What Happen Behind the Curtain to an Investment on a Real Estate Crowdfunding Website
Nowadays, there are plenty of real estate crowdfunding website with new deals coming out every week. So what happen to those deals before they make it to the platform? Who pick them and what are their criteria?
Every opportunity is unique, a certain level of due diligence is key and necessary to assessing the risks associated with a particular property. Evaluating these opportunities, also known as “underwriting”, requires an in-depth investigation during which our experienced team takes precise measures to ensure that the investment opportunity is properly vetted and meets our rigorous standards.
Here are the five steps Crowdfunding Real Estate companies go through when they evaluate the potential opportunities. As an investor or LP, you should make sure to do the same. (Continue to read)
1. Evaluate the Sponsor
Sponsor quality is a leading indicator of a worthy investment opportunity. A sponsor’s prior experience and track record are critical in deciding whether the project meets the standards for listing on the platform.
Here are things your should check on the sponsor:
Check track record: How many transaction has the sponsor done in the past. What is their asset under management (AUM) ?
Assess regional familiarity: The Sponsor should have familiarity with the region in which they are doing their project.
Perform background / credit checks: The principles of the sponsor company must submit references and participate in background and credit checks designed to uncover past foreclosure issues, court judgments and personal credit problems, as well as any concerning police records or securities violations.
2. Evaluate the Asset
A common trend we observed is that risk-adjusted returns can be found in value-add, middle market opportunities. Since each opportunity is unique, a certain level of due diligence is key to assessing the risks associated with a particular property.
Consider the asset type: A commercial property might be a multifamily apartment building, an industrial center, a retail shopping center, a residential complex focused on student housing, an office building, a hotel, or a self-storage facility. All of these asset types bring different considerations to bear; for example, retail centers are currently fighting against the rise of internet retailers, so a particular tenant mix might be required in order to consider that opportunity.
Understand the business plan: focus on value-add or core-plus opportunities which stand to benefit from some degree of renovation or repositioning of the property in the market. Analyze whether the proposed budget and improvements seem sufficient and likely to result in improved rental rates.
Evaluate return potential: The returns should be properly risk-adjusted, meaning that riskier projects tend to have a higher required return objective. Return objective requirements should vary by product type and a number of other considerations.
Review tenant profile: Focus on multi-tenant properties with a preference for assets with tenants that have been in place for multiple years, have staggered rent rolls, and where the percentage of rental income from any one tenant does not exceed 10-20% (with exceptions). This speaks to the perceived value of the location and can mitigate the risk of rental loss.
Assess leverage allocation: If the company is the not the lender, review the primary terms of the planned property loan to ensure that the structure and leverage does not present unnecessary risks. Typically, more debt can drive higher potential returns but also correlates to higher risk. Allowable leverage criteria may vary by product type and a number of other considerations.
Ensure a sufficient sponsor co-investment: Make sure that the sponsor has sufficient “skin in the game.” Depending on the property type, generally require that 7-10% of the equity is provided by the sponsor (net of transaction fees).
3. Underwrite the Deal
Proper risk analysis, through the intelligent application of data and industry expertise, is key in real estate investing.
Here’s a typical deal underwriting process:
Perform institutional-level analysis: leverage the expertise of in-house real estate professionals.
Develop financial models: Utilize more conservative assumptions than the sponsor– to stress-test the possible outcomes and assess the project’s probability of success.
Utilize data: Evaluate each project using comps for regional and historical pricing, performance data, and demographic trends.
4. Negotiate the Transaction
Review the legal terms of the transaction and negotiate on behalf of investors to ensure potential risks have been considered. In the case where later problems may arise with a project, the company want to have deal terms that allow them to step in to mitigate and hopefully recover capital for our investors.
Here’s how they negotiate the transaction:
Negotiate on behalf of the investors: In all transaction negotiations, prioritize risk-adjusted returns, the safety of investments from potential downside and that all financial terms are accurately reflected.
Draft operating agreement: The legal team ensures that financial components and fees are outlined in the operating agreement, which is a legally binding document.
Develop and/or collect applicable transaction documentation: This includes: third party reports, title, entity information, operating agreement, loan documents (if applicable), and escrow arrangements.
5. Obtain Compliance Approval
In order to protect the company and their investors throughout the lifecycle of the investment, companies normally solicit both internal and external compliance approval at every step, before preparing the investment opportunity for publication on the website.
Here’s how they normally obtain compliance approval:
Broker-Dealer compliance approval: Many of the above-described steps are reviewed by North Capital Private Securities Corporation, a registered broker-dealer and a member of FINRA / SIPC. A Series 24 registered supervisory principal reviews our work, performs their own background and bad actor checks, and makes sure that the information presented to investors is fair, balanced and discloses the applicable risks.
Internal Review: Internal investment team reviews all documents and deal pages on the website to ensure that the information is presented accurately.
Deal page launch: Publish the investment opportunity to the website and notify investors via email about the new offering.
