At RealtyShares, we take risk seriously.
Before an investment opportunity appears on our platform, it must undergo a rigorous, five-part vetting process. Still, there are risks associated with real estate investing that we cannot control. It’s never pleasant to contemplate the idea of nonpayment or foreclosure, but these situations do occur.
Here’s the good news. In the event that one of your investments underperforms, we will work on your behalf to achieve the best possible outcome. That’s because we don’t disappear after the deal is done. We are here to see it through.
Balancing Risk and Return Objectives
As a general rule, investors accept higher levels of risk in exchange for potentially higher return objectives. The less risky the investment type, the less likely that losses will be incurred in downside situations. For example, senior debt stands first in line to be repaid, so it is the least risky position in the capital stack (article continues below).
Every deal is different. When something goes awry with one of our investments, our Asset Management team follows a structured workout plan with the goal of recouping capital for our investors. Different investments call for different approaches. Let’s look at the ones we follow.
RealtyShares offers three types of debt products: first-lien, second-lien and mezzanine debt. Both first- and second-lien debt are secured by the property; mezzanine debt is not. Regardless of the type of debt, we follow the same process when both principal and interest payments become late.
If the Borrower fails to make a payment, our Servicing team reaches out via email. The borrower is informed that, after a short grace period, a late fee will be charged. Follow-up communications are pursued by Servicing for the next several weeks.
Here’s the good news. In the event that one of your investments underperforms, we will work on your behalf to achieve the best possible outcome.
After about three weeks, the loan is turned over to our Asset Management team. They order a title report and a broker price opinion (BPO) to ensure that there are no liens on the title, as well as to get a sense of the property’s current value. On approximately day 30, a default letter is sent and default interest begins to accrue.
After engaging with the sponsor, our Asset Management team corresponds with the borrower and determines whether the default is due to a temporary cash flow issue that seems likely to be resolved promptly. Asset Management also gauges the sponsor’s ability and desire to continue to support the debt. Based on this information, a full array of options is assessed. They include:
- Taking additional collateral in exchange for accruing interest
- Short sales
- Taking a deed-in-lieu of foreclosure
- Other potential loan modifications
- Foreclosure Proceedings
If the best option for the property involves foreclosure, all pertinent information is referred to a special servicer that can process foreclosures in all 50 states. The foreclosure process generally begins with a series of hearings and ends with the sale of the property.
For vacant properties, a site inspection is conducted to determine whether the property should be repaired or sold as-is. Vacant properties can typically be put on the market 30 to 60 days after they are foreclosed; there is usually some clean-up required, and a broker must be hired.
For properties that are occupied, local occupancy and eviction laws must be honored. After the property is vacated, we follow the same process that we use for vacant properties.
Our goal is to sell the property for more than the debt and interest owed, which would allow us to fully reimburse our investors. However, this is not always possible. Our success also depends on market conditions, competition, and the physical characteristics of the property—all of which are beyond our control. Selling the property for less than the total debt and interest has the potential to result in a full or partial loss of principal for our investors.
Preferred Equity Investments
Debt and preferred equity are very similar, and so is our approach to addressing late payments when it comes to these two investment types. The main difference is that preferred equity investments also have a “buy/sell” provision rather than the foreclosure right seen with secured loans.
In these cases, we send out a notice promptly after a missed payment. It offers the sponsor a short window of time in which to determine whether they wish to buy out the RealtyShares investment. We can also choose to offer them six months in which to sell the property, at which point they would then buy out the RealtyShares investment. If the sponsor has not sold the property within six months, we can take over the management of the partnership and sell the property ourselves.
While we follow a rigorous underwriting process, some investments will still underperform. In these cases, we will aggressively pursue your rights and safeguards to protect your investment.
Some third-party loan agreements have “change of control” language that cause a change of management done without the lender’s consent to be a default event under that loan. In such cases, we would need to negotiate with the lender. We have the choice of an immediate sale or, if we wish to perform minor improvements prior to the sale, another round of capital-raising.
We also recognize that there are circumstances like natural disasters that are completely outside of the sponsor’s control. In such cases, we offer a workout program to the sponsor that may involve a payment modification, an extension, or delaying or suspending payments for a short period.
Common Equity Investments
Common equity investments do not follow a set payment schedule. In these cases, distributions are provided based on the remaining cash flows after operating expenses and debt and other non-operating items (such as capital expenses) have been paid.
Provided there are positive cash flows, sponsors still have discretion as to whether to make distributions or to retain earnings (for example, to increase working capital reserves). That said, sponsors generally cannot take distributions for themselves until they have first paid investors their preferred return.
When it comes to common equity, there are no default mechanisms per se since we’re investing alongside the sponsor. There are sometimes investment “end” dates after which we can force a property sale to enable our exit from the investment; these are typically set a few years after the end of expected investment hold period.
What If I’m Not Getting My Quarterly Distributions?
According to our distribution structure, sponsors are incentivized to provide distributions to investors so that they can hit their IRR hurdles faster. If they are not providing distributions, typically there is a good reason.
If a sponsor choose to retain earnings to reinvest in the asset, then such investment could ultimately increase the value of the property. The sponsor may also choose to build reserves to cover for an increase in a liability not previously anticipated, thus avoiding a capital call. Conversely, if the sponsor retains earnings because of a lack of sufficient positive cash flows, the property may be suffering from poor operating performance.
In the latter case, we closely monitor the performance of the asset to determine whether the property can generate enough cash flow to cover its operations and debt obligations. When an asset is considered at risk of not making its payment obligations, we conduct site inspections and work with the sponsor to ensure that all measures are being taken to improve the outcome, including potential capital injections.
According to our distribution structure, sponsors are incentivized to provide distributions to investors. If they are not, typically there is a good reason.
With equity investments for which we hold more than 50 percent of the total equity ownership, we can in some situations take over the management of the asset upon a sponsor’s breach. As with preferred equity, some third party loan documents may have “change of control” language that would require lender consent in such cases.
For investments in which we hold a minority position, we would engage with the other equity holders to determine how to improve our ability to recover our investment. We might also try to sell our interest to another equity holder.
Common equity is thus the riskiest part of the capital stack. Because it stands last in line to be repaid, it is sometimes called “first loss” position. By the same token, it can also be the most profitable since, as a partner, investors share the potential appreciation of the property.
We’re Here to See It Through
Keep in mind that real estate investments involve risk and are not insured; as such, they run the risk of loss, including the loss of invested capital. Before investing, you should carefully review the offering materials and arrive at a realistic understanding of your own risk profile.
While RealtyShares follows a rigorous underwriting process and creates safeguards to protect investors, some investments will still underperform. In these cases, our team of experienced professionals will aggressively pursue your rights and safeguards to protect your investment.
In other words, we stand with you.