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Deidre Woollard: Hello, I'm Deidre Woollard, an editor at Millionacres, and thank you so much for tuning into the Millionacres podcast. If you follow this podcast, you know Millionacres does crowdfunding reviews, and I always like to meet with the CEOs to learn more about their investing mindset. You can read the review of CityVest on our website. What sets CityVest apart and what I really want to talk to the CEO, Alan Donnenfeld, today about is, it raises capital for access funds rather than investing directly into real estate investments. It's really interesting, different mindset. Welcome, Alan.
Alan Donenfeld: Thank you, Deidre. Great to be here.
Deidre Woollard: Tell us a little bit about what CityVest does and why you founded the company.
Alan Donenfeld: Sure. CityVest is a online real estate investment platform, but specifically, rather than investing in individual real estate deals or properties like most real estate crowdfunders focus on, we focus on real estate private equity funds that are more institutionally focused, larger funds, 30-200 million in size, more experienced institutional investment managers.
Deidre Woollard: Interesting. This is different than a lot of the crowdfunder we talk to where you are investing in individual real estate deals. Why is this so intriguing for investors?
Alan Donenfeld: First and foremost, the investment fund managers are institutional fund managers. They are audited. They've got administrators. They have significant amount of assets under management, typically over 100 million, many of them over 500 million. They have prior funds so you can verify a track record. All too often, you see on other real estate crowdfunding sites that there's a deal with a sponsor, and the sponsor may be small. Sometimes those deals don't pass muster with any of the funds, and so they put them on a crowdfunding site. We want to focus on investment managers that when you give them money in a fund, they have opportunistic capital, where in this market, which is a little bit overheated, they can go out and using capital in hand, take down a deal at hopefully attractive prices, better valuations, and on a time-sensitive basis.
Deidre Woollard: Interesting. These individual funds are holding a portfolio of real estate properties. Is it in a single location or across multiple locations?
Alan Donenfeld: Every fund is different, both the investment management, the target locations that they are focused on, and their specialty of what they want to invest in. There may be a specialty fund that only focuses on senior living in Texas. Another one might be industrial properties in Florida. Another one might be a GP co-invest focused on the West Coast. It varies across a wide selection, and each fund manager has their own specialty, investment niche as well as deals that they are looking at and geographic target.
Deidre Woollard: Interesting. If you are an investor, how do you get started with CityVest?
Alan Donenfeld: Cityvest.com is our website. There is a button at the top of the page that says Investments. We have an array of different investments. You can click on the latest investment that we have without having to put in a password or your email address. You will then see everything about that particular investment. There are five or six tabs at the top of the page, including the overview, strategy, team, diligence, terms, documents and track record. It's an in-depth review of all of the information that you could want to about that specific real estate private equity fund.
Deidre Woollard: You have to be accredited, right?
Alan Donenfeld: You have to be accredited. After you've reviewed all of that material, if you then want to proceed, there are on our summary page, on the opening page, there usually are a couple of different videos where we or someone else interviews the investment fund managers. That's always a quick and easy way to learn about the fund. Then we actually run daily group conference calls where any investor can login to our group conference call, ask questions, or go over the fund. It's a very transparent and hands-on process.
Deidre Woollard: Interesting. How long do these investments stay open?
Alan Donenfeld: Typically, a real estate private equity fund is a somewhat illiquid investment and long in nature. These are not two-year investment. These are not fix and flips. These are not credit deals that you might get your money back in 60 or 90 days. These are private equity funds typically last as short as five years, as long as eight or nine years, but the investment fund managers don't really have a lot of incentive to let these funds run for the full nine years. They're focused on getting a high IRR so that their next fund that might be $100 million fund, they want to generate the highest IRR that they can on the current fund so they can raise even more capital on the next one. They're IRR focused, and typically, they start selling off assets in year four or five and don't even make it to the sixth, seventh, or eighth year of the fund.
Deidre Woollard: One of the things I've noticed lately is we're seeing so much more deal activity. Is that something that you're seeing in the funds, that they are selling off properties a little early or are they still keeping to their same timeline?
Alan Donenfeld: No, I think it's an opportunistic market, and I think many fund managers are seeing that the prices that they can get for their existing portfolio assets are much higher than they ever expected. Many people are taking those profits and then raising an additional fund that might be bigger. There certainly is a lot of interest both internationally and from domestic institutional sources to invest in funds, particularly if there is a given niche in investment strategy and in given markets obviously. The Southeast, Charlotte, Atlanta are great markets. Many places in Florida, like Tampa, is a great market. Texas has been hot, and then many cities in the West Coast have a unique combination of both population growth and rising incomes, like Seattle, Portland, Denver, Phoenix are all great markets. If you find a fund manager that knows those markets well and there's raising capital, those funds can raise capital fairly easily.
Deidre Woollard: That makes sense. There seems to be a lot of capital in front of my call that sloshing around lately. There's a lot of capital. There's a lot of funds that are popping up. I know it's confusing for the average investor. You look at over 700 funds a year, what are you seeing right now?
Alan Donenfeld: There are a lot of funds. There are also fund managers that have around 50 million in assets under management, up to maybe 100, 150 million assets under management, and haven't operated five funds. If they're on fund 1, 2, or 3 and have had a great track record, then many of these funds are currently using a GP co-invest structure, which we like quite a lot because it allows our pool of capital, which typically when we invest in a fund, we're around $4-$6 million investment, so fairly a big chunk of money for a given fund. We're able to invest oftentimes in these funds as a GP co-investor, which means we can share in the promote that the manager of the fund has been able to attain from LP investors. It means that a 20 percent IRR, when you add in our share of the GP promote, we might earn a 25 or sometimes even a 30 percent IRR, much higher than the other LPs might get.
Deidre Woollard: Interesting. Does that impact using SDIRA capital or taxes in any way?
Alan Donenfeld: Not at all. We accept self-directed IRA accounts. Although as you know currently, that's under discussion in the current tax rules of how private placements can invest in investments like ours for credit investors. But no, SDIRAs are open to invest in our funds, and there is not a enhanced liability being a GP co-investor because we're shielded from that being a non-operating GP.
Deidre Woollard: That makes sense. What are you seeing in terms of concern about potential changes? I know there's so much concern about the changes to 1031s, the changes for accreditation and private placements, how much is that impacting your investors?
Alan Donenfeld: We don't have any 1031 investors in our funds. I do see a lot of activity of investors who own properties wanting to sell now and get into either a new property, a larger property. I think that's spurred a lot of activity in the market for this year. We still don't know what's going to happen at 1031, but many people believe that rollover of the taxes will change to some extent. I think it is causing a lot of people to step into other assets and creating some extra product in the market today.
Deidre Woollard: I wanted to ask a little bit about the documentation. I know that a lot of that is really confusing for people. You mentioned the office hours, that you have a conference call every day. How else do you help people understand what they're investing in?
Alan Donenfeld: Having the group conference call is really the best way for any investor to learn about our funds and generally to learn about investing. What we do, which I haven't really describe, is we create a feeder fund. Our investors invest in our feeder fund. We'll aggregate that capital, and we invest in an underlying fund. The terms of both of those, our feeder fund and the underlying fund, are very confusing for individual investors. These are all accredited investors, but I don't expect any one investing in either fund to have a strong knowledge of the legal terms. Many of them do know what they are, things like a rebalancing contribution and catch-up provisions, even a pref is sometimes not fully understood by a lot of investors. We can explain that on our group conference calls and some of the more esoteric terms, like catch-up provision in this rebalancing contribution. I can easily explain what they are, but more importantly, in our feeder fund, we have a side letter agreement with the underlying fund where we're able to negotiate better terms for those specific provisions. We're representing our investors in getting the best deal for our access fund or our feeder fund.
Deidre Woollard: As I understand it then, having that amount of capital invested gives you a little more influence. Is that how it shakes out?
Alan Donenfeld: Yeah. Many funds that are raising funds, say it's $50 million in size, if we come in with a commitment to invest 5 million in that fund, it's 10 percent of the fund. They may actually be seeking minimum investment sizes of 500,000. Still out of reach for an individual, it's a big chunk of money. Some funds have a million dollar minimum, but we're coming in with 5 million. We're able to negotiate generally a 12 percent preferred return and 80 or 85 percent of the profits over that pref, while the underlying fund for direct investors, they may only be offering an eight pref followed by a 75 percent of profit. Because our feeder fund, we call it an access fund, comes in with a much larger check, we're able to negotiate better terms for our investors.
Deidre Woollard: Can you explain what a pref is for people?
Alan Donenfeld: Pref is merely a hurdle. A 100 percent of net operating income generated by all of the real estate investments after the mortgage has been paid. That operating income is distributed to investors based on their pro-rata investments. I'll simplify it a little bit, when investors have received an eight percent IRR, in the case of direct investors in these funds, after that hurdle has been achieved, and it's sometimes an IRR calculation, after that, then the profits, that NOI, is distributed 80 percent to investors and 20 percent to the investment management group. That's only going to happen after three, sometimes even four years because there's no property that you can buy today that's going to have an eight percent return out of the box. It would have to have a cap rate of probably six or seven percent. It's just not available in the market today. It might take a couple of years for rents to go up, net operating income to go up to achieve an eight percent pref. Now in our case, we're generally negotiating a 12 percent pref, meaning, a 100 percent of those cash flows coming off the portfolio of real estate, 100 percent of that goes to us until our investors have achieved a 12 percent IRR, and after that, the investment management team starts to participate in those profits generally, in our case, it's an 80-20 split, often times for direct investors it might be 75-25.
Deidre Woollard: Great. Thank you for breaking that down. [LAUGHTER] If you have invested in these funds, how does it differ from individual commercial real estate deals? One of the things that happen sometimes is you get individual CRE deals. You get a capital call or something like that if they need more money. Is there anything that happens like that in the fund world?
Alan Donenfeld: As I described, we have a side letter agreement with these funds. Because we're coming in with something around five million, we negotiate our own terms of investment in these spots. That specific term that you just highlighted, a capital call, we negotiate that away. I don't want to have to chase individual investors for a percentage of their investment in the fund. I require the fund that we invest in to accept all of our subscription on the date that we're making our investment without any capital calls. Our investors are not going to get another call from us saying, "It's time to put in some additional money because there's two or three-year investment period." No, we're investing all of it right upfront without a capital call, and we're earning our, generally, our 12 percent preferred return on that investment from day one.
Deidre Woollard: Nice. Another concern I know that with individual CRE investments is taxes and the K1s and having to file individual K1s in different states depending on where you're investing with the funds, is that an issue? How does that shakeout?
Alan Donenfeld: K1s are always an issue. We have the underlying fund deliver a K1 to our feeder fund because we are the investor. We have a very good accounting firm, and we will file a composite return in the states that allow a composite return. Therefore, let's just say we are an investor in North Carolina, and South Carolina, and Georgia because it's a diversified fund, and they have multiple assets. We will, on behalf of our investors, file composite returns, make whatever tax payments are required in those states for all of our investors so that our underlying investors in our fund do not have to file multiple K1s in states. Having said that, there are some states that do not allow composite returns, like California, and so there may be a California state tax return if the underlying fund has investments in California.
Deidre Woollard: California is always got to be difficult.
Alan Donenfeld: Always a problem.
Deidre Woollard: [LAUGHTER] How do you conduct the due diligence when you're looking at a real estate fund manager?
Alan Donenfeld: This is an area that I think differentiates CityVest from all other funds. Not only are we looking at 700 private equity funds. Right at the outset, these are not deals. These are not individual properties. This is not one of 10,000 syndications that are happening all over. These are fund managers that have a level of experience with auditors and administrators and have a track record for how they have performed in the past. Out of those 700 funds, if any fund manager has less than a 20 percent IRR over the past 10 years, I'm not interested in that fund because the last 10 years have been a spectacular time to be a real estate investor. We had this thing called cap rate compression, where cap rates came down, which means that the rate of return that the investor expects is lower, therefore they're willing to pay a higher amount. If you were selling an asset anytime over the past 10 years, you've got a much higher price for that asset than you paid, which means you had a great return. Everybody had a great return. If I look at a fund and they generated 15 percent IRR, which sounds great on the surface, I don't really want to invest in that fund because every real estate investment fund manager should have been easily able to generate a 15 percent IRR, so I'm looking for outperformance. One level of due diligence is finding managers, not just that they are an institutional fund manager and have a fund where you can verify the assets and look at their track record, I want it to be greater than 20 percent IRR. I want to see an auditor and an administrator. I want to see skin in the game where that manager is investing in the fund. Then another way that we do due diligence once we've narrowed the number of investments down, is we can track with a third-party due diligence firm name, Buttonwood, and they do a third-party due diligence review, where they're also separately conducting due diligence on doing background reports, looking at SEC and criminal record whether there's any bankruptcies, or leans, or drunk driving arrest, or a whole array of background checks on a manager. We post those reports on every fund that we're doing on our site just for transparency. It's there that due diligence has been done.
Deidre Woollard: I like it. You're a tough grader. Let's take a quick break here.
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Deidre Woollard: I'm back with Alan Donenfeld, and we're talking about all things real estate investing, and crowdfunding, real estate investment funds. In this segment, I want to talk about some of the things that are interesting in the future. Let's start with a little bit of a dip into the past and talk about how the pandemic impacted your investments and what lessons you took out of it.
Alan Donenfeld: We had our best year ever. Funds were raising capital and even funds were investing capital. There wasn't really a break where people took time out from investing although it was extremely hard to travel and see properties, deals were getting done. But on the operating side, we did see a slight dip in occupancy rates. Our focus specifically has been in multifamily. There was, early in the pandemic, some drop in occupancy. Clearly, rents were late by a month, two, or three, but at this point, they've all caught up. Rent payers are right up there at 95 percent being current, and it's as if the pandemic has not even happened. The market is extremely hot. Rents are up across the board, and virtually, every city and every type of real estate, except obviously, some cities like New York and San Francisco are still having some issues. Retail properties and some hospitality are still having some issues.
Deidre Woollard: Absolutely. I think one of the things that's interesting about the pandemic and I don't know if you saw this too, is that there was all of that opportunistic capital waiting to be deployed and expecting commercial real estate rates to go down, that never happened. Were some of the funds that you've seen that maybe got in a little, maybe didn't pass your due diligence test? Did you see some of them trying to scramble during that period of time?
Alan Donenfeld: No. Most people that I saw were investing straight through the pandemic. There was a interesting line in Blackstone's annual report that they invest in real estate through all market cycles. It was a throw-away line, but my guess is if you look at the details of even Blackstone's investments, that they were as active as ever right through the pandemic, didn't miss a beat. I think anybody that did take a pause investing probably regret it because prices in 2021 and occupancy rates this year are both much higher than they were in 2020.
Deidre Woollard: Absolutely. One of the things with the pandemic, we've seen real estate market interest shift a little bit. You mentioned retail and hospitality that money is moving away from that. Industrial has been huge. Life science is huge. What real estate market niches are you looking at right now?
Alan Donenfeld: We've consistently focused on multifamily. Our central belief is that the population in the US has grown by about 2.5 million people a year. Commerce Department is projecting 440 million people by 2050. Now, we're not investing for the next 30 years. We're investing for the next 5-10 years. But nonetheless, 2.5 million new people a year, people have to live somewhere. We already know there is a housing shortage, and so it just goes to there will be continued rent increases. There is this fix-and-flip market, which is renovating a significant number of houses. There are lots of houses being built for brand, which is an attractive segment, but we have stuck pretty much to multifamily. There are some segments of that, like workforce housing, student housing are both quite attractive. In student housing, it's fairly easy to get the documents for any public university to see the student population growth. It's well-known whether a given university is building any new dorms, which almost no university has built any new dorms for about 20 years. There are some, but not a lot, and so all those students are moving off-campus. It used to be, 40 years ago, that everybody lived on campus. Then, it was just seniors moved off campus than juniors. Now, you have many freshmen. They go to college, and they move off campus immediately. The growth in university population is easy to see, and therefore you can extrapolate. Therefore, buying student housing near a given university would be a good investment. There are pockets of multifamily that we like. There are some development opportunities in student housing. In senior housing, there is a growing older population. I think that that specific market is very misunderstood because the last eight years or so, there was actually a small decline in the number of seniors at a time where lots of people were entering the senior housing market. It was somewhat overbuilt, so you got down to occupancy rates in the seasonal housing industry, that were down in the low 80s. Now we see that senior population growing now almost exponentially year-to-year for about the next 15 years. That should mop up all of that excess capacity. Around 2030 or so, there will need to be a lot more senior housing built just because of the demographics and aging of the population.
Deidre Woollard: You just brought up two things that I think are really fascinating. Senior housing, I think one of the reasons that there was that oversupply, I think people misestimated when people are going to need that type of housing. People in their 70s, late 70s, not moving into senior housing, but we're all living longer, so I think you're absolutely right when you predicted that. When that baby boomer peak generation starts hitting their mid-80s is when you're going to see a bigger shift in that. You mentioned student housing, fascinating sector. We follow American Campus Communities, which is pretty much the only REIT invested in that. You made such a good point there too because we've got this booming population, Generation Z, and they're all going to college, but the campuses just aren't seeing the profitability in building it themselves anymore. They definitely are making all sorts of partnerships.
Alan Donenfeld: Right. Universities are in the business of educating, not in housings too. [LAUGHTER] Any free land that a university might have, they're typically building educational buildings rather than student housing. All that student housing is being pushed into surrounding areas. There's a lot of development by very large fund that's quite attractive in student housing. Just reiterate the senior housing point because we did invest in a distressed senior housing fund, and so it's quite interesting that people, as you said, they are living longer. They stayed at home longer or through the pandemic. They lived at home with their kids and even moved out of senior living. But because that senior housing population is now on an upward path, it's easy to see that that industry will flourish. There was overbuilding in senior housing for the last five or so years, but I think all of that excess capacity is going to be used up over the next five years.
Deidre Woollard: You also mentioned workforce housing, something we studied a lot at Millionacres. One of the things that we think about a lot too. I noticed that you guys launched the Calneva Access Fund zeroing in on workforce multifamily in California and in Nevada, which is growing by leaps and bounds. What does that fund do?
Alan Donenfeld: Workforce housing is really housing for a lower-middle income class of people. People that might make 40,000-75,000, a lot of teachers, firemen, other essential workers, and so it's obviously important to have that group of people be able to live in an area that's decent. This is not poor housing. This is just lower income. Calneva has targeted their local market, which is Los Angeles, and specifically South Los Angeles, which is a very attractive market. In fact, Apple just announced last week that they are opening a new office building complex with 3,000 workers in south of Culver City, somewhat south of Los Angeles, that's just the market that Calneva is focused on. They also focus on Las Vegas, specifically North Las Vegas, where many of the people that work in the casinos actually live, so it's a strong community. The way that Calneva operates is they are a fully integrated company with a construction property management and brokerage arm, allows them to buy properties at the right price. Typically, Calneva is looking at low-income housing tax credit properties that might have graduated from the program, but the properties have not been fixed up, so they're not able to increase the rents. They clearly have not fixed up the properties because there hasn't been the higher rents to provide that floor for more capital expenditure renovations on the property. Calneva will fix up those properties, put in new kitchens, bathrooms, do landscaping, signage, whatever it might be, improve the properties and increase the rents to a market rate given the viability of the rents in a lower-middle income tax bracket.
Deidre Woollard: I want to ask you a little bit about blockchain and real estate tokenization, something I've studied for a long time, always seems like it's on the fringes of just being about to take over in real estate, never quite gets there. How do you think blockchain could actually revolutionize the way we invest?
Alan Donenfeld: I spent a couple of years talking about tokenization of real estate. This is back in 2017 and 2018. I don't think we've seen an amount of institutional interest in tokenization of real estate. Some of the deals that have been done, a famous one was the Aspen St. Regis, where it was tokenized, investors came in. It was way overpriced. The money came from China. I'm not casting dispersions on where Bitcoin comes from and who those investors are, but I believe in more traditional finance, where investors have fiat currency. They're taxed on that money. We provide K1s in all of our deals, and our investors report their taxes and pay their taxes. At least for the next couple of years, we're focused on fiat currency, making real investments with dollars, distributions in dollars. We do have some international investors that invest in our funds, but it's only if they have US bank accounts. We'll determine in three years, five years whether Bitcoin or Ethereum investments in real estate makes sense. There's plenty of capital out there in fiat currency. I don't think right now we need to stretch go searching for money in Bitcoin.
Deidre Woollard: Interesting. When your investors are looking at your funds, what kind of considerations do they have? Are they curious about ESG, or impact investing, or anything like that?
Alan Donenfeld: Not particularly. They are looking for a passive income investment that is safe as generally real estate is considered a safe hard real asset. They like the fact that there are tax benefits through depreciation in our equity funds. We have just a growing interest in our funds that are directed towards passive real estate investors who invest. They want something that has an audit administrator, and our capital raising for our funds has grown month-to-month.
Deidre Woollard: Speaking about real estate as a safe investment, one of the things that is happening now is we're seeing inflation being talked about a lot. We're seeing potential for interest rates rising. What is your view on the impact of inflation on real estate investment returns?
Alan Donenfeld: The traditional line is that real estate is a hedge against inflation. That's what everybody will always say. We are cognizant that interest rates will rise. It's a very complex calculation. If interest rates rise as they will, then the cost of financing and acquisition will rise. Theoretically, that could depress the amount that people are willing to pay for real estate, could depress the price. However, generally as we have inflation, incomes will rise and rents will increase. It's hard to see how much more rents can increase because they've been on a tear for a solid since the Great Recession. Since 2008, 2009, rents have steadily increased, so it's hard to see that they can go up much. But generally with inflation, incomes go up. We know that across the board everything is costing more. I believe that incomes will go up, rents will go up, and the net operating income, the profitability of real estate will go up. Therefore, people will spend more. Regarding and very important cap rate, many people also think that if interest rates go up, cap rates will go up. I personally don't think that cap rates are going to go up very much because I think that over the last couple of years real estate has been discovered by additional sectors of investors, notably a credit investors through sites like ours. If people can now invest in real estate which is generally a safer asset, people understand real estate, there's just more demand to invest in real estate. I think that will serve to keep cap rates down at lower levels just because there's greater demand. I think real estate valuations will continue on up again, population growth, people have to live somewhere, valuations will continue to increase. I don't see cap rates going up with the same pace as interest rates go up. We could see a spike in interest rates if we have a huge infrastructure stimulus in the trillions as discussed, but still that I think will cause incomes to go up. There's going to be a lot of money spent on a whole variety of infrastructure projects and money for salaries. I think valuations will continue up and cap rates will stay low.
Deidre Woollard: That makes sense. Last question for you Alan, what do you see as the goal for the future of CityVest?
Alan Donenfeld: We always want to improve the quality of our deals. Although staying true to our mission which is providing access to institutional real estate private equity funds for individual accredited investors. We will continue to provide that product to our core audience. I think that one thing that might change is our minimum investment in our funds, which right now is 25,000. It's likely to increase to 50,000 or 75,000 per investor. The amount that we will then have to invest in individual funds will likely go up to 7.5 or 10 million in each fund. We will continue to do deals on a deal-by-deal basis, where we find the best product in the market, the best nimble managers, providing out-sized returns. I think we will continue to do what we're doing. Maybe one of the changes for CityVest will be that we will have our own capital to provide liquidity to our investors. If we have a 5-8 year fund and an investor says in year four, or five, or six, that they need capital for any reason, health or any reason, our fund that we hope to put in place in the next year will provide that liquidity, will buy in the investor so that the stigma of real estate being an illiquid asset hopefully won't be much of an issue.
Deidre Woollard: Interesting. That made me want to ask one more question which is, in terms of CityVest and investing in different funds, do you recommend that your individual investors invest across a variety of different funds? How do you think about diversification?
Alan Donenfeld: Diversification is one of the top rules of investing. You don't want to be overweighted in any one asset, and so by the nature of our fund, typically these funds are in 8-15 different individual properties, so each fund itself is diversified. But I recommend to our investors who are saying, "Should I put in 25,000 or 50,000? I could do up to a 100." I say, "Put in 25,000." Dip your toe in the water, see what CityVest is like, do four different investments of 25,000 having a total of a 100,000, and being diversified not just in each fund across a number of assets, but by the exact strategy, and also geographically right now, we're in Los Angeles, our last fund before this was in Atlanta and Houston. We're looking at another fund that's in Texas, and Phoenix, and Denver, and so I recommend to be diversified by city and investment manager investing smaller amounts in multiple funds.
Deidre Woollard: Very, very smart. Thank you so much for your time today. A reminder to listeners, you can learn more at CityVest.com. Stay well and stay invested.
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