Crowdfunding Real Estate Investment Options

As you might imagine, I get a lot of questions here at ESI Money.

I can’t possibly respond to them all (hey, I’m retired and want some free time!), but when I see the same question over and over again, I usually do one of two things…

I either write a post about it if I’m familiar and/or experienced with the issue or ask someone who is familiar/experienced with it to write a guest post.

One of the questions I get regularly is how to invest in real estate without going the traditional route. Specifically, how to invest using one of the various crowdfunding options available today.

Since I know nothing about this subject (I buy and manage my real estate the old-fashioned way) I found someone who does.

Earlier this year at FinCon (the financial media conference) I met with EquityMultiple, liked what they had to say, and offered them the chance to write about options for real estate investing.

They went far above my expectations, covering a wide range of real estate investing options, the pros and cons of each, and so forth.

And that’s what brings us to today’s sponsored post. I will turn it over to them and be back at the end with some additional thoughts…

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Investors have more options than ever when it comes to adding real estate to their portfolio.

Before getting into the different modes of real estate investing, let’s take a step back and quickly recap why investing in real estate is a good idea in the first place:

• Less Volatility: By most measures, real estate has historically outperformed the stock market while exhibiting fewer dramatic swings. Particularly in times when geopolitical factors or other exogenous variables may influence public equities markets, private real estate can provide downside protection and reduce a portfolio’s overall exposure to risk
• Uncorrelated Returns: Real estate, like other asset classes, is impacted by macroeconomic factors. However, because real estate markets are driven by demographic trends, and real estate asset performance is driven by inherent value and management quality, real estate returns do not move in lock-step with public equities markets
• Tangibility: Related to the first two points – real estate assets are essential to society in a way that other assets are not: humans will always need places to live, work, and congregate.
• Strong Historical Returns: In the years between 2000 and 2015, real estate as a whole beat the S&P 500 by 200 basis points, and well-managed assets in burgeoning markets can consistently generate attractive yield.

Real estate can be accessed by individual investors in several different ways, with assets behaving very differently with respect to the above factors. Let’s take a look at the main vehicles individual investors have for accessing real estate.

Direct Ownership of Property

At the risk of stating the obvious: an investor seeking exposure to real estate can simply buy property.

The issue is, this means of accessing real estate is rarely simple. Buying a single-family rental property in an up-and-coming market may generate solid yield, but you may have to field calls from tenants in the middle of the night about a broken furnace or leaky faucet or, worse, deal with tenants delinquent on rent.

You could hire a property manager to handle these sorts of things, but that will eat into net return on the property, particularly at small scale. Even in the best-case scenario, a single-family rental offers little diversification: you have exposure to just one market, and the risk of being 100% without a tenant should your leases not smoothly transition from one to the next.

Owning multi-tenant commercial property (including multifamily) can offer economies of scale and opportunity for diversification, but those management headaches are only magnified.

Most individual investors do not have the time or wherewithal to take on value-add projects that can generate sizable net returns at scale, and the acquisition and sale processes become much more onerous and subject to liability. All of this assumes that you have the capital to acquire a commercial property (many individual investors do not).

In short, owning commercial property can provide uncapped return potential, but it is a full-time job, and carries significant liability as compared with these other modes of accessing real estate.

REITs

Real Estate Investment Trusts (REITs) have been around since the late 1960’s. If you have an active 401k, you probably have some exposure already.

REITs are blind funds of real estate, often diversified across markets and property types, but sometimes with a specific geographic or sectoral focus, such as retail.

On the plus side, REITs give investors the opportunity to gain some exposure to real estate, and to diversify at a low barrier to entry. Public REITs are also traded, providing the highest degree of liquidity that a real estate investment can offer.

On the flip side, however, REITs are opaque in nature: an investor holding shares of a REIT has no control as far as which properties are acquired, and often little visibility into the specific properties that comprise the fund.

The downside of liquidity is volatility: because public REITs are traded, they are subject to sentiment-driven swings, much like the stock market.

Correlation of REITs to the Public Markets

Despite the solid overall returns, public REITs are characterized by sometimes extreme market volatility.

In 2010, as public REITs shook off the effects the recession, annual returns ranged as high as 27.5% but in 2013, with the U.S. real estate market booming, returns sagged to 3.2%.

Rather than being strongly correlated with the value of the underlying real estate, the recession revealed that REITs are, in fact, strongly correlated with the public markets.

In other words, REITs provide some diversification value versus the stock market, but historically do not provide the same kind of hedge against public market swings that private-market real estate does.

Online Real Estate Investing Platforms

Like REITs, online real estate investing platforms (like EquityMultiple) allow individual investors to invest passively in real estate at relatively low minimums (typically $5k and up per investment). Because the “real estate crowdfunding” space is fairly new, the concept is often confused with REITs. However, there are some major differences:

• Illiquidity: Because no secondary markets have emerged for these assets, investors must hold them throughout, which can be anywhere from 6 months to 7+ years, depending on the kind of project. These assets provide more downside protection and less volatility precisely because they are illiquid. A recent Blackstone study showed that allocating 20% or more to private alternative assets (like real estate crowdfunding) can yield better risk-adjusted returns over a sustained period.
• Transparency: Unlike REITs, investors in “real estate crowdfunding platforms” can fully understand where there money is going: the specifics of the project and property should be presented in full detail (and if they aren’t, this should raise a red flag). This means that investors can invest in markets and properties that are appealing, and in assets that align best with their investment goals.
• Uncorrelated Returns: Again, private market real estate does not exhibit close correlation with the stock market. Returns are driven by the quality of the underlying asset, the skill of management, and macroeconomic fundamentals: job growth, supply absorption, household formation and other trends.
• Tax Benefits: Real estate crowdfunding investors generally participate in pass-through entities, such as an LLC, and can benefit from the same benefits available to the management party with whom they coinvest: deductions for depreciation, loan interest, or losses against positive cash-flow, effectively creating a tax shelter.

It’s worth noting that real estate crowdfunding platforms offer varying levels of in-house diligence, and varying risk/return profiles with respect to their individual investment offerings. It may take you some time and careful examination to get comfortable and find the right platforms and assets for you. In fact, let’s take a closer look at the different kinds of

The fact is, no two platforms within the loosely-defined “real estate crowdfunding” universe are the same.

Some definite themes have emerged, however, with respect to operating models and value to investors.

Let’s take a brief look at the most prominent categories of real estate investing platforms, and what they can mean for your portfolio.

Single-Family Debt Financing

These platforms source debt capital for single-family investors (“flippers”), and typically offer a high volume of debt-based investments secured by a lien on the house, with a relatively short term (typically 6 to 18 months) and an annual flat rate of return of anywhere from 6 to 14%.

Pros

• Protections: These investments tend to be secured by either a 1st or 2nd lien on property, so carry some investor protections.
• Liquidity: The term of the loan is typically quite short (from 6 months to two years), and they often pay a monthly or quarterly rate of return, somewhat reducing liquidity risk.
• The fixed annual returns are typically much more appealing than other fixed-rate instruments, and roughly on par with historic stock market performance.

Cons

• The single-family market is historically more susceptible to overall market swings than commercial real estate. As we move past the peak of this market cycle, these platforms may exhibit some hiccups and rate compression.
• With entirely single-occupancy homes as the underlying asset, these platforms lack some of the diversification offered by omni-asset commercial real estate investing platforms (more on that in a bit).
• On the flip side of predictable terms and security, these assets carry no additional upside. Investors seeking more attractive yields may need to look elsewhere.

Bottom Line: If you’re a fairly risk-averse investor seeking predictable, short-term real estate investment vehicles, these platforms may be worth looking at.

If you’re seeking greater diversification or upside from your real estate portfolio, or already have substantial exposure to the single-family market, you may want to keep looking.

‘eREITs’

Several of the early entrants into the ‘real estate crowdfunding’ space have pivoted to offering blind funds of income-producing real estate, very similar in practice to the REITs (real estate investment trusts) that have been around for decades, which we covered above.

Pros

• Lowest Barrier to Entry: These funds typically carry a very low minimum investment, and often can be accessed by non-accredited investors.
• Build-in Diversification: Because each investment is spread among various assets, these products offer exposure to different properties across markets at a very low entry point.

Cons

• Asset opacity: Like traditional REITs, the investor gets little insight into where their investment dollars are going, and investors cannot make elective decisions regarding which assets and markets they invest in.
• Management and return opacity: By this same token, investors have little ability to direct their investments toward appropriate return objectives and levels of risk based on their goals.
  Furthermore, the fund may not provide deep or timely insight into specific asset performance, and the practices of operators managing the individual properties.

Bottom Line: If you’re looking for a super low minimum ($1000 or less), and you want the most hands-off experience possible, you may find these platforms compelling.

However, if you’re an accredited investor who enjoys understanding the investment thesis of each property invested in, and directing your own investment decisions, you may want to instead look at platforms that offer more control and transparency.

Equity Crowdfunding

These platforms offer an investment structure similar to the real estate syndications that have been transacted for decades: a network of investors co-invest passively alongside a Sponsor (a GP, the managing partner) and can enjoy uncapped upside if investments perform well. The “real estate crowdfunding” paradigm brings greater efficiency, more transparency, lower minimum investments, and better access to individual investors.

Pros

• High Upside: Common equity investments offer uncapped upside if investments perform well.
• Tapping into Experienced Firms: assuming the platform is doing its proper diligence on the Sponsors originating investments, the network of investors will benefit from the experience and scale of the Sponsor, effectively investing in professionally-managed commercial real estate without having to directly manage the asset.
• Transparency: Investors can participate in discrete real estate projects, and invest in distinct properties.
• Diversification: Private-market commercial real estate has historically exhibited a lower degree of correlation with the stock market than REITs or the single-family market. Particularly when diversifying across CRE asset classes like office, industrial, multifamily – and alternative asset classes like self-storage and manufactured housing communities – investors can reduce their overall exposure to risk. A recent Blackstone study showed that portfolios that allocate 20%+ to private-market alternatives (like private real estate) significantly outperform those that do not.

Cons

• Risk Factors: Equity investors, as the last to get paid, accept a higher level of risk – the flip side of high potential returns. These risk factors are specific to each investment, and platforms should present a comprehensive set of risk factors. More on this in a moment.
• Illiquidity: Generally these investments will carry longer projected terms than debt-based investments, typically in the 3-7 year range. This may be mitigated by interim cash flow, depending on the specific investment.
• A bit more complexity: The payment structure of an equity investment will have a few more wrinkles than debt, or an eREIT investment that simply pays quarterly dividends. The order of repayment and profit split may vary from investment to investment. Again, platforms should present these details transparently and help investors understand the specifics of each investment.

Bottom Line: Equity real estate crowdfunding platforms offer the opportunity to tap into the experience of professional real estate management firms, and potentially earn outsized returns.

However, given the added degree of risk and complexity, these platforms are usually more appropriate for accredited investors with substantive experience making their own investment decisions.

If you want to tap into institutional-quality private CRE investments, but don’t want to schmooze at the country club or shell out $250k for each investment, this model may have appeal for you.

Conclusion: the Right Mix

When deciding which kinds of real estate assets to add to your portfolio, consider how much time you can devote to the exercise, and what your overall risk tolerance is.

If (like most people) you don’t have the time and capital to acquire and manage commercial property on your own, real estate crowdfunding may be an excellent means of accessing private-market real estate.

With their low barriers to entry and liquidity, REITs may be an excellent way to supplement your private-market real estate holdings and attain further diversification. If you already own one or more single-family rental properties, both REITs and real estate crowdfunding can provide a relatively low-risk means of diversifying into new markets and new property types.

In the nascent ‘real estate crowdfunding’ space, there’s no one-size-fits-all platform. Take a look around, examine the track records and diligence practices of each platform you consider, and don’t invest with anyone who is unwilling (or unable) to answer your questions.

While different models have emerged, this new real estate investing paradigm is characterized most by greater efficiency and lower minimums.

Fortunately, this means you can easily diversify among platforms and their constituent investments, quickly discover which platforms are worthy of your portfolio, and tailor your real estate crowdfunding portfolio to complement the real estate and other assets you already hold.

As with any asset class, diversifying your holdings within the asset class, and limiting cross-asset correlations, will help to reduce overall portfolio risk. Fortunately there are now more options than ever for individual investors to create diversified real estate portfolios.

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Overall, I thought this piece was very informative and hoped you did as well. I know I learned a lot.

That said, it left me with a couple more questions. Namely:

• What makes EquityMultiple different from all the other crowdfunding platforms?
• Do you have some sort of special offer for ESI Money readers? (I’m trying to look out for you guys.)

Here’s how they responded:

What EquityMultiple Offers

As the name implies, EquityMultiple does offer common equity investments, in the realm of ‘equity real estate crowdfunding platforms’.

However, EquityMultiple provides a few unique features:

• Commercial Debt & Preferred Equity: In addition to equity investments, EquityMultiple offers senior debt investments (similar to the first model, as described above, but secured by first lien on a commercial property) that target a 7-12% annual rate to investors over a 6-24 month term.
• Preferred equity offers a hybrid between debt and common equity: pref. equity investors are entitled to repayment before the equity holders and Sponsor are paid, but can participate in the deal’s target upside. EquityMultiple’s preferred equity investments target a 7-12% current and 10-14% total preferred return.
• Institutional Commercial Focus: EquityMultiple enables individual investors to access professionally-managed properties across markets and asset classes, with minimums as low as $5k per deal.
• In-House Diligence: While some platforms operate as laissez-faire posting marketplaces – allowing Sponsors to post deals and attract investors with little in between – EquityMultiple practices rigorous in-house vetting of deals and deal originators, ultimately selecting fewer than 8% of the potential investments we see.
• Transparency & Customer Service: Online platforms create new efficiencies and improve access, but can’t change the fact that investing remains a fundamentally human and trust-centric process. To that end, we provide robust reporting, frequent asset management updates, transparent and thorough offering prospectuses, and we’re always available to pick up the phone.

In the long run, the platforms that win high marks from investors won’t be those that hit home runs 100% of the time (over a long enough time frame, no platform will pull that off).