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DiversyFund Review 2021: Is This Platform Right for You?

Before you invest with this crowdfunding platform, here are the benefits and risks you should know.


[Updated: Apr 12, 2021 ] Jul 19, 2020 by Matthew DiLallo
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DiversyFund

2.0 / 5 stars

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Summary

DiversyFund is a crowdfunded platform that touts zero fees to investors buying its REIT, but the fees the manager charges to the REIT itself are extraordinarily high.

2.0 / 5 stars

Question Mark Icon
Highlights
    • Low investment minimums
    • Invests primarily in residential real estate
    • Higher than normal fees charged to the REIT from the sponsor.

Bankruptcy Protection 3/ 10

Deal Flow 1/ 10

Deal Transparency 1/ 5

Diversified Fund Options 1/ 5

Due Diligence 5/ 10

Ease of Use 8/ 10

Fees & Commissions 3/ 10

Investment Minimums 4/ 5

Investor Resources 5/ 10

Leadership 1/ 5

Non-accredited Investor Offerings 5/ 5

Platform Financials 1/ 5

Skin in the Game 2/ 5

X Factors 0/ 5

Total 40 / 100

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What is DiversyFund?

DiversyFund is a real estate crowdfunding platform. The company offers investors a non-traded real estate investment trust (REIT). The DiversyFund Growth REIT is open to non-accredited investors at a low investment minimum. The fund focuses on investing in large value-add multifamily opportunities (100+ units) across U.S. markets, targeting ones that can generate IRRs of 10% to 20% over a five-year investment cycle. Further, the REIT boasts having the lowest direct investor fees in the industry with no management or broker fees.

However, while DiversyFund’s REIT looks good on paper, we have serious concerns about the offering. Here’s why we do not recommend this platform for real estate investors at this time.

Summary: Is DiversyFund a good investment?

The issues with DiversyFund start at the top. We have some serious concerns about the management team. For starters, co-founders Craig Cecilio and Alan Lewis are defendants in three lawsuits arising from real estate transactions. While these aren’t related to any DiversyFund transactions, they’re still a big red flag.

An SEC filing states:

In 2015, before the Sponsor or the Company was formed, Mr. Cecilio raised capital for a project involving ground-up construction located in La Jolla, California. When the project ran into financial difficulty, with the lender threatening to foreclose, Mr. Cecilio and Mr. Lewis both personally guaranteed a loan from a new lender to protect the interests of the equity investors, although they were not obligated to do so. Although the project was completed, it was financially unsuccessful and unable to repay all the guaranteed debt. The lender has brought suit against Mr. Cecilio and Mr. Lewis for the deficient loan balance of approximately $1.9 million.

Mr. Cecilio and Mr. Lewis have asserted counterclaims against the lender. Among other things, they allege that the general contractor hired at the insistence of the lender was responsible for the failure of the project by causing significant delays and budget overruns, and that the lender and the contractor should be viewed as joint-venturers.

In the same project, an individual loaned money to the borrower entity, secured by a second lien and personal guarantees by Mr. Cecilio and Mr. Lewis. When the project ran into financial difficulty it was discovered that the second lien had not been properly recorded, resulting in a significant loss to the lender. The lender sued her lawyer for legal malpractice and the lawyer has made a cross-claim against Mr. Cecilio and Mr. Lewis relating to their personal guaranty. The amount of the cross-claim is approximately $1 million.

An equity investor in the same project has filed a lawsuit alleging that the Sponsor, Mr. Cecilio, and Mr. Lewis failed to provide adequate disclosure, were professionally negligent, and breached their fiduciary duty on several projects, all funded before the Sponsor or the Company were formed. The investor is claiming damages of approximately $774,000 in the aggregate. On a separate project, the same investor is suing on a personal guaranty of approximately $55,000.

Mr. Cecilio and Mr. Lewis are vigorously defending all of these lawsuits and expect them to be settled with no impact on the Company.

The filing further states that "Depending on the size of the judgment, Mr. Cecilio and/or Mr. Lewis could be forced into bankruptcy" and that "in a worst-case scenario, a large judgment could result in a loss or dilution of their control" of DiversyFund. While disputes aren’t uncommon when a real estate deal goes south, this issue does give us pause. Further, it’s also worth noting that Mr. Cecilio was charged by regulators at the state of California Bureau of Real Estate with "failure to supervise" and had his license suspended.

Unfortunately, the caution flags don’t end there. Another issue we have with the DiversyFund Growth REIT is its marketing. While the REIT claims to be low cost since it doesn’t charge investors any up-front fees, the sponsor and manager can charge the REIT some of the highest fees we have seen, making its low-fee claim disingenuous. Sure, the fees aren't charged directly to investors, but they are paid by the REIT, which is funded by investor capital. Just because investors aren't paying the fees directly doesn't mean they don't impact returns.

It’s also a tiny REIT compared to others available on other crowdfunding platforms. For example, as of its last SEC filing, which was for the period ending on June 30, 2020, the REIT had only invested about $10.5 million across eight assets. While the REIT markets itself as an entity focused on large 100+ unit multifamily opportunities, the current portfolio holds only three such properties. The others were a smaller 59-unit mixed-use property, another smaller 54-unit multifamily property, an 8-unit student housing property, and debt investments on two single-family homes. That small size could negatively impact its returns.

Speaking of returns, we don’t have much data since the REIT has a limited track record and hadn’t filed any financial reports with the SEC in over six months at the time of this review. It’s also worth pointing out that while most crowdfunded REITs pay cash dividends at least quarterly, the Growth REIT doesn’t distribute any cash. Instead, it automatically reinvests any dividends back into new shares.

Finally, we have received repeated customer complaints about the company. We’ve also read of similar issues investors on the platform have had with the company, including trouble reaching its customer relations team. We’ve also had issues with the company’s responsiveness, as they didn’t reply to our requests for additional information on the platform.

When you combine these and other issues, we think there are better investment opportunities for investors than DiversyFund.

What are DiversyFund's pros and cons?

Pros

  • No need to be an accredited investor: DiversyFund's Growth REIT is open to non-accredited investors.
  • Low minimum investment: Invest with as little as $500.

Cons

  • Very high developer fees: DiversyFund touts no investor fees at the fund level, but the fees it charges the REIT itself as the developer/sponsor are very high. Higher fees, even at the REIT level, mean lower returns for investors.
  • No liquidity or secondary market: There is no redemption policy as with other crowdfunded REITs, and no guarantee DiversyFund will agree to repurchase your investment. The manager intends to hold properties for five years before liquidation. If you invest, don't use any cash you may need within that period of time.
  • No income: While most REITs generate passive income, DiversyFund Growth REIT requires automatic reinvestment.
  • Concentrated assets risk: The DiversyFund Growth REIT only owns a small collection of residential real estate properties. This means more concentrated risk.
  • Limited track record in this space: The Growth REIT has only reported very limited results to date, making it difficult to measure management's ability to deliver.

Questionable management team: The co-founders are currently defendants in three lawsuits arising from real estate transactions. Further, one of the co-founders was charged by regulators at the state of California Bureau of Real Estate for "failure to supervise" and had his license suspended.

Diversyfund

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Is DiversyFund legit? How strong is it?

DiversyFund is a legitimate business with multiple real estate holdings in various entities, including the DiversyFund Growth REIT. However, as noted, we have serious concerns about how it does business.

DiversyFund's performance

We don’t have much information about the company’s performance. As of the most recent SEC filing roughly six months ago at the time of this review, the DiversyFund Growth REIT was still burning more cash than its operations were generating. It produced roughly $100,000 in net cash from operating activities and yet "paid out" almost $270,000 in dividends to investors (DiversyFund doesn’t distribute cash dividends; instead it automatically reinvests them for investors by purchasing additional shares).

At this stage, that means we have limited information about the financial performance of the business, the REITs, or the properties owned by the REITs.

DiversyFund management

DiversyFund was founded by CEO Craig Cecilio and CIO Alan Lewis, who have some experience in real estate but primarily in real estate finance (Cecilio) and finance law (Lewis).

How DiversyFund works: How are investments sourced?

DiversyFund touts itself as a vertically integrated platform, acting as the sponsor, developer, and asset manager. The concept is that this allows for a lower-cost fee structure since the company can source properties directly for the REIT, develop them to grow cash flows and increase the property value, and then sell them for a profit, sharing in the returns with equity investors in the REIT.

As a result, DiversyFund does not charge annual asset management fees to investors in the DiversyFund Growth REIT directly. However, the fees that it discloses as being able to collect from the REIT as the sponsor and developer are well above the industry average.

Who can invest with DiversyFund? What is the minimum investment?

The DiversyFund Growth REIT is open to anyone who can invest at least $500.

What are DiversyFund's fees?

This is one of the more cloudy areas for many Reg A investments. DiversyFund touts the fact that it does not charge fees at the fund level. While that’s true at the investor level, it's not an accurate representation of the impact fees will have on an investment in the REITs funds.

A review of the disclosures in the SEC filings for DiversyFund Growth REIT shows that in many cases, DiversyFund, as the sponsor and developer, will charge the REIT a litany of fees. Some of these fees are near industry standard rates, but many are far above what you would expect to pay on a stand-alone real estate deal.

Here are the various fees DiversyFund charges the REIT:

  • Developer fee: 6% to 8% of both hard (e.g., real estate, construction, renovation) and soft (e.g., professional fees) costs.
  • Disposition of property: 1% of total sale price.
  • Construction management: no range disclosed; states "shall also be consistent with industry standards, as determined by the Sponsor."

Additionally, there's this quote from the offering circular (bolding added for emphasis):

"The Company engages third parties to provide a variety of other services, including insurance and marketing. If the Manager is able to engage third parties at lower-than-market rates, then the Manager is entitled to retain the difference. The Manager will determine the market rates for the services in question -- and thus its own compensation -- based on its experience in the real estate industry and, if it believes necessary, by reviewing proposals from other providers of such services."

In other words, if DiversyFund finds better deals for some services, it can charge the REIT the higher rate and just pocket the difference.

There's more. In addition to the fees it can charge, here is the promoted interest schedule from the offering circular for the DiversyFund Growth REIT:

"The Promoted Interest is paid in two levels: first, after Investors have received a 7% preferred return on their investment, the Sponsor is entitled to a catchup return equal to approximately 53.85% of the preferred return paid to Investors; and second, after Investors have received their preferred return and the Sponsor has received its catchup return, the Sponsor is entitled to 35% of the remaining profits."

Where to start. Probably the best place is this: A promote schedule that allows the sponsor to share in profits isn't a bad thing. It helps create more incentive for a developer, as its share of the profits grows with the profitability of a deal.

But, plain and simple, it's rare to see a promote structure with this low a bar for returns, and rewarding the sponsor with an outsize share of profits. A more typical promote structure is an 8% preferred return followed by an 80/20 or a 75/25 (investor/sponsor), with no catch-up returns.

Here's the bottom line: Investors in the REIT are the ones putting capital at risk, and how the returns are split should reflect that. The DiversyFund fees and promote structure reward the sponsor more than is typical, at the expense of investors putting their capital at risk.

DiversyFund returns: What should you expect?

The jury is still out on the DiversyFund Growth REIT, which has yet to report a period with positive operating cash flows. While it targets IRRs in the 10% to 20% range, there’s a concern that its fee structure creates opportunity for DiversyFund to profit more than investors in its funds.

When (and how) can you sell DiversyFund investments?

DiversyFund investments, like most real estate investments, are illiquid in nature. One of the attractive aspects of private real estate is that it's not as volatile as other investments like stocks, but the downside is that once you've made the investment, it's hard, or even impossible, to liquidate that investment before the deal is completed.

Despite this, many other non-traded REITs have a redemption schedule or share buyback policy that gives some limited opportunity to sell, while DiversyFund doesn't offer any liquidity at all. Taken a step further, the DiversyFund Growth REIT won't actually send cash dividends to investors. The REIT reinvests all dividends into more shares, retaining the cash flows to reinvest into new real estate deals.

For many investors looking at real estate as a source of income, that makes the Growth REIT a no-go.

Going mobile: Is there a DiversyFund app?

DiversyFund has a fully featured mobile app as well as a mobile-optimized website that works well from both smartphones and tablets.

DiversyFund risks: Is DiversyFund safe to invest with?

We are limited in the information we have access to, and the DiversyFund Growth REIT is a newer investment without much of a track record. But with that said, we think there are other crowdfunded real estate platforms that could make for safer investments.

DiversyFund touts its vertical integration as a feature that lowers costs, but it also creates additional risks. When one party handles so many aspects of a real estate deal, including asset management for investors, developing properties, sourcing and acquiring them, and asset sales, there's more risk to investors if something goes wrong.

As an asset class, commercial real estate is generally a safer investment, and that's potentially the case with most of DiversyFund's investments, too. But investors should go into an investment with this platform with the understanding that since the company handles so many aspects of every deal, the potential impact of a DiversyFund failure would likely cause more harm than if other platforms were to fail or have problems.

Moreover, there are some questions about leadership that we have flagged, including past violations with state real estate regulators prior to the founding of DiversyFund as well as some ongoing litigation on a current DiversyFund development that was not disclosed in SEC filings. Company representatives said the ongoing litigation is not what it considers material to the business and that all prior violations were settled, but with past issues with regulators at the founder level, it's enough for us to want to practice heightened caution.

Lastly, there's the lack of liquidity via either a secondary market or redemption policy and no option to take dividends as cash for Growth REIT investors.

Put it all together, and there are a lot of small things that add up to raise flags for us, particularly without a substantial track record of results for the Growth REIT to justify investing in it. Right now, we think there are better opportunities for your money than DiversyFund.

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