Michael
This is actually my second career. My first career was in commodities trading. At the age of 19 years old I got a summer job down at the Chicago Mercantile Exchange and that was between my freshman and sophomore year of college at DePaul. I thought it was a summer job but it really became my career, and I was down there for a total of about 16 years. I started trading for a hedge fund in 1997, managing the futures risk on their portfolio and then after about a year or two I went off on my own and started trading for another sort of subgroup within the hedge fund before going off on my own officially in 1999.
I traded for the next nine years. It was a great trading career and I was blessed, and I ended up retiring from that business in 2005. The reason why I left that business were two-fold. Number one, computers started to come in and take the edge away from what I was doing and I wasn't a good trader because I knew where the marks were going to be tomorrow or the next day; I couldn't see around corners. I was a good trader because I was able to react to information in real time and process it very quickly and that was my advantage and my edge and when all that information started to move to the computers it just changed the risk equation.
That was one reason and then the other reason was my life had changed. When I started trading I was single I had no kids, no family, no dependents and when I was done in 2005 I had two kids, one more on the way, I was married and had stacked up enough chips where I was comfortable in life. We have a saying here that you only have to get rich once. So the next part of my career really went from building wealth to managing wealth.
I had invested passively in real estate for several years during my trading career as a high net worth individual, a lot of it passively and I'd also watched as a young kid my grandfather who was a real estate investor in Chicago manage his own properties on the West Side of Chicago. I used to help him out in the summers and learned a lot there and I saw firsthand the benefits of private real estate investing and for me I didn't want all of my assets in equities and bonds and I really wanted to take advantage of what I saw as an inefficient market. That is a market where it's not commoditized. Every piece of real estate is different. There's multiple strategies that you can follow and that's when I decided to go back to school educate myself. I got a master's degree in real estate in 2006 and then soon after that I started Origin with my business partner in 2007. We've been at it now a little more than 11 years and we built the firm originally around our own capital and that was the beginning.
When we started, in 2007 or so, it was definitely at the peak of the market but there's obviously a little bit of luck in every career and I think coming into 2007 in the market was quite lucky. Number one we were only investing our own capital and we were very cautious about what we were investing in. When you don't manage outside money it's a much different type of risk than risking your own money. You don't have to look at other people if things go wrong and we had made some investments in 2007 that led us to switching our investment strategy in 2008 more towards buying whole loans and debt from banks looking for a big edge.
That was the avenue that we saw in the market at that time where there was just tremendous opportunity. We saw loan pools going for 20/30 cents on the dollar and it was just a great way to pay all cash for assets get in at a great basis while protecting your money. That was really how we got our feet wet and started the company in the beginning.
Around 2009 we started gravitating as the market changed more towards value add larger assets and we also asked at that time ‘What do we want to be when we grow up’, and realized that in order to build the firm that we envisioned it was really going to take larger pools of capital than just ours and that's when we started inviting friends and family in syndicating deals, building the platform, bringing in people, and building infrastructure along the way. It wasn't till about 2011 that we had started our fund business so during the period of 2007 to 2011 we went from a family office to the beginning stages of an organization, bringing in friends and family while institutionalizing the process into the fund business, and creating a dedicated strategy and a coherent business model and attracting outside partners.
One thing that trading taught me is that you need an edge no matter what you do or what business model. There has to be an edge, a competitive advantage and it was very easy to see in 2008 when we looked at notes and, while those are financial instruments underneath, what was backing them was a physical asset and that physical asset had a value. What we were able to do was to really price the notes to a place where our money wasn't at risk. We were going in, buying the notes with the intention of owning the real estate and ultimately would foreclose on the note or do a deed in lieu or do something to take back, or we would cut a deal with the borrower to have him pay us off at a discount. It was a great time for us to learn about the real estate market from a hands-on perspective. At that time, it was really my partner and me doing all the work and using outside counsel to get to the real estate. It was sort of a moment in time that we took advantage of that really helped us get to the next stage. We bought some low-quality assets. we bought some high-quality assets and we met some interesting people along the way because, as you know, most banks don't sell bad real estate they sell bad people, and when you're on the other side of a distressed note you're inheriting those relationships.
Risk Management
From our perspective, wealth preservation and wealth growth strategies are not mutually exclusive to one another. You can preserve wealth and get into a great deal that has downside protection. A lot of what we're doing in buying notes was getting into value added properties but we were getting in through the derivative of the physical property by buying into the note itself. Oftentimes we would buy a property that was 8 townhomes that were partially completed that we would ultimately take over. We would finish them and then we would sell into the open market. Our value add strategy was consistent from buying notes all the way to the point where we launched our fund strategy.
The real difference was that the market changed and even in 2010 and 2011 the market got incredibly crowded and we couldn't make sense of the pricing of the notes at that time so we decided that there was less risk in actually going out and buying the physical asset and owning its fee simple from day one and underwriting with perfect information than there was in buying notes. While it was more of an opportunistic strategy it wasn't mutually exclusive to say that we were opportunistic taking high risk. I would argue that when you're paying all cash for an asset that you can buy at 50 percent of its market value you're actually taking very little risk with tremendous upside. That's always been our investment philosophy – looking at how do we generate high risk adjusted returns and take the least amount of risk and generate the highest risk adjusted returns. That's what gravitated us towards the note business i.e. not the risk but the preservation of capital in that strategy.
Perspective
Our strategy today is buy, fix, sell. There is an argument to be made that some assets should be held longer than others. We typically underwrite between three and five years all of our assets and our typical whole period is right around 3 to 3.5 years. Those were in some of our earlier funds where took chips off the table after the value was added. In Fund 3 which is the current fund that we're allocating for right now, those hold periods will probably be closer to 4 or 5 years because a much higher percentage of our overall return will be coming through cash flow rather than just the appreciation of the asset itself. In the next fund that we're focusing on, it will be a kind of 50/50 combination to generating a 2x multiple on our capital through appreciation and income.
Crowdfunding
We expanded into crowdfunding in about 2015 and it was sort of an ‘aha’ moment when my partner and I were looking at what was happening in the market as we are always trying to figure out how we can enhance our product, how we can build more value, how we can make it a better experience for our investors and even for ourselves. There was one day I was just doing my own reconciliation of a lot of the projects that I had at Origin. I was on a spreadsheet and I just realized that I had a problem that I couldn't figure out my own positions and it took me a long time. And I was looking at a T.D. Ameritrade app and it was so easy and beautiful and you could see all of your investments in one place. I went to my partner and said that we had to build something like this and he thought it was interesting and intriguing and we decided that by doing it we were really going to set ourselves apart from the crowd by building this technology. Our policy has always been to set the standard in the business and do something to differentiate ourselves. Ultimately, we both agreed and we ended up investing a lot of money into our technology and our dashboard and what that really allowed us to do was to start to market and create a lead generation tool.
Embracing Technology
We had both been in a business in the commodities trading world where we saw firsthand how computers had taken over an industry and we both agreed that we were not going to watch this time as the market changes and remain still doing business the same way we were 20 30 years ago. We believed in our product. We believed in our team, in our strategy; everything. If you have a great product and you put it in front of more people you're going to get more people to consume it. It was as simple as that. We started then traditional marketing in late 2015 and our platform really resonated with a lot of people and we brought people in on individual deals and then ultimately most of our investors came into fund 3. Today we have over 600 investors at the firm whereas in 2015 prior to doing this thing we had 65 investors. It has been a great way to meet new partners and to share our platform with other individuals. Our mission is really to transform the way individuals invest in real estate and everything we do now is consistent with that about focusing on high net worth investors like ourselves so that they can realize the true benefits of this asset class.
In the beginning when we were just concepting it, crowdfunding per se wasn't on our radar. The technology we built in 2014 and then we started marketing in 2015 and we weren't familiar with the JOBS Act. However, we became very familiar with the Act and why this had never come up before and why was it happening now and we got up to speed very quickly. What resonated with our customer base is the fact that we were an operator coming into a market with a ten year track record and two very successful funds in a market where most groups were aligning themselves as technology companies and not with the real estate part of it. We were really viewed as an expert in the market and the other thing is that when they hear our story about how my partner and I built the firm and the fact that we're the largest investors they look at our team and everything they really see a difference in our platform relative to other offerings out there. That is a big growth driver and is what helped us stand out in the market and have the success we've seen today.
Non-Institutional Capital
When my partner and I decided to start using traditional marketing to the firm it was not well received by everybody at the firm because a lot of the individuals who we have here have come from institutional companies. Going to the ‘crowd’ is just not how people market. There's had always been this notion that we were going to go from high net worth investors and then jump into the pension funds, endowments, and institutional capital markets and that's how we would grow. When we announced the fact that we were going to market our platform and apply traditional marketing to Origin it was very controversial. We said, look we hear you we get it but we respectfully disagree and this is what we're going to do. And we did it, and we did it with obviously a lot of risk and over time not everybody came on board but if you asked everybody in the firm today they would tell you that it's the best thing that we've ever done for this firm because today we have more capital demand than product. In private equity you either have too much product and not enough capital or too much capital and not enough product and it's just the balancing of this. Today we have a tremendous amount of demand from our investment group for product.
Marketing
When we started on this path we hired a marketing team. We went out and found Digital Kitchen who's a top-notch agency here in Chicago. We helped them rebrand the company, produce a new website for us, create collateral materials videos, tell our story, help us with the story. We hired a marketing team started on content strategy. We did everything, and we went all in and it was incredibly expensive, but it was probably the best money that we've ever spent and it came the ROI on it has been tremendous.
Investor Process
Some of our investors come via referral and that's obviously very different when you have a warm introduction and they meet you through that and they've already developed a sense of trust because with any organization what you want is other people talking about your product not you. That can be anywhere from a week to a month to six months where somebody signs up and there could be multiple conversations before they invest. When we get a cold lead, it could be that somebody signs up for our newsletter and they just receive educational material about us. It could be that somebody signs up for our portal and they're able to go in there and look at our deals and do due diligence. It could be that somebody signs up for a portal and request a phone call and we've put in all the steps in place and we have an amazing Investor Relations team that is very well experienced in not only our platform but in the world of real estate who have come up through the financial markets in real estate underwriting so they know everything about our PPM, our documents, our legal structure, the asset level risk, the fund risk, everything, so they have knowledgeable conversations with anybody who wants to get to know us. If anybody wants to talk to me and have a follow up call I'm always more than happy to do that. A lot of times people can just sign up and sort of sit on the side and never choose to invest and just read our educational material.
We like to get to know our partners as well and that's really what the investor relations department does. It gets to know them and educate them because it's a two sided street but the best investor is one who understands fully what he's getting into. It scares me, and we've had people do this, where they come in and sign up on day one. That's where problems get created because you haven't set expectations and then they learn along the way. So I would rather have somebody get to know us over time and really understand and see our value proposition and know exactly how our funds operate and what they can expect than just come in because a friend told them without knowing anything.
Investment Philosophy
Our investment philosophy doesn't really change from one fund to the other but what does change is our product and our strategy is evolving with the market. What we might do in fund 4 is look at a more focused strategy on just multifamily. We haven't totally decided this yet but as we look at the risk reward looking at our track record across multifamily and office, the more we've narrowed the world down the more successful we've been. In fund one we were more opportunistic and we could buy any asset class out there. Yet as the funds has changed over time, we have actually had more success being more specialized and as the world has normalized you have to know how to operate at the margin in your asset classes and really understand the nuances. Where capital ruled the world in 2008-10, that's no longer the case today when it's really about having operational excellence and being able to spot pennies and be able to pick them up along the way.
Education
We only serve the accredited investor market so that implies that somebody has essentially a million dollars of net worth or more. Now what that doesn't imply is that they know anything about real estate and our customer base really consists of people who are at the minimum threshold of a million dollars and also billion-dollar family offices. Regardless of who it is there is absolutely an educational process that has to take place because every firm is nuanced and their experience with another firm is going to be different than their experience with us. Again, this is about setting expectations. Making sure they understand who we are. No matter who you're dealing with regardless of how much money they have there is always an educational process. Now there are certainly some people who are more experienced in the market than others. But education is the key.
The Real Estate Crowd Funding Review
Ian Ippolito came from the world of tech entrepreneurship. He had run a couple of companies and started some companies, some more successful than others. He had a few failures but over the years he had built up a bunch of different companies. In 2013 Ian sold a company called VWorker. It was an online marketplace that was sold to a company called Freelancer. He enjoyed a nice exit and found it was time to move from being a tech entrepreneur to his new job, managing the finances of his family. He had to really get up to speed and had always been investing while an entrepreneur, but his job was his primary thing and he had invested passively in a whole bunch of things but had never really gotten down deep.
Go to the Shownotes for Links to Ian's Site
So at that time he really needed to get serious so he took a look at his entire portfolio and just redid everything because his risk was totally off. He had neglected a bunch of things and so started looking at stocks and bonds and traditional investments which were OK. But he also wanted to branch out to other things including branching out to peer to peer lending. Ian looked at Lending Club and Funding Circle which do business loans, and that's what led him to real estate crowdfunding. When he discovered it he thought, wow, they're taking the idea of lending to peer to peer lending which is a good one but a lot of times is based on an asset that's not collateralized so you don't have any protection or if the person defaults on the loan they're gone. But now we're putting it into real estate so if you're doing debt it might be collateralized or you know you've got equity and then you've got this tangible piece of property behind it. And he was really intrigued by it.
This was in 2013, when Ian began in CFRE and at that time there weren't that many sites but they exploded really quickly. Everyone was really excited about the idea. It was kind of like a big explosion and then it kind of winnowed back and then another kind of growth spurt. But back then there were some of the names that people are familiar with today. One of his favorite sites was FundRise and Patch of Land was around back then. A lot of the sites changed over time or changed their business models or maybe they changed their underwriting or whatever but those were some of them back then.
Limited Experience
Beforehand Ian had owned some rental properties so had knowledge of what being a landlord involved. He had invested in a couple of passive deals with varying success and had gotten into a one deal right just before the Great Recession. He invested passively with a syndication and just the bad timing didn't understand what he was getting into and didn't understand how to evaluate the terms of the deal. Looking back, it was something he never would have gotten into. Thankfully he didn't lose any money but it took about 12 years to break even. It wasn't something he wanted to repeat and he decided when he got into CFRE that he was going to do a lot more research to learn a lot more about what was going on inside and kind of up his game.
He came across a deal, did some research and contacted the sponsor directly. It was investment in residential real estate and that was their business model. The minimum was pretty high – in the hundreds of thousands and came with a beast of a PPM. It was just a huge thing. He took it to and attorney because, well the thing you do is when you get these things is you need to take them to an attorney to evaluate them. And this is really important. He learned how difficult it is for people starting out because he didn’t know who to bring it to so he asked around who's a good attorney that understands real estate. And the guy he chose to take a look at it, after charging him all of the usual fees and everything, told him ‘if you trust this person it's probably going to go ahead if not don't let me read it.’
This wasn't what Ian was looking for. He wanted someone would had evaluated 100’s of these and could tell him that the terms look good or don't and so the experience was a kind of a wakeup call because he had to educate himself. It was hard for to find that type of expertise he needed to get to do it. He found everything to be interesting but it was overwhelming because he there were debt funds, and equity, and they're investing in senior housing, or they're investing in apartments as well. What's the difference? Some are value added, some are opportunistic. It was really difficult at the beginning to piece together the relative risks and so he needed to create a coherent overall portfolio strategy and just going through the platforms and just taking it deal by deal which maybe is the way most people do it and that was the way he was doing it was just not working.
He wanted to understand what he was getting into; yes, the return looks great but how much risk taking and of course the sponsor doesn't tell you. So Ian took some time to figure out which investments he wanted to go through and thought maybe a good shortcut would be start with the platform's first because there were so many at that point and it had exploded and he thought he could find the ones he liked. That way he could weed out a whole bunch to start with and once he found the good platforms, I could start digging into the deals. So that was the way he looked at the different platforms. And there was nothing out there on the internet that would explain it which would have been the easy way. He realized he was going to have to figure this out himself. He had his research assistant help out and together they contacted every single one of the platforms, talking to the people involved. He talked to other investors asking how was their experience on the platforms.
He looked at their legal setups. If they go bankrupt what's going to happen? So just looking at what are their fees and comparing them to the other ones. So he started looking at all of these different things and it was just really for himself, putting it together over a couple months until he felt pretty confident that he had found those he liked and those he didn’t. Then people started asking him for it and then another pretty soon he found it was too much answering individuals and so he just put it out on a Web site. And that's how it all got started.
In the Beginning
To get going he just started reading and read as much as he could. And he found that after reading 30 or 40 PPMs you start to see patterns that are occurring over and over again. And then you notice something that's a little bit different; No, that's not super great of a term or you know that's pretty questionable or he’d find deals where investors were liable for a lot more than actually the money they were putting in or whatever it is. He went into a whole bunch of these things and just started looking over and over again and seeing which ones he liked and which ones he didn't.
To learn about the art of real estate, Ian went online. He wished there had been some source back then that put it all together into one place but unfortunately there was not anything like that. So he did it the way that he had learned to do his stock market investing and his mutual funds. He read everything out there and digested it, repeating over and over again each investment doing the same thing over and over again until, eventually, he figured it out.
Since the Beginning
There definitely has been lots of change in the industry in just a few short years. There was kind of the initial explosion where everyone was trying to get into it and people were raising a ton of money from venture capital. And there was an explosion of platforms and it was a very exciting time. Then there was kind of a period where if you remember there was a scandal with LendingClub and there was a financial accounting scandal. And maybe they did some things that were improper. And when that happened all of a sudden the entire Fintech space was no longer as desirable to investors. All of a sudden these companies that were raising a ton of money couldn't raise their second round or the third round. So a bunch of companies started they were laying off people massive layoffs or they were shutting down. So there was a kind of a contraction.
What we're seeing right now in the last year and a half is like another expansion that's being done in a different way because of that VC capital is no longer flowing in. Instead people are actually turning to the newer crowdfunding rules that allow crowdfunding platforms themselves to raise funding for themselves versus with the investments. And we're seeing a new round of expansion to the ones that are successful on that. Sites like Fundrise and you've got Groundfloor raising millions for their own corporate development. This is a great way for a company that maybe had trouble with the VC market or VCs aren't the best thing for a company that is not going to explode and because it pushes companies to do that. So this is kind of like a slower growth model. It seems like there's a lot of appetite for it. People are buying up these shares left and right with all these deals filling up very quickly.
Of course, investing in equity in the platform is a speculative investment where it's not a real estate deal where people are going to get income coming in on a regular basis. You're hoping for some sort of exit at the end or maybe the platform was sold to somebody else and maybe did an IPO. And then at that point then the person hopefully is going to see a return on their money.
Deal Quality
Deal quality has not been totally positive. The deals earlier on were much better. They were higher yielding and were taking less risk and as the cycle has aged the risk has been ratcheting up the yields have been going down. Each quarter it’s been getting a little bit worse and worse. So a deal that would be considered maybe a good deal in 2018 would probably be a deal that maybe would not be such a great deal earlier on. There's so much money right now that's just chasing not enough deals. And you know definitely it has deteriorated.
For example, you would find on a particular platform you could find conservatively underwritten debt deals so that maybe 65 percent loan to value or less first position a residential flip or something. And that would be yielding double digits. Now to get something conservative like that is very difficult unless it's some sort of more speculative like some sort of huge construction project or something that's not going to be double digits, most likely going to be maybe like 9 percent or something like that or eight and more likely even less. The other way that there was a change just on the debt side. It's just that back then prices were cheaper. So because prices were cheaper it just made all the underwriting that much easier. Now prices have gone up but we've had a really good run now as a result of the great performance of all those old investments. Now a lot of the properties are really expensive. So it gets harder to find the good deals.
Finding the Deals
Ian does a bunch of things to find deals. He subscribes to all the crowdfunding sites and is constantly having new deals come to him. Just at this stage we are in the cycle you know, it's not going to last forever at some point it's going to end and there's going to be a downturn. And for Ian what he wants to be in at this stage of the cycle is a very experienced sponsor who's gone through a downturn and not lost money. And it's difficult to find it on a crowd funding site. Probably 95 percent of investments if not more. So he ends up networking with people, going to investor groups and talking to other investors. A lot of the deals just don't work out, but looking for them is Ian’s job, basically working on the investments so he spends a good portion of his day doing that.
The Real Estate Crowd Funding Review
Ian created this place where he puts the ratings of the different platforms out there so everyone could see them. Once he did that people were like hey what about the non-accredited platforms that were springing up. So he I did a ranking of those that up there and then just started talking about things like real estate news as it were coming in and blogging about it; Here's my opinion about this or my views about that. And that kind of grew to a following. There are about 1600 or 1700 people who subscribe regularly. The site is getting maybe 7000 or 8000 visitors a month. So it's quite a few people are starting to come follow.
And then what's happened is he wrote something a little bit negative about one of the sites and it was an investment on a site and he felt that they were being very deceptive in their marketing and felt they were giving a guarantee that they couldn't give. There's no such thing as a guarantee really on investing. There's always risk. Anyway he wrote about that and they threatened to sue him. They looked up every single address he’d ever been at. And they sent their threats to it. They went all out and they said you need to take this down and it sounds like well you know this is a political thing as Ian was doing it for free he thought well he was going to have to shut it down or find some other way to get the information out there or do something else. So he created a private investor only forum on the Web site and vets the people that come in to make sure that they are truly investors and not associated with the platform and then that way the people themselves feel free to share information. Whether it's positive or negative. But to share it freely.
Power of the Crowd
Every single time someone asks a question it's helpful. It may be something Ian’s thought of before but a lot of times it might be something that puts him in deeper or maybe at first he thinks that's an annoying question but then he thinks about it and realizes, no that person has a great point and he digs in deeper. That kind of give and take is really important and investors on their own are kind of in a little chamber and so to have other points of view is really powerful.
The Future
Ian thinks that with certainty that there's going to be a downturn coming up eventually and he suspects that we're closer to the next downturn than we are to the last one. He is positioning the real estate crowdfunding review with this in mind and focusing on the investments he’s interested in which are these conservative investments, sponsors who have experience doing multiple cycles who have not lost investor money or maybe they are debt funds that are very conservatively underwritten. Maybe they are real estate funds which is maybe a little bit too boring for some people but for Ian it's perfect for this part of the cycle. So a lot of the focus is on those kind of things a very conservative mindset trying to preserve principle not trying to extend too much and with the idea that hey after the downturn maybe there's going to be some opportunities there. And have some cash and some dry powder might be a really good thing.