While many of the real estate crowdfunding platforms are VC-backed, EquityMultiple’s primary investor is Mission Capital, a traditional commercial real estate financing firm. And while many platform founders come from the tech world, EquityMultiple CEO Charles Clinton was a practicing real estate lawyer working in private equity before co-founding EquityMultiple alongside chief investment officer Marious Sjulsen. Yet despite that heritage, and while many other platforms aggressively chase institutional money, EquityMultiple is focusing squarely on individual investors. (After working through several flavors of real estate debt investments, I made my first equity investment earlier this year through EquityMultiple.)
Charles was kind enough to answer my questions about EquityMultiple (including explaining the “stress-test” component of their due diligence process), and share his perspective on real estate and equity crowdfunding in general.
YieldTalk: There are now dozens of Reg D crowdfunding platforms for Real Estate investing, how is EquityMultiple different?
EquityMultiple CEO Charles Clinton: Since the JOBS Act went into effect a few years back, a number of platforms have folded (due to lack of quality deal flow, inability to form a strong investor network, or other reasons) and there has been some consolidation in the industry. From our standpoint, online real estate investing (otherwise known as real estate crowdfunding) has coalesced into a few distinct models with respect to what is offered to investors:
- Direct into distinct properties: This is the closest to the original vision of real estate crowdfunding: allowing individual investors to get in on distinct real estate projects that would previously have been accessible only to ultra-high-net-worth individuals, family offices and institutional investors. These platforms do diligence on projects on their investor’s behalf. EquityMultiple and RealtyShares are two remaining examples of this model.
- Debt: These platforms offer notes backed by real estate loans, providing investors a fixed-rate investment vehicle secured by the underlying asset. The vast majority of the time, the underlying property is a single-family fix-and-flip. Remaining examples are PeerStreet, Groundfloor and LendingHome
- eREITs: These platforms provide access to funds that they manage, offering built-in diversification and low minimums but less visibility than other models. Two early entrants into the space - Fundrise and RealtyMogul - have pivoted to a focus on this product.
- Software as a service / marketplace platform: These companies are focused on providing software to sponsors, while connecting investors with a marketplace of direct-to-sponsor offerings; a more hands-off approach than the direct model. Surviving examples are CrowdStreet and RealCrowd.
We focus solely on institutional-grade commercial real estate projects and experienced sponsors, with the belief that this approach brings our investors superior risk-adjusted returns. We believe that our partnership with Mission Capital – a 15 year old firm that’s completed over $70 billion in transactions across the country provides us with a key advantage in sourcing good transactions.
YieldTalk: Real Estate investing can be quite intimidating to newcomers, even those with a business background or even some experience in the startup world. What advice would you give someone interested in Real Estate investing to improve their knowledge?
"At this point, the vast majority of our investors are individuals - doctors, lawyers, tech entrepreneurs, small business owners, retirees and younger professionals."
EquityMultiple CEO Charles Clinton: As real estate investing is made more and more accessible online, there’s also a growing crop of sites and forums that provide information and pertinent discussions on real estate investing. BiggerPockets has a real estate crowdfunding area where avid investors provide first-hand accounts of their experience investing through various platforms. Investopedia provides a wealth of articles on key real estate investing concepts, such as pro-formas, distribution waterfalls and IRR (internal rate of return) and some of the platforms, including our own, have written articles explaining some of these core concepts. [Ed: see also: YieldTalk…]
The bottom line, with respect to investing through one of these platforms, is that information on investment opportunities should be thorough, and the people behind the platform should be able and willing to answer any and all questions. If there are concepts or assumptions made that you don’t understand, or aspects of the underwriting that don’t seem fully fleshed out, ask the platform about it. They should be willing to walk you through anything that’s unclear or complex.
You describe a “stress test” for underwriting assumptions, what does that stress test look like? What does a worst-case scenario look like?
This largely depends on the deal. Generally, for equity deals, we’ll determine what will need to go wrong at the property such that returns fall below a net 14% IRR to investors (over, say, a 5-year hold). If there isn’t much room for error (e.g. assume the property sells in 5 years at a 6% exit cap rate instead of 5.5%) and returns dip below 14%, then we won’t pursue the deal. The stress test involves adjusting many different assumptions depending on the asset class, product type, and market conditions. For preferred equity and syndicated debt deals, we will look most closely at the last-dollar basis for EquityMultiple investors and what it will take for investors to get repaid. If there isn’t a clear take-out or repayment, then our Investment Committee will generally nix the deal. We always provide a portion of this sensitivity analysis to our investors where applicable. You’ll see three different variations on the underwriting (based on different assumptions), as well as a chart showing what happens if the cap rate on the exit sale is different than projected.
While lots of economic indicators (like consumer confidence and unemployment) look great right now, there’s some evidence of a profound change in the retail landscape, which some would say is quite overbuilt for the realities of e-commerce. How do you see those changes impacting commercial real estate, especially retail or mixed-use projects?
This is an excellent question and one of the big issues confronting the real estate industry over the next decade. There is an inevitability to the growth of e-commerce and decline of brick and mortar retail that can’t be denied. Further out on the horizon, the impact of autonomous cars and trucks will reshape the retail (and broader real estate) landscape in ways that are difficult to predict. More concretely, our thesis is that brick and mortar real estate is in decline but certainly not going to go away overnight and certain segments of the market are better insulated than others. When I used to work with Blackstone’s retail group a few years ago they, for example, saw grocery-anchored retail centers as well positioned in the short to medium term. In another segment of the market, core urban markets, more consistent foot traffic has slowed decline significantly. Retail will, ultimately, need to innovate to remain successful. Historically, real estate has not been the most innovative industry but for those firms that are forward thinking, the shift in retail will prove to be a tremendous opportunity.
It’s obviously still early days, but two of the biggest clusters of crowdfunding sites are in Real Estate and Startups. In both categories, I’ve repeatedly heard incumbents dismiss crowdfunding offerings as “not good enough” for the traditional funding sources (VC/angel or sponsor/syndicates, respectively). Some experienced commercial real estate investors even say things like “a good sponsor can always find money, so the ones who end up on sites like EquityMultiple must not be very good.” How would you respond to a wary investor who’s hearing that?
That’s a fair question. To be honest, we do encounter projects where the real estate firm appears to be unfit to raise capital from conventional sources - either because of lack of experience or some blemish on their track record. However, those are not the companies that ultimately make it on to our platform. Typically, we focus on deals that are under $30M in total cost. These middle-market deals are too small for most institutional investors, who focus on larger transaction so they can deploy more capital into each project. These middle market deals – which make up the vast majority of the real estate transactions – are thus fundamentally underserved by institutional capital.
It’s also worth pointing out that for most of our deals there are, in fact, other investors involved that the Sponsor has sourced. EquityMultiple investors are just part of a larger puzzle of financing a project. The quality companies that we partner with are those that are forward-thinking with respect to technology. They’re looking to expand their investor network, diversify their access to capital, and find an efficient, low-cost way of rounding out their capital stack. In many cases, our partners will be looking to round out their capital stack on a project that’s $20M or more in total capitalization and find that our platform is the most efficient way to do so, particularly as we handle communication with our investor network and asset management reporting.
So far most of the Real Estate platforms are operating under Reg D, with the exception of a few like Fundrise and RealtyMogul with Reg A+ offerings. Do you see that changing?
Yes, this will undoubtedly change as the industry continues to develop. Setting up a Reg A+ offering is resource intensive - both from a time and cost perspective - so it’s not surprising to see two of the platforms that received significant venture capital financing and have big teams be the first to try them. For better and worse, the venture capital backing these firms have received puts significant pressure on them to pursue new, unproven strategies in the name of top-line revenue growth (a major metric of success for VC investors). EquityMultiple, by virtue of its backers and partners within the real estate and investment industries operates a bit more cautiously – we’ve been sitting on the sidelines watching and learning from our competitors and evaluating Reg A+.
"If there are concepts or assumptions made that you don’t understand, or aspects of the underwriting that don’t seem fully fleshed out, ask the platform about it. They should be willing to walk you through anything that’s unclear or complex."
Our conclusion at this point is that Reg A+ holds enormous potential but offers a different value proposition to investors - it’s really only suited for blind-pool offerings, rather than the project-by-project investing that we currently focus on. It is, in many ways, much more similar to the traditional investment vehicles (real estate funds and non-traded REITs) that crowdfunding set out to displace. That being said, there’s certainly room for both approaches, even within a particular investor’s portfolio. As we consider a potential Reg A+ offering down the road, the approach we’re contemplating is fundamentally different from Fundrise and RealtyMogul. It reflects what we’ve learned from the early Reg A+ offerings and, we believe, would offer a unique value proposition to investors.
What’s the most important criteria you look for in a new sponsor or investment deal to post on EquityMultiple?
In short, we’re looking for institutional partners, institutional-quality commercial real estate assets, and projects that conservatively project to deliver strong risk-adjusted returns to our investors. We also seek to provide a range of risk/return profiles and hold periods to facilitate diversification (not least is offering debt, preferred equity, and senior debt investment opportunities - our target return ranges for each kind of project are listed on our website, and you can also review this document [PDF] for some broad guidelines on what we look for).
This emerging industry hasn’t yet been through a housing downturn, what do you think will happen when it does?
It will be interesting to see how this plays out. Some degree of slowdown is inevitable, but no one knows exactly how and when this will manifest. Overall, a housing downturn will drive some consolidation in our space, likely causing several platforms to shut their doors; consistent, quality deal flow will be harder to find. It’s likely that single-family prospects will be more adversely affected than institutional multifamily, where diversification of tenant profiles and leases will add some protection Not all markets will be impacted equally, and those platforms with broader and deeper national networks will be better equipped to find yield through market cycles.
Yield on loans offered through many other real estate crowdfunding sites seems to be dropping, do you see anything changing in your own investments in terms of likely returns?
This isn’t surprising. Margin compression is typical in lending, particularly single-family lending, as economic cycles progress. As lenders pile into the market and compete for the same borrowers they drive down the price to borrow and, typically, lending standards begin to loosen. One of the criticisms of Lending Club and other peer-to-peer lenders is that increased competition in that sector has resulted in looser credit standards (e.g., the minimum credit score of the borrower) and that will, ultimately, result in higher default rates than those platforms have historically provided. In real estate crowdfunding, where there are now so many platforms focused on single family fix-and-flip lending that same kind of competition for borrowers is playing out. Several of these platforms are well funded by venture capital firms and likely using similar marketing strategies to all target essentially the same pool of borrowers. Hopefully credit standards will remain high, even if yields drop.
EquityMultiple’s focus is solely on commercial real estate - multifamily, office, industrial, retail, etc. - so the market forces operate a bit differently. We also offer investors not just debt investments, but also equity and preferred equity. On the debt side, higher-yield opportunities are definitely more difficult to source than a few years ago. In our model, we don’t directly seek out borrowers but instead partner with local and regional lenders who source opportunities. They typically have established origination infrastructure to continue to find deals that helps them mitigate the pressure on yields to some extent and avoid deals where we feel like the yield doesn’t justify the risk. On the equity and preferred equity side, there has been gradual yield compression, particularly in major markets like NYC, though it’s less prevalent in the $5-million to $30-million deal size that we focus on shows. Further, equity and preferred equity investments where there is a value-add component to the business plan typically target a high enough yield that the compression isn’t as evident to the end investor.
How much of your customer base is individual investors vs. institutions or family offices?
At this point, the vast majority of our investors are individuals - doctors, lawyers, tech entrepreneurs, small business owners, retirees and younger professionals; it really runs the gamut. We expect individuals to remain the bulk of our customers going forward, though we have been approached by a number of family offices and investment advisors, who are interested in the quality commercial deal flow we strive to provide.
What’s the biggest constraint right now on your growth as a company?
At the moment, it’s growing our investor base. This is unusual in the broader commercial real estate industry but has been by design for us. When we first founded EquityMultiple, we did so with the knowledge that, in the long term, sourcing quality transactions is the most difficult aspect of the business but also the most important to sustained success. That’s why we partnered with Mission Capital at the outset. Mission Capital has a deep national network of deal relationships built over 15 years in business and over $70 billion in transactions executed.
My sincere thanks to EquityMultiple CEO Charles Clinton for taking the time to answer our questions.