A Capital Idea
Rhys Phillips chats with Amar Nijjar, co-founder and CEO of R2 Capital and Investments, about the birth, growth and evolution of both his firm and Fintech.
What do you define as “Fintech for commercial real estate” and what are the services and products it provides? How does it differ from traditional services?
Fintech in commercial real estate comes in a couple of different forms. [In general] Fintech essentially means the application of digital technology applied to financial sector transactions. This includes, for example, investment flows, money management and disbursements. Wrapped into this is [Fintech for commercial real estate] that deals with the capital formation process connecting private capital and equity sources with property owners and developers who need capital to do their projects.
Traditionally, that capital formation process [for small and even medium-sized developers] has been very much about friends and family as investors because it has been very difficult to find potential new investors in the community willing to listen to the developer’s story and to become a broader source of investment capital. Alternatively, these developers have had to go through a huge and expensive marketing, educational and informational program [to access larger traditional capital sources like the banks]. Frankly, the way it has been done in the past often doesn’t work [for these smaller developers] because there has not been an online “Uber of commercial real estate capital” in the private investment space.
You had to tap the public market in Canada, that is go to the stock exchange and have a listing, have a prospectus and raise money with such tools as ETFs [exchange-traded fund]. On the one hand, these channels do not work for many private players because they do not have the scale or the interest to go public. On the other hand, potential private investors are not given the liquidity that they want or sheltering from the volatility of the public market that they see in the private capital markets.
On top of this, the layer that is extremely complicating is regulations and security laws which are really challenging on multiple fronts in Canada. The biggest challenge is we have 13 different provincial/territorial regulators who behave as if each is a different country and they don’t have harmonization. What B.C. allows, Ontario may not allow, for example. The fragmented regulatory regime is actually very restrictive in many ways for capital formation.
Certainly the concept of investor protection and regulation has to be there. However, the current way the regulatory framework in Canada operates with its lack of harmonization does not allow the online portals to achieve their potential for creating a full capital formation process. For example, the crowd funding exemption set up in Ontario a few years ago to really allow small-to-medium sized developers to tap into private capital has not been used; and, it has not been used because of the way it has been set up including marketing challenges and the amounts that can be raised.
The new Ford government has a “burden reduction” initiative on the go and they are asking the regulators to revisit that. What is going to happen over the next few years is some regulatory modernization leading to “reg-tech,” that is regulatory technology that allows regulators to let the Fintech platforms do what they can do. This will reduce the pressures on our companies to leave for those jurisdictions abroad that are friendlier.
If I am a small-to-medium size developer who needs $7-$8 million to build a low rise, versus Minto wanting to build another of their high-rises, what is the difference between the traditional model and the Fintech start-up platform in terms of getting the capital I need?
Large developers like the one you mention actually do not have a shortage of capital. They have access to the market where they have a four decade track record, significant family capital and access to large institutional relationships willing to deploy equity cheques of $100 million and up. A $7-million equity cheque is something that the pension funds are not that interested in. Even up to $30-40 million, projects have few ways to raise capital if they don’t have equity capital of their own.
The way it fundamentally works in capital markets is we set up a limited partnership. Typically these limited partners are $50-$100,000 investors all of whom are investors registered under the accredited investors exemption. Currently, the smaller developers cannot go to the public market for the large institutional investors because of the obstacles I have described. Their only realistic option is to tap into 20 to 30 accredited investors who can each put in $100,000 investments into a limited partnership. And that is where R2 comes into play.
We have over 60,000 investors for our newsletters, and we have about 2,600 registered investors on our platform seeking to learn more about these kinds of projects in their communities. R2 is a central, go-to-point as a conduit to bridge customers who want to partner with these kinds of developments and projects. We use tremendous data science — customer segmentation tools — based on net worth, income, wealth and their preference for certain kinds of projects and certain kinds of markets.
We have become a data company now where we aggregate that data in a meaningful way on our technology platform and showcase our developer deals in an educational, marketing technology format so that the customers are intrigued and want to respond to these property owners. There are 2,600 [potential investor] clients but tens of thousands more in the community who want to latch on, to learn more about what is going on in their communities and who potentially may invest in property development. So we have a platform that beautifully facilitates that.
What is the form of this investment? Is it in the form of mortgages or in the form of equity?
It is always in the form of equity through limited partnership units with a general partner who takes on all the developer’s risk and who also has skin in the game by retaining 10 to 20 per cent of the equity. The limited partners will enjoy strong returns without having to give loan guarantees, without having to be there to worry about the day-to-day construction management. The general partner does all that. Less used are preferred shares; same concept but a different legal arrangement. The syndicated mortgage [not restricted to accredited investors] is broken and it has been dismantled and will not be used anymore going forward.
What is the pivot R2 has just made in its approach?
R2 is now not about selling, which is what it was at the beginning. We have transitioned our business to being a conduit between suppliers and users of capital. We are not about the selling of investments but more about emphasizing our data and related capabilities. Our goal is to create a sort of wealth map of every interested real estate investor/client or even a colleague in Canada that wants to invest in a commercial real estate project. For example, we are doing advance level wealth or data mapping and cross checks against social media profiles. One of the things we are working on, for example, is if you have an iPhone and you go to certain kinds of restaurants, we are able to track that and we match this against data profiles available in the general market and on the internet — you travelled to certain kinds of markets, stayed at certain kinds of hotel — without knowing too much from a granular level to protect privacy. We are able subsequently to map that you have a higher propensity to invest in a certain type of project at a certain level amount. We are becoming a data company in the real estate scene that will then monetarize the data on our technology platform. We will be showcasing our platform most importantly to those development projects in Canada and the U.S. Investors can learn more and get comfortable with things like risk scores, walk scores, property scores, competitive area-based transactional analysis. This will provide the research and data to customers and then map their interests and propensities to invest into certain kinds of properties. We then seek to monetarize that data.
With this shift, where you are not selling securities anymore, where does R2 make its income, from where is your revenue stream coming?
Our income comes from the marketing and technology fee around our data services. We don’t make fees from selling investments or trade fees; we don’t act as a broker dealer anymore. That is a strategic shift we made in the last three months. We want to focus on our core competencies around this marketing technology and really around machine learning and AI. Over time, we will develop a platform that really focuses on matching the propensity of a customer to invest in a certain type of project with suitable projects. We have a marketing dashboard where investors interested in commercial real estate can come and see 40, 50 or 60 kinds of deals and they can interact in a very user friendly manner and express their desire to learn more about certain kinds of projects. That is the extent of it; and, then we work with other broker dealers or we will provide interested parties’ information to the developer. We introduce that individual and then the developer can work with that investor’s lawyer or a broker or a securities dealer to formalize the actual investment deal.
Who is your traditional competitor? Put another way, who are you disrupting?
It is the perhaps the large financial institutions and banks that we are in the long run planning to disrupt in a small way. Right now, in terms of private capital, the smaller guys don’t have the family or country club network. Or, if they do have a network, they tap out very quickly. So the only other choice they have is the Investment Industry Regulatory Organization of Canada (IIROC) financial advisor channel.
The only option they have is to go to Richardson GMP, Laurentian Bank Securities or Bank of Montreal Private Placement. Then these operations will sell it through their investment banking relationships to high net worth investors or investors in their funds. That is what we are partly disrupting because, as you can appreciate, the smaller developer can interact with investors directly. We are here to provide an excellent capital source, a channel that previously was provided only by the big banks, although sometimes they were just not interested because they don’t want to work on smaller equity raises. It was just not worth their time. They want to go after the big fish. They don’t make the kind of fees that they make on much larger deals.
Look at all the secondary towns in Ontario, the dilapidated malls that Zellers and Sears have vacated. These towns are becoming deserted. These retail centres need to be redeveloped but no bank, none of the traditional capital sources want to go there. They want to go to Toronto or other big cities. That’s fine, but from that perspective we can open a flow of capital where the community wants to invest in their own back yard.
We also work with a lot of clients who come to us and say they want to build a retirement home in their secondary or tertiary community on a small lake. But it’s only 15 units and they need only $4 million in equity capital. There is nowhere for them to go. Platforms like ours can help communities to rebuild and it can certainly help in larger towns and cities by helping smaller to medium-size developers access growth capital and create jobs because they now have the capital to do their projects. So our country is not just about 10 large developers and five banks; that is what it has become. If you look around in Canada, there are many oligopolies operating in the banking, financial, insurance, and real estate sectors. That is because we do not have a lobby for and the right calibre of innovation and entrepreneurship in the small to medium-sized development industry that should be the backbone of the country.
Does this investment model help a developer get in the ground more quickly?
For sure, because a developer can buy a piece of land which is relatively cheap but then has to spend upfront money on lawyers, accountants and architects. He has to go to the city [and] carry the mortgage on the land. All of that is capital. They can buy a $4 million piece of land with a mortgage, then still may need another $2 to $3 million to go through the process and set up a sales centre. And before setting up that sales centre, you need the Tarion warranty at $30-$50,000 per unit. You need to cover those costs and they are not cheap. Then you have to throw in the site servicing costs. Only once you have done that and have your sales centre in place can you go out and get your construction mortgage. You just cannot get there without the capital and this is where we come in and that is the bridge capital that we open up.
What do you see will be the penetration of CRE platforms in Canada which may be doing reasonably well but are behind the U.S. and the U.K.?
We are big time behind the U.K., big time behind Singapore and certainly behind the U.S. In many ways, we are the most conservative regulatory regime in the world. Our regulators take a lot of pride in avoiding the worst of the 2008 crisis, but we also didn’t have the growth other countries created during the up cycles. It is all a matter of optics because optics control bureaucracy and bureaucracy controls regulations, particularly in Fintech. Our governments and our regulators have to understand Fintech, they have to understand that we need to expand a bit outside of the big banks and the oligopolies that have been unintentionally created. Until they do, Fintech is going to lag in Canada. If you look at the actual amount of capital that is transacted on Fintech platforms in the private capital market it is lacklustre, it is negligible.
If you as a firm do reach a certain level of success and profitability, what are the chances a bank or other large institution will walk in and buy you out as a profitable subsidiary to their main operations?
Well that’s the market, but hopefully the entrepreneurship and innovation is so big that there remain multiple players. Some of them may get gobbled up; but, the others may become stronger on their own as well. Amazon is a monopoly today, or at least becoming one, but 15 to 20 years ago people were asking “why would I buy a book on line?” Times change. I think that right now we just don’t have enough capital innovation because of the oligopolies and the big banks.
Are the banks still focused on post-war traditions and not the future?
They have a huge lobby and have clout through their chief economists. The small shops cannot keep up with that, especially when it comes to influencing the regulatory changes needed. In other areas, you can open up an operation with a good idea without too much hassle; but, if you are in a Fintech space or one of the other regulated industries, you can only be what the regulators allow you to be. Policy needs to be set by the government with the regulators abiding by that policy. Given that this is an investment industry and Fintech lacks sufficient clout, we are going to continue to struggle because the regulatory will is just not going to be there. In order for us to really innovate, the government and regulators have to work hand-in-hand with the industry.
Where do you think CRE Fintech platforms are going to be over the next 10 years?
What I think is encouraging right now is the regulatory reduction initiative which is now really moving forward within the Government of Ontario. It is certainly moving in the right direction. The momentum for the short-term in Ontario is going the right way. The next 12 months will be key to see what kind of relief we can get and how far the government will commit to getting the 25 per cent burden reduction completed and to putting the reform process to work. If it does not, I think we will continue to lose some of our talent pool. We really need this better political will to ensure the regulatory system can foster this innovative potential offered by our smaller Fintech companies and start-ups.
R2 has a securities licence in all provinces in Canada. But because of the lack of harmonization we found ourselves actually operating in 13 different “countries” and it was a nightmare. We have pared back over the last year to Alberta, B.C. and Ontario only. The actual act of selling securities and investments and operating a trading platform providing investment management is so heavily regulated and broken, it will not work for small businesses. This is why we have moved away from selling investments and securities and refocused on becoming a technology and marketing platform instead with a lot of work on the data side.