Crowdfunding Thought Leader Adam Kaufman Talks Market Stigma, Competition And Surviving The Coming Down Cycle
In the real estate crowdfunding market, offering institutional-grade investment opportunities to the masses as transparently as possible is the key to survival.
“Only the successful people in the industry — people who are real estate-focused first and have the experience in real estate [to] pick the quality deals to present to the crowd — are going to be the ones to survive,” said Adam Kaufman, co-founder and managing director of New York-based crowdfunding platform ArborCrowd.
Kaufman has firsthand knowledge as a longtime observer of crowdfunding. He helped launch ArborCrowd — an affiliate of multifamily lender Arbor Realty Trust — in 2016.
ArborCrowd closed out its first offering in July. Investors who participated in the offering bought equity in a three-property portfolio in Alabama and Mississippi called Southern States Multifamily Portfolio. SSMP is the first of seven ArborCrowd deals to complete its investment cycle. Presented on the platform in February 2017, the fund raised $2.1M in just five days on the site, and the sponsor sold the three assets for a total of $25.8M, generating an internal rate of return of more than 29% for investors.
“Our expertise is in multifamily assets and workforce housing. We believe that that is the bread and butter of the industry. When you’re asking investors for the first time to come and invest in real estate, that’s the most secure asset class in the commercial real estate landscape,” Kaufman said.
The firm launched its seventh offering on the site in late July for a 200-unit apartment community called Cove West Hartford in West Hartford, Connecticut. Arbor aims to raise about $3.5M in equity for the six-building portfolio; the remaining interest will be owned by CS Acquisition and ArborCrowd’s private equity sister company, Arbor Management Acquisition Co. The assets are expected to perform well with a projected 14% to 16% internal rate of return.
To better understand the challenges facing the real estate crowdfunding market, Bisnow sat down with Kaufman to discuss the growth and legitimization of real estate crowdfunding and strategies that players like ArborCrowd are employing to overcome the industry’s past stigma.
Bisnow: When did crowdfunding gain momentum in the real estate industry?
Kaufman: Following 2012 when the JOBS Act was passed and signed. For the first time, people in real estate could go after the general public and ask them via the internet essentially if they would like to come in and invest in opportunities. That was previously restricted to only be able to invite people that you had a direct relationship or contact with, such as a close family [member] or friend. It was very interesting seeing that happen and come to be because of technology and the way the world is moving and progressing.
Bisnow: How has oversaturation in this space become a problem?
Kaufman: What happened in the industry really quickly was a lot of these different technology companies saw this opportunity was being made available and tech was the conduit to accessing these transactions. [These individuals] essentially formed the first real estate crowdfunding companies immediately.
A lot of the tech companies came to market to capitalize on creating this tech that connects investors with real estate. What happened was they ran into a whole slew of issues. The biggest problem was that these companies at the end of the day are not real estate companies and don’t have the same level of expertise in the ultimate product, which is real estate. So they have to build out the tech platform, source investors that have never invested in real estate before and educate and give them enough information to decide to invest in real state.
Bisnow: Where does Regulation A-plus come into the picture and what problems has that presented for real estate crowdfunding?
Kaufman: In 2015, they introduced this Regulation A-plus model, which allows these tech and other crowdfunding companies to [use] the capital in a fund structure that is similar to a privately traded REIT.
It gave them flexibility [but], at the same time, this also was very dangerous because you’re essentially offering non-accredited investors, which is anybody and everybody that wants to invest a minimum of $1K [in real estate]. People who have no exposure to real estate [and] probably don’t invest in general in their lifestyle — now you’re asking them to invest in an entirely new asset class, to come into these transactions where you’re actually only marketing one to two pages of materials because the assets haven’t been purchased yet.
It became a dangerous thing because what if this company didn’t raise $50M, they only raised $20M? All of a sudden an investor who was marketed that they were going to be able to diversify their portfolio, they’re not going to have as much diversity in that portfolio if they only raise $20M and instead can only buy two to three assets versus the five to seven if they [had] raised the full $50M. That really changes the impact of what investors knew going into the transaction.
Bisnow: How does ArborCrowd’s business model differ from that of its competitors?
Kaufman: ArborCrowd is the newest member of the Arbor family of companies. Within this Arbor family of companies, what we share is the same leadership — the same leadership and the experience — and what transcends is the proprietary network that we have by being in the business for over 30 years and the relationship with access to quality deals that we can present to investors.
The model that we chose was not the model that the majority of the other crowdfunding platforms had moved to — which is this Reg A model. We said, "No." We think the future and long-term stability of this industry is … presenting one investment opportunity at a time where we only go to accredited investors. A lot of the investors are making investments in a lot of different areas and walks of life through a lot of different vehicles … they’re familiar with investing and have a predisposition for investing in general. They had never been able to access commercial real estate as an investment opportunity in the past. Now they could and they could access the institutional-quality deals that we sourced from our proprietary network. We entered the market with this model and what we offer behind that is the greatest level of transparency because we do something differently that a lot of the other companies don’t do.
Bisnow: What is this “level of transparency” you’re referring to?
Kaufman: We front the equity, we close on the transaction [on day one] and then we put the offering materials together to present to the crowd.
Bisnow: How does that work?
Kaufman: So, the deal closes. We believe in the deal so much that we put our money on the line in the interim period before we fill it with the crowd money — that’s how much we believe in the transaction. And then we take a great deal of time to put together offering overviews presenting the same information that made us invest in the deal to the crowd in a way that they can understand … everything from the sponsor, the business plan, the sponsor’s track record, realized and unrealized investments, market, supply, demand, rent comp [and] sales comp.
We give the investors the opportunity to really go through those materials, come to an understanding if they want to make that investment for themselves at the end of the day based on their own investment preferences ... We also focus on one deal at a time because right now the market’s tough.
Bisnow: Why make only one offering available at a time on your site?
Kaufman: A lot of people are buying at crazy costs and overpaying or they’re overleveraged, and, as we know, when the market takes a downturn and there’s little value created on those properties or a property performs really poorly, all of these crowdfunding investors are going to say "Wait a minute, what’s going on here? I didn’t realize the risks associated with this investment."
If these deals don’t perform, people are going to be really upset and they’re going to go to the companies and ask what happened, why is this happening — and want to hold them accountable. I fear as somebody in the industry who sees this as the future of this new class of investors entering the market, it’s going to give it a bad name … and what’s going to happen is a lot of these other companies are going to go out of business.
Bisnow: When you say "give it a bad name," what do you mean?
Kaufman: Don’t forget, crowdfunding has only been around during an up cycle. It was enacted into law in 2012 with the JOBS Act — we haven’t hit a down cycle yet.
The volatility of the stock market is scaring some people, people are trying to understand even politically what’s going to happen with steel and aluminum tariffs and whether that’s going to impact other investment. So people are moving towards real estate, but real estate’s in an up cycle right now ... But at the same time there’s a lot of people buying out there and overpaying.
So, when the life cycle of these transactions — which usually spans between two to five years — comes to fruition, people are going to be really upset and only the successful people in the industry, people who are real estate-focused first and have the experience in real estate [to] pick the quality deals to present to the crowd, are going to be the ones to survive.
We’ll have to face the uphill battle of making sure that crowdfunding doesn’t get a negative stigma attached to it as an industry.
We put up the capital on day one so that the deal closes, and that really just serves as a proof point that we believe in the transaction so much we put our money on the line.
Bisnow: If ArborCrowd puts up the initial capital for a deal, what happens if you’re unsuccessful and don’t raise the full amount?
Kaufman: Our money is still left there and we’re comfortable with that, whether it’s our money or an affiliate’s money that we bring in. We’re still comfortable with that because you know, we like the transaction the way we underwrote it and understood it.
Investors like that. A lot of the transactions we present on the platform, our private equity shop invests in the equity as well.
We do not always have a live project on our site simply because we take what we believe are such rigorous efforts to underwrite and find good transactions. We see hundreds of transactions that we pass on — a lot of which ... we see posted on other sites — only to pick the ones that we believe in enough to put our money into. And, right now, where the commercial real estate industry is, it’s really hard to find quality deals because people with less experience are going to pay more than you — and actually achieve very little profit — or actually take a loss when the market changes and the cycle shifts. So, it’s been really hard to find quality deals.
Bisnow: Tell us a bit about the close of your Southern States Multifamily Portfolio offering.
Kaufman: [In] the SSMP deal we raised a little over $2M. Our capital was fully subscribed really in four days — which was remarkable — and the sponsor sold the property in just 15 months and IRR was over 29%, where our model projected IRR to be 17%.
We’ll always be more conservative in our model, and we would rather outperform if we can and show that to our investors than state an aggressive number, lure investors in to invest more quickly and then disappoint them. That, we don’t believe in. We think that is ultimately what a lot of other platforms are doing and are actually tricking their investors and will face the repercussions of that when the life cycle of these deals comes to fruition.
CORRECTION, AUG. 8, 9:50 A.M. ET: A previous version of this story incorrectly listed Adam Kaufman’s title. He is the managing director of ArborCrowd. The story has been updated.