By Lawrence Fassler
Several recent self-storage acquisitions have been financed by crowdfunding companies—online marketplaces for real estate capital that raise funds nationwide from accredited and institutional investors. How does this work, and how does it benefit self-storage owners?
Raising equity (or even debt) funds can be quite a chore, even for an experienced self-storage owner. Larger financial institutions typically aren’t interested in properties valued at less than $50 million, so the capital-raising function often falls on the owner’s shoulders. This means having a broad network of investors who can write checks large enough to make the effort of soliciting them worthwhile, or knowing wealth managers or investment advisers who can help market the opportunity to others. Throughout the process, one has to be aware of securities-law restrictions and other legal issues that may snare the unwary.
Online capital marketplaces can attract large numbers of qualified (accredited) investors who appreciate commercial real estate investing but often aren’t in a position to write $100,000 checks. If an investment amount is a little easier to manage—say $10,000 to $20,000—then those in this group may be quite interested, particularly since commercial real estate investing had traditionally been out of reach for most of them.
The leading marketplaces pool these investors into a single legal entity so the property owner only has to deal with a single “investor.” They deal with all the communication, distributions, and tax reporting for the individual investors in that single legal entity. As a result, the storage owner gets to increase his brand awareness (there will typically be thousands of investors reviewing the project) with little or no extra effort. And investor interest in self-storage seems to be especially strong.
“Self-storage facilities continue to be a popular asset class for online real estate capital marketplaces, since they have the potential to produce steady income to investors,” says Nav Athwal, CEO and founder of RealtyShares, an online capital marketplace. “Regardless of how the economy is doing, people will always need to store their stuff.” RealtyShares and other online investment marketplaces can originate not only equity financing but also the mortagage loan associated with the acquisition of a self-storage facility.
How Does It Work?
Dealing with a good crowdfunding company isn’t much different than working with any other sizable investor. After the initial introductions (via a short online application), the company will want to start with some basic due diligence on the self-storage operator and its principals. It will want to understand the operator’s experience level and track record, the combined real estate investing experience of the principals, and the aggregate value of the operator’s prior investments. It may also want to follow up on references from firms or individuals that have worked with the operator.
The crowdfunding company will then want to discuss the operator’s strategic plan for the subject property. (Most crowdfunders don’t finance ground-up construction, though some will help with short-term bridge financing.) What value does the operator think it can bring to this particular facility? What are the turnaround plans—do they revolve around upgrading to more air-conditioned units, altering the mix of unit sizes or better marketing?
The crowdfunding company will also want to understand the nature of the property management and other fees the operator hopes to charge in connection with the project. Will it charge financing, property-disposition or construction-management fees? Are there other special expenses for which the operator might expect compensation and, if so, is there a maximum to such amount? The investors a crowdfunding company brings to a project aren’t necessarily opposed to such fees, but they’ll want to understand the nature of those fees and how they compare with those of other operators.
There are many more areas of due-diligence inquiry that will be ongoing until the financing closes; but before proceeding much further, the principals of the operator can expect to undergo background and credit checks. Past liens, judgments or foreclosures generally don’t kill a prospective deal, but the crowdfunding company will likely want some further explanation about such circumstances.
Pro Formas and Financing Terms
Now, down to the nitty-gritty. The crowdfunding platform will typically want a relatively detailed forecast of the expected income, operating expenses and debt service, and will “stress test” the assumptions made to confirm the projections are realistic. It will want to clarify whether the all-included projected return rates meet the usual expectations of its investors. If those appear acceptable, the operator will typically need to agree to a couple key matters:
How much will be raised. As the crowdfunding for real estate industry grows, companies are often able to provide all (or nearly all) of the financing needed by the applicant. They may not be able to promise the full amount, though; the crowd sometimes responds with more or less than expected. A crowdfunder will typically be comfortable reserving a certain allocation amount, and then will keep the self-storage operator informed during the course of the raise as to its progress.
Basic operating agreement terms. Part of what crowdfunding companies offer to their investors is a closer look at an investment’s progress. They’ll likely want to cover some basic information in quarterly updates. They may also want tax returns prepared promptly, so they have time to prepare their own investors’ returns, and some exit arrangement if the storage operator wants to hold on to the property for longer than expected. If the crowdfunding company is coming in for more than a majority of the financing being sought, it may also ask for some say (usually just a consent right) in major decisions, such as refinancing or extraordinary expense outlays.
A Win-Win
Although the above process may seem like a lot, online capital marketplaces leverage technology to make it as efficient as possible. Accordingly, most can complete the diligence and fundraising process for a self-storage facility in as little as two to three weeks.
Online real estate marketplaces can save self-storage owners a lot of time and resources. By off-loading their capital-raising chores to such platforms, owners can focus on their core strength: acquiring and operating great properties. At the same time, they can elevate their brand strength through the exposure to the crowdfunding platform’s vast investor base. Finally, the better crowdfunding companies can practically eliminate the post-financing chores of investor communication, multiple distributions and tax-return preparation. What’s not to like?
Lawrence Fassler is the corporate counsel of RealtyShares, an online real estate capital marketplace that offers equity securities through WealthForge LLC, a member of the Financial Industry Regulatory Authority and Securities Investor Protection Corp. For more information, visit www.realtyshares.com.
