Real estate crowdfunding provides investors with access to private real estate deals previously only available through personal relationships. This is game-changing for investors. However, it remains challenging for investors to understand which platforms and deals are the right fit for them based on their investment objectives.
We’ve seen continued evolution with platforms like PeerStreet offering auto-investing and Acquire Real Estate taking a strict focus on institutional-quality deals and investing alongside the crowd. These platforms simplify the investing process and provide investors with a level of safety/trust that was previously unavailable. While the evolution has made investing easier, one of the biggest challenges remains investors’ ability to understand the differences in each investment model, risk in deals, and implications of different structures. In this post, I lay out the various investment opportunities, the implications to investors, and help you decide which platform is right for you.
Direct Equity Investment with a Sponsor
Select platforms have opted to be more of a technology platform with a focus on connecting sponsors with accredited investors seeking direct real estate investment. The platforms underwrite the sponsor, and once approved, investors connect directly with the sponsor. The platform does not use a clearing agency/broker-dealer because they are not the manager that is issuing the securities. The deal structure and terms are dictated by the sponsor, which requires investors to have basic real estate knowledge. The sponsor handles all distributions, reporting, and investor accounting, using the platform technology as an investor reporting/management tool. In addition to individual deals, these platforms also offer investors the opportunity to invest in funds, which have their own unique structure and also require real estate knowledge to understand the intricacies.
Characteristics: Limited liquidity and typically 5+ year hold periods. Returns, risk, and deal structures vary wildly, but typically deals offer a preferred return (6% – 9%) with a cash flow split above the preferred return.
Direct Equity/Debt Investment in a Newly Formed Entity
Other real estate crowdfunding platforms have opted to control their investors. Rather than connecting directly with operators, the platform forms a new entity to invest in a deal and acts as the company issuing the securities. The deal structure with investors is dictated by the platform rather than the sponsor and the platform handles all distributions, reporting, and investor accounting. These platforms profit by charging an annual asset management fee and making a spread on the structure they offer investors versus the structure with the sponsors.
Characteristics: Equity investments offer limited liquidity and longer-term hold periods, although certain platforms are working on creating liquid secondary markets. Returns, risks, and deal structures vary wildly, but typically deals offer a preferred return with a cash flow split above that specified return hurdle. The debt and preferred equity investments offer a fixed rate of return and finite hold period, typically between 1 and 5 years. Preferred equity and debt investments are inherently less risky due to their position within the capital stack, however the upside is capped.
One of the biggest trends in real estate crowdfunding is the shift toward auto-investing. Auto investing solves the issue of investors having to analyze individual investment opportunities, review deal structures, and underwrite sponsors, by allowing them to set their investment criteria, then using proprietary underwriting algorithms the platform will automatically allocate them into investments that fit those parameters. The automated approach enables them to offer investors a fixed-rate return while scaling their own platform to ensure the long-term stability of the company.
Characteristics: Deals offer between 6% and 12% and have terms of 6 months to 36 months.
Fundrise eREIT (Non-Traded REIT with lower fees)
The Fundrise eREIT is an innovative model that allows both accredited and unaccredited investors the opportunity to invest as little as $1,000. The Fundrise Income eREIT (currently raising capital) is focused on debt investments and offers investors a fixed rate of return, low fees, quarterly distributions, and quarterly liquidity*. For the first 2 years (through December 2017) Fundrise is promoting 0% in asset management fees unless investors earn a 15% annualized return. The Fundrise eREIT solves some of the issues with the non-traded REITs, offering current cash flow, quarterly liquidity, and lower fees.
*Liquidity is great in theory, however it’s easy to sell shares when the market is improving, but it’s hard to sell when the market is in decline. By definition liquid entails not just the ability to sell, but the ability to achieve a price equal to or close to the last price. I’m not sold on the viability of offering liquidity for assets that are inherently illiquid, especially in a down market with investors who may not have deep pockets.
Real Estate Crowdfunding ‘Fund of Funds’
In addition to diversifying across deals within a fund or the Fundrise eREIT, platforms are popping up that invest across other real estate crowdfunding platforms. This provides investors further diversification and access to deals, however the success is driven by the quality of the team doing the deal selection. One downside of the real estate ‘fund of fund’ structure is that investors may be exposed to double fees, one at the deal level and another at the fund level.
Over time, each of these investment models will continue to evolve, structures will become more standardized, track records will become public, and general transparency will improve the private real estate investment space. For now, it’s important for investors to understand that each structure carries its own set of risks and challenges and it’s vital for investors to review the opportunity, ask the right questions, understand the important return metrics, and avoid bad deals.
If you’re looking to invest in real estate through a crowdfunding platform, ask yourself a series of simple questions to determine which model is appropriate for you:
- Do I have the expertise to underwrite/compare real estate on a deal-by-deal basis?
- Do I have trust with a particular platform or sponsor?
- What’s my hold period?
- What’s my risk tolerance?
- How much do I have to invest?
Which model is right for you?