[Editor's Note: I have had a number of representatives of real estate crowdfunding sites wish to submit guest posts to the site. I have turned a whole bunch of them down. Most of the posts discuss all the great benefits of crowdfunded real estate and provide a link to their site, which I find to be not particularly useful to readers. I can easily write a post about the benefits, and besides, the site already has posts discussing that. I have asked most potential guest posters to return with a post either discussing the downsides, or better yet, comparing one site to another, or even how to choose between investments on any given site or even between sites. This is the first post I've gotten back after one of those requests.
This is written by Lawrence Fassler, who currently works as counsel for RealtyShares. His compliance folks want this statement in the post: ” RealtyShares offers equity securities through WealthForge, LLC, member FINRA/SIPC.”
When I first met him, he was working for Realty Mogul (a WCI advertiser and WCI Scholarship Gold Level Sponsor), and in fact has submitted a guest post featuring their firm in the past. Lawrence knows this industry as well as anybody. I liked how his post compares one firm to another, and also the fact that he is one of the few who has personal experience with more than one company. You will notice that I have inserted a few comments into the post detailing my limited experience with these companies. All my comments are in italics.
By way of introduction for those to whom this concept is new, what I like about these investments is the following:
- I qualify for them (since I'm an accredited investor.)
- No management hassle. Once I select an investment, it takes little more hassle than holding an index fund.
- High projected returns. Projected returns on most debt investments (basically hard money lending) are in the 9-10% range (and backed by a hard asset.) That's dramatically better than high quality bonds, and although less than I'm doing with P2P loans, are significantly less risky given the hard asset backing. Projected returns on most equity investments are in the 12-17% range, far better than anybody thinks the stock market is going to do over the next 5-7 years.
- An opportunity to be paid for illiquidity. The investments generally must be held for 5-7 years. I don't mind having some of my portfolio illiquid, as long as I'm paid for it. The promised returns are adequate payment in my view.
- Low correlation with my other investments. The obvious alternative to this sort of thing is just buying a Vanguard REIT index fund. However, those of you who held that fund with me throughout the Global Financial Crisis remember that not only did it NOT provide any useful diversification against the rest of the stock market, it fell even further (78% peak to trough.)
- Low minimum investments which allow me to diversify against that which I don't know, rather than spending large amounts of time and money doing due diligence. Many of you remember Dennis Bethel, MD who wrote some guest posts in the past. He works with a firm that does these sorts of private real estate deals, but the minimums were $50-100K, which are a little high for poor old me. If I'm going to drop that kind of money into a single project, I feel like I need to run a background check on the principals, fly out and meet them, walk through the project etc. But for $5K? It's not worth my time or money to do that sort of thing. Instead, I can spread myself over 10-20 different projects, so if it turns out one or two are poor investments run by scammers, I should still be okay.
- The ability to invest in real estate outside my local area. What are the odds the best investment returns are available in my home town? Pretty darn low.
At any rate, as you'll notice in my comments below, I'm only dabbling a bit (like I did when I got into Peer to Peer Lending) in this relatively new industry, but I'm seeing a lot of promise and anticipate increasing investments in the future. As noted below, I now have a financial relationship with RealtyShares. Without further ado, on to the guest post.]
Real Estate Crowdfunding Sites – A Comparative Overview
Online capital marketplaces have come to real estate, with many companies now providing accredited investors access to a new “passive” way to invest in commercial properties. These new marketplaces give accredited investors (net worth > $1 million, or annual income > $200,000 [single, $300K married-ed]) a platform that allows for direct access to commercial real estate investments such as larger apartment buildings, retail centers, self-storage facilities, office buildings, and other commercial properties that previously were beyond the reach of all but the biggest investors.
A lot of entrants have come into the field, and many have their own particular focus and strategy. Some real estate crowdfunding sites make direct investments in real estate, others buy mortgages, and others make peer-to-peer loans. There are probably 50-plus platforms now in the market, each with slightly different operational characteristics.
Despite all the new companies jostling to gain position in this new industry, however, only a half dozen or so are emerging as leaders in the space. Here’s an overview.
RealtyShares
A quickly up-and-coming company with headquarters in San Francisco, RealtyShares has distinguished itself by its variety of investment offerings. It features not only conventional equity and 1st-lien debt offerings, but also “preferred equity” and mezzanine (2nd-lien) debt investments. These hybrid investment types present somewhat more risk 1st-lien debt, for example, but are less risky than conventional equity. Mezzanine debt and preferred equity investments can pay accordingly higher return rates than conventional 1st-lien debt, and have been met with enthusiastic demand from investors. The company recently raised $10 million in a Series A financing round led by Menlo Ventures, a leading Silicon Valley venture capital firm, and through July 2015 had helped fund over 200 different properties worth more than $450 million. The real story, though, is that over 50 of those properties were funded just in the last quarter, and the company is starting to move ahead of firms that had a sizable head start. Its recent acceleration translates to year-over-year growth of approximately 500%, making it a platform to beat.
[Editor's Note: Obviously this is Mr. Fassler's current firm, so it is listed first in his post. However, it is a firm I have some limited familiarity with and like what I see. On the date this post was edited, there were three investments available on the site, all debt at 9-11.9%, with minimums of $1,000-5,000. I have one relatively new tiny investment ($2K) with them, a 1 year, hard money loan on a single family home in New York paying 9%. ]
Equity Multiple
[Editor's Note: Update 2/7/17: This is a newer crowdfunded company, but is backed by a firm that has been around since 2002. They generally charge 10% of profits on both equity and debt deals. They are ranked # 14 out of 85 by one review site. I have an affiliate relationship with them but have not yet had a chance to invest with them. As I learn more about them, I'll be sure to share. If you choose to invest through them, I would appreciate you using this link.]
Fundrise
This Washington, D.C.-based pioneer in the field began by letting local investors participate in nearby community redevelopment projects. The idea had a lot of appeal, but selling securities to the broader public meant that it had to pay for expensive SEC registration statements. Fundrise now focuses on accredited investors, like most other crowdfunding companies. It has a particular focus on debt investments; for equity deals, it refers investors directly to the sponsoring real estate companies, sort of like an “eBay” for real estate projects. The company recently received significant funding from Renren, a Chinese social networking company, so Fundrise is likely in it for the long haul.
[Editor's Note: I am also familiar with FundRise. I have a relatively new, small investment ($5K) with them FundRise, an apartment building being built on the same street as another syndicated real estate investment I hold– the offices for my practice in Salt Lake City. It is a preferred equity investment projecting 14% returns. On the date I edited this post, there were five investments available to fund on the platform, two debt (5-11% returns, 2-5 years) and three preferred equity (13-14% returns, 3 years) all with a $5K minimum. ]
Patch of Land
Another company with some serious recent financing ($24 million) under its belt, this debt-focused platform has also seen solid recent growth. It takes advantage of the new SEC Rule 506(c), which allows it to show investments even to newcomers on its platform — although as a result it requires extra financial documentation from investors. It also recently started a move in the industry toward bankruptcy-remote lending vehicles, providing some assurance to investors, who now have their investments handled by an independent trustee.
RealCrowd
With its headquarters in Palo Alto in the heart of Silicon Valley, RealCrowd is another platform utilizing Rule 506(c) “open” offerings. The company has focused on equity transactions that revolve around its “no investor fees” model, where it derives revenue from payments made by sponsoring real estate companies for access to its investor network. Investors are referred directly to sponsor real estate companies, who are then free to set minimum investment amounts and deal directly with investors. RealCrowd has landed some respectable partner real estate companies and was recently named as one of AlwaysOn’s “Companies to Watch” for 2015.
LendingHome
This relatively new entrant on the scene has attacked the market for business-purpose residential loans with gusto, originating more than $100 million of loans in a little over a year. It has a large staff based in San Francisco, and to a significant extent, utilizes institutional capital to help finance its loans. The company is another recent beneficiary of the Chinese investment firm Renren, reportedly garnering, in the spring of 2015, nearly $70 million — among the largest financings of any industry player.
Realty Mogul
Based in Los Angeles, Realty Mogul was one of the early pioneers in the space, and its young CEO, Jilliene Helman, is known for her dynamic personality. As of July 2015, the company had completed over $80 million in fundings, and recently itself garnered a sizable $35 million of financing in a round led by Sorenson Capital. Observers like the company for its having taken an early lead in industry compliance efforts; it was one of the first in the industry to align itself with a broker-dealer. The company has worked with several top-grade sponsors, and recently made a push into loans on larger commercial properties. If you would like to get a free $150 Amazon gift card (and give one to me), when you sign-up put in “JamesD” as your referral code. (Deal limited to first 6 who open an account- you don't even have to fund it.)
[Editor's Note: I met Jilliene at FinCon a few years ago, which eventually led to them advertising with WCI and to me making a small investment ($10K equity position in an apartment building in Indianapolis) with them a little less than a year ago. It's too early to really know how it will do. On the date I edited this post, there were two investments available on the platform, one debt (10%, 12 months, $5K minimum) and one equity (14-16 years, 5 years, $30K minimum.)]
iFunding
This New York-based company specializes in equity offerings and has taken tentative steps toward establishing a foothold in Asia. It has also created a mobile app that allows visibility into some of its website features from investors’ smart phones. The company was in the news recently for its consulting relationship with former New York governor David Paterson, and recently “crowdfunded itself” by raising $2 million through the site Crowdfunder. Its East Coast base may give it a leg up in dealing with New York-based institutional financing sources.
Most of these platforms feature current cash flow as their primary attraction, although some have also gotten involved in riskier “ground-up” development projects. All are currently focused primarily on accredited investors. The business models vary widely – some are tied strictly to an eBay-like transaction fee stream, while others charge an annual investor fee, and still others utilize fees charged to both the sponsoring real estate company as well as to investors.
Real estate crowdfunding is a relatively new model for financing commercial real estate, and we haven’t seen a recent recession cycle to see who might potentially fall out. As the aggregation of online capital continues to rise, time (and results) will tell which of the companies is garnering the most investor support and have the most sustainable business models.
[Editor's Note: I hope you found that overview helpful. If you have invested with one of these firms, readers would love to hear your experience in the comments section. This is obviously a very new area for investing, so tread carefully. Fees are dramatically higher than you would pay in an index fund, both for the crowdfunding site and for those actually doing each deal. There are no guarantees that any of these investments will work out well, or even that these practically brand new crowdfunding sites will stay in business. That said, I think there is a lot of potential here. My approach thus far has been to utilize multiple sites, since there are so few options available on any given site. When I have some money available that I'd like to invest this way, I go to the sites to see what is currently available, then choose what looks best to me from the available options. I'm still working out how these investments will mesh with the remainder of my portfolio (in the past I've generally excluded my relatively small real estate holdings from my asset allocation, aside from REITs.)]
What do you think? Have you invested through a crowdfunding real estate site? Why or why not? If so, which one? How has your experience been so far? Comment below!
Featured Real Estate Partners
Can you please say a word about the tax implications of investing in this area?
There are some tax advantages (depreciation) but since that gets recaptured in 5-7 years and exchanges to avoid that are tough, and since rents are taxed at your full rates, there are significant tax costs compared to a low-turnover index fund.
I agree, this is the issue I grapple with each time I invest in real estate, especially a crowdfunded real estate venture that plans to sell in 5 years
Thanks for the reply, I had the same question too.
So the fees are high….can you give a rough or typical range?
Thanks for the article.
The debt fees are usually all handled between the crowd funding site (Patch of Land, Realtyshares, etc) and the borrow. The listed interest rate paid to the investor on the loans is typically net of all fees, but you’ll need to look at the fine print on each deal as it can vary.
For equity investments, it gets more complicated. As I have typically seen, the syndicator will often pay the crowdfunding site a fee/percentage of the money they raise. The syndicator will then typically charge an annual management fee on the property, often in the 2-5% range. After all expenses, mortgage, etc are paid, there is usually a preferred return (typically 6-8%, but have seen higher) that is paid to the investor before the syndicator takes any profits. The crowdfunding site will often take a 2% or so annual fee from this before paying it to the investor for their part in the process. After the preferred return has been paid to the investor (usually cumulative if some years have not reached the preferred return), then the remaining profits are typically paid in some type of split fashion (typically from 60/40 to 80/20, meaning 60% goes to the investor and 40% to the syndicator). There are variations from this, but most follow something similar to this type of pattern.
Typical might be 1-2% a year, plus 30% of all gains over 8% a year.
1-2% of what, the property value or your annual profit?
1-2% of cash distributions to the partnership, so if you’re earning an 8% preferred return, you’ll get 6-7% net
From the Realty Shares FAQ: “Your Form K-1 may show income that relates to (among other things): (1) interest income; (2) net rental real estate; or (3) gains from the sale of real estate.
Interest income is considered portfolio income and will typically be taxed at your marginal tax rate. Net income from rental real estate is also taxed at your marginal tax rate, but is subject typically to passive activity rules. Capital gains will be taxed at rates of 15% to 20% depending on your tax situation.
The taxation of different categories of income is an important issue to taxpayers. Make sure that you discuss these classifications with your tax advisor.”
Since I’m at the highest marginal tax rate at present, I’m not sure it’s worth it to get more taxable income at that rate. Wouldn’t it just be better to invest after tax money into low cost index funds (in a taxable account) and pay long term capital gains? IF I can get a good ROI and only pay capital gains tax, then I’d definitely be interested.
A few comments:
1) I agree with Mike in that an overview of representative investments’ fees with these companies would be more useful for this audience than an overview of these firms’ capitalization as your guest poster summarized.
2) I also agree with Still have concerns in that a breakdown of perhaps your “test” investments in how much of the gains are disbursed as regular income and how much as LTCG would also be very relevant.
3) For these debt-based investments I gather that the dissolution of the lending intermediary company wouldn’t affect one’s claim to the debt?
4) WCI mentioned that the Vanguard REIT fund did poorly in the 2008 global financial crisis. Were any of these companies around? How did analogous investments do in this era?
So far I’m not seeing the extra risk that _must_ be there made explicit: if it’s just an issue of fees and the return is greater than that expected for index funds either these instruments are priced inappropriately (too much return for risk) or the risk is hidden.
1) I agree. Want to write the post?
2) If I had the info yet, I’d share it.
3) I believe so.
4) None were really around. I presume poorly like most real estate investments. But with a 5-7 year horizon, many markets had time to rebound prior to when the underlying properties were sold.
I’m not convinced this market is as efficient as your comment would suggest.
1) Agree, but capitalization is very important too (see #3)
2) I’ll add in regards to the tax implications, you should also note that the depreciation losses will only offset passive income unless you are a real estate professional (most of this audience is not).
3) Very good question. Patch of Land recently had to address this issue (http://landing.patchofland.com/legal). Not all debt platforms use this structure. In fact, Groundfloor (a similar platform to Patch of Land) even disclosed the risk that a bankruptcy of its platform could jeopardize the investor’s interests in the debt investment. Because of this risk, the platform’s capitalization is very important.
4) These crowdfunding platforms were not around during 2008 (its doubtful they would have survived). But I take exception to the performance of the Vanguard REIT as an indication of diversification–the global credit crisis was CAUSED by real estate. It’s no wonder the REIT index collapsed by that much. In fact, I would go further and say that your crowdfunding investments would have fared far worse. Diversification of your investments helps, but timing of repayment is even better.
I have been been investing through these platforms (RealtyMougl and RealtyShare) for almost 2 years now — Mostly in multi-family apartments. So far the distributions (cash on cash returns) have been mostly in line with what has been projected at the initial investment. Although the fees are high, access to private real estate deals in different geographic areas is appealing.
I only have equity investments, so you get a K-1 form each year for each investment. There is pass through depreciation so you wont pay tax on the full distribution. However, I am assuming when the property is sold, this will be recaptured through capital gains taxes which would be better than taxing at ordinary income. Also keep in mind, there could be possibility of needing to file non-resident state tax return depending on the state and level of distributions…So far I have not had to do this. my accountant handles the K-1, so this is not my area of expertise.
I dont have any debt investments, but I believe you will get 1099-int form for that.
This is a hugely important question that I have as well. This is passive investment income which is taxed. However, many real estate investements can be depreciated which boosts the returns signficantly. Please discuss the tax implications in more detail. Otherwise, thanks for the post as it is the first I have heard of this.
It only boosts returns minimally (basically defers the taxes for a few years) UNLESS you can exchange until death (at which point heirs get a step-up in basis), which is tricky with these companies.
Curious as to how you concluded that capital gain tax will be applied to depreciation recapture. I always thought recapture was at ordinary rates.
I agree with David, I believe recaptured depreciation is taxed at normal income tax rates. I believe the increase in value of the property (above purchase price) is taxed at capital gains rates.
Believe it or not, you’re both wrong. It is not at capital gains rates, nor ordinary rates. It is at 25%. A bit of an arbitrage available there for those in higher brackets. Save it at 39% and recapture it at 25%.
http://www.wgcpas.com/news/alerts/405-tax-matters-tax-implications-of-depreciation-recapture-when-selling-real-estate
Thanks for the correction. I have yet to sell any real estate so have not experienced it first hand.
This is Josh Stech, Founding Partner at LendingHome. I will quickly comment on our fee structure. Since we focus strictly on 1st mortgage loans on residential assets (1-4 unit properties) we have a very straightforward and competitive fee structure. We charge a servicing fee equal to 10% (so a 12% gross annual interest rate would be 10.8% after the servicing fee). There are no other fees unless the loan defaults. It’s worth noting that we currently charge the same fees to our institutional investors (Colony Capital, for example) as to our accredited retail investors.
As an FYI, SA, we have 24 loans available for investment right now. They carry an average gross interest rate of roughly 12% (min 8.25%, max 18.25%). You can check us our at http://www.lendinghome.com/invest. Make sure to enter “WhiteCoat” when asked how you heard about us.
I invested in equity crowdfunding here http://crowdfund.co/equity/ eight years back. Until last month, I didn’t receive a single penny on my investment and my wife each day scolding me to take money back. Somehow I managed to pass 8 years and last week I received the good return on my investment and it was really a nice moment for me.
I’ve invested in 8 different equity deals in just over the last year. In my experience, I have found the most desireable sites for equity investments to be RealtyMogul and RealtyShares. I have toyed with a couple of equity investments with I-Funding lately, but haven’t pulled the trigger. I have 3 equity deals that are now about 1 year old, still too soon to say for certain, but 2 of the 3 don’t seem to quite be keeping pace with their lofty projections. That’s probably the hardest part of crowdfunding. Your decisions are often based on projections from those that want you to invest with them (?overly optomistic). Definitely a buyer beware type situation, but as WCI pointed, there is a hard asset behind these investments. However, the equity deals are leveraged in the 70-90% range which still leaves investors with plenty of risk of losing their entire investment if the market turns. I also have my own commercial building portfolio that I own, and the crowdfunding aspect is obviously much easier, as someone else takes care of all the hassles–K-1 statements, management issues, bills, etc–even with a property manager in place.
For debt, I think the best site, hands down, is Patch of Land. They only do debt deals (no equity) and seem to have a better grasp/focus on the debt deals than the others I have seen. Patch of Land’s interest rates also seem to consistently be better by 1-2% (their deals don’t seem to appear to be any more risky than the others). The downside of the debt deals is that the interest income is taxed at your marginal tax rate. Because of this, I have not invested in any debt deals, however, I having been toying with dedicating some Roth IRA money to the debt deals to avoid the taxes. (As for IRA money for equity deals, I understand that you still need to pay taxes on the increased value due to the leverage, making IRAs less helpful in leveraged equity deals). The debt deals are hard money lending type deals and are often appear to be flip investments (dumpy house, upgrade, sell for profit). A ton of people lost their shirt on these type of deals during the last down turn. The hard money debt loans appear to be not as leveraged, often 60%, however, they base their loan to value on AFTER REHAB value estimates (lofty valuations are a definite likelihood).
Hard money loans and syndicated equity deals have been around forever, however, with these crowdfudning sites it is now much easier to gain access to these type of investment and access many more opportunities than any one investor could previously access. M2C
Hey Bob. This is Josh Stech, Founding Partner at LendingHome. Couple of thoughts in response to your post:
– Equity investments are simply more difficult to underwrite, take longer to come to fruition, are more subject to macro risk given their multiple year durations, and are the most first to absorb losses in the entire capital stack. This is why LendingHome chose to focus strictly on debt. I do hope your 8 deals turn out well.
– We very much admire what Patch of Land is doing. I would argue LendingHome competes very well, however, as evidenced by 2 facts: we have raised the most equity financing (~$110M) and have originated the most loans (>2,000) of any platform in the online real estate financing space, including all of those mentioned here. You have not heard of us as often as others because our management team’s background (www.lendinghome.com/about) allowed us to raise institutional capital to fund our loans from the very beginning. It wasn’t until a few months ago that we opened the accredited investor retail platform (www.lendinghome.com/invest).
– Investing in real estate debt out of your IRA is something you should absolutely consider. We allow it on our platform.
– There is risk in all real estate assets in a downturn. By focusing on realistic valuations, conservative LTVs and short durations (our average has been 9.7 months).
[Post truncated.-ed]
[correction]
– There is risk in all real estate assets in a downturn. By focusing on realistic valuations, conservative LTVs and short durations (our average has been 9.7 months) we believe that risk is mitigated.
I do have some really simple questions
1) what is 1st lien or 2nd lien debt?
2) What is equity investment in real state?
3) What kind of fees are you exposed to?
I don’t mean to sound flip, but if you don’t know the answer to those questions, you do not need to even think about investing in these types of vehicles, as I do not feel you have the ability to accurately understand the risks involved.
But to answer them anyway:
1) 1st lien and 2nd lien refers to the order in which creditors get paid in the event of default. Anybody who holds “1st lien” (similar to 1st mortgage), would have claim to any equity in the property in the event of a liquidation/foreclosure and would have to be “made whole” BEFORE any 2nd lien holders. 2nd lien holders therefore have inherently higher risk of losing all/most of their investment.
2) Equity investment refers to buying an actual share or percentage of a property. Say you own 10%, you’re entitled to 10% of the net profits of the property in perpetuity. Of course if the property does not make money then you don’t make money. This differs from a debt investment wherein you lend money to someone and then collect interest at a set rate on that money, regardless of the underlying property’s profitability (and you are in fact a drag on that profitability).
3) I’ll leave fees to the post author.
thanks and I am not invested in it
PK,
I know Matt is well intentioned and I agree with his point that before investing in any such type deal, I would spend a ton of time looking at deals, asking questions, and learning about real estate, syndication, fees, etc (I spend 5+ years looking and learning about commercial real estate before I purchased my first commercial building); however, I applaud you for asking questions and trying to learn, everyone needs to start at the beginning. Don’t feel bad for asking questions and trying to expand your understanding.
PS, sorry for all the typos in my posts 🙂
1) When the deal goes sour, the 1st lienholder gets paid completely before the 2nd lienholder gets anything.
2) When you own it, it’s equity. When you’re just lending money, it’s debt.
3) 1-2% a year plus 20-30% of everything over 6-10% a year.
So to sum up the tax implications.
Equity investments are taxed yearly as a K1 and therefore subject to marginal tax rate.
When your equity investment is sold after the holding period and you hopefully get the appreciation on the building, as long as it was held for > 1 year it is capital gains tax.
All debt investments are 1099-INT, therefore taxes at your marginal tax rate.
This sound right?
Seems like I would need to do the math, but if I am getting taxed 39.6% on almost all of my profit yearly except for when the equity investment sells, this would not be too appealing compared to long term holding of index funds. This would of course change when I am entering into retirement and am at a lower tax bracket anyways.
You are correct in that the equity investments show up on a K-1 statement for tax purposes, however, all distributions are not necessarily taxed at your marginal rate. Let’s say you have a distribution of $1,000 for the year, the K-1 should show a depreciation expense to offset gains (the depreciation should be split evenly among the investors…make sure the syndicator will not be assigning the depreciation only to their investment prior to making your investment). Now let’s say the claimed depreciation for the year shows a depreciation of $2,000 for your portion of ownership, thus showing loss for your investment ($1,000-$2,000= loss of $1,000)–no taxes paid on your distribution and in fact you get a tax deduction for that year for the “loss”. Investment losses max out at a fairly low amount ?$3,000? for the year but can be carried forward and can also be used to offset other passive income for the year. Of course, these tax savings will all be recouped in the year that the property is sold. Recaptured depreciation is taxed as ordinary income when the property is sold, any increase in value above the purchase basis is taxed as capital gains. So in essence, depreciation results in a tax deferment until the property is sold at which time the tax man comes a knocking.
Yes, interest income (debt deals) shows up on the 1099 and is taxed as ordinary income. Much more straightforward, but more difficult to get favorable tax treatment unless it is in a tax protected account, like an IRA.
BTW, I am not a tax accountant, just a dumb MD–correct me if I’m wrong with any of the above statements.
Additionally can these be 1031 exchanged to avoid capital gains taxes? This is how “accredited investors” make real money on these deals….depreciation and 1031ing. I don’t know the answer. Can these be 1031’d??? Thanks.
The ownership structure is set up in a way that they do not qualify for 1031 exchanges. I have seen 1 opportunity presented out of hundreds that I have seen in the past couple of years that did afford a 1031 exchange.
My understanding is no, unless every single investor in the deal wants to do the 1031, which is almost impossible unless there are only a few investors involved.
Bob you are correct. However, the 1031 doesnt really apply with these investments.
Not easily. I keep suggesting it to these companies when I get a chance though.
As far as I know, you don’t get a tax deduction for showing a paper loss from depreciation–at least not if you are at the income level of most physicians. The loss just gets carried forward to the next year. Also you can 1031 exchange into another property depending on how it is structured and if you do it within a certain timeframe.
Be careful not to let the tax tail wag the investment dog. If the after-tax returns are good and the correlation with the rest of your portfolio is low, there may still be a place for a tax-inefficient investment in your portfolio.
So it sounds like if you were to do an equity deal on one of these platforms you would get a K-1 at the end of the year and your taxable income could likely be zero depending on the amount of depreciation from this property vs your “cash on cash return” each year. However, when the operator sells the asset you will be taxed on the depreciation recapture at 25% (effectively whatever income you didn’t have to pay taxes on in the years before, you are now paying on now at 25%) and then the rest of your profit is taxed at 15%.
This sounds better than being taxed at my 33%-39.6% marginal tax rate, however you don’t get the benefits of investing in a taxable investment account because you are only charged on this brokerage account when you sell and you can defer all of your profits until you finally want to withdraw. However, with the real estate syndication deal you are having to pay each time the property you invested in is sold.
Sounds this is a good strategy to stick with equity if you have marginal tax rate north of 25% due to arbitrage of depreciation at marginal tax rate and recapture rate at 25%.
For straight debt seems best to use self direct Roth IRA, I do that for P2P with LC.
But yeah if you have money laying around and want to chase returns better than a bank then RE crowdfunding and P2P are good alternatives plus they also offer non-correlated assets. If you subscribe to Efficient Frontier theory then these are great to add to a diversified portfolio mix.
Question for others:
How many out of state income taxes are you filing? Seems to avoid that hassle stick with states with no income taxes TX, FL, OR, etc… or stick with your home state as you need to pay that tax anyways :(.
You are right Larry this is a good strategy to stick with equity.
Anyone can comment on state tax fillings for K-1? I don’t want to end up with a headache at tax tax. Are people sticking to no income tax states?
You can limit your equity investments to the states w/o income tax to avoid filing the out-of-state forms: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
All things being equal I pick one of those states, or my home state since I have to file that state anyways :).
If you look at doing a fund instead, definitely reach out to the sponsor to understand which states they plan to invest in and how many state k-1s they expect. I had one fund say they don’t know since the fund is just beginning. The projected returns looked good, but I didn’t want to be stuck filing a dozen out of state of the next 7-10 years which was the fund hold!
But hey if you have a flat fee accountant already or just love playing around in TurboTax then this is not a concern.
As with anything it pays to do your due diligence.
I think the most important question to those of us index fund users is: “what’s the cost/expense ratio?”
Are the 8-12% returns before or after these fees?
as a very inexperienced investor, my take is that real estate can have higher returns with more risk/volatility, but in the end, its not worth the headaches and hassles for the average investor. Would you rather learn about about depreciation, recaptures, and 1031 exchanging -vs- “set it and forget it” vanguard funds? I guess I’m the latter.
While no guarantees, these are after-fee, before tax.
There are many roads to Dublin. You can certainly be very financially successful investing by marrying an adequate savings rate with an index fund only portfolio.
After learning of real estate crowdfunding on this site, I jumped into investments about 18 months ago. I’ve invested in 1-5 yr equity and debt offerings on RealtyShares, RealtyMogul, CrowdStreet, iFunding, and RealCrowd through a self-directed IRA. So far, I’ve been pleased with the returns. A fix-and-flip through RealtyShares earned 19% annualized, while a skilled nursing facility on CrowdStreet returned 14% annualized. I’ve had only one investment come close to losing money (and should have) but the site strongly advocated for the investors and we got our money back with a small profit. The only investment I still have that worries me is a hotel being constructed in the Bakken oil region that I plunked money in right before oil prices nosedived (the sponsor of this project is not among those I listed above).
One caveat to be aware of is some deals having low target raises and high investor interest can fund very quickly. I even saw one that funded in 4 minutes!! There’s obviously no way to perform due diligence in such a short interval. I’m not sure how to solve this problem without some sort of lottery or preference system.
As others have touched on, if you invest through an IRA and leverage is utilized, you’ll be hit with Unrelated Business Income Tax for any profits derived from rental income. Investing through an IRA can be cumbersome and some sites restrict IRAs with higher minimums or to specific types of deals.
WCI – just wanted to clarify that the income threshold for accredited investor status for married folks is >$300K only if you want to include both spouses salaries. If one spouse earns >$200K, then he/she can invest without utilizing their spouse’s income.
Good point. Thanks for sharing your experience.
Hey Pathdoc. This is Josh Stech, Founding Partner at LendingHome. I’m glad you’ve had a good experience with other sites so far. As I mentioned in a reply to a prior post, LendingHome only recently opened an accredited investor retail platform. Previously we sold our loans to institutional partners such as Colony Capital. That said, we’ve originated >2,000 short term, 1st lien mortgage loans on residential properties in 2 years. Currently there are 24 loans available for investment. They carry an average gross interest rate of roughly 12% (min 8.25%, max 18.25%).
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What sort of default rate or failure rate should an investor use as an assumption for these hard money lending equity or debt deals? Is there a rule of thumb to go by?
For example, in a similar publicly traded asset class (junk bonds) normal default rates are around 7% per annum and default rates tend to peak out just under 20% in a really bad economic environment (1932 or 2008). Should an investor in these deals expect these type of default rates for hard money lending or is the actual number lower or higher?
While hard money loans and fractional equity investment has been around forever, it has traditionally been done as individual deals with no real regulation or tracking. Most are done with small mom and pop hard money lending shops or real estate professionals that piece together deals with investors. These places don’t publish their data. I have never seen any good data on this. Investor beware: hard money lending typically is done because they can’t get traditional financing from banks= higher risk.
Good question I’d like to know the answer to.
I run a site that utilizes historical property performance to translate these crowdfunding investments into ratings that are loosely equivalent to publicly traded junk bonds. It isn’t perfect, because yield and performance on Junk Bonds is very limited below CCC. I use this approach because it’s more forward looking than using dated real estate comparables.
I mention this because I haven’t been able to apply this approach to hard money lending investments like the ones shown on Patch of Land. There is no available performance data outside of bank balance sheets, and as a previous poster suggested these deals are listed because they couldn’t get traditional bank financing.
Default rate is only one metric, loss rate is another. If I had to garner a guess, I would assume a default rate equivalent to Subprime debt (10-15%) with significant loss severities in the range of 50-60%.
Zillow data is actually quite good and may be used as a proxy for the property value volatility.
WCI: It would be great to get another post on this topic, perhaps from some of the commenters above? I think it would fit nicely with your P2P updates. It would also fill a missing niche — I am surprised that there is not more of a discussion about this on bogleheads.
The Bogleheads are great, but tolerance for alternative investing viewpoints can be limited at times. “What?!! You invest in something besides the three-fund portfolio??!! Heretic!”
I’d welcome a guest post from a reader on the topic and I’ll try to do regular updates of my experience.
Can Bob or someone else explain the logistics of getting a Roth IRA that can lend money via Patch of Land?
You just need to go to a “self-directed” IRA provider. Fees are higher than you’ll see at Vanguard or Fidelity, but it may be worth it for the tax savings.
I have used 2 different companies. I currently use Sunwest Trust and have been very happy with them. Transactions are always a pain because each one has to go through the custodian. There is a streamlined approach which is called a “checkbook self-directed IRA” or “self-directed LLC IRA” which allows the owner control of the LLC/checkbook for investments, but then the custodian holds the LLC. This way you control all the transactions. There is some debate out there whether the government will disallow these at some point. I don’t see any reason why they would disallow them as long as you are not taking part in prohibited transactions (self dealing, etc), but the government does a lot of things that I don’t think make sense! 🙂
If you already have a Roth IRA, you would need to set up a Roth IRA account with a custodian that handles self-directed accounts for private equity/real estate investments and then rollover funds into the new IRA. There are a number of such custodians out there and I’ve only had experience with one (and have encountered a few problems), so I’d hesitate to make any recommendations. I”m certain if you contact PoL that they could direct you toward companies they’ve dealt with. I’d also check with PoL to see what their minimums are for IRA investments and whether there are any other restrictions.
Sorry, this was meant as a reply to Xeno’s post.
When the crash happened in 2008-ish, there was a company called DBSI that did similiar things; not online so much, worked mainly with 1031 exchanges, but same idea where a bunch of investors would send DBSI the money, it would get put in to a property, and the investors would get rents back.
Problem is that they co-mingled all the funds, even paid off properties were left nearly bankrupt, and the principals went to prison, most investors got next to nothing back.
How do we know these companies will put the money where they say they will, other than the fact that they take our cash and they send us statements?
(One article: http://www.law360.com/articles/698561/dbsi-trustee-wins-18-6m-judgment-against-ex-ceo)
Some of these platforms setup special structures/entitiesto deal with bankruptcy and to protect investors. Realtyshares was touting this in a recent newsletter I got:
https://www.realtyshares.com/blog/new-debt-offering
That being said if someone is scrupulous and wants to defraud you doesn’t matter the documents signed, structure or paperwork. This is where due dillegence and diversification comes in.
There’s literally 100s of RE crowdfunding sites, stick to the ones that better funded, have some track record, and the founders look like the know what they are doing.
If you do decide to jump in, diversify across platforms so nothing is in “one basket”/platform.
Of course don’t invest anything if you’re not comfortable or don’t understand.
There’s a reason why these are “alternative” investments and limited to acrediated investors only. They have a much higher level of risk but with that risk you have the potential of higher returns.
Is there a table comparing key features of the main crowd funding companies; this would help greatly thanks Howard,
I learned about real estate crowdfunding after reading Dennis Bethel’s post on here and he linked me up with a real estate syndicator which was not mentioned here at all. They focus mainly on B grade multi-family commercial real estate properties in the Houston, TX area. In 3 years I’ve invested in about 5-6 assets. As WCI pointed out, the minimum is 50K for each of these. I’ve been extremely happy so far. The distributions have been exactly as promised (or better). Because they focus on a very specific asset class in a very specific market/location, they know these assets through and through and are impeccable about doing their due diligence. As a result, to my knowledge, the assets that they have picked thus far have generally done well. As pointed out in this thread, it is difficult to know exactly what the management fees are because it’s complicated–I’m sure if you want to you could talk to them and calculate all that but at the end of the day as long as the distributions are coming in on time, as promised and as expected or better, I don’t care, I’m a very passive investor and have better things to do. If you ever have a question you can pick up the phone and talk to one of the 3 or 4 main people in the company and get an honest and straighforward answer. When I first started investing with them 3 years ago it was easy to go in on a deal, but over the past 3 years, probably due to this site and to Dennis, they have had a ton of physicians come on as investors to the point where now, when they announce an upcoming deal, people are crawling over broken glass to get in on it and it’s usually filled up within a matter of hours. If you want to invest through an IRA they will help you do that. I have invested through my taxable account and as far as taxes go, I have paid zero dollars in 3 years on all my distributions because I have shown a paper loss on my K1s due to depreciation. Keep in mind I have not been in long enough to go through a sale/1031 exchange to see how that works out and what the tax implications are with recapture etc., but I don’t expect any big surprises. They send you a K1 every March and it takes about 5 minutes to input that into Turbo Tax and you’re done, it’s that easy. You do have to file an out of state tax return but again Turbo Tax will do it for you and the minimal extra fee for that is negligible compared to the returns and tax benefits. The only downside I can think of is that if you want to diversify, this company is not for you since all their assets are of similar class in a similar location, so that’s a bit risky. I did check out RealtyMogul a year ago after seeing a guest post on here and was not satisfied at all with their attention to detail or due diligence. I inquired about a few deals that were advertised and either got no response or was told that the details were still unknown or that the deals fell through–not exactly reassuring. Just wanted to share my experience so far…
Thank you for doing so.
Doctor K,
I have some family in the Houston area who know the city well. Would you mind telling me the company in Houston you were referring to? The more due diligence the better, and local people who can offer opinions on good investments is appealing.
Thanks
Hey Doctor K. This is Josh Stech, Founding Partner at LendingHome. I’m glad you’ve found some success with a fund manager in multi-family properties in Houston. One great thing about the websites mentioned in this post is the ability to diversify across asset classes and geographies. As evidenced by the oil crisis in TX, geographic concentration risk is real. In LendingHome’s case we provide loans in 22 states.
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If you show a negative state k-1 (due to depreciation/losses) do you still need to file the out-of-state? If not then how do the losses carry forward without tracking? Or is this tracked at the fed level via the auto-magic of TurboTax? Also have you ran into any states that have a minimum threshold? I read some have a $1K min earning before the require filing or might have read it wrong.
Thanks!
It’s different in every state. Some have a minimum threshold, some require a composite return, some don’t have an income tax etc.
@DoctorK — Curious, if your RE investments are in Houston why do you need to file out of state (as I know TX has no income tax)? What’s the timeframe for the entire investment? 5yrs? 10yrs? Indefinite? I like that you have cash flow coming in that’s tax deferred, better than interest income taxed at marginal rate :(.
Larry you are correct, I was speaking in general terms but luckily I personally have not had to file an out of state return since, as you mentioned above, the properties are in TX–but I wouldn’t make a decision based on this. If you are investing in a property in a state that collects state taxes and you are showing a paper loss, I don’t believe you would have to pay state taxes either.
And yes, the timeframe for each investment is generally about 5-10 years at which point the company says they will usually refinance (where you can get your cash out) or do a 1031 exchange.
@DocK — guess I’ll need to check back in in 5yrs. 😉 Be interested how they can do the 1031 exchange as you need to roll it into another property also would it have to be with the same sponsor/developer/syndicate for it to work? Usually I hear people just take the long term capital charge as well as pay for the depreciation recapture at the end. Still decent returns and of course secured by real stuff :). Not a bad option to add in a well diversified portfolio.
@ Larry–so I just completed my first 1031 exchange after an early sale of a property, and it went seamlessly without me having to do anything at all. The initial property was held for 18 months, and sold for sizeable gain. This was rolled over in a 1031 exchange into another larger and newer property, allowing us to defer any capital gains and depreciation recapture and acquire a larger, newer asset with a larger depreciation bank and newer depreciation clock. To answer your question–yes, the exchange would probably have to be through the same syndicator for all these cards to line up favorably the way they did. I’m very grateful to be working with a very good one.
I did some p2p lending (non real estate) and that worked out great until the 2008 recession — of course that may just mean I’m a poor lender. With crowd source real estate, wouldn’t this behave similarly? Typically lower credit / higher risk ventures (as evidenced by the 9-11% bond rates) subprime like default rates / high permanent impairment. Eventually if enough people sign up, the cost of debt may decrease on the whole, making returns more meager and emboldening even more speculative building? (Ok, so we maybe a long way from point 2, I guess I’m just not sure I trust this yet). Do you think the liquidity premium is so high that it justifies excess returns here?
Excess of the risk you’re taking? Probably not. But I think you’re being compensated for your risk and lack of liquidity.
I am interested in investing on this business. Is there any institute can gave me training on it?
Hey Kevin. This is Josh Stech, Founding Partner at LendingHome. If you’re an accredited investor someone on our team would be happy to help you think through this. You can check us out at http://www.lendinghome.com/invest. Make sure to enter “WhiteCoat” when asked how you heard about us.
For non-accredited investors, Groundfloor (http://groundfloor.us) offers investments in 9 states, with a $10 minimum.
Interesting. That might be worth looking into.
Not sure if I understand, self and other investors interested in this entity lend money and get a fixed return? If so, over how long is expected? Of I we investing in this enterprise like an etf or mutual fund or can you boil it down in simple terms? thanks.
It’s debt lending where you’re lending YOUR money for people doing real estate deals. The terms vary per deal some as small as 6mo others 5 years plus! Your money is LOCKED during this time similar to a CD. You’re trading risk and illiquidity for higher returns.
You can get returns in the double digits (APR). However, there is RISK as in the borrower may not be able to pay back at which point you own notes (sometimes senior or junior) that can have leins against the property (think of a foreclosure where if you have senior debt you’ll get paid out first upon liquidation).
I would say if you’re comfortable with Peer2Peer Lending (Lending Club and Prosper). This maybe a little more “conservative” as you own rights to property in the case of default. In Lending Club and Prosper If they can’t repay you. You lose your money minus any recovery they can do plus the charge off on your taxes. But With P2P you spread risk with $25 investments across 100+ notes.
In Real Estate Crowdfunding the typical amounts are $1k all the way up to $50k (with equity deals).
Most Real Estate crowdfunding requires you to be accredited ($200k individually, $300k joint annual or over $1M in assets excluding main house). P2P anyone can do it. Groundfloor.us is an exception which allows general public if you’re in a qualified state.
Personally, trying to move more investments into equity for the tax benefit. For debt you’re taxed at marginal so if you’re accredited ($300k+ annually) the tax for those interest gets pretty high :(….
Disclosure:
I have investments in:
Lending Club (P2P)
Prosper (P2P)
RealtyShares (Debt)
RealCrowd (Equity)
FundRise (Debt)
Groundfloor (Investor)
FYI: some of the sites are doing referral till th end of the year so be sure to use referral codes to the max bonus if you’re signing up!
Again: only invest in things you understand and willing to lose. There is risk with any investments and you should be prepared to lose everything. I.e.: please don’t go gambling the mortgage payment.
You and the other investors are either buying an equity investment, in which you participate in gains and losses, or a debt investment, in which you are loaning money to someone at a fixed rate. The debt deals tend to be 6-36 months. Equity 5-7 years.
Thank you for this post. I plan to go through it with a fine-toothed comb. I currently invest with Realty Shares (nothing else to disclose…they don’t know me from Adam) through a self-directed 401K trust. I’ve been with them a little over a year, and have “tentatively” invested a little over $25k. My experience has been nothing but positive thus far. I have received my promised returns, and have not “lost” any of my investment. I guess my CPA will let me know if I’m “doing it wrong” for my taxes and we’ll adjust course accordingly, to reduce monetary waste. I absolutely love the real estate investing world, but given the nature of the day job, don’t have time to do all of the ground work for an actual fix & flip, etc. This has been a fun and, so far, profitable addition to my portfolio. Knock on wood!
Tell me about your self-directed 401(k). Who do you use? What are the fees? How is the service? Is there are a Roth option? How are your equity real estate investments affected by being in a tax-protected account etc.
I’ll throw my experience in- I opened an account for my wife with Goldstar Trust Company in Texas because I saw that they provide a service that allows for investment in crowdfunding platforms. However, they need an agreement set up with the platform prior to allowing your investment.
I wanted to invest with Peer Street because I like their model better than Patch of Land’s, but unfortunately they did not want to deal with the reporting requirements necessary to work with Goldstar. I was directed to open an account with their preferred provider, SD IRA (check their website for info). SD IRA also works with Lending Club which was a big reason Peer Street aligned with them. Unlike Goldstar, SD IRA’s setup was completely online and very easy. My funds have not been transferred over yet so I can’t comment on them beyond the initial setup.
In the case of Goldstar I did not see if a Roth was available but I recall that as an option with SD IRA. My intent is to use this account for debt investments only, as there would be no depreciation benefits and I’d otherwise have to pay tax on the 1099 income.
I already have a SD IRA for LC, so if they can work with RealtyShares/RealtyMogul/Fundrise that would be an option for me for debt investments. I agree with you that I prefer equity investments in taxable, especially if the companies can provide more 1031 eligible investments than they have in the past.