A question that investors often ask real estate crowdfunding platforms is whether or not they can withdraw their investment before the realization of a deal.
Generally, the answer is no. Real estate is an investment option that often requires time for its value to appreciate. Notwithstanding this, some real estate crowdfunding platforms have touted redemption programs that allow investors to withdraw their invested capital early. This may give investors a sense of having liquidity, which is the availability of cash or assets that are easily and quickly convertible to cash.
But are these investments truly liquid?
We can look to how these redemption programs have played out during the ongoing COVID-19 pandemic for an answer.
In times of uncertainty, it becomes more important to have liquidity, as it allows individuals and businesses to meet their financial obligations. However, during the financial crisis caused by COVID-19, there has been a liquidity crunch for individuals and businesses, and certain platforms have suspended their redemption programs in order to maintain cash reserves — unsurprisingly, at a time when investors may need liquidity the most.
These suspensions demonstrate that redemption programs may not in fact afford investors true liquidity in real estate crowdfunded investments. In this article we will further breakdown redemption programs and explain why they merely create an illusion of liquidity.
Do All Platforms Offer Redemption Plans?
There are two main types of crowdfunding models, the “fund” model and the “individual deal” model.
Redemption programs have been primarily marketed by real estate crowdfunding platforms that launch investments through the fund model, which operate under Regulation A (Reg A) of the Securities Act of 1933 (the Act). Under this model, a platform could raise up to $50 million from investors within a single year. Various crowdfunding platforms utilize Reg A to form online real estate investment trusts (REITs) that are not publicly listed on an exchange, with the goal of investing in a portfolio of deals. Reg A platforms often raise money for funds prior to actually investing in specific properties, and therefore pitch investors an investment “strategy” without concrete financial and underwriting details for the underlying investments. These investors do not own interests in the real estate assets, but rather they own shares of the fund.
ArborCrowd utilizes Rule 506(c) of Regulation D (Reg D) of the Act, which allows it to raise funds from investors for individual deals. Therefore, investors know exactly where their capital is going and have deal-specific underwriting to make their investment decision. The ArborCrowd model is unique even in the Reg D space because it invests in deals with affiliate capital upfront before offering deals on its platform, putting its own capital at risk and aligning its interests with investors. Platforms that utilize Reg D are less likely to offer redemption plans. This is partly due to the fact that investors actually own indirect interest in the real estate itself. It takes time for a property to appreciate in value so that a return can be achieved and it would not be in the best interests of the property or investors if money could be withdrawn at any time.
Penalties and No Open Secondary Market
One of the key characteristics of liquid assets is that they can be exchanged on an open secondary market of buyers and sellers. A common example of this would be stocks or bonds, which can be sold or bought on public exchanges with many independent and willing participants.
Public REIT stocks allow for this, but real estate crowdfunding platforms generally don’t have an open secondary market. Instead when an investor requests to redeem their interests from a Reg A crowdfunded REIT, they typically only have one buyer for those shares: the platform. Furthermore, the platforms themselves determine the Net Asset Value (NAV) per share of the fund as opposed to independent market participants. This means that the sole buyer of the shares unilaterally sets the purchase price without any input from the seller, who is the investor. Additionally, there is usually a hefty penalty associated with a redemption that is a certain percentage discount to the NAV.
The penalty for a withdrawal of funds typically depends on how long the investor has been in the fund. The less time the investor has their capital in the investment, the larger the penalty would be to redeem their shares and vice versa. However, penalties can range from as little as 1% to as large as 10%, depending on the platform. Platforms can also change their redemption rules at any time or even suspend them — as some have already done because of the current economic disruption — denying investors the ability to withdraw their investments.
Waiting Periods Tie up Funds
If a Reg A investor has fallen on hard times and needs liquidity, some platforms allow them to submit a request to redeem their shares. This usually means that the platform will repurchase the investor’s shares in the fund.
Typically, there are many stipulations for these requests, and they can be denied at the sole discretion of the platform. But even if the redemption is successful, the capital will not be available immediately and may take months for the investor to actually receive it.
Most platforms indicate that an investor can only request a withdrawal after being invested in a fund for a certain amount of time. These lockdown periods could be for 90 days or even two years. Moreover, after the request has been submitted, there will be a waiting period during which the request will be reviewed. Some platforms have waiting periods of 60 days, but it could be 90 days for others. Additionally, various platforms limit the amount investors can request to withdraw per quarter.
Returning to the question posed earlier: does Reg A redemption programs make investments truly liquid? The answer is no. The current liquidity crisis caused by COVID-19 has forced some real estate crowdfunding platforms to suspend redemption programs for their Reg A REIT funds, demonstrating these programs simply manifest a false sense of liquidity in real estate crowdfunding, and they could be absent when investors need them the most. Additionally, the waiting periods for the withdrawal, the penalties, and lack of open secondary market further diminishes the value of being able to redeem a real estate investment early. Real estate is a tangible and inherently long-term, illiquid investment that needs time so that a business plan can be properly executed and its true value can be unlocked.
Originally published June 8, 2020