Real Estate Crowdfunding: When Things Go Badly

Scott Purcell  |

I've been hearing some unsettling things in the real estate crowdfunding sector. One mid-tier platform (approx 100 deals done) is not letting investors log onto their accounts, is not answering their phone and not responding to email, with unsubstantiated rumors that a lot of their deals have gone south. A major-tier firm is, from what I've heard, experiencing default rates in excess of 30%. Wow (if true).

This is NOT a "doom & gloom" alert by any means. We open, on average, 70 new escrows a month, the majority of them for real estate folks. And as we handle the payments to investors for many of these platforms and operators, we see a lot of money flowing back to investors from successful projects.

RISK: as long as investors are prepared to hold, then there really shouldn't be much of a downside. But this depends upon two factors:

  1. The structure of the deal and investors position & security in the capital stack, and/or their rights to assist if the deal goes sideways. And,
  2. The platform or operator's commitment and ability to do workouts.

People often ask me "what happens when the next real estate downturn hits?" - the answer is "it depends". Provided #'s 1 & 2 above, it could be that the time horizon for the hold gets extended by some number of years. The operator may need to take direct control of the asset and rent it out for awhile (with the rents going to investors, net of debt servicing (if any) and management fees). However, if was highly leveraged then the first lein holder may seize the asset if there isn't enough cash flow, leaving equity investors hanging out to dry.

This WILL happen. There will be another cycle downturn and some deals won't work out as hoped. And even in this hot market, there are deals that go sideways.

Knowing this, every platform and every operator should...

  • •Have a plan of action on how they will handle workouts;
  • •Commit to that plan, allocate resources, and train staff regularly & repetitively so they are prepared;
  • •Articulate the plan to investors - overcommunicate it.

In the litigation-happy USA the operator and the platform executives may be held personally liable by investors, regulators and courts. There's a good chance that your LLC or partnership structure will not shield you, especially if you just walk away from a deal and leave investors high and dry.

As a real estate investor myself, I know that there is always the chance that an expected one year investment could turn into a 5+ year hold. And I'm okay with that, as in the long term I know that real estate (depending upon location) goes up in value, regardless of periodic downturns. I would even be okay with an operator asking investors for additional cash to take out a first leinholder, as a way to protect their capital. However I'm not okay with having my investment wiped out because of a bad deal structure or mismanagement. And I think most investors would concur.

I've checked a lot of real estate crowdfunding websites looking for clearly articulated workout plans. I've yet to see something decent. That, I think, has got to change quickly.

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