My last update letter came in the wake of the Presidential election and addressed, in some small way, what lay ahead, while recognizing the fundamental limitations of forecasting. Broader social and political issues aside, the short term economic picture has remained surprisingly steady. Economic indicators like growth and employment have neither spiked nor nose-dived; interest rates appear set to continue the gradual increase outlined by the Fed; and, perhaps most surprisingly, the public markets are again hitting record highs. This stands in stark contrast to the wave of truly fundamental reforms being pushed by President Trump and the Republican party. This seeming lack of correlation between political and economic activity speaks to the fact that, though related, these two key vectors of American life frequently move on different timelines. While the public markets are quick to react to political and regulatory changes, their true effects are far less predictable and have far deeper and long dated ripples.
This same complex relationship is seen in the long tail impact of innovation on the economy (and culture). Innovations are frequently heralded (or scorned) at their outset and, once the fanfare starts to fade, go through the real work of widespread adoption and transformation. This phenomenon has been playing out, ever so slowly, in the retail sector for close to two decades. During the first internet boom of the late ‘90s and early ‘00s e-commerce was born and the internetization of retail (and the world) was widely predicted. What happened? Well, a lot of things, but ultimately the new economics of e-commerce didn’t work yet. The efficiencies of software and online ordering weren’t strong enough to overcome the wall of advantages held by traditional retailers. In 2001 the dot.com bubble burst, leaving a trail of early internet darlings in its wake. Amazon, a company that began by selling actual physical books of all things, survived and gradually began expanding. Fifteen years after the bubble burst, Amazon looks more like an infrastructure company than an online bookstore – not only is it putting pressure on a huge range of traditional retailers, it’s quieter business line, Amazon Web Services, has become one of the backbones of the internet and its recent foray into home automation positions it to integrate even more deeply in our lives. Amazon is now not only realizing the takeover of retail by e-commerce that was predicted two decades ago, it’s expanded in ways that not even Jeff Bezos could have dreamed back when he was selling books.
Bill Gates, arguably history’s most successful entrepreneur by any measure, famously said: “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.”
The physical world of real estate moves more slowly than Gates’ realm of technological innovation but the point is nonetheless valid and applicable. Most real estate investments simply aren’t long dated enough to suffer (or benefit) from fundamental changes in the way the world works. Even thinking about the world of retail, where the change is already well underway, we should be careful not to overestimate how different the world will look in the next few years – remember, Amazon is stepping down from the cloud and into the world of brick and mortar locations. While there is an inevitability at this point to the growth of e-commerce and decline of brick and mortar retail, our view is physical shopping isn’t going away overnight and certain segments of the market are better insulated than others. Blackstone is still buying grocery-anchored and power centers, though the speed of acquisition doesn’t appear as fast as a few years ago. Dense urban markets that offer retailers consistent foot traffic are feeling the pressure, but better positioned to sustain value. Retail will, ultimately, need to innovate to remain successful. Historically, real estate has not been the most innovative industry but for those firms that are forward thinking, the shift in retail will prove to be a tremendous opportunity.
As we look out into 2017 and beyond, we’ll certainly be wary of traditional retail based strategies, particularly outside of urban markets. However, we won’t be scared off of projects with retail components, particularly shorter term projects given that things change slower than we think. We’ll also be on the look-out for Sponsors who figure out how to use this shift in consumer behavior in their favor, rather than pretend it doesn’t exist.
Let me shift to providing a more specific update on EquityMultiple. We’re excited about the progress we’ve made since my last letter – we’ve seen growth in all aspects of the business and our cash-flowing projects have been producing strong average returns to investors (more than 9% net). Below is more detailed look at our transactions, investment growth, investment performance and product development.
Overall commercial real estate transaction volume was down significantly in 2016 compared to its high-water mark in 2015. There are several factors expected to drive total volume down further in 2017, including political uncertainty, raising interest rates and reduced capital outflow from China. While overall transaction volume is expected to decline, some economists are expecting an increase in middle market transaction activity, where some of the factors constraining institutional investment aren’t as relevant. EquityMultiple is focused squarely on the middle market, and the relative consistency of that portion of the market – combined with our growing origination capability – should help us continue to grow transaction volume. Marious Sjulsen, our Chief Investment Officer, remains committed to a quality-over-quantity approach and two to four investments per month will be our cadence in the near term.
Investors who have been with us for a while have likely noticed the increased speed with which our investments are funding. For both our recent Saratoga Springs loan and the Los Angeles condo conversion, our original allocations were fully subscribed in less than 24 hours. In both cases, we were able to go back to the lender/sponsor on those projects and increase our position in the deals so that additional investors could invest. This solution won’t always be available so we’ve established a pre-launch program to afford select investors early access. The program is currently open to our repeat investors, investors who have referred their friends, family and colleagues and a select group of other investors. If you’re interested in learning more, please ask. This is a program we plan to continue to develop over time so stay tuned for updates. Speaking of investor referrals, we’ve seen a significant increase in recent months and we’re very grateful for that. If you’re considering referring someone and have questions about our program, please reach out.
Transparency is a word that we use frequently at EquityMultiple. We believe it’s one of our core value propositions to investors and something we can help spread as a norm in the real estate industry as we grow. It radiates through all aspects of our business but, understandably, the area where we get the most inquiries is on deal performance. We break this down into two areas – the information investors receive about their investments (reporting) and the information we provide about EquityMultiple deal performance overall (track record). Improving our reporting is a big focus for our team over the rest of 2017 and I’ll address that more in the product development section below. For track record, the ultimate goal is to publicly provide ongoing performance information on each project. There are, unfortunately, complexities to doing so, caused by confidentiality obligations and industry expectations. What we can provide right now is aggregated performance information across all our closed deals. The next step will likely be anonymized project specific performance.
Of the 24 projects we’ve been involved with to date, 12 of them are either cash-flowing to investors or have been fully repaid. The other projects fall into three camps: 1) equity investments with value-add business plans that take time to implement; 2) ground-up condo developments (two projects) where there will be no cash flow until sale; 3) deals that are closing or were very recently closed. Over time, we expect the ratio of cash-flowing projects to total projects to increase, as we increasingly prioritize immediate or short-term cash flow and as early projects finish the value-add phase of their business plan.
Here are some key stats on overall deal performance across EquityMultiple deals through the end of Q1 2017:
- Annualized yield for cash-flowing/realized projects (gross): 9.96%*
- Annualized yield for cash-flowing/realized projects (net): 9.05%*
- Projects completed (principal returned): 3
- Projects running more than one quarter behind schedule: 2
- Projects in default: 0
- Loss of principal: $0
While we of course hope that all the deals we’re involved in go smoothly, there will inevitably be some bumps in the road. Currently we have two projects we classify as underperforming, either as a result of delay (more than one quarter) or substantial deviation from pro forma projections. For the first project, the substantial delay is the result of an extended construction timeline. Many factors have played into the delay, including enlarging the scope (and increasing rent), unforeseen construction requirements related to the physical condition of the property and significant delays in the tenant portion of construction. The project is slated to open this summer and appears poised for success despite the delay. The other underperforming project is a very different issue – the project was cash-flowing to investors but missed an anticipated distribution in Q4 ‘16 and is delayed on the Q1 ‘17 distribution as the Sponsors try to wrap up a refinance. The refinance is expected to go through this month and help get the project back on track, both in terms of the missed/delayed distributions and in terms of cash management and project flexibility going forward.
You may have noticed a number of small improvements to the platform over the last few months. Among other things, we recently released improvements to both the account creation and investment “checkout” process, reducing the time and effort involved to finalize an investment. We also upgraded our ACH processing so that money transfers happen more quickly, both for sending and receiving investor funds. Many of these updates improve the mechanical aspects of investing – a quick and easy process isn’t something you’re likely to notice but that’s exactly the point. After this period of maintenance and bug fixing our tech team, led by CTO Peter Shankar, is excited to begin rolling out improvements that are more obvious to investors.
Improvements to our asset management and portfolio level reporting are the next big items on the technology roadmap. Investors typically receive updates on their investments at least quarterly. This is largely done by email at the moment but we have exciting plans to move all of this reporting online so investors have a clear record of all their updates. We’re also working on simple updates to the Portfolio page, so that key payment information and return metrics are more visible for your existing investments. Transparency and ease of use are again guiding principles here so we encourage you to reach out directly to Peter (firstname.lastname@example.org) with any thoughts or suggestions.
We’re excited to continue building EquityMultiple and couldn’t do it without investors like you. If you’ve invested with us before you already know that our team is always available by phone or email and we truly appreciate your thoughts and questions.
Co-Founder & CEO | EQUITYMULTIPLE
Legal Information and Disclosures
*Average returns reflect non-weighted average.
This memorandum expresses the views of the author as of the date indicated and such views are subject to change without notice. EquityMultiple has no duty or obligation to update the information contained herein. Further, EquityMultiple makes no representation, and it should not be assumed, that past investment performance is an indication of future results. These materials contain projections and other forward-looking statements. Any statements that are not historical facts are forward-looking statements that involve risks and are inherently uncertain. Moreover, wherever there is the potential for profit there is also the possibility of loss.
This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Equity Multiple, Inc. (“EquityMultiple”) believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.
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