When it comes to real estate, the old adage is “location, location, location.”
With the rise of real estate investing platforms, it’s now easier to diversify your portfolio geographically.
What’s a little harder to do is diversify it based on the asset class. With publicly-traded REITs, you often get a sizable allocation of commercial property – malls, storage facilities, medical parks, etc. American Tower (NYSE: AMT), one of the largest REITs, is concentrated in commercial sites (cell phone towers). Prologis (NYSE: PLD) owns logistics facilities to facilitate the global supply chain.
What if you wanted to go to the other end? Residential?
That’s where a firm like DiversyFund comes in. They’ve identified an underserved niche – multifamily real estate.
Table of Contents
- Who is DiversyFund?
- How Does DiversyFund Work?
- DiversyFund Fees
- DiversyFund Taxes
- DiversyFund Risks
- Value-Add Investment Cycle
- Local Real Estate Market Risk
- Illiquid Investment Period
- Lack of Diversification
- DiversyFund vs. Fundrise
- DiversyFund vs. RealtyMogul
- Who Should Invest with DiversyFund?
- Is DiversyFund For You?
- DiversyFund Pros & Cons
Who is DiversyFund?
DiversyFund was founded in 2016 by Craig Cecilio and Alan Lewis, two experienced real estate investing professionals, and began offering a real estate investment trust after being qualified by the SEC in November of 2018.
They offer one fund, their Growth REIT, and it invests in multifamily real estate (apartment buildings) with a size of at least a hundred units across the United States. They aim to get an internal rate of return of 10%-20% with a value-add cycle of about five years.
The strategy is not novel. I’ve personally invested in a private REIT that invests in apartment complexes with the same strategy. As leases end, the operator renovates them and charges higher rents to the new tenants. As the complex turns over, the property is improved, rents are increased, and the value of the investment grows.
They are also vertically integrated, which means they do everything in-house. This will come into play later when we talk about fees.
How Does DiversyFund Work?
DiversyFund is pretty straightforward – you have one option (Growth REIT). No choices, just a single fund, pretty simple.
DiversyFund has a $500 account minimum and you do not need to be an accredited investor to invest, since you’ll be investing in a fund and not an individual property.
You can invest as an individual, joint, entity, or through a trust. As an individual, you need to be 18 or older, have a Social Security Number, a legal U.S. residential address, and be a U.S. citizen, permanent resident, or have a valid U.S. visa. Pretty standard stuff.
Your returns are based on when the properties are sold, which they anticipate will be near the end of 2023. When they sell the properties, you will get your principal investment back plus a 7% preferred return. This return is paid before the company earns anything. The remaining profits (if there are any), are paid on a schedule. Investors get 65% of the profits until they reach a 12% annual rate of return, then the remaining profits are divided 50/50 between the investors and company.
What is a Preferred Return?
A preferred return relates to the order in which money is distributed to investors.
The DiversyFund Growth REIT offers a preferred return of 7% of the invested capital from the operating cash flow. Which means that the first money paid is to the investors until they get a 7% return.
After that, investors can then collect 65% of any remaining cashflow after the REIT sponsor collects a catch-up contribution. Investors can earn an annual return of up to 12%.
While a preferred return isn’t guaranteed during a bad investment year, investors can calculate their long-term investment income.
How to Sell Your Shares
One difference between a crowdfunded real estate REIT and a publicly-traded REIT that trades on the stock market is liquidity. Investors can trade public REITs by buying today and selling tomorrow penalty-free.
However, it can take several years to redeem your DiversyFund shares. Most investors will have to wait until the REIT fund manager decides to close the fund and liquidate the shares. The estimated liquidation date is at the end of 2023.
It’s also possible for investors to sell their share early but making a sale isn’t guaranteed. Investors must notify the fund manager about their desire to sell shares. The fund manager has the first right of refusal. Investors may also be able to transfer shares to another investor.
If the multifamily real estate market plummets or many investors want to sell, DiversyFund may refuse to buy back any shares. Due to the open-ended investment horizon, it’s wise to only invest cash that you don’t need until several years down the road.
DiversyFund says that it doesn’t charge you fees, which is truthful, but not the full picture. They do not charge a management fee on the fund.
Whenever you have multiple entities involved, fees are assessed at different stages. With real estate, you have various entities like the fund, the developer, and the sponsor. As you’d expect, everyone needs to be paid so the fund may be charged fees by the developer, property manager, etc. Since DiversyFund is vertically integrated, the fund is paying “itself,” in a sense.
The fund may not charge investors a fund management fee, but there are monthly/annual as well as transaction-based fees being paid for by the fund. So indirectly, there are fees (there are always fees).
If you review the Growth REIT circular, you’ll see that the section for fees is quite extensive. It includes an asset management fee as well as a sizable developer fee. Each month, a small percentage is taken out to pay management.
These types of fees are common. The question is whether you believe them to be too high (or low) – that you have to decide for yourself.
Since you are invested in a fund, you get a Form 1099-DIV at the end of the year. If, and when, they liquidate the REIT, you will still get a 1099 but it’ll be treated as capital gains.
This highlights one advantage of funds vs. individual ownership. When I bought a fractional share of a property via RealtyShares (now defunct), I became a limited partner in a partnership that owned the property. Every year, I received a Form K-1. On its own, not a big deal. But this also meant that I needed to file taxes in another state. As a Maryland resident, I don’t normally file a North Carolina tax return… until I received a K-1 from a partnership based in North Carolina. 🙂
Another Form 1099-DIV is no big deal, it doesn’t change how you file your taxes.
Assessing investment risks for any potential investment is part of performing your due diligence. While you can make money with DiversyFund, this platform isn’t exactly a low-risk investment.
Value-Add Investment Cycle
It’s possible to earn more by investing with DiversyFund than similar REITs you can buy through your online broker. But the vertical integration of their services is a bit worrisome.
There are multiple stages to the investment process:
- Capital raise: Open funding round to collect capital and purchase properties
- Acquisition: Purchase qualifying investment properties
- Renovation: Repair and improve existing properties to add potential value
- Appreciation: Allow time for the property value to increase after renovations
- Disposition: Sell properties and distribute profits to investors
The offering circular originally launched the Growth REIT as a “blind pool” offering without any existing benefits or identified projects. There are now several featured projects that give investors an idea of what the fund invests in.
Initially, the annualized investment returns can be lower than expected due to the upfront costs of acquisition and repairs. Yet investment returns can increase if the property managers can increase rent and ultimately sell a property for a profit.
Relying on property appreciation may not be ideal if you want a steady dividend income. Investors can receive them through the monthly rental payments from tenants. It can also be difficult to estimate the potential total investment returns.
As the minimum investment period is five years, property values can be somewhat difficult to predict. A lot can happen to a local real estate market in a half-decade. Profit isn’t a guarantee. Sometimes, improving a property and waiting to sell for a profit takes longer than expected or doesn’t happen at all.
Local Real Estate Market Risk
As an asset class, multifamily real estate can be a great long-term investment to build wealth. But there are investment failures. DiversyFund rewards investors with profit by issuing dividends from monthly rental income and selling properties for a profit.
However, several factors can reduce property values:
- Changes in the local economy and real estate market
- Competition from existing properties and new construction
- Zoning law changes
- Fire, floods and other casualties
- Uninsured losses
DiversyFund strives to mitigate risk by investing in markets with strong job growth, a growing population, and below-average vacancy rates.
Cost overruns, unexpected repairs, and future borrowing can also increase the investment cost basis. Investors will most likely lose money if a property sells for a loss – or fails.
Unlike FDIC-insured savings accounts and certificates of deposit, investors cannot recoup their lost investment balance.
Illiquid Investment Period
The DiversyFund Growth REIT is a “public non-traded REIT” without a secondary market. You cannot sell your DiversyFund shares like stocks and ETFs to raise cash quickly.
There is a multi-year investment period and DiversyFund liquidates the shares when the REIT liquidates. The liquidation date is open-ended and investors can either reinvest the shares into another offering or cash out.
Some of the first investors that purchased shares in 2018 when the REIT launched will invest for approximately five years. The current planned liquidation date is at the end of 2023.
Investors can offer to sell their shares to the manager. However, the manager can refuse to buy back the shares. Shares sold six months after the purchase date sell for 90% of the fair market value. Transferring shares to another buyer is possible under select circumstances.
Lack of Diversification
The DiversyFund Growth REIT offering circular states that most of the investment properties will likely be in the southern California market. The sponsor is most familiar with this local market which can reduce investment risk.
However, the Growth REIT may not be a good option when you don’t want exposure to California real estate. REITs with a nationwide portfolio have more natural diversification.
DiversyFund vs. Fundrise
The closest competitor to DiversyFund is Fundrise, which offers three account levels – Starter ($10 minimum), Basic ($1,000), Core ($1,000 min), Advanced ($10,000 min), and Premium ($100,000 min).
With Starter, you can get into an eREIT. With Starter, you can get into an eREIT that invests in commercial, multifamily, and single-family properties. You can earn quarterly dividends.
With Core, you can select the investments you want (Balanced Investing, Supplemental Income, Long-Term Growth), and auto-investment is included.
As you move up the plans, you can start adding individual properties as well as access to additional funds.
Fundrise charges a 0.15% annual investment advisory fee (that can be waived under certain circumstances, such as when you invite another investor) and is similarly illiquid.
You can read our full Fundrise review for more.
DiversyFund vs. RealtyMogul
RealtyMogul is another top alternative to DiversyFund and can be a better option for accredited investors. The high net worth investor can invest in individual “Private Placement” offerings and 1031 exchanges. Investing in handpicked offerings provides more control in the investment process and may have higher potential income.
Non-accredited investors can invest in two different REITs. Each REIT has a $5,000 minimum investment but has a different investment strategy.
MogulREIT I can be more risk-averse and focuses on debt offerings to earn monthly dividends from rental income in commercial real estate. The annualized post-fees distribution yield is 6.0% APY.
MogulREIT II is similar to the DiversyFund Growth REIT by investing in multifamily properties. One difference is that the RealtyMogul portfolio can have a wider nationwide footprint. Most of the properties are in the southern and eastern United States. This REIT has an annualized 4.5% annual return and can earn more when properties sell for a profit.
The asset management fees can be up to 1.25% of the equity value. This ongoing fee can be higher than what DiversyFund charges. But you will also need to compare the other incidental fees such as the costs to acquire or sell properties.
Who Should Invest with DiversyFund?
Investors that want exposure to multifamily real estate in southern California with a five-year investment horizon should consider DiversyFund. It’s possible to earn annual returns that compete with the historical average annual return of the S&P 500.
DiversyFund isn’t risk-free but earning investment income can be less volatile than investing in real estate stocks. The $500 investment minimum and the ability for non-accredited investors to invest makes it easy for anyone to directly invest in real estate.
Is DiversyFund For You?
If you’ve wanted to invest in multifamily real estate, this is one of the better options to consider. Since they only offer one investment option, the question is whether you are comfortable with their fee structure.
High Investment Fees
When I compared it with my private investment, DiversyFund rates seemed high. My private investment charges a 2% property management fee, but it was assessed on the rents collected. This is similar to the monthly fee listed in the SEC filing (though based on my reading, that fee is assessed on the investor’s capital account). This review by Motley Fool was not a fan of DiversyFund because of their limited track record, higher than average fees, and several other items.
One, less obvious, area that Motley Fool keyed in on was that of the return structure. DiversyFund offers 7% preferred and then a 65/35 split of the profits up to 12% annually. There’s also a catch-up, via Promoted Interest. Motley Fool said that 80/20 or 75/25 (with no catch up) is more typical.
In my private deal, I got an 8% preferred return with a 70/30 split with no catch-up or any step down in the split based on return.
Alternatively, if you simply want to get into real estate and aren’t sold on multifamily as an asset class, there are plenty of other ways to invest in real estate. You can go with the real estate crowdfunding platforms or keep it simple and pick a publicly-traded REIT.
DiversyFund Pros & Cons
- $500 investment minimum
- Invest in multifamily investment properties with multiple tenants
- 7% preferred return
- Can be less volatile than publicly-traded REITs
- Investors don’t have to manage properties
- Multi-year investment commitment
- Property values may not appreciate
- Fees are higher than other investment options
- Small investment portfolio
- No private placements for accredited investors
- Narrowly focused geographically
DiversyFund makes it easy for investors to start investing in multifamily real estate. With a minimum $500 investment, many investors can afford to open a small position and diversify their portfolio. If you want to invest in alternative assets, DiversyFund can be a rewarding long-term idea if you’re comfortable with crowdfunded real estate REITs.