This article was updated on Jul. 7, 2017, and originally published Jun. 23, 2016.
Scrolling through my Facebook feed, I stumbled upon an ad for Fundrise, which promise incredible returns from crowdfunded investments in real estate. The company, which combines investments as small as $1,000 from individual investors to make larger loans and equity investments, boasts on its track record page that investors could have earned a 6.95% dividend yield in 2016.
Fundrise has a number of funds that have varying investment strategies. A recently formed fund by the name of Fundrise West Coast Opportunistic REIT has a stated goal to generate returns by investing in real estate projects in large metropolitan areas like Los Angeles, San Francisco, Seattle, and Portland, for example.
But all that glitters may not be gold, and though Fundrise isn't a scam in the sense it is going to run away with your money, its claims should come with a few asterisks. Deep in its filings for its so-called eREITs are pages and pages of conflicts of interest and risks that investors should give particular attention.
All funds carry fees, but Fundrise's fees appear particularly conflicting.
At virtually every step along the way, the fund's managers will seemingly collect another fee from investors. When the fund managers find a deal to invest in, they carve out an origination fee of up to 3%. The company's filings state simply that "we will not be entitled to this fee," referring to the investors in the fund. Management thus has an incentive to offer loans with higher origination fees (which flow to management), offset by lower interest rates (which would result in less income for fund investors).
Likewise, managers collect ongoing management fees equal to 1% of the funds' net asset value on an annual basis, in addition to servicing and property management fees, which can add up to 0.50% of assets.
But that's not all. Fund management also stands to collect every time Fundrise sells a property on behalf of its investors, collecting 0.50% of the gross proceeds after repayment of property-level debt. Notice that this fee rewards management for activity, not investment returns. Buying and selling a property at a loss would theoretically generate earnings for fund managers at the expense of capital losses for its investors.
Perhaps worst of all, there are higher fees charged to the eREIT when management makes an underwriting error. Tucked away on page 16 of a regulatory filing is the notice that a special servicing fee is assessed on non-performing investments at a rate of 2% of the asset's value annually. It goes on to warn that "whether an asset is deemed to be non-performing is in the sole discretion of our Manager."
The company notes that it has hired an "independent representative" to approve or disapprove of potentially troublesome deals where the interests of shareholders may conflict with the interests of the manager. As it details in its filings, the "independent representative" is a man by the name of William Thomas Lockard, Jr. Investors might not take comfort in his independence from the company, however. As recently as 2015, Mr. Lockard worked as a Senior Vice President of Rise Companies Corp., the parent company of the REIT's manager.
One of the trickier issues with real estate and loans to real estate operators is that the assets are typically illiquid. In some ways, real estate investment trusts (REITs) offer a solution to this problem by enabling investors to sell shares to other investors, or back to the REIT manager.
Should you want to sell your shares, though, expect to pay a price. Investors who have held their shares for fewer than 90 days can redeem their investment and receive their investment back, minus any dividends received during the period, resulting in no return, or perhaps a slightly negative return when taxes on dividends are taken into account.
Those who hold shares for a period ranging from 90 days to five years will be able to redeem their shares at a discount ranging from 1% to 3% of their current value as estimated by the funds' manager. Only after holding for five years or more can investors redeem their shares at 100% of their then-current net asset value. In every case, the redemption amount will be reduced by "third-party costs" which are not quantified in its SEC filings.
Make no mistake: Fundrise borrowers aren't the kind of borrowers who would sail through a bank's underwriting department. A recent SEC filing for an established fund under its umbrella reveals the company is frequently making loans with eye-popping interest rates of 9% to 12% to fund projects that include condo conversions, apartment renovations, and more speculative land acquisitions.