Raising Capital via Crowdfunding: I'm Intrigued But...
In the last two blog posts, we took a long hard look at raising capital for your self-storage investment using crowdfunding. This week, we are going one step further and exploring what self-storage operators need to prepare to take advantage of crowdfunding and relieve some of your potential worries about it.
What do I need to do first?
Before you do anything, build your business plan and financial model including your self-storage feasibility study. Analyze how many properties you want to buy, how much it is going to cost to buy and run them, and what kind of revenue that is going to generate because you have to understand that to know how much money you need to raise.
“Start by having a conversation with us,” invites Ian Formigle, vice president of investments at CrowdStreet. “Whether you are a credible operator with a deal that is ready to fund, or even if you don’t have a deal yet, you can contact us and explore qualifying as a sponsor.”
Overall, when crowdfunding platforms are funding equity into a development model, it is predicated on a scenario where there is a construction loan that has already been sourced. The actual closing and funding of your deal will be contingent on the funding of the equity raised through crowdfunding.
Will crowdfunding platforms consider deals in secondary or tertiary markets?
According to Brad Minsley, co-founder of 10 Federal self-storage, most crowdfunding deals are going to be the secondary and tertiary markets because of the possible returns.
He explains, “The reason for that is, for example, if you are a private equity guy in New York and with a billion-dollar fund, you've got to make big investments and it takes big markets to support big deals. So they're going to be doing the $50 million apartment community in Washington, DC. And they're going to be competing against every other private equity guy, pension fund and government endowment with gazillions of dollars to invest. These groups often are happy making a 9% to 11% rate of return.”
“There's less competition for the smaller deals in the secondary and tertiary markets. And with less competition, sponsors have the opportunity to be more profitable and support the kind of return that crowdfunding investors look for,” Minsley says. “I definitely think crowdfunding is going to be much more concentrated in the secondary and tertiary markets.”
Formigle supports this conclusion. “Primary markets are fine, but you generally have to turn over a lot of stones in a primary market to find good opportunities with attractive risk-adjusted returns,” he says. “Secondary markets are our sweet spot. We pay attention to markets with a growing population and job base.”
Formigle adds that CrowdStreet will do deals in tertiary markets but the reason to go there must be compelling because of the risk due continued viability of demand for the product from a real estate standpoint.
Who do I need on my team to do a crowdfunding deal?
When a self-storage operator approaches a crowdfunding platform, they are evaluating you to see if you have credible investor and property-level expertise. The platform needs strong confidence in your ability to make a profit and report to investors. This translates into your professionalism, how you underwrite and analyze property, your self-storage feasibility study, your exit strategy – all the details that make up your deal.
“Mom and pop operators often struggle when it comes to institutional quality analysis – it has to be there or there is no story to tell,” warns Formigle. “You can’t do a deal and just say trust us. You must be able to articulate the targeted return and the path to achieving it. This translates into an operator’s ability to demonstrate an institutional level of understanding when it comes to underwriting and analyzing deal the deal.”
Although there is a lot of opportunity on a crowdfunding platform, there are also a lot of expectations. A sponsor needs to have a small group to be successful and meet the platform’s – and ultimately the investors’ – expectations. According to CrowdStreet, the internal and external team members usually include:
· Two or more key principals – these are the people who provide the overarching strategy of how the sponsor will create value for investors. They possess the key industry relationships and they sign on the loans.
· At least one acquisitions person – this team member finds, negotiates, underwrites and closes the deal.
· A legal documents person – works with attorney to structure the deal, make the documents clean for investors, and make sure they tell the sponsor’s story cleanly and concisely.
· An investor relations person – this position may overlap with another. He/she needs to be an internal team member who communicates with investors on a quarterly basis.
· An Accounting solution – delivers k-1s and financials accurately on time.
As you grow and your crowdfunding deal progresses, you may add additional people to your team to build your portfolio, handle entitlements and get through municipality approvals, and sell your asset.
What are the chances my crowdfunding application will be approved?
According to CrowdStreet, they have to review a hundred potential deals for every five or so that make it on the platform. “There is a lot that shows up on our doorstep that is not eligible for us to spend any time on – deals without a business plan, financial analysis, qualified sponsorship, etcetera,” says Formigle.
Don’t be discouraged. If you know what platforms are looking for and embody it, you are part of a completely different odds game. “When a credible operator shows up with a good-looking asset in a good market with the senior debt term sheets and expertise in this space, there is a decent chance we will do that deal,” Formigle adds. “The operator should know coming in right away if they are among the top fifteen percent narrowing down to three. This means that even if the proposed deal doesn’t work out that there is probably a different deal that could work out in the future, we’ve just got to get there.”
What happens if the crowd responds with less than expected?
According to Formigle, the CrowdStreet Marketplace has grown at a 2.5 - 3x rate of growth every year since its 2014 inception. Crowdfunding platforms have tremendous momentum and substantial growth quarter to quarter.
It is not worth the risk for the operator or the platform to enter a deal where there is a realistic possibility that the deal dies because there wasn’t enough interest from investors. “Over the course of five plus years and 325 deals the amount funded (or not funded) through our Marketplace has never to a deal failing to close,” Formigle says. “There have been deals that have not funded because the operator killed the deal over something they found in due diligence, which actually builds confidence amongst investors. There have also been deals that failed to attract as much capital as we anticipated. However, given our best efforts structure of our platform, in those relatively rare instances, the gap was filled by the sponsor and/or their other investors.”
Whenever CrowdStreet reviews a deal that is potentially a stretch for the Marketplace, the platform has an honest conversation with the self-storage operator about the total equity requirement. CrowdStreet then sets a conservative number for what they think the deal would attract on the platform and compares that number with the amount of equity the operator has already sourced or is highly confident of sourcing. If those numbers combine to 120% or more of total equity requirement, the deal will be good, and both parties will avoid a scenario where it doesn’t get funded.
Although crowdfunding may be new to self-storage investors, and even a little intimidating, it also has the potential to dramatically simplify and grow your self-storage portfolio by offering a single platform to raise capital and manage your investors.
About the Author
Katherine D’Agostino is the founder of Self-Storage Ninjas, a self-storage feasibility consulting firm focused on delivering unbiased reports that enable you make informed decisions. Contact Sensei Katherine via her website, www.selfstorageninjas.com.