AIPIS 80 - Connect Investors Directly To Properties Online with Daniel Miller of Fundrise

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Welcome to the AIPIS show for accredited income property investment specialists and those who desire to be. This is your host Jason Hartman where we talk about increasing your income, your productivity and just generally having a better life while serving your clients better with America's most historically proven asset class income property. We have a great interview for you today and we will be back with that in less than 60 seconds.

It's my pleasure to welcome Daniel Miller to the show. He is co founder and president of fundrise and they are a crowdfunding company, one of the earliest, if not the earliest in the space. And it's a pleasure to have him coming to us from New York City today. Dan, welcome. How are you doing?

Well, thanks for having me on the show.

Yeah, good to have you. So crowdfunding is all the rage right now. What inspired you to get into this business?

So my brother and I founded fundrise in 2010 and actually initially was a spin off of our real estate development business. So our family had been in Development, Washington D.C. my brother and I spun off, started buying and developing our own properties, mainly kind of mid sized urban infill, rehabbing old buildings, leasing them to local tenants, you know, office or residential above with ground floor retail. And we took a handful of these deals, traditional private equity funds, large scale institutional investors, and realized they just weren't the right fit for the deal. They didn't know the neighborhood, they could only write equity checks 10 million and above, which in a neighborhood like H Street Northeast where we were developing, that was a sizable amount. So we thought let's build a platform, let's let anybody invest with us in these deals. Why can't individuals who live nearby or who are real estate investors, why can't they be invested directly in this project? So we built fundrise as a platform to raise that funding online, worked through the securities law. Actually two years of filings on our first deal, about 500,000 of legal to make it possible. In 2012 we launched fundrise, raised $325,000 to 175 investors, any resident of D.C. or Virginia could invest for as little as 100 bucks in the project.

Okay, so wait a sec, hang on, I got a bunch of questions. You keep adding here. So you spent a half million dollars in legal fees and this was before the JOBS act, right?

Yes, this was before the JOBS Act. We, this was the only way to be able to sell to non accredited investors online. So it was the first crowdfunded real estate transaction in the country. And at that point this was the only route to do it.

Right, and so what law did you do it under? Was it a 500 series offering or.

Using regulation A, which has been on the books the whole time but rarely used, it requires a state and SEC joint filing to get qualified an offering and then you can sell to non accredited.

Why did you go the non accredited route? Were you able to advertise? You must have. I mean if you're looking for people that are doing tiny contributions, 100 bucks, you gotta advertise, Right?

That was the plan. So when we went to attorneys and said, we want to, you know, we're developing this real estate, we want to put it online, let, let anybody invest and publicly market it, the first response from most attorneys was, it's a terrible idea, that's not possible. And at that point, before the JOBS Act, Reg. D did not allow general solicitation. So the goal from the beginning was letting anybody invest. But had Reg. D allowed general solicitation, we might have used that route. But because at that point it only could be existing network and family and friends, it defeated the purpose of creating this portal. And we found the rule, regulation A, which one let us generally solicit so we could broadly advertise, distribute online social media marketing. And it let anybody from that state invest, which was important to us because we thought, why can't the people who live in this neighborhood, why can't people who know this area, who know the building, who know the tenant moving in, you know, they make sense as an audience of people to be investing in this project. That intangible, the knowledge they have, you know, should relate to them being more comfortable making investment.

Yeah. Okay, good, good. That's pretty interesting. I mean, the hurdles had to be just monumental. I mean, obviously there are half a million bucks with the lawyers and it.

Was figuring it out. I mean, when we sent the filings to the D.C. state regulators and the SEC, I mean D.C. regulators hadn't seen one of these since the early 90s. The reviewer didn't even know what to do with it. So it was A lot of education, walking them through the process. After the first deal, we started to have real estate companies from around the country reaching out to us, asking to use the platform fundrise to raise capital for their deals. And that's when we've shifted to where we are now, which is funding third party real estate companies.

Well, wait, so funding third party real estate, what does that mean?

So we.

We are not a developer anymore. We are providing funding for commercial real estate transactions or real estate transactions for developers around the country.

See, there's. There's a lot of difficult communication here. Of course, crowdfunding, like anything, you know, you got to create a new vocabulary to explain things. So when you say funding real estate companies, to me, and I think to the casual listener, it sounds like a real estate business. Now, I differentiate that from a real estate deal, which to me connotes a single purpose. Of course, it is a company. It's an LLC or a. Or an entity of some sort. And it's a company in the legal sense. But to me, it's just like this is a deal versus a, you know, like a business that sells widgets.

Right, yeah, understood. That's what we're funding. So we're funding specific, single identified transaction, not blind pool funds, not operating platforms, a specific identifiable deal.

Now that I'm mention that with the vocabulary question, are there any vocabulary words that people should know about crowdfunding? Like what do you call the person who has the deal? Do you call them the sponsor or the promoter?

We call them the sponsor, which works in most cases, except some marketing people think of it as an actual sponsor, but we use sponsor as the principal in the transaction, the real estate operating company that is controlling the deal. I mean, crowdfunding in general is used as a broad term, but it also relates to a specific regulation. So, I mean, it's really an online funding platform. That's the innovation, that you're using technology to distribute the investments and take investors at a size that would previously not be economic. So having people invest 5,000 bucks, traditionally, you wouldn't have done that with a private placement. It would be too much effort and paperwork. But the incremental cost for an investor is near zero. So you can therefore let investors in at smaller amounts. So to us, that's.

And any other vocabulary words?

No, I don't think anything else.

Okay, so go ahead about your story. This is a. It's a fascinating story. So you're not doing development now, and you're strictly helping people invest and helping sponsors find investors, right?

Yep. It's really matching both sides. We have sponsors come to us, you know, offline introductions online. We have offices around the country, so, you know, comes through both channels. We underwrite them as a company, get an understanding of what types of transactions they do, and then they start sending us their deals, their specific transactions. We underwrite them. We issue term sheets. We now fund with our own balance sheet so we close with our own capital. There's no risk of kind of online funding risk is not the sponsors risk. That's our business risk. So we fund the transaction at closing, then put the deal up on fundrise to let investors buy into it for $5,000 increments.

Okay. Oh, and not $100 increments anymore.

Some of the deals we make available for 100 for true retail. But we do a blend. Probably 80% of the deals we do are limited to accredited. So we do both, but the majority are accredited only.

So every deal that comes to you, you buy it and then you crowdfund it.

Correct. And the main reason to do this is the sponsors we're working with have existing capital sources. Our competition is not another crowdfunding platform. It's another investment fund. If we can't guarantee the funds at closing, it's not going to be a viable source of capital. And so we raised about $35 million last year for our organization that we use as our balance sheet for these transactions.

And when you buy the sponsor out and you and fundrise owns the deal, do you buy them completely out or are they still in and they have some shares?

We're mostly funding rehab, development, construction. And so we'll come in closing with the construction loan and then be paid out at stabilization, if that's, if that's what you were asking.

Yeah. Okay. And. And is it all development or, you know, I mean, I know you specialize in kind of the infill area, which is sort of underserved. And it's great that you're bringing capital to this market, by the way, because I like these projects, personally. I think they're good for society. I just think they're, they're a good, good type of product. You know, we need more mixed use. We need more walkable communities. And I assume that's some of the angle of what you're. You're really funding.

Yeah, and it plays to our theme. I mean, our family and my brother and I, we were doing urban infill development. You know, we think there's a much. There's a broad macro trend there. It's an underfunded Segment of the market. Each deal is unique and different, which is why traditional national funding platforms often have difficulty with it. But what we traditionally do right now is preferred equity on development construction deals. So we'll close traditional senior loan will lend 65% on the property and instead of the developer sponsor having to put in 35% equity, we might fund half of that amount. So 17% of that as preferred equity fundrise capital. And then the most junior, 17%, is their own capital as a developer. It's a specific segment of the market, but it is between debt and equity. Gives a high yield to the investors, but also gives them a fixed maturity and exit. After we've done about 50 deals so far, that's what we've seen to be what we need on the consumer side and what is needed in the deal. What we've seen matches both sides the best.

Why on the supply side, on the sponsor side, why do they come to you or any other crowdfunding platform? Is this just a lot more lucrative to them? Not all crowdfunding platforms buy them out. You do, or at least partially. But why don't they go to a bank or raise their own money? I mean, all of these people pretty much have raised money. It's not like.

Every developer, it seems like just goes out and raises money from their investor pool. What's the advantage to them?

Why are they working on us? And I think that's a valid question. So there's a few different reasons. One is we're fitting within the capital stack. So there is traditional bank debt on most of the deals. There is syndicated equity junior to us, we just reduce the equity burden. And so providing them funding in between 12 to 16% is cheaper than their equity. So they can basically increase their yield. Second, we fund transactions that are below the scale of institutional private equity. So below 30 million, there really aren't many sources of capital to raise 2 or 3 million dollars of preferred funding for an urban infill deal. So it's just an underfunded part of the market. So it's somewhat like the small medium enterprise. A lot of the developers we work with, they'll have a $200 million ground up apartment building, their building, but a few blocks away there's a nice smaller project, a $6 million building they want to buy and renovate. But that capital partner and other deal won't fund a deal that small. And so instead of them having to raise all the money with their own friends and family in their network, we can step in and provide a portion of that funding. So it really is a gap in the market that has been ignored because it's small and less profitable for large institutions.

And I can defin. Definitely see what you're saying, Dan, on the institutional side, but they always have, you know, their sort of groups of investors that have funded other prior deals. But you know, I guess that's just a lot less efficient. It's easier to go to you and.

It lets them stretch their equity, you know, so they're still bringing on some investors, they're still syndicating, but it lets them, you know, do twice as many deals or stretch their equity twice as far.

Good, good stuff. Well, okay, so what's the advantage to the investor? Investor? I mean, investors have options. They can go to Wall street, the, what I call the modern version of organized crime. And you're not too far from it, I'm sure. In New York, our office is at.

7 World Trade Center. So we're right, we're right on top of it.

You're right there in the belly of the beast.

And it's funny, I have to say, you know, when I repeat that quote as I'm interviewing Wall street people, they oddly or not offended, they, they don't.

Disagree, doing their part. And it's the broader system that's a problem. So I feel like they don't feel accountable for it.

Right, right, exactly. So, so don't take it personal. If you're a Wall street or, you know, you're, you're just part of the evil conspiracy. But, you know, they've got that option, they can do direct deals. They can, you know, where does this sit in the mix for investors?

So a few different things. One, it drastically simplifies the process. So you can come to our platform. You can see deal flow. You'll get emails when new deals come available, you'll see the underwriting. We've done a project overview. You can transact digitally. It'll be in your portfolio when you log in. So if you want to make a series of investments into real estate deals, it's a very efficient way to see the deal flow, make the investment. So that's number one. Second, dollar sizes, $5,000 minimums is way lower than any private placement would traditionally allow, which is 100 to 250,000 minimums. Third, what we've seen, we have our first set of institutional investors on our platform, is that we give them access into a size of deal they traditionally would not underwrite themselves. So instead of looking at one $3 million deal or position, which would be Too small for them. They can invest in 10 or 15 deals on our site and create a portfolio of smaller urban infill projects that gives them a scale that's needed. So there's really a bunch of different benefits, and particularly for the retail investor, as the new crowdfunding rules get put into place. I mean, giving an everyday investor who's not accredited the opportunity to invest in commercial real estate. They're shut out of almost every asset class. They can invest in the stock market. They can buy bond funds. They can't even really buy a single bond, which is crazy to me. And so giving someone the chance to buy directly into commercial real estate, earn between 12 to 16%. Those are the yields on our deals. It's a very high yield product. It's very attractive in shorts, private. It's relatively illiquid. There is risk for each deal. We think a portfolio of our transaction is going to be higher yield and better returning than the other opportunities that are available.

Are you allowed to quote returns?

Yes, we can broadly returns, but on each specific deal, not during the fundraising process. And particularly when we're raising on the transaction, we have to be very careful about talking about it. So I could give you a sample deal that already closed, but it would be not wise to be discussing a transaction as it's raising.

Okay, see one that says on your site, projected return, calculator, principal $5,000. Gross annual return, 14.5%. Term 24 months. Total return, $1,450. So where is this 14.5% coming from? That's not a number I can change. I can change the amount invested, but I can't change that number.

Yep. So that's the yield on the project. Can you give me the name of the specific deal so I can just give you some context on it?

Well, I honestly don't know. I'm just kind of surfing around here.

It doesn't say.

So I'll break down a typical deal. So maybe a $10 million project. They're buying an old vacant building. They're going to rehab the ground floor, lease it to a retail tenant, put some apartments above. They'll get a bank loan from a traditional local bank, 60% of project cost. They might get that loan for 4%. Something between 4 and 5%. It'll be generally personally guarantee. So that's what the bank charges. Then we come in as the fundrise preferred equity from 60 to 80% in the capital stack. And that's the yield, 14.5%, let's say, on that single Transaction.

It's modern industrial, by the way.

I found modern industrial.

That's in East New York. It's in a neighborhood in New York that 15 years ago you would not want to go to. Now is emerging up and coming.

This has D.C. this is on Gerard.

Street in Washington D.C. okay, so that's a condo project then.

Yeah, right, yeah, condo project, exactly.

So they're buying and renovating. So they're going to pay our investors 14%. So once they sell condos, they're going to pay off the senior loan first. Then they pay the fundrise investors all their principal back plus 14 and a half percent. And then proceeds are distributed to the real estate developers. So they won't see any profits until our investors are paid back fully and receive 14.5%.

I'm sort of not understanding for sure what the investors are investing in. Are they investing in debt or equity or.

It's preferred equity. It's between the two, similar to mezzanine debt, basically.

Right, so when that says fundrise investment, that means your investors, not you, the company.

Yes, that's the position in the deal they're in. It's the second position. They're junior to the bank loan, but they're senior to the rest of the equity.

Okay, so in this example, this makes it clear and it's nicely laid out. I like the way you're saying sites laid out. It says equity, the source is the sponsor and they've got a certain amount. Then in preferred equity, that's the fundrise investors. And then there's debt. And that's Citi first. I guess that's the name of the bank, the lender probably, right?

Yes, local bank in D.C. interesting.

Okay, what else should people know, Dan?

I think that we basically created that product and it's something that people are starting to understand. And I think the reason why we created it is one, it gives you a fixed yield, so one three, five year term and gives the benefit of high yields without being stuck in a long term equity investment.

Where do you see this industry going?

Starting in 2010, there was a huge resistance to the idea of crowdfunding. We actually had to crowdfund our own transactions initially because traditional real estate developers were worried about the concept. But it's really broken out. I mean, now there's 50, 100 platforms and it's technology entering the investment world and it's allowing digital networks to distribute investments at a cost previously unimaginable. And so we see that the financial system right now is very centralized. There's a few Conglomerates that control most of the funding in the country, most of the credit cards, most of the lending, most of the IPOs. And so money centrally is gathered around the country. It goes to New York, it's then distributed back out. And that's how the system had to work before the Internet. But now that you can have people connect directly online, similar to what you had with Twitter and Facebook, people create their own following and their own digital networks. Now people can actually raise funding directly through these platforms. It's really an alternative that undercuts the centralized banking model. And I think it's going to give within the next five or 10 years, be a fundamental kind of existential threat to that model being able to deliver capital faster at a lower cost. So I think this is really fundamental to the financial system. I think it's a rebuilding of using more decentralized digital networks that are more efficiently bring capital to places that need it in the US but also bring a kind of lower cost of capital because of all the middlemen that are currently in between. Many of them will be cut out.

Right? And that is the disintermediation that the Internet is famous for and the democratization that the Internet is famous for. And these are great things. They really are. It's kind of like a blend of those two things. And I don't know, it almost has the flavor of the sharing economy and all sorts of interesting things. I had Catherine Austin Fitz on the show a while back. I don't know if you know who she is, but she was gave an example where she was sitting at a luncheon late and there were a few women around her who were talking about what they were doing in their financial life. One was borrowing money on their business, another one was investing in bonds, and they were doing all these different things. And another one was talking about their credit card. And it's interesting that all of this had to go basically to New York and it all got funneled through there. And they all could have just traded that money directly, funded and borrowed and invested directly, and cut the middleman out, which is the bankers and Wall Street.

What we see happening is similar parallels to the publishing industry. You had a few large conglomerates that controlled most content, who got it at what price when it was distributed. And then blogs and Twitter were created and they were able to digitally distribute content directly to people at no cost. And it initially started small, but with the exponential growth of These networks, within five or 10 years, they had the same distribution as a large publishing outfit with a fraction of the cost and none of the overhead. I think you're going to see similar parallels in the banking and investment world. Online platforms operating at a lower cost, directly connected with investors and borrowers cutting out a lot of middlemen and I think a real fundamental shift in how the US Economy is structured.

Yeah, I do too. I think it's fascinating and I'm really looking forward to it. It's happened to so many industries. It's just the world is getting flatter and the music industry had their day of of their comeuppance and so, you know, everything's changing.

Time for the bakers to get it eventually.

They're going to get it eventually too. So good. It's good having you on the show. The website is fundrise.com Dan Miller, thanks for joining us.

Thank you very much.

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