Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.
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www.REBusinessOnline.com Western Real Estate Business • September 2017 • 59 CROWDFUNDED REITS: THE CHEAPER ALTERNATIVE By Jeffrey Karsh, Partner and Co-founder, Tryperion Partners in Los Angeles M o d e r n - d a y c r o w d f u n d i n g kicked into high gear in 2012 when Pres. Obama signed the Jobs Act into law, which made investing in start- ups and small com- panies easier and more accessible to the "crowd." Within the crowdfunding space, real estate has particularly matured in ways that other asset classes have not because they failed to generate the same level of interest. The best way to understand the evolution of the real estate crowd- funding industry is to start with the difference between real estate crowdfunding 1.0 and real estate crowdfunding 2.0. The former is a project-by-project syndication mod- el, allowing the crowd to choose in- dividual investments through one of the various "platform" websites, while the latter is a crowdfunded REIT model, enabling the crowd to invest in a diversified portfolio of commercial real estate. Version 1.0 involves acquiring a property or originating a loan with the intent to raise money from the crowd to capitalize each individual acquisi- tion or origination. As compensation, the crowdfunding agency/platform that aggregates the crowd investors often charges an upfront fee and/or an ongoing servicing fee throughout the life of each individual deal. This model enables the crowd to invest in one or many specific deals of their choosing. Version 2.0 reinvented real estate crowdfunding by allowing the crowd to invest directly into a REIT through Regulation A+, a more inclusive type of securities offering established by the Jobs Act. Instead of choosing in- vestments based on pretty pictures, the crowd can now invest in a diver- sified portfolio of real estate selected by professional real estate investors, while also benefitting from passive, tax-advantaged income in the form of dividends. In addition to diversification, many crowdfunded REITs — like stREIT- wise, Fundrise and Realty Mogul — provide the crowd an entry point into real estate without the sizable com- missions charged by financial advi- sors, which can potentially translate into greater profits. As the real estate investment crowd grows, costs will continue to come down and middle- men will continue to become disinter- mediated. It makes sense that investors who are less concerned about liquidity would prefer a non-traded REIT over a traded REIT. But non-traded REIT shares are generally sold through fi- nancial advisors, and their incentives might not always align with that of their clients. But this is complicated by the fact that non-traded REIT shares are generally sold through financial advisors who charge commissions. Financial Advisors: The (Former) Gate Keepers Financial advisors provide wealth management services to a wide range of individuals and work collabora- tively to optimize their client's invest- ment portfolio. A financial advisor's compensation may vary greatly de- pending on the investments chosen. For example, non-traded REIT shares often result in a 7 percent commis- sion to the financial advisor – and that commission is deducted dollar-for- dollar from the client's initial invest- ment. A key question to ask yourself is why financial advisors charge such high commissions for selling non- traded REIT shares to their clients. The reason is financial advisors require ample enticement to recommend an investment product that itself charges excessive fees. The upfront costs of non-traded REIT shares are typically 10 percent to 15 percent of the initial investment. 1 Then there are ongoing costs, such as asset management fees, acquisition fees, disposition fees, fi- nancing fees and incentive fees, all of which impact total returns negatively, sometimes severely so. This paradigm is rife with conflicts of interest be- tween financial advisors, non-traded REIT sponsors and investors. The Solution Crowdfunded REITs were designed to combine the benefits while avoid- ing the shortcomings – of both traded and non-traded REITs. By structuring themselves as non-traded REITs and disintermediating the financial advi- sors by selling shares directly to in- vestors online, they're able to provide direct access to a diversified portfolio of institutional-quality real estate with an ultra-low cost structure. Here's a concrete example of the value proposition: Suppose Company X is a non-trad- ed REIT with 12.5 percent upfront costs. Assuming the same 3 percent annual appreciation and 7 percent annual cash yield over a five-year investment period, an investment in this REIT earns 42 percent more profit than Company X does based on up- front costs alone. And with that, the future is upon us. 1 SEC's Office of Investor Education and Advocacy, Investor Bulletin: non-traded REITs, August 31, 2015. Karsh Source: Tryperion Partners $10,000 INVESTMENT: stREITwise vs. Company X Commercial Real Estate Financial Expertise Since 1972 A market leader in arranging non-recourse debt on all commercial real estate asset types. PSRS is a life company correspondent with deep relationships among banks, conduits, agencies, and various credit facilities. PSRS is a founding member of Strategic Alliance Mortgage, LLC ("SAM"), an organization of 22 commercial mortgage firms having 35 offices throughout the United States. SAM members have arranged over $135 billion of commercial mortgage loans since 2001 and currently service $40 billion. Local Expertise. Nationwide Platform. San Diego Los Angeles Newport Beach Santa Barbara www.psrs.com 2016 Loan Volume $1.6 Billion 2016 # of Loans 251 Current Servicing Balance $5.4 Billion