What A Potential Real Estate Crowdfunding Loss Looks Like

My first potential real estate crowdfunding lossDo you ever feel like your faith is being tested? I’ve been feeling this way a lot more recently. For example, I always get to the bus stop right after the bus leaves. Yet every time I drive down the hill because I’m sick of waiting 20 minutes for the bus, the bus drives by.

I recently published The Worst Landlord Horror Story Ever, a story about a reader who bought a Las Vegas residential property several years before the bottom fell out in 2008-2009. He went through hell dealing with maintenance issues and suspect tenants. Eventually, the complex started accepting Section 8 housing where the government would subsidize 80% of the rent to lower income earners. His housing complex of 157 units turned into a drug infested war zone. Only after buying two more units at the bottom of the market did the reader finally break even after 13 years.

So it is with complete surprise that I got an e-mail the very next week notifying me my real estate crowdfunding fund invested in a 168-unit garden-style apartment complex in Las Vegas! This was also after I decided to invest another $250,000 in the fund, bringing my total up to $500,000.

Here’s the e-mail,

“The Fund’s Investment Committee has approved a $600,000 preferred equity investment in Vernazza Apartments, a 168-unit garden-style apartment complex in Las Vegas, NV, only 3.5 miles from the Las Vegas Strip, 4.5 miles from McCarren International Airport and 8 miles from downtown Las Vegas.

The Property was originally constructed in 2001 as an affordable housing development. In 2016, the Property was purchased by the seller under a “qualified contract” that released the Property from its affordability requirements. Although technically a market rate property, residents in occupancy during the conversion maintain protected below market rents for a period of up to three years, and as of May 2017 only 54 of 168 units (~32%) had rolled over to market rate units.

The Nathan Family Office and Madison Residential (together, the “Sponsor”), see an opportunity to purchase the Property and roll the remaining below market units to market rate units, especially after restrictions are lifted in October 2019.

The Nathan Family Office and its management partner, Madison Residential (“The Sponsor”) has successfully raised capital on the RealtyShares platform for three prior deals, and all payments for those investments are current. For Vernazza Apartments, the Sponsor is contributing $3.5mm of capital to the deal (100% of JV equity), putting its own money at risk before any losses would be incurred by RealtyShares. Additionally, the Sponsor is expected to set aside 28 months of preferred current payments in a RealtyShares controlled account.”

My heart sank when I read that not only was this a Las Vegas apartment complex, it was also an affordable housing development. I’ve got nothing against affordable housing from a social good perspective. Rocketing housing costs are making it difficult for everyday people to live.

But as an investor who is hell bent on staying financially free due to his investments, I worry about investing in an affordable housing complex for all the reasons my landlord horror story mentioned and the fact that in order to get the target 13% IRR, the Sponsor is relying on turning the remaining 114 units (68%) into market rate housing. It remains to be seen whether the tenants will simply accept the rent increase, move voluntarily, or be evicted with potential buyouts.

RealtyShares Las Vegas deal

Here Are The Investment Highlights and Risk Mitigants

RealtyShares Vegas Investment

Target IRR: 13%

Demonstrated Rent Increases: As of the May 29th rent roll the seller has rolled 54 units to market. Of those 54 units 24 have been renovated. Leases executed in the last 60 days have achieved the following:

1) Unrenovated market rate units have leased at an average $112 (~10%) per unit over affordable units, 2) Renovated market rate units have leased at an average of $188 (~24%) per unit over affordable units.

Attractive Basis: The subject property is being acquired off-market and was sourced through a relationship of the Sponsor. The Sponsor believes that the $108k per unit price basis is well below comparable assets of a similar 2000 vintage. The sales comp summary included indicates that the purchase is 15.2% below the comp set on a per unit basis and 13.7% on a psf basis. It should also be noted that the average age of these comparable properties is 5 years older than Vernazza.

One thing to note from my landlord horror story is that an institutional investor picked up their 157 units during the financial crisis for roughly $60K/unit, but I’m not sure if these units are like for like since the Vernazza is newer.

Strength of Submarket and Primary Market: The Property is located in the Spring Valley submarket of Las Vegas, which reported a mean vacancy rate of 3.2% in Q1’17 across all property classes per REIS, and average vacancy is expected to decrease to 2.6% by 2021. The included proforma assumes a 5.5% stabilized vacancy for conservatism.

Alignment of Interest: The Sponsor will have approximately $3,500,000 of its own money at risk before losses would be incurred by RealtyShares.

Reserve for Preferred Payment: At closing, the Sponsor is expected to set aside 28 months of preferred current payments in a RealtyShares controlled account.

Population Growth: According to ESRI, within a 3 mile radius of the Property, the population is forecasted to grow by 6% over the next 5 years translating to over 8,000 new residents in the near vicinity.

Access to Local Amenities: The Property is located in close proximity to numerous amenities and employers not the least of which is the Las Vegas strip located 3.5 miles due East.

RealtyShares Las Vegas Property Location

Setting Low Expectations

Perhaps I’m being too pessimistic on the deal given the Sponsor is putting up $3.5 million of their own capital before investors lose money. The catalyst is very clear: a “qualified contract” that releases the Property from its affordability requirements by October 2019.

But given the risk involved, I’m disappointed the target IRR is only 13%. A target IRR of 18% seems more appropriate. For reference, a 13% IRR is lower than all the previous target IRRs for projects in the fund that aren’t investing in affordable housing.

But here’s the thing. The seller is selling the property to us for $18,200,000 after they had bought the property for only $11,530,000 in August 2015! I’d be selling too if I could make a 58% return on my money in two years. Yes, the sellers had to spend money renovating some of the units, but they couldn’t have spent that much since 68% of the units are still below market rate units. Therefore, even if the seller loses $3.5M of its equity financing, they would still make a 27.4% gain in two years ($3,117,000). It is the seller who is playing with the house’s money, not us.

Housing prices

I personally would not have invested in this deal because I’m trying to stay away from coastal boom bust cities like Las Vegas, the #1 city that got crushed during the housing crisis. The other cities that got hit the most were Phoenix, Fort Lauderdale, Miami, West Palm Beach, and Tampa according to Trulia. I’ll be happy if this project just gives us our money back (0%) return in three years.

Now you know the downside of investing in a fund. You can do all your research, but once you hand over your money, it’s up to the investment committee or fund manager to decide how to best invest your money. Sometimes their investments won’t align well with your beliefs, and you’ve got to be OK with it.

My problem is that I’ve been hands on with all my investments my entire life. Therefore, it’s hard for me not to watch where every dollar goes. But as a 40-year old father who has better things to do than pick every single investment, I need to outsource my investing to others who do have time and expertise.

The more I can let go, the more I can focus on enjoying life to the fullest. And who knows? This Las Vegas investment might very well return 40% after three years as targeted. I’ll be sure to let y’all know if it does! And if it’s a big bust, I’ll be sure to let you know too. At least this is only one of potentially 10 – 20 investments within the fund.

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What do you think about this Las Vegas multi-family property investment? Do you think it will return a 13% IRR for three years, or do you think it’s going to be a money loser? Anybody from the Las Vegas area want to do a drive by or tell me what they think about the apartment complex? Have you noticed good deals getting harder to come by in real estate crowdfunding land?

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