(Bloomberg Markets)—Real estate fund managers Michael Episcope and David Scherer had Georgia on their minds—specifically, Atlanta. The city, part of the third-largest-gaining metro area in the U.S. last year, according to Census Bureau data, was only getting hotter. So when the co-founders of real estate investment company Origin Investments spotted an opportunity last year to purchase a 125-unit apartment complex, they jumped on it. The property’s location, in Virginia-Highland, an affluent Atlanta neighborhood that’s home to organic shops, cocktail bars, and an indie film theater, was great. Yet Episcope and Scherer had a problem. They reckoned it would take about $19 million in equity to buy the building and an adjacent undeveloped lot, but they wanted to invest only $12 million. Their solution was somewhat novel: Instead of bringing in a partner, Origin brought in dozens of them.
Origin emailed hundreds of investors with an offer to invest in the complex. Twenty-four hours later, the Chicago-based company had raised an additional $6.6 million from 39 investors and had 23 more takers on the waiting list.
“It was spoken for very quickly,” Episcope says. “We came in the next day and had to send out an email and say, ‘We’re filled up because the number of inquiries is more than we could satisfy.’”
Episcope and Scherer founded Origin in 2007 to invest their own money in office buildings and apartment developments in secondary U.S. cities, areas other than inflated markets such as New York and San Francisco. By the time the partners closed a $151 million fund raised from 450 investors last June, they’d transformed the company into something different: a real estate private equity fund that uses crowdfunding-like tactics to raise money from family offices and high-net-worth individuals.
That business model relies on U.S. Securities and Exchange Commission regulations, updated in 2013, that govern the way investment firms can raise money online. A rule known as 506(c), introduced following the JOBS Act, lifted the ban on “general solicitation.” Investment firms became free to market offerings to accredited investors, who are typically worth more than $1 million, through advertisements or blast emails. Real estate fund managers have used the go-ahead to solicit a wide array of these investors for funding hotels and warehouses from Florida to Wisconsin.
The model sounds a little like crowdfunding, though that term has become more associated with adventurous young entrepreneurs pooling relatively small amounts of money from average Joes over the internet. The JOBS Act let startups and investment firms sell equity stakes to nonaccredited investors. That’s not what’s happening here. What these real estate fund managers have been doing might be called crowdfunding for the wealthy.
As Episcope puts it, the rule changes have made raising funds a lot easier. In the early days of Origin, he says, “it was my partner and I, knocking on doors and meeting with people and stretching our network as far as we could.” Their reach has now significantly increased. “If you have a great product and you put it in front of millions of people, they’re going to buy it.”
Companies such as Origin see a fertile market in the world of family offices, which on average allocate 16.2 percent of their portfolios to direct real estate investments, according to a 2017 report by UBS Group AG and researcher Campden Wealth Ltd. While the biggest family offices can afford to buy properties on their own, Episcope says his model has the potential to bring higher-quality deals to smaller investors.
“Origin has always been designed around providing the individual investor with the same opportunities, service, and fee structure that the multibillion-dollar investors enjoy,” he says. “We believe there is still a large gap.”
Origin has followed a two-pronged plan. It has hired experienced professionals to buy and manage undervalued real estate, targeting net returns of about 15 percent, similar to a large private equity fund focused on real estate but with lower fees than what noninstitutional investors normally pay. At the same time, Origin built a technology platform that gives investors real-time information on how their investments are faring and doubles as a tool for marketing to new investors.
Driftwood Acquisitions & Development LP, a Miami-based hotel owner, took a different path to a similar strategy, says Carlos Rodriguez Jr., the chief operating officer. During the recession, the company saw cheaply priced hotels it wanted to acquire, but found that institutional partners it had relied on when the economy was growing had less appetite for risk during the downturn. Rodriguez and his father, Driftwood Chief Executive Officer Carlos Rodriguez Sr., raised $50 million in equity, mostly from previous investors, to fund acquisitions, then set to work formalizing a network of accredited investors interested in buying into Driftwood’s deals after an acquisition had closed.
It’s a traditional syndication strategy with a twist. Driftwood buys hotels with its own capital, then uses its own website to solicit investors to co-invest a minimum of $100,000. That type of marketing was forbidden before the JOBS Act. The company’s website says investors can expect an internal rate of return exceeding 15 percent.
Driftwood was expanding its model in 2013 around the time the SEC was lifting its ban on solicitation. Driftwood began advertising the past performance of its hotel deals on its website and sending blast emails whenever it had a deal to syndicate. What started as a plan to communicate with existing business partners turned into an invitation to investors to come in off the street and get to know the company. That was the case last year when Driftwood bought the Tan-Tar-A Resort in Lake of the Ozarks, Mo., and announced plans to convert the property into a Margaritaville hotel. Local media coverage of the project led new investors to reach out to the company, though none ponied up the $100,000 minimum investment Driftwood was seeking.
Still, the younger Rodriguez says using crowdfunding-style models will expand Driftwood’s investor base. “How do we leverage what we know is a good model and what is already set up for accredited investor crowdfunding and really scale it?” he says. “We’re trying to ramp it up.”
Part of the challenge for Driftwood and other companies vying for family office allocations is distinguishing themselves from the masses of crowdfunding platforms that have sprung up over the past five years. There are now more than 100 such companies. The crowded field has made it hard for investors to know which platforms they can trust to deliver quality deals, says Richard Wilson, who represents 23 family offices and serves as CEO of the Family Office Club. “Nobody knows which will die or survive, and it feels messy,” he says.
Yet these online real estate platforms argue they’re providing investors with information in a way that is anything but messy. Cadre, a real estate investment platform, gives investors access to a package of information on closed deals and current offerings, including projected returns, drone video of the property, and the company’s rationale for investing in the deal.
Cadre doesn’t describe its business model as crowdfunding. Currently the platform is open only to accredited investors, which include select clients such as family offices and high-net-worth individuals, and each investment is typically structured as a limited partnership. For each one, Cadre enters into a joint venture with an operating partner who invests alongside the company.
Cadre was co-founded in 2014 by Ryan Williams, a serial entrepreneur and an alumnus of Goldman Sachs Group Inc.’s tech, media, and telecom group and the real estate arm of Blackstone Group LP. Some of the initial investors in the company included White House adviser Jared Kushner as well as Thrive Capital, the venture capital firm led by Jared’s brother, Josh Kushner.
Cadre has closed more than a dozen deals and recently landed a $250 million commitment from Goldman’s private bank. The average offering size on the platform is about $30 million of equity, according to the company, with most of the properties falling in the categories of office space, multifamily homes, and retail.
Williams sees much bigger business opportunities for Cadre in the future. The company wants to open up the platform to nonaccredited investors and market to a larger base within the next couple of years, he says. The SEC regulatory changes would allow it to do that.
The company competes head-to-head with pools led by big private equity companies, but Williams is confident he can win. “This is an institutional-grade asset,” he says. “We’ll beat them by being able to find deals, move faster, and pay the same price, if not a better price, because we have fewer fees due to our technology.”
To contact the authors of this story: Patrick Clark in New York at [email protected] Julie Verhage in New York at [email protected]
COPYRIGHT
© 2018 Bloomberg L.P