Real Estate Crowdfunding: Lofty Fees, Lofty Promises
By Harmel Rayat CrowdFunding Beat guest contributor,
Owning real estate always has been, and always will be, the foundation of building significant, long-term wealth.
You can invest in everything from vacant land, to developed properties and REITs to “value-add” assets, which require a lot of work, time and experience. Or, for investors with limited time, knowledge and resources, an attractive option is private limited partnerships, which essentially pool money from investors to make investments.
One of the hottest new ways to do this is through crowdfunding ventures, such as Fundrise, a Washington, D.C.-based start-up that lets investors participate in neighborhood development projects. Its first widely available offering, a two-story building at 1351 H St. NE in Washington, D.C., attracted $325,000 from 175 investors who invested as little as $100 each.
The combination of community projects and a spirit of inclusion when it comes to investors earned it kudos from the New York Times and a host of online observers as a game-changing way of doing business. Lawmakers even invited co-founder Ben Miller to address a subcommittee examining “Innovative Ideas for Raising Capital.”
But the idea is not new. Before crowdfunding, there was syndication.
The iconic Empire State building, for example, has been a syndicated property for more than 50 years. Lawrence Wien and Harry Helmsley purchased it for $39 million in 1961 in a deal financed by a combination of a $6 million mortgage and equity posted by investors.
Wien and Helmsley raised $33 million by selling 3,300 units at $10,000 each to individual investors through a limited partnership. Since then, those units have generated almost $500 million for unit holders.
Recently, changes to federal legislation have opened the playing field to parties of all stripes, not just insiders and the wealthy able to pay significant sums for a stake in landmark buildings. By the end of 2014, the number of crowd-funded real estate ventures is expected to top 100.
But is all as it should be?
One of the age-old dangers of syndication lies in who gets paid first. The managers of syndicates often present themselves as disinterested curators of investors’ funds who take only the final cut, but in reality a number of fees often have them taking the first cut, too.
A recent survey of crowdfunding platforms show that such shenanigans are just as prevalent in the brave new era of social media as in the days when society did deals face-to-face.
Most analysts who have reviewed the documents Fundrise provides its investors, for example, note that fees abound – 3% of any lease, 1% for asset management, 1% for financing, as well as development fees. One review of the venture suggested that for every $350,000 raised, a seventh would go to fees – that’s a haircut of more than 14% right off the top.
Realty Mogul, another platform, goes a step further.
Its asset management fee is just 0.25%, but it assesses investors 2% fee cover reporting and technology costs, as well as acquisition, refinancing and construction management fees – the latter estimated at 10%.
Prodigy Networks, on the other hand, has no stated fees but charges 2% annually for asset management and a 3% development fee when it launches projects. Costs associated with legal fees, travel and expenses, and promotional events are assessed on an as-needed basis – preventing investors from predicting what these might total.
And what about the final cut?
Many of us know of crowdfunded initiatives that never delivered. What happens to the money that gets put in? Kickstarter includes a mechanism for returning contributions from – dare we say it? – investors, but most real estate ventures don’t offer the same guarantee. Once the money’s in, it’s in. As one pundit said of the cash one crowdfunding platform is raising, “This should be money [investors] could otherwise just flush down the toilet.”
With the kinds of fees they’re charging, most of the instigators behind crowdfunding platforms have little to lose. It’s the investors who are on the hook.
It doesn’t have to be that way.
Some platforms, such as our own, have opted to not charge fees or commissions. This strategy helps to assure investors that the financial interests of the managers are aligned with those of investors. Crowdfunded real estate can benefit from other social platforms, such as Facebook and pledge that participation is, “free and always will be.”
Of course, that slogan is taken, but the world of social media and crowdfunding ensures that the practice isn’t limited to one company. Success demands on openness, and maximizing access to the opportunities. And if the success of social media lies in greater connection, the pay-off for participants in crowdfunding ventures should lie in the return properties deliver.
This is where the real emphasis should lie, and where investors should be able to distinguish between platforms that work, and those that don’t – not on the fees they pay up front.
Harmel Rayat is the President and CEO of Talia Jevan Properties, Inc., www.taliajevan.com, a privately held commercial real estate investment firm specializing in the acquisition and long-term ownership of “signaturesque” commercial real estate assets throughout North America. Through www.HighIncomeRealEstate.com, a subsidiary of Talia Jevan Properties, Harmel and his team of dedicated professionals introduce accredited investors to limited partnerships that own high-yielding Class-A commercial real estate properties.