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Institutional Quality Crowd Funding*
Lew Feldman founded Goodwin Procter's California offices, served on the firm's Executive Committee, was a member of its Real Estate Capital Markets Group, led the firm’s Public Finance Practice, and founded its Crowdfunding Practice. He now serves as CEO of Heritage Capital Ventures LLC, a private equity concern that invests in online financial technologies for traditionally offline processes that result in greater efficiency, greater capital access, and lower costs. Lew serves on the Board of Directors of Wikirealty.com and KBSDirect.com, and advises ArborCrowd.com, Crowdstreet.com, TV4ent.com, Realcrowd.com, and Wealthforge.com. He also chairs the Ziman Center for Real Estate at the UCLA Anderson School of Business, the nation's premier real estate graduate program.
REITs in the Crowd Fund World
KBS was basically an analog company built on the broker dealer networks under the old non-traded REIT business model for capital raising, but that business just fell off completely because of regulatory changes. Robert Stanger came out with an article where it showed that they were raising $20 billion a year and now they're raising somewhere around $1 billion a year. This is because rule 15.02 now requires more transparency in the way that non-traded REITS are booked and now must show value less any load, whereas before they didn't do that. Additionally, changes to the fiduciary rules and the way that's changing the requirement of disclosing fees, or not even selling into retirement accounts by broker dealers, when they have high load products.
This has fundamentally changed the way that capital is aggregated for investment by the major wire houses and that's now shifted from commissions salespeople to registered investment advisers who are people who work on a share of assets under management as opposed to a transaction fee. With all of that then came the JOBS Act in 2012 which opened up the doors to general solicitation and advertising in a way that go beyond just the accredited investor. There has been a lot of success with the bigger institutions waiting for the smaller guys to figure this area out before they became adopters.
Now you're seeing Hines and KBS getting into the field, and guys like Ray Wirta who founded Rich Uncles and Fundrise and RealtyMogul who were the pioneers are out now able to raise at some greater scale. People are becoming more comfortable doing things online and mostly the drivers of this economy are the Millennials and Gen X’ers. These folk don’t want to have to shake your hand if they want to do a transaction, they just want to trade it directly or buy it directly. It's just the way they are.
The Trust Factor
So now the trust factor is the big thing for the person who wants to invest online. Getting big institutions or people with big names is logical because it's typical network dynamics. You’re taking an influencer or using that brand, or having other people who are influencers maybe at a smaller level, and going all the way down to the retail customer at the end of the day who's influenced by all of them. You can call it the Warren Buffett effect for business or you can call it for fashion the Kardashian effect.
These younger generations are people who are influenced by people they trust, as in the case of Kardashian, people who vouch for a product. Nike has been doing it for a long time with brand athletes and so has Adidas with Ronaldo. It's the same thing in any business you find. But it's not like you grab Ronaldo and he tells you to crowdfund. That's not going to work. But if you grab Ronaldo and he tells he's going to do a masterclass on soccer you're going to subscribe to that. So just like in real estate if you've got somebody who is a Sam Zell who goes direct to the public and says you can invest with me and you get my management, you get my ideas, you get my timing, you get my capital along with yours; you're going to invest in that because you know that Sam knows what he's doing.
Sam's not going to crowdfund for you know he doesn't want to deal with investors. He wants to do it himself, but an institution like KBS or Grubb & Ellis or whoever you know, like the old guard types like Ray Wirta, you’re looking at people who've dealt with a lot of capital in the past. For example, you couldn't invest with KBS unless you were a government or a sovereign wealth fund or a pension fund. Behind KBS there's a whole organization to serve that caliber of investor and they're highly monitored. They have an institutional understanding, they've done public offerings, they've done joint ventures. KBS is a very sophisticated shop. It's not like a typical Crowdfunder like somebody who's kickstarting a baseball cap with a fan in it.
Real Estate Superstars
The primary reason there are no widely known celebrities in real estate is that they couldn't advertise. Even for a company like KBS which has done public offering, has launched seven REITS, they were not allowed to advertise; cannot make any forward statements. The regulations are very precise; you have to be very quiet. Historically it created a culture of everything done behind closed doors. Now with sophisticated players like KBS, the key is being is being a gentle person, whether gentle man or gentle woman, but someone who is rational and reasonable and not out there like crazy Eddie trying to sell stereo equipment.
In the past though they couldn't say anything, whether it was cultural or advertising prohibitions, and now with the JOBS Act people can get to know who's behind the real estate. People can get to know who really is a star in the area. Who is the Warren Buffett of real estate, or the Warren Buffetts of real estate because if someone can invest with a number of major people in the field, they are going to whether it's a Draper in tech or Buffett in stocks or somebody like a CIM in real estate or Oaktree in debt. Investors know those guys and know who the celebrities are and that they are not able to invest with them because they are getting money from other people with much greater scale.
Now, however, there is an addressable market that exists for people who can reach them and can communicate there for the first time. They can learn who the superstars are and why they're so good. Hopefully that transparency and the ongoing relationship that can be developed through a community on the Internet will end up being a new capital aggregation model.
People like Sam Zell who recently wrote a book that was published; Sam is known as the grave dancer. He buys a lot of distress although Sam is so diversified that a much smaller percentage of his assets are in real estate. He was the largest owner of apartments in the United States and had Equity Office. Sam's a star. When he shows people know. He's the best salesman there is. In industrials there’s somebody like Dick Ziman who people know from Arden. I'm the chairman of the Board of Trustees of the Ziman school at UCLA and Dick called the industrial surge a while ago and created Rexford. People know him when he shows up.
However, the idea of accomplished professionals stepping into a broader limelight is nothing but a notion other than trust and verification of whom investors should entrust their money to and on what basis. To the extent that the investor is seeking something which is institutional one has to look at the sponsorship and that comes from someone who's a serial achiever. Those serial achievers are the people that you want to be investing in, because it's about the real estate first. In commercial real estate, it's about the people who are operating that real estate, collecting that money for you, dealing with the expenses, getting it back to you and knowing when to sell and knowing when to buy. Real estate is pretty complicated and that's what you're paying for.
If you're paying for management that's one thing, but if you're paying just to get into that deal and get into access that's a problem. Investors don’t want to pay points just to get into deals but they’ll put their money with somebody like Zell, or Ziman, and pay them to manage it without having to pay a bunch of intermediaries if they don't have to.
Advertising Changes Landscape
And that's really where we are today. We don't have to pay the intermediaries anymore but we do have to trust the people we're working with. In real estate you're probably not going to end up with branded athletes, but is Warren Buffett a branded athlete? Perhaps he is in financial services. In Berkshire Hathaway people invest because Warren Buffett says it works and he's been right. Perhaps if someone were to invest with Chuck Schreiber and Peter Bren in KBS, you'd realize that they have been right for a long time. Peter really saw these opportunities and he's been around long time and he has a great mastermind of other people who can help him look at markets and figure out where those high job growth markets are when they go in and where they can add value.
What the elimination of the advertising prohibition achieves is the opportunity through the Internet, through videos, through speaking engagements, through podcasts, for these superstars of real estate to become known. Online is where the true transaction and people connection can be made. Mike Milken talked about prosperity, economic and social prosperity, being a function of the application of technology to three things: real assets, social assets, and human assets. By taking real assets and combining with tech, giving data to the investor, giving data to the sponsor to know who the right investor is, having the ability to use that technology to better manage property, better communicate with investors the social aspects of it, it's going to just add to the prosperity. However, it all depends on the human capital applying it, and that's when we talk about how do we know, who we're investing with. It's that human capital and the technology. The technology that can magnify who that human capital is because that's really important when it comes to commercial real estate.
Choosing the Crowd Fund Route over the Institutional
While KBS is building a fund based on a crowd fund platform, for the company the institutional funds don't stop. The way that money is raised and from whom it can be raised depends on the vehicle and also depends on the institutional appetite for being in a comingled fund with other investors. This direct investment vehicle is not a substitute for pensions, it's not a substitute for sovereign wealth. It is an additional channel for aggregating capital for real estate projects.
So why do it? It's because it's available now where it wasn't before. It's no different than what used to happen in the days of Fred French and the Manhattan syndicators, Leonard Wien, Harry Helmsley. Those folks would get people in the Jacob Javits Center and syndicate for $90 million or whatever the Empire State Building cost, or they bought the Plaza Hotel or the Gray Bar or The Fiske or any of the things that were there and they did it with physical signatures and a serpentine distribution of signature pages throughout the Javits Center. They’d have 3,000 investors who would all buy into that. So that was the 1950s and 1960s.
Since then you've just had changes and regulations and other things which have obfuscated that, that have just made it much more opaque with regulations and a bunch of other things. Not many of which are very helpful, though good accounting is helpful and proper disclosure is helpful. All the things that are necessary to ensure that the correct story is told and that nothing is missing, and everything's included good bad or ugly. At the end of the day, though, all those regulations add up to a lot of expense and then with enforcement actions and other things behind them, which are extremely necessary, it tends to make raising money just much more expensive than it was way back when things were, and it's hard to call Manhattan the Wild West, but when it was the Wild East.
Today what the Internet has done with the JOBS Act is it has brought us back to a place with good regulation in terms of disclosure, and greater transparency because everything is listed. It’s easier for the FCC to audit, easier for state and local governments to audit. Clearly requiring registration under Reg D or Reg A, to make sure that the government knows what's going on. There are things that are in place, but the big difference is that you have a computer screen just like your broker did - the guy who was selling a deal to you and charging you 12 or 15 percent at the end of the day to get access to a building. Now you don't have to pay that. Now you can get access to the building, directly, as an individual.
Facts, figures, and details
Real Estate Crowdfunding eBook
Democratizing Real Estate
The second factor is that KBS wants to democratize the opportunity. It makes sense to set the minimum at anything you want $25,000, $50,000, $200,000, $1 million, but in KBS they want to get people familiar with them. So they lowered it so that people can come in and they can make money and then they can add overtime.
At the same time, KBS will continue, as a must and as it desires, working with the sovereigns that they work with and working with the pensions that they work with that's not going to go away. The best capital aggregation model always wins. Institutional capital remains the cheapest and the most transparent one unless regulation comes in and there's fraud or something crashes. Many people are concerned about that; that there is going to be a lot of internet fraud in real estate which if you have a funnel where you stay with the quality management and stay with quality product and read the documents, having confidence that the person who is the sponsor is giving you the full story, then you can invest and then you can make money and make money to have a stable source of income or appreciation or in the case of a growth and income product, both.
Initially, people were suspicious of crowdfunding. Certainly, the product crowd funders like Kickstarter and Indiegogo gave people the confidence to invest or buy a product, but a lot of people like banks and like brokers and certainly want advice as to how and where to put their money when it comes to investing. The generations though that are comfortable with Indiegogo and Kickstarter as a way to raise capital, or Seed and Spark if you have a film, or Thumbtack if you want to get service providers, whatever it is, the use of disintermediation is a trend that will continue.
The use of data to provide greater information to those who are educated to be able to make informed decisions and not through gobbledygook but through true community will continue. There is demand for products where you don’ t have to deal with people in a world where we're barraged by so many pitches made by so many different people who are trying to get our attention. It requires the ability to filter things out to find out who you can trust and not to be the schmuck. It’s the Amazon effect of just being able to go in and save your time and find what you want and not have to go to Black Friday is exactly the same thing that exists in investment today. It's why in 1985 Accutrade turned into an online brokerage that is now E-Trade, and in the late 1980’s you saw the banks come online and the ability to save time, not get into a car if you don't have to, use your brain and use your data to distribute and to originate.
That's the future that's here today. It's happening.
That's the social and economic prosperity that results through the application of technology to human capital and distribution. Capital flows are and will continue to benefit from transparency. That's what killed the non-traded REIT world. Investors saw the transparency, they saw the fees, and all of a sudden it changed and the aggregation model is now from that to let's go direct, let's avoid broker dealers who charge these fees, let's do what's best for the investor and instead of being paid fees to manage let's go side by side with the investor which is what the KBS's, what the Fundrise’s and the RealtyMoguls and others do now. KBS, when compared to the young wonderful incredibly bright and brave talented people like the Miller Brothers and the people who put together RealtyMogul, are very different animals but they're using the same technology.
The biggest challenges are more for real estate and not for the Internet. The prospect of a downturn is real. This is real estate first, technology second. It's not the application of real estate to technology, it's the application of technology to real estate. So as real estate goes, there are a variety of sectors. There's industrial and today's industrial is hot because we're dealing with the Amazon effect. The KBS effect is the idea of a direct origination, direct distribution model through the Internet. Last Mile is a big area. Now, for same day delivery or even same half day delivery you see Amazon acquiring WholeFoods so they could have internally at the worst case they have some of the best distribution in urban environments in the country.
The hotel area's different. If you look at hotels they're very much dependent on the cost of energy and the amount of disposable income the consumer has. When the economy is doing well, hotels do well, when the economy is doing poorly, hotels do poorly. People can invest in that, but you go into residential, and you can go all the way through the different food types in real estate. It's real estate First. When we have a downturn in real estate we're going to have a downturn in real estate investment. We're also going to have direct investment vehicles that will allow people to buy into distressed funds that invest in the down cycle that are truly value add or Sam Zel graveyard type funds which in many ways built much of what you see today, like Blackstone and OakTree and a number of those who went out during distressed times and bought assets. Large homebuilders do it all the time.
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There be funds that can scrape and invest in a bunch of different offerings and you can invest in those with kind of robo trades. There's a lot that can be done far in the future. Right now sponsors are increasingly going online to reach investors or to manage investors and many of them start that way where instead of sending out paper to everyone they have them log in and they have a box and that's the way Crowdstreet works. They really started as a marketplace but they quickly shifted to investment management software for their sponsors and capital raising software and now they do both. RealCrowd does their marketplace. They don't really sell their software. They’re a big media and marketing machine to get the word out so people can invest for their sponsors. Fundrise and RealtyMogul are REITs and what they do is they raise money in Regulation A from either accredited investors and from unaccredited investors and the people there can invest as little as $100 at a time and build exposure to commercial real estate that way.
People say, ‘well, just wait till there's a downturn.’ As underwriting is constrained and people aren't doing the crazy 110 percent loans and we have a governor on the amount of capital that can go into these deals and the amount of leverage that can go into various product we're fine. That’s why a commercial REIT like KBS direct will never take on more than 50 percent debt. Ever.
REITs are going to be viewed on how much debt they have because people want security when it comes to their dividend that they're going to be receiving from that REIT. They also want to know in a downturn that their property is not threatened, so there's a certain amount of discipline.
Lew does not believe that CFRE is going to be the next mortgage meltdown. People will lose money along the way like they do in other investments and so that's why the trust factor is the most important thing. Knowing who you're investing with as well as what you're investing in before you put your money in is paramount.
Lew was a lawyer for about thirty three years. He still is a lawyer and he still does a bit of practice. Primarily, however, he puts money in companies that have what he views as having great ideas that solve important pain points and problems, and he believes that direct investing is a great idea. He looks for problems to solve, and then looks for really talented people who have demonstrated ability to execute on the ideas and the execution.
It's in your control to select the people that you associate with. The First Amendment is great because it gives you a right to associate with anybody you want to. You can even travel places, talk to people. Those things are important, but what you can't control is timing. You can get a sense of it. You can look at history. Mike Milken said the best investor is a social scientist. You can get a sense of that but you can't really control timing. Black Swans events happen. You do your best to see what the risks are, and that’s what Heritage looks at. They invest in business models that look like they have some kind of a clear path to an exit or for scale. And they like to do inflection investing.
Find a company with a great idea, a proven concept and then take it and scale it and move it. The last factor is that the people Heritage invests in can see that they can benefit from Lew’s involvement and that his capital is strategic and is worth more. As Sam Zell would say, his simple rule is to go where gus capital is worth more. He won’t go to China because it's not transparent enough so his dollar over there isn't worth as much, but he can go to South America, to Brazil or to Manhattan where he sees there's an opportunity and his money is going to be worth more because he understands Manhattan. He understands Brazil.
Heritage employs Sam's rule. They try to go where their money is worth more, where their money and that of their investors can benefit much greater. That usually means you’ve got to just roll up your sleeves and get your hands together and get to work and be active. Lew has come out of real estate and saw tech and the application that. Folk like Nico mêlée who wrote The End of Big, and Malcolm Gladwell with David and Goliath and Mike Milken with his Milken Institute and Wharton. All of those things have influenced Lew to see how tech can be applied to simplify the way that we live and we work and we engage. He invests in thematic investment either in something with data, something with social, something with distribution.
He tries to keep those themes in mind as he looks forward but disintermediation is a big theme that he likes, and knowing real estate he ended up just falling in love with the idea of direct investing and helping smart people get access to deals because we think about the capitalist system as being one where we're free to earn income, but the capitalist system is where you're free to get capital, and real estate capital and capital assets produce value.
The only way to create enduring wealth, people say, well the American dream is getting a house. That's how you get enduring wealth. It's true but that house goes up in value but you have to buy it first to make sure you're getting all the value. With commercial real estate you can invest in that same kind of asset and get income from the first day. A lot of books are written on that stuff. The Rich Dad Poor Dad whole kind of thing that came out of it. The Goofy Ranker infomercials of how to make money in real estate. All about cash flow, but to do it with institutions other than through broker dealers and having lots of points taken from you. That's all brand new and it's where everybody should be. They should be able to have capital access and access to being capitalists so they can get wealth today and maintain income. To me the travesty of what existed in the past is just how inefficient the information flow has been and how coagulated capital becomes in places like Wall Street. You go back to someone like Mike Milken and while he's not necessarily what everyone holds up as a great general standard bearer he's done a hell of a lot of good.
More importantly he in many respects was a disintermediator who was penalized by Wall Street. He took bonds off of Wall Street into Beverly Hills, looked at a company and figured out in 1982 that the company wasn't worth its price earnings ratio, it was worth the application of finance. You know what happens if you apply a different interest rate and loans to the cash flow that's coming from a business, that's the value that you can produce and if it's worth more than what the stockholders are valuing go buy it, take the difference. That’s what he learned how to do. That's where the LBO came from and it's just a simple arbitrage not basing things on an old formula. That’s what got him in trouble because people on Wall Street didn't like the idea that it could be done anywhere and you could take Main Street banks and acquire Wall Street companies. Or build Las Vegas without them etc.
There are a lot of companies being pooh poohed in an area that's new when a paradigm shifts but there's no doubt that Las Vegas is real. There's no doubt that all the people from Oaktree and CIM and Patrick Soon-Shiong in Los Angeles is incredible in the bio area, and others have benefited by viewing and created so much prosperity by viewing the paradigm differently. Lew sees what he does as he tries to look at the paradigm a little bit differently and invest in these inflection companies. Fundrise, KBS, Patch of Land which is a fix and flip lender, Pay Forward which is a rebate company that uses instantaneous technology to send a dollar in a hundred different directions from new rebates that come from families but doing it instantaneously and it can go to pay mortgages or health care or whatever rebates that people don't even know they get. Things like Wiki Realty which fits in the qualitative space between a Trulia on the residential tech side giving access to homeowners to things like walk scores and school scores which is now merged with Zillow which is very much a broker, a property feature but nobody talks about the neighborhood.
Those are, whether it's home tech or construction tech or direct investment, those are the kinds of things that Lew thinks are continue to make sense; he tries to see trends and to be that social scientist so he can be a good investor.
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* Content of this article is taken from a transcript of the podcast conversation with guest Lew Feldman. No recommendations or advice of any kind is given or implied. Please refer to the important disclosures and website disclaimer at the bottom of this page and please be sure to listen to the podcast.