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Why 1031 Crowdfunding Is Launching its First Private REIT

The vehicle, with a specialty in assisted living and memory care properties, aims to eventually be accessible to both accredited and non-accredited investors.

As more and more investors, including non-accredited ones, express an interest in opportunities available in commercial real estate, private REITs can serve as a vehicle for them to gain exposure to the sector while avoiding the volatility of the stock market. 

The latest entrant into this arena is online real estate investing platform 1031 Crowdfunding. In early November, it launched Covenant Senior Housing REIT Inc., a non-listed, perpetual life private REIT that plans to invest in assisted living and memory care facilities nationally. At the time of the launch, the REIT owned two properties in Oregon and one in California. This week it closed on an additional property in Idaho. Its total asset value as of Nov. 9 was $51.25 million.

The REIT’s founders hope to attract both accredited and non-accredited investors to the vehicle—the company is currently in the early stages of initiating a Reg A+ offering. It is also developing an app to target the younger investor demographic—those in the 20- to 25-year-old range, according to Edward Fernandez, president and CEO of 1031 Crowdfunding. The investment minimum for Covenant Senior Housing REIT is currently $5,000.  

Fernandez aims to deliver investors 6% cash-on-cash returns while relying on a portfolio of stabilized properties in secondary markets with occupancy at 90% at higher. At the same time, the REIT plans to invest in assets that have no property-level issues, but may need a new operator, and foreclosed properties that have gone back to the banks in order to grow its share price.

Today, investing in the more labor-intensive seniors housing properties, such as assisted living and memory care, creates an opportunity to take advantage of the coming “silver tsunami” of baby boomers needing extensive care, while at the same time featuring more affordable cap rates, according to Fernandez. Covenant will only invest in assets at cap rates of 8% or higher, he noted.

According to a report from the National Center for Senior Housing & Care (NIC), seniors housing occupancy in the 31 markets NIC tracked reached 84.4% in the third quarter, an 80-basis-point increase from the second quarter. Occupancy levels at assisted living facilities specifically reached 82.6%, a 90-basis-point increase quarter-over-quarter. The organization forecasts that the seniors housing industry will reach or exceed its first quarter 2020 (pre-pandemic) occupancy levels as soon as next year.

In addition, NIC found that in the third quarter, for every 10 new units of seniors housing that were added to the national market, 28 units were absorbed, indicating that the demand for units was higher than the available supply. recently talked with Edward Fernandez about what was behind 1031 Crowdfunding’s decision to launch a REIT, the types of investors the company hopes to attract and Covenant’s three-tier investment strategy.

This Q&A has been edited for length, style and clarity. Can you talk a bit about your platform, 1031 Crowdfunding? Is it mainly for people who are doing 1031 exchanges?

Edward Fernandez: It’s not actually. We have several tabs on our platform. Right now, I think we have 80 different Delaware Statutory Trusts on our website and that is going to be for exchanges.

But on our non-exchange tabs we have REITs, we have partnerships, we have note programs, all in real estate. And in that tab, I think we have 30 different options.

And then we also have Opportunity Zone funds for those investors that are trying to defer taxes on personal property, and we have about 15 of those on our platform today.

Anyone who’s interested in real estate in a passive way, we provide it all. Do you work with RIAs and wealth advisors?

Edward Fernandez: We do. We have hired a couple of new employees in our capital markets group that are constantly creating relationships with the RIAs. We get a tremendous amount of phone calls from RIAs who want to utilize the exchange products, but are really not experts in that area. So, they utilize our professionalism and our expertise to help their clients put into a DST that will actually meet the requirements of the 1031 exchange, especially if those investors get tired of dealing with the tenants and the toilets and the trash. Those RIAs reach out to us so we could help their clients. How interested are they in the other offerings on your platform, including this new REIT?

Edward Fernandez: Because we can do it at Net Asset Value, meaning no commission, the RIA is more interested in a fee-based type structure and if we can actually provide the commission to the investor’s account, the RIAs like that. We get calls all the time from RIAs.

When they call us, we have to make sure they are not involved with a broker-dealer or FINRA-type registration, so that we can avoid the selling away. So, the first thing we do is we ask them about that. But most of the time, they are just registered investment advisors looking for opportunities for their investors. Why did you decide to go with a private REIT structure for your new vehicle? What were the advantages you saw in it?

Edward Fernandez: In my past career prior to starting my own company, we ended up doing two public non-private REITs. These are public offerings, but they were private REIT structure and the reason why is we don’t want to be subject to the volatility of the stock market. A public REIT you can buy today and sell three days from now. It acts more like an equity, so if there’s volatility in the stock market that means your REIT shares are going to act the same way.

If you go with a private REIT structure, the actual value of the share price is the underlying assets. That’s why we decided to go with a private REIT structure because a private REIT structure is a non-correlating asset to the equity markets and that’s what people are looking for today. Can you tell me what those REITs you worked on before were?

Edward Fernandez: There was one called Sentio and the other one was Summit Healthcare REIT. In the press release announcing the REIT, you said you were eager to reach accredited investors. How are you trying to make them aware of this opportunity?

Edward Fernandez: On our website, we built the brand over the years, and people know who we are. People constantly register to our site—we get anywhere from 500 to 800 new registrations a month. We currently have 80,000 registered members. It’s not difficult to let everybody know what we are doing. We also through publications are making people aware that we do have this REIT out on the street.

And seniors housing is becoming a lot more popular in today’s market. Especially because the real estate market really hasn’t softened much, the cap rates are still very strong. But in seniors housing, because there is a barrier to entry, you need to really know the business in order to take advantage of the opportunity, the cap rates are anywhere between 8% and 9%.

If I am buying at 8% or 9%, I can borrow money at 7.5% or 7.75% and still have positive leverage, when the other asset types that are still in the cap rates of anywhere between 6.0% and 7.0% can’t do that. That still allows us to borrow money and have positive cash flow. Do you have any partnerships with broker-dealers for this REIT?

Edward Fernandez: No, the broker/dealer channel is something that I come from, I’ve done that in the past. Our REITs that we did in the past also went through that distribution channel. And that distribution channel to me is a way to least equity. Unfortunately, if a deal goes bad, a broker/dealer community can decide whether they want to sign your next deal or not. For us, that’s just too much risk.

We have a tremendous amount of traction when it comes to investors directly. Number two, we are creating an app, we are in the middle of development, we are about 50% there. The app will allow the 20- to 25-year-olds to entertain the idea.

We are also doing a Reg A+ offering. We are starting on the initial parts of that Reg A offering, so that we can entertain non-accredited investors as well.

We’ve got a lot of things working right now that raising equity or getting investors to invest in our opportunities is not difficult to do. Can you talk more about why you decided to go with seniors housing as the sector you chose to invest in? I understand the properties that you are holding today include assisted living and nursing facilities?

Edward Fernandez: Yes, assisted living and memory care. Even though 1031 Crowdfunding come April will be 10 years old, we as a team have been doing seniors housing for 15 years and the two REITs that I mentioned were seniors housing.

Today, the reason why we go to seniors housing is we have tremendous amount of experience in that asset type, it’s a need-based property and everybody has been waiting for what’s called the silver tsunami. And that silver tsunami is going to hit in 2025, when every day 4,000 people will be turning 80 years old.

There is currently no construction going on in the seniors housing space, so the demand is going to outpace the supply and this is going to create tremendous opportunity for our shareholders. I have to ask—seniors housing had two major issues in the past couple of years. One was obviously COVID, when the sector was very hard-hit by the pandemic. And then even predating COVID, there were labor issues, it was hard for seniors housing operators to find labor and keep people on staff. Have you seen any kind of after-taste from that in investors’ response, are people still concerned about those things or have they been more or less put at the back of the mind?

Edward Fernandez: Now it’s back of the mind. When we were in the middle of the pandemic, it was something that never happened to any of us before. We were trying to figure things out and didn’t know what the local government was going to require. Some states were not as stringent as other states.

For example, in the state of Oregon, if residents were dying due to COVID, you could not replace the resident until all the residents and all the staff tested negative, and that was literally impossible to do. Other states, like California, didn’t require those things. Now that COVID is behind us, we are not where we were pre-COVID as far as occupancy is concerned, but the national average right now is about 84%. Our portfolio currently is about 89% occupied.

And in regards to the labor markets, yeah, it was very difficult. We had to use agencies to hire people, so for somebody we used to pay $20 an hour we were now paying $35 an hour for. But that’s starting to loosen up now because the Fed has been increasing interest rates dramatically and the next thing, unfortunately, for inflation to settled down at the target of 2.0%, the next thing that needs to happen is people need to lose their jobs.

We are starting to see that happen now, where the labor market is loosening up, we don’t have to use agency anymore and that means our operating expenses are coming down back to the normal place.

I think all the bad things that we experienced in the past three years are behind us. I think in 2024 we are going to see the labor market suffer a little bit more, unemployment is going to go up—it’s unfortunate for the people that are going to lose their jobs, that’s going to be a bad thing. For us, it’s going to be a good thing. I understand that for the REIT you have three different investment strategies—the stabilized product, the value-add and opportunistic. Can you tell me about how that’s going to work?

Edward Fernandez: The stabilized assets are something that’s 90% to 95% occupied, at a certain cap rate, that’s producing a tremendous amount of cash flow for the investors. Because the REIT, we are paying a 6% cash-on-cash return to the investors, so we have buy stabilized assets to make sure that the cash flow is going to be supported by funds from operations.

The opportunistic and the value-add approaches are going to be more to grow the share price. Because we have what’s called a floating NAV and next year, we’ll start doing appraisals on the properties and we’ll start giving notifications every 90 days of what the NAV share price is worth. In order to do that, opportunistic would be an asset that might be 60% occupied and there’s really nothing wrong with the asset, there’s a great geographic location, but we’ve realized that the operator is not a good operator. We would buy that asset, replace the operator and get that asset into the high 80s-90s% [occupancy] and that would create value in the share price.

As far as value-add is concerned, some of these individuals that we’ve hired have relationships with banks. Banks are starting to receive some of the assets on their books and they don’t want these assets on their books. They want to just get them off the books. A value-add opportunity would be something we would buy from a bank. It could be an empty building that was built for seniors housing and we would put an operator in that building, lease it up and also create value.

So, the opportunistic and the value-add strategy would be more to drive share price, the stabilized assets would be more to give you consistent cash flow. So just to reiterate—you are looking to provide shareholders with a 6% cash-on-cash return?

Edward Fernandez: Yes. And you are going to be providing NAV notifications every 90 days?

Edward Fernandez: Yes. NAV share price will start getting calculated a year from now. We will appraise all the properties, do one annual appraisal and that would drive NAV. So we are going to do a 10-year discounted cash flow analysis on the property and that will help determine what the share price would be. And we will notify investors every 90 days of the changes in the share price. I understand from what you’ve told me that you are not going to be an owner/operator for these properties. You are going to just be purchasing these properties and then getting an operator to come in?

Edward Fernandez: That’s the strategy today. But we had a meeting a couple of weeks ago with my team and we are now looking now into potentially becoming an operator.

Here’s why. If you get a really good operator and you have a great relationship with the operator, that works and there’s no need to change that. But you are subject to their performance, which leaves us out of control. And so it’s better for us, in my opinion, to maintain control. How do we maintain control? If we are the operator, we can control the expenses, the lease-up, it’s us who’s doing it, which just gives me more of a comfort level that the asset is going to perform for our investors.

Today, we have great operators. We use regional operators, I think right now we have eight relationships that we use. But that’s not to say that won’t change. We may go into the business if it is prudent and accretive to the investors and to the assets that we are currently owning and going to buy in the future. But that’s “To be continued.” How complicated is that transition from owner to owner/operator? This asset class is very labor-intensive, right?

Edward Fernandez: It is. We need to acquire the right people. It’s not something we want to try to learn, we can’t take that risk. But if we are able to acquire the right people to be part of our organization, which has a tremendous amount of experience in that area, we will actually become an operator and operate our own facilities. Right now, the REIT owns three properties in Oregon and California. Is that correct?

Edward Fernandez: Yes. We have two in Oregon and one in California. And we are closing on another one actually tomorrow in Boise, Idaho. How much are you planning to grow the portfolio and over what period of time?

Edward Fernandez: Over five years, $2 billion in seniors housing. You mentioned you are closing on a new property; I am not sure if you are in negotiations on anything else. Can you tell me what you are looking for in properties to acquire?

Edward Fernandez: We are looking for properties near hospitals, that’s very important for us. Number two, we are, for right now, going to only entertain what I would call “free states” instead of “controlled states.” “Free states” I would define as the local government and legislature allowing real estate owners to be in control of their own destinies, whereas in “controlled states,” local legislation at the stroke of a pen could dictate the outcome of an investment. We are going to stay away from those areas for right now.

We are looking for assets that are 80 units or greater, it minimizes the volatility of people passing away, so we don’t have a census issue. And we are looking for assisted living and memory care, that’s our bread and butter, more on the private payer side as far as the payer mix instead of reimbursements. We’ll take some reimbursements, maybe an 80/20 split—80% of it private paid, 20% reimbursement. Cap rates need to be above 8%, as far as the value of the real estate. How much leverage are you planning to use in your deals?

Edward Fernandez: About 60%, give or take. You mentioned assisted living and memory care are the types of properties you have experience with. But if you are going to invest in seniors housing, why did you decide not to go with 55 and older communities?

Edward Fernandez: It's the cap rate. Because 55 or older, independent living, the cap rates in independent living are 5.0% or 5.5% and institutions that were chasing multifamily are now chasing those assets. And independent living really doesn’t have a barrier to entry. It’s really just apartments for older people, that’s all it is. So, cap rates are very, very low and it’s very difficult to use leverage and create positive cash flow. As far as putting that in an Excel spreadsheet, some of those prices don’t work for us, especially if we are going to pay a 6% cash flow. Are you finding a lot on the market that you like? Is that a bit more challenging right now?

Edward Fernandez: We have plenty of inventory because of the banking relationships that we have. Some of these banks have assets on their books that they want to get rid of. Every time we’ve gone to acquire an asset, we have closed. We get a lot of off-market deals as well.

Inventory for us is not an issue. It’s just figuring out which ones we want to entertain and which ones we do not. Is there anything else that we maybe haven’t talked about, but you feel is important for people to keep in mind?

Edward Fernandez: We are just trying to provide an alternative to what’s out there for those investors that are looking for non-correlated assets.    

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