Real Estate Investing Online - Part I: The Basics

Over the past year and a half, I have been investing in many real estate deals online, via websites like RealtyShares.com and RealCrowd.com. I’ve done quite a few now -- over two dozen -- and I have learned a lot about investing in real estate online. I thought I’d share a few things with my dear readers.

Thus, over the course of the next several weeks, I will write about my experience with these online marketplaces, the nuances of different types of real estate investments and the gotchas and pitfalls to watch out for.

Let’s start with some of the basics first: Why invest in real estate, how to invest online and the differences between two of the online investment sites I use.

Why invest in real estate

I’ve expounded on real estate investing before on this site. Basically, real estate investing has a few interesting properties:

1. Leverage. It’s easy and relatively cheap to use leverage to acquire properties, via a mortgage. Leverage will increase returns, if properly used.
2. Income. A property allows one to derive income from, via rents. This is not always true with say stocks, which may or may not pay dividends.
3. Control. Owning a property outright may allow you some wiggle room to control how much income you derive from it. One typical way of getting more income is by increasing rents when appropriate or by rehabbing the property to make it “worth” more to tenants, thus allowing for higher rents. Owning a dividend-paying stock or a REIT is great, but you ultimately have little control over the dividend.
4. Tangibility and simplicity. It’s relatively easy to “see” a property and value it through comparables and rental income. This is often not the case with large companies and their complex balance sheets and cash flow statements.
5. Tax and depreciation.  Oftentimes, the tax treatment on real estate can be constructed in beneficial ways, by taking deductions on the mortgage and depreciation and by using tax laws such as 1031 exchange.

All told, real estate often yields a solid stream of income with relatively low volatility. Of course, there are disadvantages too such as not having as much liquidity as with stocks and bonds and the added headaches of owning a physical structure that decays over time and needs maintenance.

How to invest online

Gone are the days one had to go see a realtor, stop at a bank and at a title company to buy real estate. Now this can all be done online, sometimes in a matter of a few seconds. Sites like RealtyShares and RealCrowd are making these investments very easy to make. Here are the US-based sites that I know of:

RealtyShares.com - Invest as little as $5000. Equity, debt.

RealCrowd.com - Deals starting at $25,000.

RealtyMogul.com - $10,000 minimums.

ProdigyNetwork.com - Manhattan only. $10,000 minimum.

FundRise.com

I have first hand experience with the first two, RealtyShares (in which I am also an investor) and RealCrowd. I will describe my experience with them. Both have many similarities, such as in how they present deals. They simplify the selection process by showing investors what they’re investing in. They show pictures and descriptions of the properties, financial terms (returns and fees), and the types of deals they are: preferred equity, equity, debt.

How online sites differ

Despite their similarities, RealtyShares and RealCrowd have big differences too. The biggest one I see is how they trade-off fees for ease of investing.

Fees

RealCrowd does not charge investors a fee to invest, while RealtyShares will typically charge 1% to administer the deals on behalf of investors. However, that cost comes with some benefits too, such as not having to deal with various operators and their individual preferences and quirks (see below).

Transparency and Complexity

Investors in RealtyShares don’t need to deal with operators (the companies that sponsor the deals). Everything is done through a separate entity -- an LLC -- for each deal. RealtyShares deals are investments in an LLC that pools money together and subsequently invests in the deals the operators promote. This means RealtyShares is responsible for collecting checks and providing investors with statements and their end-of-year tax documents (typically K-1s). In my experience so far, everything has been standardized with RealtyShares. They make it easy to see my returns with an integrated dashboard and they deposit payments directly to my bank account.

With RealCrowd, payments to the operators and distributions from them need to be dealt individually with each operator. RealCrowd does not track my returns for me. If you invest with only one or two operators, that’s not a big deal. But I have a dozen or so deals with RealCrowd and some operators pay by wire transfers or ACH and some send me checks in the mail. They each require a different way of funding their deals, which must be initiated by me. RealtyShares, on the other hand, will ACH the money to and from my chosen bank account automatically.

Operators on RealCrowd communicate with me directly, which is good for transparency, but it can also be messy as some prefer to call me on the phone, others send email and a few insist on sending me physical letters, making it more complicated to keep track of updates. Also, they each send their tax statements in different ways and at different times. I had three K-1s that were delayed and hence forced me to file for an extension on my tax returns. RealtyShares, on the other hand, sent me all the K-1s on-time and in one fell swoop.

Deals on RealCrowd, however, are more transparent, as one gets to see the exact terms the operator is offering and read all the paperwork associated with deals first hand. Investors also get to communicate directly with operators and have their questions answered from the horse’s mouth. RealtyShares investors are investing in a proxy deal which RealtyShares itself operates, which in turn has terms similar to those originally offered by the operators.

The trade-off here is clear: one pays for standardization and ease of use.

Minimums

RealtyShares typically has deals starting from $5,000. Sometimes, a few deals can be found for as low as $1,000, especially when deals are near closing and there are only a few spots left.

RealCrowd deals are more expensive, starting at $25,000 and oftentimes minimums of $50k or $100k have been seen.

Deals on RealtyShares tend to close more quickly too which can be good and bad: good because you put your money to work faster. But bad because I’ve seen deals fly-by in a few hours, making it really hard to do my due diligence and read all the disclosures.

My experience so far

I have done about two dozen investments so far. A few more of my deals were on RealtyShares than on RealCrowd, but I invested slightly more money via RealCrowd, given their higher minimums.

I have not noticed any difference in quality of deals between the two sites so far. Deals on both sites have done mostly well and all are functional. No deal has defaulted in over a year that I’ve been investing in them. Most are already paying back regularly. But there are a few deals on both sites that have delayed their distributions more than they had anticipated. I’m not concerned though as complications are part of the process of investing in real estate and all operators have been open about their difficulties so far.

Partial Returns So Far

Total returns are hard to speak of as the exact accounting for depreciation, losses, fees and taxes play a role in computing them. Many deals offer 7-10% cash-on-cash with expected total return after the holding period of around 15-18%. But there are deals offering 12-14% fixed payment with little or no upside. And as I said, some deals are not yet paying, making it hard for me to know exactly what my real payoff will be.

So far, I have gotten about 3% return on all my disbursed dollars -- meaning, I got 3% back from what I’ve paid into deals in 2014, not accounting for any depreciation or tax breaks. That may not sound so great, but many deals that closed in the last 6 months have not yet paid a distribution. If I include only deals that closed in 2014, my partial returns on disbursed cash have been about 4%.

However, if I continue to invest in deals at this rate and they continue to offer the current mix of return -- cash distributions and expected returns upon sale of properties -- I roughly expect a steady stream of about 12-15% returns as some deals close out (sell appreciated properties) and others continue to return cash in the form of collected rents.

I will provide an update on returns by the end of this year to see where things stand.

In the next post, I will talk about things to look for and how I triage investments on these sites. And then after that, I will explain some of the pitfalls to avoid and things to look out for with these deals.

Disclosures: I’m a minority investor in RealtyShares. I’m not authorized to speak on behalf of the company. This is my own opinion as a real estate investor. I was not compensated in any way by any of the parties mentioned here.

Never Fall In Love

Falling in love with a company, its services or its products is well-known to cause its stockholders more financial harm than good. Avoiding this trap is a common advice. And it's a good one.

A Concrete Example

As a real past example, let me tell you about when I invested in Jamba Juice (JMBA), the smoothie shop that is so ubiquitous and keeps expanding. I thought the concept was great. After all, being from Brazil, I know how popular freshly-squeezed fruit juice and smoothies are over there. The fact that Jamba was aggressively expanding outside of its home state of California was a big plus.

This was back in 2005, and I had just discovered Jamba Juice. I immediately fell in love with the idea and wanted to invest in it. But Jamba was a private company back then and all they gave me was a discount coupon when I offered to invest some money into the company. Silly me.

So I waited for its IPO and then waited some more for the post-IPO hype to die down. In 2007, I finally decided to buy, based on its expansion plans, and a lot of excitement about its products and business model. After all, who wouldn't want to buy a Jamba Juice smoothie?

Result?

Price paid: $6.49 per share in 2007.
Current price: $2.37.
Maximum price in the last two years: $3.83.
Dividends paid: $0.

Now you do the math.

What went wrong? First, I didn't stop to analyze the market. I assumed everyone must love smoothies. But it turns out that outside of California, Hawaii and Florida people don't care as much about smoothies. Moreover, only during the summer months do people care enough to look for Jamba's colorful stores. Also, Jamba's expansion plans were so aggressive and it expanded so quickly that it had to close some poorly-performing stores, hurting the bottom line.

And how could this business model be so popular in Brazil? Despite the weather differences, juice and smoothie shops in Brazil typically freshly squeeze their fruits in front of customers, while Jamba mainly freshly blends fruit concentrate with a sugary "dairy base", according to their own in-store information.

I took my losses on JMBA today, after keeping a shred of hope for the last 3+ years.

Conclusion: it pays to look beyond products and services before investing. Look at the market, management quality, financial situation and company expansion plans.

Avoiding a Current Trap

With the lesson learned from Jamba Juice, I recently avoided a similar trap.

I'm a big fan of Vitacost, my supplier of vitamins, herbs, protein, etc. Their products have the lowest price, they ship super fast and their customer service is great. In fact, over the many years I've been using them, I've only had two minor problems with shipping, which they resolved so quickly and satisfactorily that I even wonder if they caused the problem on purpose so that I would fall in love with their speedy customer service.

Sounds like an ad for them, right? But I'm in no way affiliated with them. And that's for the betterment of my pocket.

You see, I wanted to invest in Vitacost for a while and like with Jamba Juice, it was still private when I first thought about investing in them. Today, I discovered that they've been public since 2009, ticker VITC. So I started looking into a possible investment.

Even before turning to their financials I find a slew of terrible news about the company. First, it failed to file for the required paperwork with NASDAQ and it is at risk of being delisted. The CEO has left recently, and it is postponing its shareholder meeting. Worse, it's being sued by not one, but three law firms for security irregularities. Something about its executive team having allegedly lied about its products, services and financial strength to mislead investors into a higher valuation.

Of course, all the bad news could mean that the stock price is depressed and when things are resolved this could be a terrific opportunity to buy. However, for a company with such short track record and with so many problems accumulating right out of the gate, I can't even start considering an investment in it.

I will continue to enjoy Vitacost's good product selection and quality service. But I'm not buying any piece of the company any time soon.

Conclusion

The advice "don't fall in love with your stock" is a good one. Treat all your investments as anonymous machines working for you. If they fail to work for your best interests, it's time to replace them. There's a large pool of good ones out there. All you have to do is do your due diligence, look at the fundamentals and choose carefully.

Disclosures: No position in any of the above mentioned securities as of the time of writing.