All Forum Posts by: Elijah Brown

A Recent History of Pooled Real Estate Investments

Investment in commercial real estate, and specifically the pooling of capital to acquire property has been around for thousands of years. In the United States, it became less popular because the Securities Act of 1933 made public solicitation of investments illegal unless registered and restricted under the Securities and Exchange Commission (SEC).

President Franklin D. Roosevelt Signs The Securities Act of 1933

With a much smaller network of potential investors to fund deals, syndicators relied on tax benefits to convince high-net-worth individuals (HNWI) and institutions to participate. For decades, U.S. tax laws allowed investors to depreciate properties over a very short period, resulting in high amounts of negative taxable income. This major benefit was sold to investors on a forward-basis, which made raising capital easy.

However, lawmakers passed the Tax Reform Act of 1986, which extended depreciation schedules and once again reduced a major source of equity for real estate projects. Additionally, lenders reduced available leverage, which further increased the need for equity financing.

President Ronald Reagan Signs the Tax Reform Act of 1986

Smart entrepreneurs like Sam Zell formed private equity funds to raise capital for commercial transactions, and in 2012, the Jumpstart Our Business Startups (JOBS) Act introduced multiple changes to SEC regulations that allowed public solicitation to specific investors.

Samuel Zell, Founder and Chairman of Equity Group Investments

Yet, access to most commercial real estate investment is still dominated by large institutional investors and UHNW individuals with the capital and connections needed to participate in these opportunities. U.S. Real Estate Investment Trusts (REITS) have been around since 1960 to give public market investors access to income-producing real estate, but these vehicles only give exposure to real estate without depreciation benefits or direct ownership.

Fractional Ownership at Scale

The latest development in the industry is the tokenization of equity in real estate deals, a process that is revolutionizing the way real estate assets are bought, sold, and managed. Fractional ownership, made possible by tokenization, allows investors to purchase and own small portions of a real estate asset in the form of digital tokens stored on the blockchain. These tokens are governed by smart contracts, which automate the management and distribution of revenue generated by the asset. Companies like InvestaX and RealT offer services for this.

The tokenization of equity in real estate deals is ushering in a new era of democratization and decentralization in the commercial real estate world. With the ability to break down real estate assets into smaller, more accessible units and sell them as tokens on blockchain platforms, true public ownership is now possible. This not only provides a more efficient and cost-effective way to raise capital, but it also increases accessibility to real estate investment for the average person.

Decentralization is an Illusion

The shift toward fractional ownership in the real estate industry has brought about the potential for decentralization through the tokenization of equity. However, this decentralization may not necessarily result in a more equitable distribution of ownership:

-Large institutional investors now have access to the market and can accumulate significant control, potentially diminishing the democratization that tokenization aimed to achieve.

-Due to the impracticality of giving every small shareholder a seat at the decision-making table, only a limited number of decisions will be available to shareholders. The power of decision-making will rest with the deal manager, typically a large institution.

-As equity liquidity increases, the negotiating power of shareholders will decrease. Management fees and profit splits favoring the manager will increase, which will reduce investor returns.

-Increased liquidity will make real estate markets more efficient, which will significantly reduce the potential for acquiring assets below intrinsic value. Shareholders will get to participate in cash flows, but may see less probability of equity upside.

-The best deals will not be tokenized. They will be quickly acquired by larger and more sophisticated investors and not offered to the public.

The decentralization of ownership through tokenization may paradoxically lead to a concentration of ownership, control, and profits in the hands of large institutional investors, and will lower return rates for shareholders.

My Prediction

BlackRock headquarters - the world's largest asset manager, with $10 trillion in assets under management

Final Thoughts

While tokenization is not inherently flawed, it is important to acknowledge the potential unintended consequences of adding liquidity to real estate. To avoid undermining the democratization of real estate ownership, a combination of technological solutions (smart contracts, decentralized autonomous organizations (DAOs), and regulatory frameworks that ensure a level playing field for all participants) would be necessary.

However, I don’t think even the most restrictive of regulations could stop the concentration of ownership by large entities. As we navigate this new paradigm, it's important to be aware of the possibility that the "decentralization" may not necessarily lead to a more equitable distribution of ownership.

I personally would not invest in a highly restrictive market like you find in the PNW. However, those restrictions ensure that there will be very little development, and when there is little development, the supply problem becomes way worse.... the net effect is an increase in values. You give up some income in exchange for higher property values. Obviously this doesn't always hold true when everyone wants to move away from that area, but there is a reason why some of these restrictive markets have the highest property values.

@Account Closed I think you missed my point here and it seems you didn't read my article. I specifically said rent control and government restriction DOES NOT WORK. I am not a fan of lots of government intervention. What I'm saying here is that building more units of housing needs to be more profitable for investors. One way to do this is by incentivizing investors.

No one wants to invest in the locations you listed above. The liberals running those cities and states have ensured the problem will get way worse. Those leaders aren't looking for viable solutions to the affordable housing issue.

@Caroline Gerardo I love the recommendations and I agree with what you said. Thanks for contributing!

@Account Closed I think the government needs to provide more incentives to real estate investors instead of free handouts. Social programs don't work. The only thing that will really solve this problem is increasing the supply of units to meet the demand. Investors won't build units unless it is profitable to do so. 

@Tim J. lol No. Good idea though!

@Account Closed Can you be more specific? I'm not sure I'm following your argument here....it's a bit confusing.

What did I recommend that Russia did that failed?

Do you not think the lack of affordable housing is a crisis?

I agree that people need to move where their skills and talents allow them to thrive.... at the same time, we can find ways to ensure more people can stay in the cities they've lived in for generations by making affordable housing more profitable for investors.

Why I'm Triggered

Every week I read stories on social media about someone’s unfortunate situation driven by the increasing cost of housing and wages that have not kept up….and I’m sick of it.

Part of me wants to message these individuals privately and offer words of financial advice and encourage a solution-based mindset rather than outcries of injustice. I have always been a believer in self-reliance and the mindless complaining and blaming is not productive.

…but then I think about John, the American hero who spends long hours driving an ambulance to provide for his family and make alimony payments to his ex-wife. I know that John may never be able to buy a home and may always be one accident away from bankruptcy.

The reality of our current position in the economic cycle is that home prices are high and mortgage rates are high enough to ensure someone like John may never qualify for the loan. Furthermore, rents are increasing at a much higher rate than his 3% annual wage increases. Eventually, John may have to move to a more affordable area, leaving behind his job, friends, and the community where he has lived for many years.

I’m not here to preach pity and argue the morality of raising rents. After all, my livelihood is based on buying multifamily real estate and renting units to working class Americans. Rents must be raised to keep up with the inflation of expenses and provide a minimum return on investment for shareholders. I have always been a proponent of free market solutions to real world problems and there is no emotion involved in the calculation of economic equilibrium.

John’s situation is a reminder that the hardworking people who service America will increasingly struggle to afford life’s basic necessity of shelter, and this reality has second and third order economic effects that reach far beyond John.

How This Dumpster Fire Happened

The root cause of the housing crisis is a lack of new construction, coupled with rising housing costs (home prices, interest rates, and rents) and stagnant wage growth. The lack of available land for development, and several regulatory barriers that make it more difficult and expensive to build new housing, are the main reasons behind the shortage. This has led to skyrocketing housing costs, and a widening gap between the cost of housing and median incomes.

So What?

The consequences of the affordable housing crisis are dire and wide-ranging.

• Businesses will struggle to attract and retain employees, which leads to reduced productivity and economic growth.
• Reduced purchasing power of low and middle-income families will reduce consumer demand and lead to economic stagnation.

I believe in the power of the market to drive productivity. There is a supply problem and we need to take a market-based approach to solving it. We must increase the supply of affordable housing units, and remove regulatory barriers that are preventing the construction of new housing.

This is not a problem we can afford to ignore because it threatens the economic well-being of our nation. It's not just the right thing to do, it's also a smart economic move.

We Can Make a Dent!

There are several steps that can be taken to address the affordable housing crisis without increasing restrictions such as rent control or providing additional free handouts. Forcing investors to create affordable housing will never work because there will always be a more profitable investment elsewhere. Additionally, social programs are expensive, often abused, and can kill ambition.

Instead, the solution to this problem must make investment in affordable housing more profitable. Similar to how pets are trained, humans respond positively to incentive-based conditioning, and negatively to punishment.

Steps Toward Progress

Here are 11 steps that could result in a significant increase of affordable housing units:

1. 1. Increase funding for affordable housing programs such as the Low-Income Housing Tax Credit (LIHTC) and Community Development Block Grants (CDBG) to build and rehabilitate more units.
2. 2. Introduce more local incentives such as density bonuses, reduced permitting fees, and streamlined approval processes to developers who build affordable housing units.
3. 3. Offer surplus government-owned land to investors at a low cost for the construction of affordable housing units.
4. 4. Form Joint Ventures (JVs) between governments and investors to build and finance affordable housing projects.
5. 5. Expand Housing Trust Funds (HTFs) to provide grants, loans, tax credits, and other forms of financial assistance for affordable housing.
6. 6. Encourage the development of micro-units and accessory dwelling units (ADUs), which can be more affordable for low-income renters and can be built in existing neighborhoods, rather than requiring the construction of new developments.
7. 7. Change local zoning and land use policies to allow for a greater density of housing units, making it easier and more financially viable for developers to build affordable housing.
8. 8. Offer tax relief to landlords who agree to rent units at below-market rates to low-income tenants, making it more financially viable for them to do so.
9. 9. Establish more government-sponsored loans for acquisition and construction of affordable housing units, which can be offered to real estate investors with better terms than traditional financing.
10. 10. Promote the use of modular and prefabricated building techniques, which can help to reduce the cost of building new housing units and can make it easier to build in difficult or remote locations.
11. 11. Re-purpose existing asset classes to affordable housing. 30% of office buildings can be converted into housing....and can make cities more affordable, more equitable, safer, and more fun.

Final Thoughts

The affordable housing crisis is a multifaceted problem that is affecting people from all walks of life. The root cause is a lack of new construction, coupled with rising housing costs and stagnant wage growth. It is crucial for our society's stability and economic prosperity that we take urgent action to solve this crisis.

Instead of using restrictive measures such as rent control or providing additional handouts, a market-based approach should be taken to increase the supply of affordable housing units and remove regulatory barriers preventing the construction of new housing.

If you know of any additional steps that can be taken to solve the affordable housing crisis, add them in the comments section below!

If you have any questions, please leave them in the comments section.

Thank you @Devin James!

@Nicole Heasley Beitenman Wow, that means so much to me. Thank you Nicole!!