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.
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.
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.
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.
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,
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.”
There are many factors that you should consider. You will note that earlier on, most people used to visit banks in order to get loans that could enable them build or buy a house of their dreams. This used to work well for some people.
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This can play a major role in helping you save more money.
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The process of getting a home loan can be very tasking. You have to visit different lenders so that you can compare their interest rates. Sometimes, you might not have all this time. You might end up choosing a lender who charges you more interest.
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At trillions of dollars, it’s no secret that the real estate market has been one of primary resources for the world’s wealthy to pad their accounts.
But contrary to popular opinion, real estate is still a desirable asset class for entrepreneurs with smaller bank accounts. Here are five ways to fund your first real estate investment—even if you’re low on cash.
1. Know Your Numbers
Remember, while property values fluctuate, your rental income is locked into a leasing agreement—and so is your valuation.
That means, as long as the numbers work, the market can do what it wants. Asset-based lenders (B2R Finance is one) lend primarily on the cash flow of the property, rather than personal income like more traditional lenders.
For instance: If you have a lead on a four-family property that’s fully leased and cash-flowing, you can finance up to 80% of the property’s value.
Or translated in layman’s speak: You don’t really need a credit score or a great job to get financing.
Have you ever driven around your city and seen all these apartment complexes, shopping plazas, or even office buildings? I always used to think they were all owned by rich billionaires.
…some of them are, but not all.
The reality is that a lot of these large properties are actually owned by regular people like you and me to generate passive income.
The answer: with real estate syndication.
It’s what I used to recently close a 192 unit deal in San Antonio with my partners.
But what exactly is real estate syndication?
Syndication is a way which multiple real estate investors pool their funds together in order to purchase a property that is more expensive than any of them could have afforded on their own.
Generally, there are two types of partners in these deals: 1) General Partners (GPs) who accept additional risk, put the deal together, and operate the asset 2) Limited Partners (LPs) who have limited risk and invest more passively.
Real estate syndications are an effective way to spread risk. Since each investor can allocate a smaller sum to each deal, they can effectively spread their risk across multiple property types and diversify by geographic region.
Real Estate Syndication Structure
Syndications in real estate are amazingly diverse in their structure so it’s impossible to cover everything. In general, there are four components:
Return of investor capital – Limited partners should always get paid back first, and this ensures they get paid first
The preferred return – Not all deals have a preferred return, but when they do this is where it pays out. Investors get the first portion of the deal before the general partners.
The catch-up – Many deals don’t have a catch-up tier but this is where the sponsor will get 100% of the profits after the preferred return until the predetermined split is met.
Carried interest – profits are split based on the agreed amount (such as 80/20 or 70/30)
Let’s break it down further…
What Is A Preferred Return In A Real Estate Syndicate?
According to Mark Kenney over at ThinkMultifamily, a preferred return is “a return that investors received BEFORE the general partners receive a return.” In essence, after the investors receive their initial capital back, they received a preferred rate of return before the general partners get any payout at all.
Mark, an investor and real estate coach who owns over 2,000 doors in Tennessee, Georgia, and Texas, says that he doesn’t like to use a preferred return but has in the past on deals that didn’t expect any distributions for 12 or 18 months.
The preferred return would accrue and give incentive for people to invest in the deal.
Andrew Campbell, the co-founder of Wildhorn Capital, a multifamily operator based in Austin, Texas has a different opinion. He said he likes to have an 8% preferred return for the majority of his 450 door portfolio.
It “gives some certainty to investors about their overall returns. Plus, 8% also happens to beat the historical stock market return of 7%.”
What Is A Waterfall In A Real Estate Syndication?
The waterfall refers to the overall distribution of funds and tiers that were mentioned above, but it is often referred to as how profits are split after the preferred return is met. Andrew Campbell explains it perfectly:
“Profits generated above any preferred returns are generally split between investors (Limited Partners) and deal sponsors (General Partners). In our case, above the 8% pref we split profits 70% to Limited Partners and 30% to General Partners.
Some deals and sponsors will have additional “waterfalls” where at 18% IRR (for example) the split would go to 50/50. The general idea is that the higher the returns are to investors, the more the sponsors make, and everyone is happy.
The downside of multiple waterfalls is that sponsors can sometimes be incentivized to return investor capital early (to boost the IRR) and trigger these waterfalls.That can sometimes put unnecessary risk on the asset if they are being to aggressive.”
Kenny Wolfe, the founder of Wolfe Investments who has been involved in over $91M in real estate transactions doesn’t like the complexity of the waterfall structure many syndicators use.
“We have steered clear of preferred returns mostly because those are usually accompanied with up-front fees charged to investors. Our investment structures are tied to the performance of the investment, and not just closing deals like the typical preferred return strategy.”
“If we make our investors money, then we’re rewarded. If we don’t then we aren’t rewarded.”
I originally didn’t plan to dive into the fee structure at all, but since Kenny brought up some great points, I think I’ll dive into the fees and how some different structures affect the incentives and performance of deals.
The Fees When Syndicating Real Estate
There are a lot of different types of fees used in syndication. Some are more common than others but all have their pros/cons. Here are the most common ones
I’ve seen this anywhere from 0 to 5 points with 2 being the most common. Acquisition fees in a syndication are really common and most have them, but not all.
Syndicators are running a business and that has costs. Acquisition fees help pay for the operating costs, staff, flights, hotels, diligence, and other costs that are needed to run the business.
On the other hand, acquisition fees can be enormous on large deals and can drive some deal sponsors to be short-sighted and focus on closing deals rather than operating deals profitably.
Think about it, a $10M deal with 2 point acquisition fee is $200,000. That adds up fast! You can see how some sponsors will lose track of buying good deals and focus on just closing deals, regardless of how good they are.
Asset Management Fee
This generally ranges from 1-3% of gross rent revenue. This may or may not go to the deal sponsor and it goes to cover the cost of managing the asset and management team that was hired.
Since the syndicator only gets paid when the asset is cash flowing, there isn’t much incentive to take on difficult projects. That’s where the construction fee comes in. If there is a major rehab project a fee can be imposed to compensate the project manager while the asset isn’t producing income.
It can vary but is often 1-2% of the construction cost.
There are a lot of competing interests in a deal and it’s difficult to align everyone 100% of the time – that’s why trust must be built with anyone that you’re investing with.
But, a few major points to consider are how all the fees and the preferred return and waterfall all fit together.
Deals with high preferred returns and high fees create incentives for the sponsor to find and close deals, but not a lot of incentive to maximize cash flow. As Andrew pointed out, deals with huge benefits to the sponsor at certain levels can cause them to sell early to bump the IRR artificially and trigger that waterfall distribution.
But, deals that compensate the sponsor more will create more incentive to produce high returns.
That’s why there are so many different ways to structure deals! Every sponsor and investor pool is different so they can create deals that work for everyone.
Structuring a Syndication Deal – Example
Similar to how Andrew structures deals, let’s say that in this deal there will be an 8% preferred return, 70/30 split thereafter, and have a 2 point acquisition fee and 2 point asset management fee.
The limited partners will get 70% of the returns after the 8% pref and the sponsor will get the other 30%. The sponsor will get 2 points up front and 2 percent of the gross revenue.
Example 2 – Syndication Structure
Kenny, on the other hand, keeps it simple. He might charge an 80/20 split with no acquisition fee, no waterfall, and no preferred return. The asset management fee is 2% as well in this example.
So, the limited partners get 80% of all the profits and the general partner gets 20%. If it does well everyone does well and if it does poorly everyone does poorly. There are very limited fees except for the asset management fee.
Example 3 – Hybrid Structure
Mark kind of does it a third way. He said he generally does the 80/20 split, but he does charge an acquisition fee and asset management fee but rarely does a preferred return.
The acquisition fee is more similar to Andrew but his split is more similar to Kenny.
It’s interesting to see how 3 different real estate syndicators have three entirely different ways to structure their deals.
How To Find Real Estate Deals to Syndicate?
These are large deals and you don’t typically see them on the MLS, so how exactly do you find deals for a syndication?
Well, three different deal sponsors had three different answers:
“Now that we’re established as a solid buyer we get off-market deals across the US. We look at the on-market deals as well. These days the off-market deals have been much more attractive.”– Kenny Wolfe
Andrew Campbell appears to have a more holistic view for finding deals.
“It’s a full-time job, and it all comes back to relationships. Meeting and networking with brokers, talking to owners, title agents, insurance providers, property managers. Leads can come from anywhere, and in this market, you want to make sure you can see as many properties as possible, and the earlier and more off-market/limited market they are the better.”
Mark Kenney has seemed to be extremely successful working directly with commercial real estate brokers.
“We generally work through brokers to finds deals.”
What About LoopNet for Commercial Real Estate Syndication?
I’ve known about LoopNet for a while, so I was curious about it. Kenney put it simply though:
“Loopnet is far from dead. We do a ton of volume on it and use it almost exclusively for smaller listings.”
How Do You Find Commercial Brokers and Get Them to Take You Seriously?
Commercial brokers are dealing with a lot of big players in the market, and it can be difficult to get them to take you seriously if you are a new player.
Mark pointed out that “a market generally only has a few major names. The top 2 or 3 people have access to virtually all the deals, so you just need to identify them.”
He continued, “it’s not hard to get yourself onto their email list, but it can be more difficult to get people to take your offers seriously. It’s important to have some experience in the field and if you don’t, then partner up with someone who does have the experience.”
In the end, money talks and the highest offer usually wins. So, you can make up for experience with higher offers.
The Cost To Syndicate A Real Estate Deal
Now that we’ve got past the “what is a syndication in real estate” and the “how to syndicate in real estate” part of the article, we can get into the costs and money aspect.
The first logical question is about the cost of a syndication.
There are several major fixed cost items that every syndication requires, including – SEC attorney, earnest money deposit, diligence, private placement memorandum, loan application fees, and more.
So, let’s break them down. As some fees are percentage based, I’m going to create a hypothetical $2,000,000 deal.
Attorney for Contract – $3,000
SEC Attorney for PPM – $12,000
EMD – 1% – $40,000
Diligence – $25-$50 per door – $2,000
Loan Application – 1% – $20,000
Other Financing Costs – 0.5% – 1% – $20,000
Total Costs – $97,000 to get the deal done, of which $40,000 goes toward the purchase.
So the total fixed costs are $57,000 or 2.85% of the total deal price. As you can see, this is not cheap!
The syndicator has to front all the money and if the deal doesn’t close most of that money can be lost. So, you can see one reason why syndicators are compensated pretty well.
How Big Do Syndication Deals Need To Be?
We are talking some pretty big numbers here overall. Realistically though, how big or small does the syndication deal need to be in order for it to make sense?
Universally, all of the deal sponsors wanted to do larger rather than smaller deals. Both Mark and Kenny said they want deals over 80 units which allows for full-time on-site property management. Andrew prefers to look at it as a dollar figure and prefers to do deals over $8 million to keep the fixed costs as a small percent of the total costs.
How Do You Find Investors?
Most people reading this are probably wondering how you can find people to invest so much money. Most people can save up $50-100k, but you are talking about raising hundreds of thousands, or even millions of dollars for a deal. How?
Andrew says it’s a “second full-time job” which comes back to relationships and marketing. He does at least 5 sit-down meetings a week to grow those relationships.
Kenny is so well established that most of his new investors come from referrals though he also does a meetup, podcasts, and general outreach.
Example Syndication Deal
You might be wondering how much a syndicator can actually earn from one of these deals. So, I put together this example based on the knowledge I gained.
Let’s assume we found a property somewhere in Texas with a 6.5% capitalization rate. It’s about 70 units and is selling for $60,000 per unit. That’s $4.2M total.
A 6.5 cap rate means the property has a net operating income of about $273,000 per year before finance costs.
With about $875,000 as a down payment, that’s about $190,000/year in finance costs (I’m rounding).
So the cash flow is about $83,000/year.
Of course some of that goes toward principal, and eventually, the deal will be sold and that will get distributed back to the investors. For now, though, let’s just focus on cash flow and not the entire return.
What The General And Limited Partners Earn In A Syndication
I’m going to keep the numbers super simple so I can do it all in my head. Let’s take the 1% asset management fee out of the gross rents. We don’t have a number for gross rent (only NOI). Let’s say it’s $8,000. If you were the asset manager, great you get to pocket that. If not, someone else does.
The rental income is now $75,000.
Of that cash flow, let’s say the syndicator is doing a 90/10 split and will earn 10%.
And let’s say he also put in about $100,000 into the deal, they would have a total equity of 21.4% and would get about $16,050 in cash flow. That’s about a 16% cash on cash return for the principal (excluding the asset management fee). Don’t forget, they earn the same returns as other LPs on the cash they invest, and then get their split just for doing the deal.
Realistically, this example doesn’t include any growth in value and is a very simple example.
Now You Know The Basics
…and it’s time to download your deal calculator to help you start analyzing your next deal.