Crowdfunding 50-Unit Deal: Are These Fair Terms?

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Crowdfunding 50-Unit Deal: Are These Fair Terms?

Mark S.Pro Member
Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes

I have an opportunity to invest in a crowdfunding, 50-unit opportunity with the following terms:

- 8% preferred return

- 25% net rental income

- 50% profit upon sale 

Property management fee is 7%.  Markup on maintenance can't exceed 10%.  

For a passive investor, would you say these are fair terms?

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Mark RobertsonPro Member
Investor · Salisbury, NC · Member since 2014 · 314 posts · 386 votes
9y

Those are horrible terms! There is 1000's of syndications and crowdfunding deals that offer 8% pref with a 70/30 split or better. (with the investor getting 70% after the 8% is paid and you receive your return or capital).  I am in deals from 15% preferred 50/50 to 8% pref 90/10.  5% is a typical management fee.  I would run not walk away from this deal.

Also read the ppm and find out what all the gotcha fees are.  Asset management fee is a favorite that can kill your returns if not structured fairly. 

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  • Steve K.
    Denver, CO · Member since 2017 · 265 posts · 234 votes
    9y

    @Mark S. , I'm on that email list too.

    I looked into that crowd funding site a few months back, and saw that new offering in the past 2 days. I have not personally invested, but I first read about it here:

    https://www.biggerpockets.com/blogs/6664/60797-hav...

    You might get feedback from @Larry Fried , who is very familiar with it.

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y
    Thanks, Steve K. Very interesting link. Sounds like things are going well for him.
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  • Mark RobertsonPro Member
    Investor · Salisbury, NC · Member since 2014 · 314 posts · 386 votes
    9y

    Those are horrible terms! There is 1000's of syndications and crowdfunding deals that offer 8% pref with a 70/30 split or better. (with the investor getting 70% after the 8% is paid and you receive your return or capital).  I am in deals from 15% preferred 50/50 to 8% pref 90/10.  5% is a typical management fee.  I would run not walk away from this deal.

    Also read the ppm and find out what all the gotcha fees are.  Asset management fee is a favorite that can kill your returns if not structured fairly. 

    3Reply
  • John B.
    Chicago, IL · Member since 2017 · 46 posts · 20 votes
    9y

    @Mark Robertson I believe for this specific deal:

    - There is *no* acquisition fee (typically it's 1.5% PP)

    - There is *no* asset management fee (typically it's 1-1.5% gross income)

    - The 7% fee is the actual property management cost

    - There is no debt service: equity investors fully own the property (the sponsor has some equity too by bringing some capital in the game), the long term goal is to fix it up and refinance

    The sponsors of this crowdfunded deal also own the property management company (so it's not a typical syndicated deal), and that's how they make money on top of the split instead of the typical asset management fee/acquisition cost.

    Considering that the property is not leveraged and the 8% preferred return to investors, the sponsor is hardly make significant money with the 25/75 split.

    They bought at a cap rate of 10% and through renovation and fixing vacancy they're hoping to refinance at a 8% cap rate and then sell to get the 50/50 profit.

    Does it still sound horrible? Appreciate your opinion

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  • Ian IppolitoBusiness Member
    Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    @John B.,  What is the projected hold of the investment? That's needed to calculate the effect of moving  fees from the more typical front end, to the backend as it's being done with this  structure. 

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  • John B.
    Chicago, IL · Member since 2017 · 46 posts · 20 votes
    9y

    @Ian Ippolito

    - by end of year 1: rehab as much as possible, reduce vacancy and potentially increase rent

    - by end of year 2: refinance and pay back investors (keep some reserves for larger capex) depending on the refi LTV

    - year 3-5: investors still get cash flow

    - year 5: sell at 8% cap rate, return capital to investors and split profits

    The sponsor is flexible on the timing of this plan depending on the market, since there's no leverage or baloon payment or interest only mortgage there is less risk. I actually see it as some sort of debt deal structured as an equity deal at the end of the day... (perhaps I'm wrong)

    Thanks

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  • Ian IppolitoBusiness Member
    Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    @John B.,  I'm a bit confused. If there's going to be a refi, then there is going to be a loan to pay and leverage after year 1.

    Also, how much equity are investors putting in?  That's the other piece needed to  compare fees. 

    (Basically, you should run the investment through two scenarios. 

    Set it up using a  traditional structure where there is a reasonable acquisition cost, say 1.5%, and asset management fee of 1%.  Over the seven-year hold period calculate the dollar amount of your fees. Then divide that by the equity and you have the percent that fees take up. 

    Then do the same thing using the existing set up. At the end you will also get the percent of equity that feeds take up.  You can then compare the two numbers  and see if it's a good deal or not. )

    Finally, @Larry Fried is a promoter for that sponsor, and should not be looked at as a neutral source of independent information.

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  • John B.
    Chicago, IL · Member since 2017 · 46 posts · 20 votes
    9y

    @Ian Ippolito

    Pardon my wording, I'm essentially still a novice at evaluating deals, what I meant exactly was that if the refi goes right after year 1 and the sponsor is able to get a 75% LTV refi based on the 8% cap rate and increased rents (from the 10% at purchase), investors should be getting a very significant amount of their money back, so after that the risk is minimized in my opinion. This of course is assuming many other things, like market conditions and such.

    Also, to answer your question, the sponsor is bringing 6.5% of their own capital into the deal. I consistently see 3%-15% ranges in other syndicated deals, so that should be within normal range.

    That being said, thank you very much for taking the time to explain the proper two scenarios, I will make sure to run the numbers as soon as I have enough free time to fire up my spreadsheet. From a newbie, this is really appreciated!

    Thanks!

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  • Ian IppolitoBusiness Member
    Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    I see. Well please let us know what numbers you come up with, and/or if you need any help  with the calculation. 

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y

    @Ian Ippolito, @John B.

    Thank you for commenting on the thread I started.  I tried to crunch some quick numbers on a spreadsheet and would like to see if I'm on the right track in my quick analysis.  Here's what I did:

    Analysis Under Typical Deal Structure (per Ian's comments):

    $1,550,000 deal
    1.5% acquisition fee: $23,500 at beginning of project and done
    1.0% asset management fee: $15,500 annually for 7 years
    Total after 7 years: $131,750
    $131,750 / $1,550,000 = 8.50%

    Analysis Under Actual Deal Structure
    $1,550,000 deal
    No acquisition fee
    No asset management fee, per say.
    7% ongoing property management fee of gross rents ($27,750 month gross scheduled rents x 7%): $23,310 annually for 7 yrs
    10% markup on estimated maintenance costs (rounded to $3,100 maintenance x 10% profit): $3,720 annually for 7 yrs
    Total after 7 years: $189,210
    $189,210 / $1,550,000 = 12.21%

    I did not include any figures on the 50/50 profit split on the exit.  I also did not include the 75% of net rental income that they keep.  Please guide me as to where I'm off and what else should be included.  At first glance, it seems like it's NOT a good deal compared to a "typical" deal structure.  Open to feedback, please.

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  • Ian IppolitoBusiness Member
    Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    @Mark S., yes, you have the overall idea correct. To be fair, property management fee would have to be paid either way so should also be factored in. To me, 7%  is alright but not great. Prices might vary in a different part of the country, but I was expecting to see something like 6%. I would recommend factoring in a 6% fee for the alternative. Once you do that they will be closer.

    At that point, you will be able to compare this investment with a typical 80/20 split. You will have to project a hypothetical sales price to calculate the split. I will often run two or three different hypothetical returns to get an idea of what might happen if the investment performs poorly, average, or above expectations. I suspect what you'll find is that the better the property performs, the worse this investment returns versus a traditional set up.

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y

    They just announced they're hosting a webinar on Monday at 9:00p.m. EST.  I plan to attend.

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y

    @Ian Ippolito, thanks for the clarification.  I think I see what you're saying.  I ran the numbers again, assuming 6% property management fee as part of the standard case.  When doing so, fees for standard were 17.52% versus 12.21% for the actual proposed investment.  At first glance, this makes the actual proposed investment look good.

    Going a step further, per your advice, I went ahead and projected three hypothetical sales prices: Poor ($1,550,000 break even), Fair ($1,800,000 their projection), and Good ($2,160,000 which is 20% higher). For simplicity, I assumed rental income would remain the same. I adjusted the standard case rental income upward by 1% gross rents to account for the reduced PM fee (of 6% versus 7%). I ran this out for 7 years with the profit split for the above projected sales prices and did an IRR calculation by entering in the cash inflows and out flows.

    Here's how it came out:
    Standard Case IRR: 10.57%, 12.07%, 14.02% respectively (80 investor/20 split)
    Proposed Investment IRR: 8.29%, 9.16%, 10.34% respectively (50/50 split)

    As you mentioned, at higher exiting sales prices at the end, the numbers on the "standard" deal work better. Not only is the IRR higher, but the IRR moves higher more quickly because of the larger share of the profits going to the investors. The proposed investment has a lower IRR for one and second, it does not go up as quickly because only 50% of the profits go to the investors (versus 80%).

    Am I still looking at this correctly?  Anything I'm missing?

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  • Ian IppolitoBusiness Member
    Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    @Mark S., you nailed it. Yes, that's exactly how to do it.

    What you found isn't unusual. Most investors substantially underestimate how much they are actually paying in a structure with an unfavorable split. Even a slightly more unfavorable split (like a 70 investor/30 sponsor split instead of 80/20) will usually reduce investor IRR substantially if the project is successful. And the more successful, the more it reduces the investor return.

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  • John B.
    Chicago, IL · Member since 2017 · 46 posts · 20 votes
    9y

    Thank you guys for providing such value, it's a joy to read this thoughtful analysis. 

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y

    @Ian Ippolito, thanks for the feedback and guidance.   Honestly, I was more focused on the seemingly unfavorable 25/75 net rental income split that I essentially overlooked what seemed like an equitable 50/50 split on the back end.   I'm assuming it is what it is, but it's tempting to mention on their upcoming webinar how the numbers don't seem all that favorable to investors.  It'd be interesting to hear their response, but I'm not too sure how many deals like this are out there for non-accredited investors.  

    1Reply
  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y

    I was on the webinar last night and took the following notes:

    - $1.4M purchase contract to close on 8/18/17
    - $150K renovation budget, so $1.55M total cash for 50-units
    - Supposedly $1.6M-$1.83M valuation based on $128,729 NOI w 7%-8% cap rate. Burned out owner willing to sell for less

    - (Proprietary) property management company that will manage this complex currently has 9 team members and manages 150+ units currently

    - 12 month refinance plan w existing lender relationship, who is supposedly eager to take on deal

    - Want to wait full 12 months in order to have new FMV assessed (versus just taking sales price) on refi in order to increase max loan amount

    - Tenant vetting process: 3x income, >= 650 credit, no violent charges in last 5 yrs, no evictions last 7 yrs
    - ROI stated on the call is 8%-9% CCR in first 12 months; 11%-13% CCR on "any money left in the deal" after refi.

    - 60/40 on their accredited/non-accredited investors based on current investors 

    - Crime/gang activity comment raised on call due to online reviews of the complex; hosts said they were not aware of this and it did not come up in initial due diligence


    - The 25% (of the 25/75) rent share continues on % ownership in the LLC after initial investment is returned.

    My remaining concerns:

    - Appears as though most, if not all, of investor capital plans to be returned after refinance in 12 months.  This means that after the first year, I'd likely have to re-deploy this capital elsewhere and would no longer be earning a return on it.  So, in a nutshell, they're essentially using my money, along with other investors, to acquire the property and do the value-add, pay us an 8% preferred return for that year, then refinance the property, cash us all out (or mostly all out) and only pay a return on the measly 25% rent share.  Maybe I'm missing something, but I don't think this looks all that attractive.  


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  • Michael Le
    Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    So the investors take the upfront risk and when the risk is gone, the sponsors keep all the upside? Nice deal for them.

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  • John B.
    Chicago, IL · Member since 2017 · 46 posts · 20 votes
    9y

    @Michael Le I think you're forgetting the 50/50 profit on sale, so it's not "all the upside". I believe the split is so sponsor favorable because they're not taking any frontend fees. That being said, I sort of agree with what Mark said. 

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y
    Originally posted by @Mark S.:

    I have an opportunity to invest in a crowdfunding, 50-unit opportunity with the following terms:

    - 8% preferred return

    - 25% net rental income

    - 50% profit upon sale 

    Property management fee is 7%.  Markup on maintenance can't exceed 10%.  

    For a passive investor, would you say these are fair terms?

    The terms for this deal have been updated recently (as I'm assuming they had a hard time getting investors to commit capital under the original terms).  Here are the new terms for investors:

    - 8% preferred return (no change)

    - 75% net rental income (was 25%) above the preferred return

    - 75% profit upon sale (was 50%)

    Property management fee still at 7%.  Markup on maintenance still can't exceed 10%.

    If investors recoup all of their invested capital upon refinance, their share of rental income received drops to 30%.  Slightly better than the 25% unchanged share from the original terms, but not great.  

    Under the new terms, I re-ran some of the numbers I originally calculated with the help of several folks who responded on this thread. Overall, I found an IRR improvement of between 0.27% and 1.18% based upon the exit sale price after a 7-year hold (at $1,550,000 and $2,160,000, respectively). This means my calculated IRRs are: 8.56% (at $1.55M sale), 9.84% (at $1.8M sale) and 11.52% (at $2.16M sale).

    I'm starting to become interested again.  Anyone else have any thoughts?  Am I missing anything?

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y

    @John B., @Michael Le, @Ian Ippolito, @Mark Robertson, @Steve K.,

    Just wanted to tag you all so you could see the updated deal details and see what you think.  For some reason, it wouldn't let me tag anyone yesterday but now I'm able to.  

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  • Michael Le
    Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    Still looks bad to me. And if your IRR calculations are correct, the math would seem to agree. Once you get your capital back on refinance you get 30% of the rental income. So basically you take most of the risk with your equity up front, make 0% (which is basically what getting your equity back means), and only then you make 30% of the income.

    I mean, compared to a bank CD it's fine. Maybe even compared to a Vanguard index fund but that's even debatable in this current equities environment. But compared to most other syndications out there, it doesn't compare.

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  • Ian IppolitoBusiness Member
    Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

     Many of the terms are starting to look a lot more competitive.

    However, this  term is still extremely uncompetitive: "If investors recoup all of their invested capital upon refinance, their share of rental income received drops to 30%".  

     You said they most likely will refinance, so you are almost guaranteed a 30/70 split (Investor/Sponsor). If so, that's monumentally  unusual and uncompetitive. 

     Again, I would recommend comparing the fees to something with a more traditional structure.  70/30 at the worst, or 80/20 if a little better.  I think you might be surprised at how much more you'll be paying. 

    In my opinion, the sponsor needs to bring something amazing to the table in order to make up for something like that. Like they are experienced through 2 cycles and are investing 25% of the capital or something like that.  If not, there are probably hundreds of other better opportunities . 

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  • Mark S.Pro Member
    OP
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
    9y
    Michael Le , yes we'd only be getting 30% of rental income after capital is returned, but when they do sell, we get 75% of profits. Does that change your mind at all?
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  • Michael Le
    Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    @Mark S. The rental income is something that comes in quarterly and is tangible sooner. That obviously affects IRR. The profit from sale is basically just a guess. What is the reversion cap rate are they using? Is it the same as what they are buying at because it's very likely it will be higher by a point or so? Either way, it's a guess as to what the value would be 5-6 years from now. And you would have to wait that long just to get this promised money. That will lower your IRR.

    Secondly, they've already lost my trust by trying to get the initial set of numbers they did. In the end you have to decide if the numbers are good enough for you. Not near good enough for me but I have better options. Maybe you don't.

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