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At GowerCrowd, we take a realistic view of commercial real estate investing, providing pragmatic insights for passive investors who are looking for sponsors they can trust and opportunities they can invest in. You’ll find no quick fixes or easy money ideas here, no sales pitches, big egos or hype. Real estate investing for passive (accredited) investors is turning messy with vast swathes of loan maturities approaching which is going to send many sponsors into default causing their investors to lose capital. While this is nothing to be celebrated, it will also bring in a period of wealth transfer and opportunistic investments. We’re here to guide you by looking at the harsh realities of real estate investing, examining the risks and the rewards in conversations with some of the world’s top experts so you can make informed decisions. You’ll learn how to build your wealth while protecting your capital investing as a limited partner in commercial real estate investments, even and especially during an economic downturn. Each week we add new episodes that provide you with access to the foremost specialists in commercial real estate investing with a focus on discounted distressed real estate and the associated market dynamics. We provide interviews and explainer videos that dive deep into the trends driving today's real estate industry, how the economy impacts returns, how to access and invest in distressed real estate deals, and how to protect your capital by mitigating downside risks. There’s no doubt that it is a very challenging time right now for the average investor. With the impact of COVID still being felt and the era of record low interest rates behind us, commercial real estate is experiencing severe headwinds. This creates financial distress for many CRE owners who did not include contingencies in their original business plans and who now face dramatically increased debt costs, increased construction and maintenance costs due to inflation, and reduced revenues from rents as the economy slows down. Is the commercial real estate world on the cusp of a major correction? Is it 2007 or 1989 all over again? Will passive investors (limited partners) who have invested in syndications (through crowdfunding or otherwise) see losses they had not predicted? How can you access discounted real estate opportunities this time around that were only available to a select few during prior downturns? Let us help you prepare your real estate portfolio no matter what the future holds, whether it be business as usual for real estate investors or a period of wealth transfer where those less prudent during the good times, lose their assets to those who have sat on the sidelines, patiently waiting for a correction. Be among the first to know of discounted investment opportunities as the market cycle plays out by subscribing to the GowerCrowd newsletter at https://gowercrowd.com/subscribe Subscribe to our YouTube channel: ⁠⁠⁠ https://www.youtube.com/gowercrowd?sub_confirmation=1 Follow Adam on Twitter: ⁠⁠⁠ https://twitter.com/GowerCrowd Join the conversation on LinkedIn: https://www.linkedin.com/in/gowercrowd/ Follow us on Facebook: ⁠⁠⁠ https://www.facebook.com/GowerCrowd/ *** IMPORTANT NOTICE: This audio/video content is for informational purposes only and should not be regarded as a recommendation, an offer to sell, or a solicitation of an offer to buy any security. Any investment information contained herein is strictly for educational purposes and GowerCrowd makes no representations or warranties as to the accuracy of such information and accepts no liability therefor. Real estate syndication investment opportunities are speculative and involve substantial risk. You should not invest unless you can sustain the risk of loss of capital, including the risk of total loss of capital. Past performance is not necessarily indicative of future results. GowerCrowd is not a registered broker-dealer, investment adviser or crowdfunding portal. We recommend that you consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks associated with any investment opportunity. Unless otherwise indicated, all images, content, designs, and recordings © 2023 GowerCrowd. All rights reserved.
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Now displaying: April, 2018
Apr 16, 2018

Rethinking Real Estate

Dror Poleg has spent the bulk of his career, a little over 10 years, in China developing institutional real estate.  There he developed around thirty million square feet of shopping malls space, offices, about twenty-six thousand apartments and some serviced apartments.  Together with a Dutch Israeli fund some of these assets were sold to institutional investors, and they were partners with BlackRock in most cases selling other projects to private equity funds in Asia and to a REIT in Asia.  His experience is, therefore, across the whole real estate development process from beginning to end; buying land, developing large projects, leasing them and then either selling or stabilizing them.  He has consistently brought in financial partners and taken assets all the way to being owned by an institutional investor once they become mature quality assets. He arrived into the real estate world from the world of online development and design –  digital design of all things. He was partner of a digital design agency in Israel which is where he is originally from, and then worked in Australia, in China and through helping real estate developers on some projects he gradually got sucked into the business from the marketing side to the market research side to the presenting to investors and government to leading the leasing of commercial assets and then finally to really just handling the big deals.

Check out this episode in the Shownotes here.

Today Dror operates a small consultancy based in New York City advising large scale real estate owners and operators and private equity firms on innovation in real estate. He covers anything from understanding long term trends that are driven by technology such as, changes to the nature of work, how people get married, or education trends,  autonomous vehicles different things that impact the real estate industry, longer term to more immediate terms such as different technologies and tools and business models that they can implement today in order to produce more value out of their assets, up to really looking at the underwriting of specific deals that involve some innovative components mostly co-working, flexible office, co-living, or anything along that spectrum.  On the other side of his business he works with startups that are focused specifically on the real estate industry. This includes anything from modular construction, building management systems, different sensors and IOT, to kind of more communal ventures and operating systems for a whole neighborhood.

He does not have a typical client having worked with clients in Japan, in Turkey, in the UK, in New York, on the West Coast, in China. It is really diverse.  His clients range from startups to very large owner operators companies like British Land which is a company with about $25 or $26 billion of assets under management, as well as some smaller real estate companies of around $5 billion assets under management and above, and some funds that are either based in the U.S. or based out of Hong Kong.

Private Equity

Private equity in Real Estate is, basically, using private money as opposed to public money in order to fund the equity or to acquire and operate real estate projects. Similarly, REITs are public equity that allow retail investors to own a piece of a real estate portfolio, and private equity mostly refers to funds that are managed in order to acquire and generate as much value as possible out of, usually, large scale real estate projects. These funds are usually capitalized by institutional investors or high net worth individuals.

Funds

For a private equity fund the clearest division is between what is called the general partners, people that are actually actively managing the fund and its assets and are also partners in the fund and the limited partners.  The general partners sometimes put in some of their own capital into the fund and the limited partners are people that bring money into the fund but do not have any managerial responsibility and thus no liability in some ways, at least in terms of their legal exposure. Limited partners do, of course, have liability in terms of being able to lose the money the invest and have no control over, or limited control over, how the general partner manages the fund.

These limited partners are often institutional investors.  People that have a lot of money to allocate are not necessarily real estate specialists, so like a pension fund, an insurance company, a sovereign wealth fund, people that manage a lot of money and have huge portfolios where usually a very small percentage of them is allocated to real estate. The general partners are the folk who manage the fund.  They are usually property professionals or private equity real estate professionals that have experience of actually running an asset.

Typical Structure

It's an interesting because the daily life of a fund manager is changing in line with technology. Most of these funds originally have relatively small teams. If they have several offices or focus on different geographies they might have a handful of people in each area. That would mean, several general partners who are really the ones managing the fund, and then a few analysts. Sometimes, depending on the type of assets that they invest in they would have additional people that have operational capabilities or specific expertise, let's say in shopping malls or, office leasing. People that can help when you do due diligence on an asset or when you oversee the people that are operating the actual asset then you can kind of know when you know things cost too much, or you can leverage relationships that you have for other assets in order to make that specific asset better. But part of what is changing now is that real estate as a whole is becoming much more operationally intensive. And if in the past the operators were almost like commodities, and the owner could just hire people to do certain tasks, today more and more you see that the good owners, which means a good fund managers, are people that have unique operational expertise as well, or unique relationships and in some cases even unique technology.

Raising Capital

The vast majority, or a lot of the time of the fund managers, is dedicated to raising funds, and some would even say that their main skill is the ability to raise funds, so more than actually picking the right investments, and definitely the traditional fund, the ones that are still leading the market today are.  Their success is very much attributed to the relationships that they have and that they've built over the years with the investors so their ability to raise capital.  When they set up a new fund they go and try to raise money for it, they usually have a target. They either rely on their direct relationships, they can rely on companies that are called placement agents, which are companies that assist limited partners so institutional investors and high net worth individuals who allocate their own capital into different funds. Placement agents are another type of middleman. They're theoretically familiar with all the different funds around the world. There are other third-party companies that grade some of these funds assuming that these funds have a track record. When institutional investors are looking for investment they may have placement agents to assist them and they have third party bodies that, that give them feedback or kind of rate the type of funds that they about to invest in.

The general partners go to institutions and the institutions there are individuals who are responsible for huge amounts of assets that they have to deploy and they have to allocate a certain amount. An institutional private equity will fund to raise $50 or $100 million from any individual institution, and that will typically be based on the relationship, probably with, maybe just one guy at the institution that they have, whose job it is to allocate those funds. Now at the institutions they're going to have investment committees and whatever else they're out to authorize the divestments.

So relationships matter but it is definitely not one guy's decision. There are investment committees. These institutional investors to begin with have their own mandate and very strict criteria in terms of their risk profile. Sometimes geography, sometimes type of asset, sometimes the holding period. The fund has to feed all of these. Another thing to note, is institutional investors also vary in terms of the size of the team and level of expertise that they have. If you start at the top you have some sovereign wealth funds like JIC from Singapore, or the Canadian pensions which have very relatively large and very professional real estate teams.  They really have their own knowhow and ability to evaluate funds. They also invest in assets directly because of their capabilities, and on the other hand you might have, we can call it poorer institutional investors that manage a lot of money but have very small teams and very small budgets in terms of their own overhead. Something like the Illinois pension management board or institution which operates with a very small team and really relies completely almost on other people's opinions and feedback when they decide how to invest.

How Fund Makes Money

The second that they close the fund, basically once they're done raising the money, they're already starting to make money, in theory.  So, the compensation models for these funds is along the lines of what is called 2 and 20. They take a certain percentage, 2 percent, but these days probably less, one and a half or one percent of the total funds raised per year as a management fee and 20 percent or, less these days, in a carried interest profit which is the added value that they create through those assets, so, 20 percent from the upside.

Deal Types

Depending on the strategy of the fund, there are four main strategies that private equity funds look at, starting from core investment which are really the most stable best quality asset in the center of main cities. Core plus which are assets of the same kind but that might have some, some very limited value add potential such as leases that are lapsing or renovations or certain little things that could improve them, then complete value add which are assets that are still relatively good and developed but have some more major potential for value creation. Either the occupancy is quite low and there is room to change things or there's one tenant that has issues that could be replaced or needs some type of negotiation skills that the existing owner can't handle or several leases that are lapsing within the next year or two that the new buyer assumes that he could find better people for that will pay significantly more, or sometimes on the financial side, restructuring, refinancing of different kinds that can ultimately create a higher return for the new equity. The last category is opportunistic investment, which entails significant more risk. This includes anything from ground up development, taking distressed asset and repositioning them; basically doing things that are riskier and targeting much higher IRR, towards a 20 or higher.

Deal Execution

Fund managers do not typically execute on the business strategies themselves although sometimes they might. Sometimes they cooperate with others. They go and look for deals, like the rest of us in some ways. They use brokers, all the large broker firms like Cushman and Wakefield, Jones Lang LaSalle, CBRE, Savilles, Colliers.  They have their own capital markets team or kind of investment brokerage and people that tend to these types of clients and try to find them opportunities. They also leverage their own relationship, again, through their own network, looking for opportunities to invest in.  Some funds also specialize in sourcing deals and they have unique sources for whether its different types of foreclosures or other similar large investors that own certain things but need to liquidate for certain reasons. They buy or sell from other funds that are focused on different strategies. 

Let's say, there's one fund that has an opportunistic strategy.  It owns an asset that was under development and once the asset is almost stabilized it can sell the asset to another fund that has let's say a value add strategy and can take that asset from 80 percent occupancy to 96 percent occupancy, at which stage you could sell it to a core plus fund or to a core fund that could just buy it as a stable asset for a much higher price and not bring much more value but just enjoy the yield, which is what institutional investors ultimately want.  Institutional investors don't want to take a very high risk. In a perfect world they would just buy you know something that brings in 5 percent a year or 6 percent a year, and not have to do anything to it and just be happy. But it's getting harder and harder to find assets like that especially when you have so much more new money to allocate each year.

Controls

One of the projects Dror developed in China was a shopping mall. It was still a new mall not fully stable yet at around 80 or 85 percent leased.  About 80 percent of the space that was leased was already open and operating. They received an investment from a fund that is owned by BlackRock, which is more known for managing other investment products but they also have like a, small about 10 billion dollar real estate private equity business and they bought 50 percent of the holding company of Dror’s mall, and became their partner. To do that though they arrived at the deal through a broker, in that case through Jones Lang LaSalle. They spent, a lot of time several months, doing due diligence ahead of agreeing to a deal, looking both at the market at large and specifically, at the project and everything the operator/developer could tell them about it including assessing them as managers, so spending a lot of time with the team. They challenged them on the rent roll and on each specific tenant that they had; Why did we give them these terms? Why not those terms?  Blackrock looked at underlying assumptions about the additional space that will be filled et cetera. Once they became partners, they sat on the board, they had a seat on the board of the project, and in the operating agreement which was signed when they invested, they also defined certain key decisions that they have a say about, or even a veto on. The original company remained operating the asset but major decisions such as major capital investments, changes to more than a certain percentage of the tenant mix and other things had to be approved with them or by them.

The most contentious issues are things that are purely financial. For example, if the management team wants to refinance the assets. If they want to sell a piece of their ownership. What to do in case there is an opportunity to sell the whole project. What to do if they buy the whole project and the managers don't own it anymore. What are the responsibilities in terms of operating it and ensuring that there is a successful and smooth transition. Mostly these type of things are very common to any type of kind of merger or acquisition elsewhere.

Default Triggers

Triggers that could allow the investor take over the project included terms of not performing as had been projected.  Although the investor does not want to run the project, at the end of the day, they invested in an asset that they assumed that they're almost unable to operate, without their partner. But the terms allowed for them to bring in a third party. Part of the assumption is that they're taking a big risk and that they trust you and if they wouldn't, they probably wouldn't go into the deal to begin with especially with something like a shopping mall or a hotel which is very operator dependent.

The investor can, de facto, replace certain people in management. In an extreme situation they can replace the manager completely as operators of the assets, who would remain their partners in ownership until there's a new buyer but who would have to cede the actual operation to another operator. There may be a budget approval procedure each year with quarterly reviews. During that process, if they want to make life difficult for the manager in terms of how they spend money on a project they can make it difficult.

There are bad boy clauses, key man clauses.  These limit what the manager can do if they have some really talented person there that the manager might want to move to another new project that's something that they may not be able to do. There's all sorts of things. In China mostly the bad boy was about indemnifying investors in case the manager did certain things like bribing or doing something that is illegal, locally or internationally. These terms are very similar in the US too.  The investor’s goal is to be completely indemnified as much as possible from anything that the manager does but on the other hand they want to have as much power as they can get away with, in balance with the previous point.

 

Promote & Fees

Deal structures can vary.  In some cases, the sponsor could be a straight up partner, or it could be a 50/50 partnership. In those cases there's no waterfall and there's no promote. Basically, both own the asset. If the asset does well, both make money. In that case it also means that probably the 50 percent that the private equity fund owns, or was sold to it by the sponsor who originally brought in the project.  So assuming that the sponsor already made some money already, on that piece of the deal on that half and when they both sell in the end, they're going to make more money.

Other structures, have a promote which is very similar to how it works in smaller deals. The sponsor can get sometimes a small piece in the beginning just for bringing the deal.  Something between half a percent to 2 percent, which sometimes is expected to be reinvested or kept as part of the deal. Then upon exit or other major financial events such as refinancing there's a promote structure that means that once the returns for the private equity investors meet a certain hurdle, and that depends on the type of the asset.  It could be 5 percent 8 percent, 12 percent 15 percent.  Then the rest of the returns are split between the two partners. Whether it's 80-20, 70-30, 50-50, or even with a few different steps and a more complex waterfall.

Impact of CFRE on Private Equity

There are several ways in which crowdfunding impacts private equity, both directly and indirectly. First and foremost, technology means that access to information is being democratized, so, suddenly everyone can know almost anything, both about investment opportunities and the investment details of specific opportunities. Also, they can know a lot about the market, like today. Definitely in development markets in a place like New York City almost every building that you look at, you can find online. You know how it is performing, who are the tenants who bought it before who bought it later, if there are any violations or complaints. You have access to rich information that previously only people with unique expertise, or with unique relationships, had access to. Technology does that and crowdfunding contributes to that and benefits from that.

Second, it democratizes access to capital. Which means that developers or sponsors today, that have a good deal or a track record. They can go directly to people with money and raise money from them instead of relying on private equity funds or larger investors. They can pull together resources from smaller investors and still get larger and larger projects done. As is happening.  Which means that to an extent it poses an alternative to private equity funds. Not a significant one yet but a growing one. It empowers, in a way, the flight of talent, from, big funds, and big developers. So. If in the past someone was managing, working for a private equity fund and they were doing really well, they could maybe go and find a job with a similar fund. But today, there's actually an alternative for that person to say 'Hey I'm actually really good at finding those deals. I have relationships with developers and maybe even with the government. I know the market better than anyone. Why don't I just go and syndicate myself?' They can then put themselves out there and raise money through crowdfunding. It's incentivizing executives to go at it alone albeit in a limited way

CFRE also does things that in some way benefits the larger private equity, real estate funds.  Crowdfunding is mostly focused at the lower end or the lower part of the market and, in a sense, it makes the market much more fragmented than it was because it empowers a lot of small players which means that those funds that are really large and usually have unique operational capabilities as well are only getting bigger, and it's harder for medium size funds, or for medium sized operators to compete with them or gain leverage when facing them. If we need an example, we can start with the retail world because their dependence on the operator is most obvious. You can have companies like Simon or Westfield which have unique operational capabilities. They're proprietary brands they have proprietary technology they have proprietary relationships with tenants. And they have their own fund management business so they can raise money. And they leverage their network and their scale to benefit all the different assets that they own. To the extent that if someone just buys one shopping mall, it would be very hard for them to compete with these guys, in terms of their leasing capabilities marketing capabilities, and asset management technologies etc. And when the middle and bottom of the market is getting more fragmented, it means it's harder and harder for people to climb out of that space and compete with those really large operators or fund managers. Another example is Blackstone. These guys manage more than $100 billion of different real estate assets most of it is office, and they're investing in startups and companies that specialize in operating office space and in technologies that optimize the way energy is used, and the way space is marketed etc. And unless you're a very large, it's hard for you, as an owner of one asset or five assets or even 20 assets, to compete with them. This is going to get harder and harder.

Impact of Tech on Real Estate

Technology at large, meaning not one technology but different technologies together, are creating dramatic changes in the real estate industry, starting from the way they impact the way people work, the way people raise their families, the way people move or don't move, the stability of jobs in general the fact that even people that are doing well and are educated and experts, don't have 20 or 30 year careers with the same company which means that, they are less likely to stay in the same place less likely to take a mortgage, sometimes less likely to even want to own anything. Technology is impacting real estate this way which is indirect but it's very significant.

More directly, technology is basically redefining all the basic tenants of real estate value, starting from the meaning of location, and the value of location, and the meaning of visibility and accessibility. The meaning of regulation. We've seen in the past few years, the technology redefined each one of these aspects because of, you know, ride sharing, autonomous vehicles, remote working, online marketing, which means that you get your lead not by being in the most prominent location but actually most of your tenants come through online channels and other channels.

The fact that disruptors can leverage the crowd to undermine regulation and rules. If you look at what, for example Airbnb has been doing.  The hotel industry was assuming that since Airbinb was illegal, it's not going to compete with them but they've seen that Airbnb has so many users that depend on it, and love it, both the people that lease space and the people that are guests, that governments in many cities basically succumb to or had to adjust regulation, in ways that people couldn't imagine before. Technology is undermining all of these things and that boils down to maybe the most important point which basically means that real estate as a whole, even the most stable asset that people assumed previously, that are valuable forever, just because they are where they are so they have inherent value. These assets are becoming destabilized to the point where unless they're operated very intensively and very creatively and probably, reinvented and readjusted constantly, they do not retain their value. To cite an example, if you look at office buildings in central Manhattan, that until a few years ago people assumed that they can just buy them and they'll have a stable yield and it’s a very boring business. Today they are competing with people like We Work in the building becomes dependent on its operator. If we look at retail, retail on Fifth Avenue again, until a few years, the safest bet on earth. No longer safe. A hotel next to Disneyland. Likewise, Airbnb suddenly comes over, partners with a local developer, and starts competing with your hotel and create new supply that is not zoned as a hotel even, sometimes, basically serves your potential customers.

That's the ultimate impact of technology really destabilizing what real estate means. This has immense implications to the institutional investors which means immense implications for our own pensions and our own savings for the future, what we can assume about the returns that we're going to see. Something to keep in mind.

Apr 3, 2018

From Zero to 300 Million

When he formed Patch of Land, Jason Fritton hadn’t had any career experience related to real estate. It was an aspirational, ‘somewhat naive goal’ of his to start a real estate company, as he describes it, and he came into it with absolutely no knowledge beforehand. Jason’s background is more on the technology side. He had worked providing solutions on the telecommunication side for very large public sector clients and had done very well with that and had built a nice company that he owned 100 percent of. Unfortunately, in 2008 and 2009 when the financial crisis hit, he learned the mistake of having just a few clients or one very large client and when that client went away his company went away with it.

See The Narrative and Listen to the Podcast in the Shownotes

This was an extremely painful experience. He lost everything and wanted to do something again because, as he says, “once you start a company that does well that is what you're going to do for the rest of your life. It's in your blood at that point.” Jason had to take a day job in deciding what else he was going to do next. He wanted a company that had thousands of very happy loyal customers and clients. He had known the CEO of a company that was doing crowdsourced graphic design and who was just blowing up the entire industry and doing very well and this gave Jason the idea that this kind of company was the future. He felt that this is how things are going to move because we're so interconnected today that the ability to be able to reach out to people that you didn't have any sort of previous relationship with, and to be able to focus their resources their skills and their experience into what had previously or what would otherwise be very difficult project was very powerful. 

Jason sat down with a scratch pad on his couch one day and asked himself ‘how would this type of thing work in a big scalable fun sense?’ Driving his inspiration that day, was that one of the biggest things that was really traumatic to him about losing his company beforehand was that he lost his house and a lot of people really take for granted just how nice it is to have your own place your own piece of the planet your own patch of land – which is where he came up with the name.  Real estate resonates with people. Deep down everybody wants to feel like they have some corner of the earth that is theirs.

Even though he didn't know anything about real estate at the time, around 2010 which was the depths of the market, he went and took a look at the auctions out in Chicago to see what type of opportunity was there. What he found was that there was always just the same group of 12 guys at this particular point that were bidding on good properties. These were smart guys. Highly experienced guys.  Wealthy guys. Always the same small group of people that were on a first name basis. It was a very insular group.

At one of the first auctions he went to there was a property that came up nearby where Jason was living. The current appraisal on it was $300,000 dollars. By today's standards after the recovery it is probably worth $600,000 or more. But back then that appraisal was $300,000 and minimum bid on it was $20,000.

And nobody bid on it.

The clique of regular buyers who all knew each other were highly experienced and at all those auctions they were bidding on the big properties and multimillion dollar properties and small properties, that Jason considered to be the bones of real estate, were a little bit beneath their attention at that point. Not only that, but because it was the depths of the housing crisis nobody else had the money because banks weren't lending. Private lenders really had massive liquidity problems and the usual real estate professionals didn't have access to the capital. So this great property went back to the bank or was abandoned and in this Jason saw a real opportunity. He went to his attorneys and to a bunch of mentors that he trusted and told them that this was what he wanted to do.

And without exception they told him that it was a great idea and there's something that they would be really excited about it but that if he did it, he was going to go to prison. They were worried about public solicitation over the internet but Jason, who describes himself as being a stubborn guy always trying to find solutions to complex problems, found out there were a couple of Congress people that were cosponsoring what became the crowdfunding exemptions to what became the 2012 Jobs Act. He worked to advocate for the passage of the idea and once the President indicated his willingness to sign the bill Jason put together Patch of Land full time in an incubator space out in Chicago.

Now the company has gone from that little tiny company built from his couch to one with a run rate of about a third of a billion dollars in annual lending, and climbing rapidly to half a billion by the end of 2018. Jason started from not knowing anything about real estate and now has reviewed billions of dollars worth of opportunities.

How POL Grew

Jason says that the growth of the company is down to one thing, that “begins and ends with a lot of hard work and determination.”  When the company first started he was fairly new with the idea of providing access to real estate to people who may have no prior experience whatsoever and the goal was to allow people to invest in real estate from two minutes flat from their phone from their couch from their pajamas if they want to and that was exciting to the wider public.  They started doing some press demos and Jason put together a small team in the Chicago incubator space and got a minimally viable product out doing just the absolute minimum of what they would need to be able to get business done in a very minimal sense. They started doing some tech demos and started to get a little bit of press about this. It kind of grew organically at that point. It wasn't something where they just took off and the Wall Street Journal picked up on them. It was very homegrown.

“Every entrepreneur has huge dreams or you wouldn't be an entrepreneur to start with,” says Jason, “And of course along with every huge dream comes every bell and whistles you can think of that's going to great for your customers.  A problem is if you go that route right from the very beginning you end up with this development paralysis essentially where you never get the product perfect. It's not exactly what you envision in your head and you delay launching until the opportunity has passed you by.”  To overcome this issue he and his team wanted to put together a basic framework online that would allow people to review good real estate opportunities and then place a commitment within them. That was the base of the problem they were solving. They wanted a thousand people to come together and to put a little bit of money into an opportunity to make a big opportunity happen that wouldn't have been possible with these folks individually.

The minimum viable product that they developed was really just providing the ability for somebody to view a real estate opportunity online, review the due diligence, for POL to upload docs and everything to show why it was a credit worthy, good project and then be able to place a small commitment fractionally and have that tracked. Once they had accomplished that the story became real because for an entrepreneur what you're trying to do may be very clear in your head but one of the biggest challenges to getting something off the ground is communicating that to other people and getting them to believe in it.  Consequently, you have to be able to show somebody relatively quickly and to be able to show the wider public relatively quickly what your idea is. What exactly is the value of it. With their MVP, they were able to show that someone was able to come into a deal and put a tiny little bit of money into real estate and be able to own real estate across the country and that they can do it from their phone. 

That was enough to get some articles written about them even though they hadn't done any business at that point, it was enough to be able to say “hey, look at these guys over here. They have this kind of cool little idea,” and it blossomed from that because you never know who's looking at those type of articles. And somebody else who was looking at other marketplace lending companies at the time all of a sudden saw this and said “OK I've got real estate experience and this makes complete sense to me” and that person was Carlo Tabibi, Jason’s co-founder.  He has a very prominent powerful family out in Beverly Hills and he's done hundreds of millions of dollars worth of real estate on several different continents.  Carlo came to Jason told them that if they were willing to relocate to Los Angeles he would put in a few hundred thousand dollars worth of seed capital to get the company started.  So they started from this very simple idea, without actually having done any actual business to getting the right person to believe and that took them to the next level.

At that point, however, Jason could not move his entire Chicago team because they had families and lives in Chicago. So just Jason and Carlo who started up the business in Los Angeles.  Jason moved to L.A. and put another team together and did that very slowly because they did basically all of the work themselves to begin with. They worked 16 hour days every single day, seven days a week to try and get the platform ready in anticipation of launch.  He arrived in Los Angeles in September of 2013 and launched the Web site with their first little tiny opportunity in October of 2013.  They were set to go speak at a trade show so launched their first project and jumped in the car to go out to Las Vegas to do the presentation. 

The deal was only for a $100,000 project and they expected it to take 30 days to fund. It funded in hours and that presented its own problem because they didn’t want to have dead space up there where they didn’t have anything new for investors to get involved in and then see them lose interest. So while in Vegas they had to crunch to find a new a new opportunity to launch from there. From there they picked up speed and really operated in kind of a beta sense. When you have a real estate investment company where the founder doesn't have a whole lot of real estate experience they wanted to take things slowly. Working with other people's money, they were cognizant of that and respectful of that, so they operated most of 2014 in a beta stage while they put the system together.

Scale

They wanted to build a platform that was scalable. Essentially a lot of real estate companies are real estate lenders are built around a few men and women that have been in real estate for a very long time and have a big book of business and they operate off of that that book business but they really don't have the ability to grow far beyond that without finding other men and women who have that type of book of business themselves and getting them to come to their company.  Jason wanted a system where they could generate the book of business internally with a very strong conversion funnel on externally developed leads and then be able to have a strong group of smart people internally that they would train up into their products and into their system that could convert and close the leads and be able to handle clients respectfully, efficiently, and with a positive experience. They spent 2015 and 2016 building that system.

 

Capital

 

Patch of Land was financed through a few hundred thousand dollar seed round provided by Carlo in Beverly Hills. Then the company raises a Series A.  They went the traditional venture capital route which Jason found to be exhausting. You have to convince very smart people that not only do you know what you're talking about directly but that what you're building has the ability to grow into something that's 100 times the size of what it is today and to be able to do it in a relatively quick timeframe. He found that at the same time as it was very challenging, it could also be very discouraging because most VCs will take a look at a hundred different companies before they give one Yes. Which means that say all things equal a company may get ninety nine no's before they get one Yes assuming they ever get a yes.

In addition to the VC community, they also went to Wall Street.as well as to family offices and that's eventually what allowed them to get a lead for the A round. They found a very prominent family office that was also involved with other marketplace lenders like Avant and Ondeck and other companies in different asset classes that had experience with it. They promised a good amount of capital to begin with and then Jason went out to his crowd. The nice thing about building a crowdfunding marketplace lending type company is you end up with a great deal of very happy customers, assuming you're doing your job right. They tend to have significant resources of their own and the entire baseline idea still stands whether it's funding real estate or funding a company that a small amount of capital from a whole lot of people adds up very quickly.

 

They were able to produce the Series A with a very sophisticated lead from a big family office and then fill it out with clients and who were the best investors because they know what you do and they've had an experience working with you and they're happy with who you are. That's a big advantage that POL has even today.  If they ever get in a position where they need capital they have thousands of investors in the platform from whom they can potentially raise capital as long as they can show that they have a good plan for making them a positive return on their investment.

Prefunding

The Series A round raised a little over $23 million and was built from a combination of debt and equity. Some was a straight cash infusion and then an additional amount, a larger amount was POL’s first prefunding line. When they create an opportunity with a real estate developer they have to move fast and can fund a deal on a property in 46 states in as little as a couple of days.  But to be able to do that they can't and go have it staged up on the Web site and go out to investors and have them wait for their money to come in.  That's not really workable. They found that they had to be able to use thei own capital to fund the property to begin with and so depending upon how quickly they scale, if they’re doing $20 or $30 or $40 million dollars a month, they have to have that amount of capital available to fund deals to begin with. Once funded, they can then take it out to investors. Much of the Series A was earmarked for that capacity.

Another part of the A round was used to reinvest in the company. They needed staff, they needed offices, they needed marketing materials, they needed marketing channels, they had trade shows to attend and they needed press releases. Most people don't realize how quickly money goes when you're a new company. It's a huge achievement to eventually get to be cash flow positive.

Finding the deal flow from developers or generating the investor base presented respective challenges. Sometimes one drove the model, at times it was the other depending on the stage of the company’s growth. Initially they had a decent amount of opportunities to be able to fund but they had no investors. So they had to get new investors on board because you can't promise a real estate professional you're going to fund their deal when they may have earnest money down on it if you don't have the investment backing to make it happen.  At the same time how do you get those investors if you don't have deals. So there's a chicken or egg argument early on.  They needed capital just like any small company to make these opportunities actually happen and it can be difficult advertising for this type of opportunity. They had a constraint in capital initially both on the warehouse lines for prefunding and as well as just investment capital from investors.

Deal size was also a constraint.  They can't do a $10 million deal if it's going to take two years to be able to fund while sitting on a Web site. And then once they started getting a lot more attention they started to grow organically on the investment side. They were producing around an 11 percent return backed by solid hard asset that was worth more than the investment to start with. So that was a very appealing product. And once their investors started to see a good return on their investments and be able to get their money flowing in every single month they would tell other folks and it would grow very organically from that. Eventually you get to the point where that balance started to tilt towards having too much money and not enough product and then we had to take internal capital and market back out and find out how to reach out to what can be a very insular group of real estate professionals to be able to get the opportunity to work with them and then it goes back and forth depending on what stage of the company you're in. Today they have billions of dollars worth of capital commitments and can fund pretty much as much as they can get in as far as solid opportunities are concerned as long as there are good opportunities.  They get a lot of applications from folk who have big dreams but really don't have a good plan for how to make their project happen and, naturally, they can't fund those. As of the date of recording the podcast, they were constrained on the deal flow side as opposed to the capital side.

 Deal Types

 Currently, POL only works on construction opportunities with real estate professionals on non-owner occupied properties. A lot of what they do can be called a fix and flip or a fix and rent or a refinance to rent. They deal with folk who know what they're doing in real estate. POL goes back to their investors and are able to say this person has a reasonable expectation of being able to pull off this project primarily on single family residential and small multifamily although they are now branching into small balance commercial as well in the $1 to $5 million dollar segment.  They are also doing new construction in specific markets and they are going to be expanding aggressively as they continue to develop skills and making sure to adequately underwrite additional markets for that type of product. They also want to move into long term investments.

To date they have been constrained on doing long term because they have been working with the crowd and the crowd doesn't want their money tied up for five years or seven years or 30 years but that's 85 percent of the market. So it's absolutely a priority for POL to get into that market. As they have grown they’ve developed credibility have been able to engage and interest billion dollar Wall Street firms. Those firms take a look at the loan tape and their underwriting criteria and the viability of the company itself and they've been able to do a forward flow for this type of product. For the longer term product they are currently negotiating and expect to have something in place by year end 2018.

The new products will be along the lines of a 5/1 ARM for a rental portfolio and not owner occupied. They don't want to move into owner occupied opportunities at this point simply because of the regulatory environment is extremely burdensome. When they started this they started because there was a massive fragmentation. There was a failing in this type of industry where the banks wouldn't lend on these types of opportunities but there is a huge market and hundreds of billions or even trillions depending upon how far out in the asset class you go. But the banks didn't do a good job with it. So there's a huge opportunity. The banks do generally a pretty decent job with residential mortgages but Jason believes that POL is in a much bigger market that is so huge that even if he is able to scrape together a tiny bit of market share he figures they will be doing very well.

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