build a Rental Property Portfolio

The overall Gist of the BRRR method is to add enough value to a property that when you refinance it you will get most, if not all of your capital back. This allows you to take your money and use it over and over again to buy deals.

Just in case you aren’t yet aware, BRRR stands for Buy, Rehab, Rent, Refinance. Alternatively, some people call it the BRRRR method which stands for the exact same thing, except the last R stands for “repeat.”

So, BRRRR method is Buy, Rehab, Rent, Refinance, Repeat.

Step 1 – Buying

There are 3 basic parts to buying any property – finding, analyzing, and closing the deal.

Finding a Deal

The most important part of the BRRR real estate strategy is to find great deals. Without an amazing deal, it simply doesn’t work (but that’s kind of true about making money in real estate anyhow).

In general, people refer to deals as either “off-market” and “on-market.” An off-market deal is essentially every sale that is not listed with a real estate salesperson on a listing service such as the MLS, LoopNet, or CoStar.

There are a ton of ways to find great off-market deals. These includes:

  • Starting an Investor Website
  • Direct Mail
  • Knocking on Doors
  • Bandit Signs
  • MLS
  • Bird-Dogs

…and a couple dozen more methods. The only thing limiting you is your imagination!

Analyzing Rental Property

It’s important to have a couple different calculators to get this job done. The most important is your “back of the napkin” calculator.

The reason why a calculator like this is so important is because you will literally look at hundreds of deals. It’s impossible to use an advanced calculator and cull through dozens of deals a week.

Instead, it’s best to use a very simple calculator, toss in the basic numbers, and just see if it’s even remotely close.

Once you do that, you can take the deal and do a deeper analysis. If it’s not any good, just toss it aside and you’ve saved hours of your time.

I put together a free BRRR calculator for you to use to screen deals.

Closing Deals

The most important part of closing a deal is….financing it.

We’ll talk a bit more about financing at the end when we talk about the third R – Refinance, but it’s important to know that your financing up front will be different than how you refinance the deal.

Up front, you are generally using cash or some kind of private or hard money. Banks don’t like risk, and deals that need work are considered risky.

By using cash or private money, you’ll be able to purchase something with a bit of risk so you can add value.

The other reason is because distressed properties often need to close quickly. Banks are anything but quick.

So the key here is to use private money to purchase, then refinance into something longer term such as a good conventional or long-term commercial loan.

Step 2 – Rehab

You don’t want to rehab a BRRR rental property the same way you would fix a flip.

When you analyze a project for a flip, you look at the cost of the work vs the increase in value. If a kitchen costs 10k and increases the value by 15k, then it has a 50% return (15k – 10k = 5k return. A 5k return divided by 10k invested = 50% return).

That same kitchen may add value to your rental, but since you aren’t selling it, it’s the wrong way to measure value.

That $10k might add $15k in value, but add barely anything in extra rent. Since we are looking for cash-flow, I’d rather focus on renovations that add to the amount of rent I can charge.

BRRR Step 3 – Renting The Unit

Finding great tenants that will pay market (or higher) rents is key to your strategy. The 3 key steps are to findscreen, and retain.

Step 4 – Refinancing

The goal is to get your money back so you can repeat the process, which makes this step the most crucial.

because the rules for commercial lending are slighting different than personal lending, let’s take a quick step back and go over the rules/requirements for commercial lending:

  • You will need around 2 years of “experience.” This can be rehab experience, landlord experience, or even experience as a realtor if you can convince the bank that it’s directly applicable.
  • Most banks require 6+ months of “seasoning” before they will finance it at the market price rather than the purchase price. This means the property has been stable, fixed, and rented for around that period of time. Basically, they need you to justify the higher price with some evidence of stability and improved rents.
  • Banks lend 75-80% of appraised value on this sort of deal.

It’s not hard to see the “trick” once all the criteria are laid out.

  • Banks will lend around 75% of the appraised value after 6 months of seasoning.
  • House flippers are looking to be “all in” for around 75-80% of the property value.

So, buy a rental property like you’re going to flip it, then just refinance it – you’ll get all your cash back plus long-term rental income.

But, in order for this system to work well, you need to be able to be “all in” for around 75-80% of value.

Step 5 – Repeat and BRRR More (aka brrrr)

Once you have most or all of your money back, it’s time to find another real estate deal to BRRRR! The extra R stands for Repeat.

You’ll have your cash back and a new stream of income. Could life get any better?

Have you ever used the BRRR Strategy? Tell me how it went in the comments below.

This article originally appeared on IdealREI. Follow them on FacebookInstagram and Twitter.

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