Online Syndication Platforms are NOT the New TICs
- Nov 04, 2016
By Lawrence Fassler
Something happened on the way to tougher risk retention rules and other changes in the commercial mortgage-backed securities (CMBS) market. Online marketplace investment platforms (such as RealtyShares), who have become a significant force in the equity financing of small-balance commercial real estate projects, are being greeted with confusion or even suspicion by some CMBS lenders unfamiliar with the new environment—sometimes even being thrown in the same “undesirables” bucket as tenancy-in-common structures, trust arrangements, or other more difficult financing situations.
This is a mistaken viewpoint. Not only are marketplace equity providers easier to work with than many other capital sources, but they can be significant sources of referral business to CMBS lenders and thus should be seen as welcome financing partners in commercial real estate projects.
Marketplace platforms are not “crowdfunders”
One of the biggest misconceptions is that marketplace real estate investment companies are pulling in investors of every stripe and that CMBS lenders might be facing increased litigation risk from legions of unsophisticated investors. On the contrary, nearly all of the major marketplace financiers, including RealtyShares, limit themselves to accredited and institutional investors–so that these equity syndications are really no different in structure than those utilized in the past by sponsors who have previously financed their transactions through a CMBS execution. Indeed, RealtyShares and other high-quality marketplaces are proactive in their compliance efforts and work with broker-dealers and make sure that their investors meet the necessary suitability requirements and pass all the anti-money laundering and other controls required by such financial institutions. In these cases, sponsors and lenders have increased assurance about the nature of a project’s equity financing.
Centralized management of marketplace investors
A significant advantage over prior syndication structures is that marketplace financiers typically centralize the management of their investors so that sponsoring real estate companies–and their CMBS lenders–only have the marketplace companies to deal with. RealtyShares, for example, offers its accredited investors membership interests in a special-purpose entity (SPE) that RealtyShares organizes and controls. Decision-making is streamlined, but investors still can feel confident in alignment between themselves, RealtyShares, and the sponsor. Each SPE is dedicated to a single investment in a particular investment opportunity. Investors are members of that SPE (so that the investment is a “pooled” one), but have no direct tie to the sponsor’s project entity.
This structure is mutually advantageous both for sponsors seeking equity capital and for investors. Investors are members of the marketplace SPE, but not of the sponsor’s project vehicle. Since the sponsor sees only the single SPE as its investor, sponsors just send a single distribution payment to the marketplace company, and a single Schedule K-1 for year-end tax reporting. The marketplace handles all of the communications, distributions, and tax work for its underlying investors, and uses its own technology to develop the pro rata return distributions and the tax allocations to its various investors.
The marketplace company (or its subsidiary(s)) serve as the manager and adviser to each SPE; these affiliates ultimately control any operational decisions or consents that may be required of the SPE. Although the better marketplaces are diligent about providing regular reporting updates to their investors, management of the SPE is entirely in these companies’ hands. Thus, unlike a tenancy-in-common or other ownership structure involving multiple decision-makers, working with an online syndicator is no different than working with one of the many private equity firms that populate the real estate financing world.
This makes control and decision-making much more simplified, and facilitates the marketplace in working with sponsors and lenders of all types. Indeed, RealtyShares and some other platforms the better marketplaces have a dedicated asset management team and credit department that work closely with sponsors and lenders in workout situations, and so are in a position to make prompt and reasonable project management decisions when required.
Broad and deep access to capital, including for capital calls
In addition to their partnerships with large institutional capital providers, the better marketplaces have developed access to a sizable pool of accredited investors that were previously a largely untapped source of equity capital for real estate sponsors. The SEC estimated in 2010 that over 7 percent of all U.S. households, or approximately 8.7 million households, qualify as accredited investors. That’s a significant investor market that was previously not fully accessible to sponsors focused only on a certain region or certain types of properties.
This is also a key investment group for “small-balance” ($15-50 million) value-add properties. Institutional investors are often focused only on larger “core” or Class A projects. Moreover, these institutions don’t reach the vast number of accredited investors; pension funds are typically more focused on public employee retirement assets, and private funds typically look for $1 million or more in minimum investment amounts—a high bar for any accredited investor with a net worth of less than $20 million.
The better marketplaces have many thousands of registered users and are adding investors every day. “Many of our active users are repeat investors, with holdings in multiple vehicles across the platform’s various offerings,” said Nav Athwal, CEO of RealtyShares. “This broad investor base also provides sponsors with increased brand recognition, and facilitates follow-on offerings by these same sponsors.”
This access to a deep well of investors also means that marketplace financiers will be in a position to come forward with additional capital if a project goes over budget or otherwise needs bailing out via an unanticipated “capital call.” A marketplace can:
- approach existing investors for additional capital
- bring new members into the SPE to increase the aggregate investment
- sell preferred securities through an entirely new SPE, to a new group of value investors
- leverage its institutional relationships to source other capital providers
- utilize its own balance sheet to extend loans via its SPE
With this panoply of options, then, marketplace financiers can actually bring a much broader range of capital sources in case of future capital calls–and the network effects of the platform actually help to facilitate the tapping of these sources.
It seems odd that marketplace financiers would be discussed in the same breath as tenancy-in-common structures, trust arrangements, or other more difficult lending situations. What is clear, however, is that some of these marketplaces have become go-to capital-raising partners for many sponsors, particularly for those focused on the small-balance commercial sector. These marketplaces provide those sponsors with access to a broad and deep capital pool made up of sophisticated, accredited investors. They invest as a single investor, in a manner that is legally compliant, with investment vehicles over which they retain management control. And they’re in a position–better than most–to step up when an unanticipated additional capital call or other workout financing is required.
These marketplaces should be preferred partners for CMBS lenders, particularly since their size and geographic reach give them access to thousands of potential sponsors and borrowers across the country. These marketplaces are well positioned to be sources of referral business to those CMBS lenders that welcome such business and are actually a credit enhancement to the capitalization of these middle-market deals given the institutional pedigree of their underwriting teams, their internal risk management capabilities and their broker-dealer compliance, as well as their broad-based capital network. With CMBS lenders already facing increased regulatory burdens and other challenges, these new sources of business should be cheered.
Lawrence Fassler is the corporate counsel of RealtyShares, a leading online real estate marketplace. Previously he served as the general counsel for another prominent real estate finance company; had run a real estate construction firm; and had worked for over 15 years as an attorney with prominent New York and Silicon Valley law firms (Shearman & Sterling and Cooley). Lawrence also earlier served as the general counsel for a Bay Area medical device company that was ultimately acquired for over $4 billion. Lawrence holds Series 7 and 66 licenses, and has a BS in Mechanical Engineering from UC Berkeley and a joint JD/MBA from Columbia University.