Real Estate Crowdfunding for Non-Accredited Investors

Non-accredited investors have only recently been allowed to invest in real estate crowdfunding and until August 2016, I’ve only been aware of one real estate crowdfunding website that has allowed non-accredited investors to invest in real estate crowdfunding, and that’s Fundrise.com. Let me know in the comments section below if you know of others. Fundrise.com offers the non-accredited investor two options, an Income REIT and a Growth REIT, both of which we’ll discuss more below.

Real estate crowdfunding just got a little bit more interesting for the non-accredited investor. In August 2016 RealtyMogul entered the playing field and offered a REIT that is also available to non-accredited investors. This is a great development for non-accredited investors who want to participate in real estate crowdfunding opportunities. I have been considering investing in one or both of the Fundrise REITs, so I was thrilled when RealtyMogul announced that they were also launching a REIT that is available to non-accredited investors. I like options! Lets review these REITs and decide if they look like good investments.

REIT Overviews

The Fundrise Income REIT invests proceeds of the REIT in commercial loans (senior mortgage loans, subordinated mortgage loans, mezzanine loans) and direct investments in commercial real estate through majority-owned subsidiaries. They may also invest in commercial real estate debt securities (CMBS (commercial mortgage backed security), CDOs (collateralized debt obligation), and REIT senior unsecured debt). The focus of the Fundrise Income REIT will be to invest in debt and debt-like instruments that generate a low volatility income stream that provide consistent cash distributions. Target portfolio leverage is between 40-60%. The Fundrise Income REIT has a minimum investment of $1,000 and provides dividends on a quarterly basis.

The Fundrise Growth REIT focuses on properties with significant possibilities for short-term capital appreciation such as properties that require development, redevelopment, repositioning, properties located in markets with a high growth potential, and properties from sellers who are distressed or face time sensitive deadlines. The growth REIT may also invest in CMBS, mortgage loans, and Section 1031 tenants-in-common interests. The target portfolio leverage is between 50-85%. The Fundrise Growth REIT has a minimum investment of $1,000 and provides dividends on a quarterly basis.

The RealtyMogul MogulREIT 1 REIT will invest in debt and equity investments with the objective of achieving consistent and increasing cash distributions supported by recurring cash flow and by capital gains from appreciation of investments in equity. The REIT intends to hold up to 55% of the total value of assets in commercial debt, such as senior mortgage loans, subordinated mortgage loans, mezzanine debt, equity in companies who own and operate commercial real estate, CMBS, CDOs, as well as publicly traded REITs. The remaining 45% will be held in equity instruments, primarily in real estate related companies. The target portfolio leverage is up to 70%. The RealtyMogul MogulREIT 1 REIT has a minimum investment of $2,500 and provides dividends on a quarterly basis.

Differences in the REITs

When reading the offering circulars of each of the three REITs, they all seem surprisingly similar. It is obvious that they all started with the same template and just made minor tweaks to it. They do have some differences though. Some of the significant differences are outlined below. Note, I’m only providing a top level summary of some of the primary items of interest for me; some details will be left out for the sake of brevity (each circular is ~200 pages long). For full details, please see the circulars for each individual REIT. The three differences that interested me the most are described below:

1. Can the investor make an investment through a self directed IRA?
   1. Fundrise Income REIT: Yes
   2. Fundrise Growth REIT: Yes
   3. RealtyMogul REIT: No
2. Is there a back-load fee for selling the REIT?
   1. Fundrise Income REIT: 5% if held for less than 2 years, 4% if held for 2-3 years, and 3% if held for greater than 3 years.
   2. Fundrise Growth REIT: 8% if held for less than 2 years, 7% if held for 2-3 years, 6% if held for 3-4 years, 5% if held for 4-5 years, 4% if held for 5-6 years, and 3% if held for greater than 6 years.
   3. RealtyMogul REIT: 5% if held for less than 2 years, 4% if held for 2-3 years, and 3% if held for greater than 3 years.
3. What is the management compensation?
   1. Fundrise Income REIT:
      1. Organization and Offering Stage (one time fees): $1,000,000
      2. Acquisition Stage (each time a property is added to the REIT):
         1. Origination fee for purchasing the property: The REIT pays anything above 3% of the purchase price of the property (their borrowing partners in each investment in the REIT pays the first 3%). The amount paid will effectively reduce the returns of the REIT.
         2. Reimbursement of Acquisition / Origination Expenses: In addition, the manager will be reimbursed for actual expenses incurred in connection with the selection, acquisition or origination of each investment.
      3. Operational Stage (recurring fees):
         1. Asset Management Fee: 1% of the value of the assets under management
         2. Servicing Fee: Between 0 and 0.5% of the value of the assets under management
         3. Special Servicing Fee: 1% of the original value of a non-performing asset within the REIT (only to be charged if there is an asset in the REIT that is non-performing).
         4. Other Operating Expenses: Undetermined amount for “out-of-pocket” expenses.
   2. Fundrise Growth REIT:
      1. Organization and Offering Stage (one time fees): Same as Fundrise Income REIT
      2. Acquisition Stage (each time a property is added to the REIT):
         1. Origination fee for purchasing the property – Same as Fundrise Income REIT
         2. Reimbursement of Acquisition / Origination Expenses – Same as Fundrise Income REIT
      3. Operational Stage (recurring fees):
         1. Asset Management Fee: Same as Fundrise Income REIT
         2. Servicing Fee: Same as Fundrise Income REIT
         3. Special Servicing Fee: 2% of the original value of a non-performing asset within the REIT (only to be charged if there is an asset in the REIT that is non-performing).
         4. Other Operating Expenses: Same as Fundrise Income REIT
   3. RealtyMogul REIT:
      1. Organization and Offering Stage (one time fees): $300,000 – $1,500,000
      2. Acquisition Stage (each time a property is added to the REIT):
         1. Origination fee for purchasing the property: The REIT pays anything above 1% – 3% of the purchase price of the property (their borrowing partners in each investment in the REIT pays the first 1% – 3%). An additional 2% – 4% will be paid by the borrowing partner to the management team. Both fees will will effectively reduce the returns of the REIT.
      3. Operational Stage (recurring fees):
         1. Asset Management Fee: 1% of the value of the assets under management
         2. Servicing Fee: 0.5% of the principal balance and accrued interest of each loan
         3. Special Servicing Fee: 1% of the original value of a non-performing asset within the REIT (only to be charged if there is an asset in the REIT that is non-performing).
         4. Other Operating Expenses: Undetermined amount for “out-of-pocket” expenses.

Should I Invest In These REITs?

Some additional aspects to consider when deciding whether to invest in these REITs.

Amount available to invest: All three of the REITs are trying to raise $50,000,000. But they have different fees, and those fees affect the amount each REIT has available to invest in real estate and ultimately affect the return of my investment. Lets look into how much these fees will impact investor returns.

Assuming each REIT achieves their target raise amount, the money the REITs have available to invest in properties that offer a return on investment will differ due to the expenses of organizing each REIT. Both Fundrise REITs will only have $49,200,000 available to put towards the REIT investments. The RealtyMogul REIT has higher organizational expenses, and they will only have $48,502,250 available to invest in properties that return an investment for their shareholders. So what does this mean? If everything else is equal, it means investor returns will be less with RealtyMogul’s REIT vs. the Fundrise REITs. But how much less? Lets use an example to calculate the difference in returns due to the organizational expenses of the REITs that an investor would receive from investing in each REIT.

Example: Assume each REIT invests in properties that provide a net 10% return on the money they are able to invest. After 1 year, the Fundrise REITs will each return $4,920,000 ($49,200,000 * 10%). After 1 year, the RealtyMogul REIT will return $4,850,225 ($48,502,250 * 10%). Now lets assume an investor invests $10,000 in each of the REITs. The investor will own 0.02% of each REIT ($10,000/$50,000,000 = 0.0002 = 0.02%). Their return on investment in the Fundrise REITs will be $984 (0.0002 * $4,920,000) after one year, which equates to a 9.84% ($984/$10,000) rate of return on this hypothetical investment. The investor’s return on investment for the RealtyMogul REIT will be $970 (0.0002 * $4,850,225) after one year, which equates to a 9.70% rate of return on this hypothetical investment.

The difference in return is only 0.14% due to the differing organizational expenses from each REIT. When I decided to make this calculation, I was thinking, ‘wow, RealtyMogul has an extra $700K of organizational expenses vs. the Fundrise REITs, it must have a significant impact on my returns’, but after making the calculations, I would consider this a minor 2nd order impact on my investment returns.

Quality of Investments: Another thing to consider when deciding whether to invest in these REITs is how the platform chooses to invest in properties in their corresponding REIT that they operate. RealtyMogul plans to give their REIT first pick of all investments that clear their underwriting team. Any investment that RealtyMogul chose to underwright that the REIT did not choose for their portfolio will then be made available to investors to individually invest in those properties if they choose to. I view this as a positive thing for the RealtyMogul REIT as they will get the cream of the crop of investments coming through the door at RealtyMogul. Fundrise puts 100% of the properties that they choose to invest in into their REITs. They do however, invest in less than 2% of properties that are presented to them, so I believe the are being very selective with their investment choices as well.

What Are The Expected Returns?

I have to make a lot of assumptions here, neither Fundrise or RealtyMogul come out and say, “Your return on your investment will be this ____”. It would be stupid for them to say something like that because if they didn’t meet those returns someone would sue them. But we do get some clues. For the Income REIT, Fundrise states that, “During the first two years of the investment, you pay $0 in asset management fees unless you earn at least a 15% annual return”. This would imply that their target is at least a 15% return. It doesn’t mean they will achieve that target, and they don’t actually state that 15% is their target, but nonetheless, I’m interpreting their statement to mean that 15% is their target. The Fundrise Growth REIT states that, “Fundrise will pay a penalty of up to $500,000 to investors if the Growth REIT earns less than a 20% annual return”. To me, this implies that their target annual return is at least 20%. Both of these could be sales tactics to make you think their returns will be high when they really won’t be anywhere near that level. Its unknown until after you invest with them, and then you will find out.

RealtyMogul is much more conservative and doesn’t give you any clues on their website as to what they expect the returns to be on their REIT. However, buried deep in their offering circular on page 92, they state that they are targeting investments that return at least 7%. If you look around in the crowdfunding world, 7% is on the low end of target returns. I’m hoping they are under promising and plan to over deliver because 7% isn’t reason enough for me to get out of bed in the morning.

When Will The Investment Start Paying Out?

The Fundrise Income REIT states in their circular that they will start paying distributions in the first full quarter after the quarter in which they make their first real estate related investment. The Fundrise Income REIT currently has 10 investments in their REIT, so they should be paying their investors a return on their investment already. Distributions are quarterly, so if I choose to invest, I should start seeing a return a maximum of 3 months after I make my investment.

The Fundrise Growth REIT does not specify a timeline in their circular of when they will start making distributions to their investors, they simply state that they expect to make distributions once the proceeds of their public offering are invested and they are receiving operating cash flow. They currently have 4 properties in their Growth REIT. Considering they are a REIT, which means they are required to return at least 90% of the profits to the investors, I’m assuming they are also currently providing a return to their investors. Distributions are quarterly, so if I choose to invest, I should start seeing a return a maximum of 3 months after I make my investment.

The RealtyMogul REIT states in their circular that they will start paying distributions in the second full quarter after the quarter in which they make their first real estate related investment. Their website shows that they have already made a quarterly dividend of 8%. This should be a good thing, as I was originally expecting them to make their first distribution at the beginning of 2017.

The Bottom Line

I like all three of these REITs. From the research I’ve done, the Fundrise Income REIT should offer a higher initial return compared to the Fundrise Growth REIT, however the Fundrise Growth REIT should catch up and surpass the return of the Income REIT once the Growth REIT starts cashing out on the assets they purchase. Considering the RealtyMogul REIT is already providing an 8% annualized return on investment, I’m expecting the RealtyMogul REIT will outperform the implied target of 7%. The RealtyMogul REIT seems to me like it is a blend between the Fundrise Income REIT and the Growth REIT, given that RealtyMogul REIT’s planned leverage is somewhere in between the planned leverage of the Fundrise Income REIT and Growth REIT. The bottom line is I think these will be solid investments for non-accredited investors who are looking to get into real estate crowdfunding.  Just make sure to do your own due diligence.

Readers, what do you think of these REITs? Would you prefer to invest in a REIT or an individual commercial property?