A Student of the Real Estate Game


The Real Estate Crowdfunding Investor Checklist

Dec 2, 2014 | Passive Investing

Real estate crowdfunding provides high-net-worth investors with access to institutional-quality private real estate on a deal-by-deal basis that previously was only available through direct personal relationships. This is game-changing!

However, how can non-real estate professionals make educated investment decisions in such an opaque and fragmented space? Yeah, real estate crowdfunding platforms are doing some diligence on the deal and sponsor, but their revenue models are predicated on scale, so for them to survive they need to start doing more deals which means loosening their diligence standards.

Innovations like the Fundrise Rating System will enable investors to compare deals side-by-side, but this has no bearing on the merits of the deal. For the most part, investors don’t understand the intricacies of the asset and the economic deal structure that matter. I created an investor checklist to help investors ensure they’re aware of all the risk involved in a real estate syndication.

The Real Estate Investor Checklist

  1. Direct real estate investment is a key component of any well-diversified portfolio. All investors must understand the dynamics of a real estate investment and its potential correlation with their overall portfolio.
  2. Downside Scenarios: Understand what happens to your investment in the worst case scenario. If you’re not comfortable with losing your full principal investment, just stop now. If you’re comfortable with the downside scenarios, keep going through this checklist.
  3. What has to go right for the sponsor to hit their investment targets? What’s the probability of those things happening?
  4. Is the sponsor best-in-class? What’s their reputation/experience in the market and in particular with this asset class?
  5. What is the anticipated term of the investment? Are you comfortable having your money locked up for that time period? Direct real estate investment is highly illiquid.
  6. How much leverage is on the deal? What are the terms and conditions? What happens if the sponsor defaults on the loan?
  7. What are the tax implications of the deal?
  8. How much money is the sponsor contributing to the investment? 5%-10% of the equity contribution is typical. You always want a partner with significant “skin in the game”.
    • Where is this money coming from? Transparency in the partnership is key.
  9. What is the economic deal structure?
    • What is the preferred return “pref”? What is the split after the pref? Are there multiple hurdles?
    • How often is the pref paid? Quarterly distributions is typical.
    • Is the pref paid current? If not, does it accrue? Is it compounding?
    • Is the investor’s pref senior or pari passu with the sponsor’s pref?
    • Is distributable cash flow treated as return on or return of capital?
    • Is there any clawback mechanism if certain return hurdles aren’t met?
    • Note if the returns quoted are project-level or investor-level.
      • If you’re a non-real estate professional, make sure you understand the mechanicals of the cash-flow splits and how that impacts your investment.
  1. What am I required to do in the case of a capital call? What happens if I don’t invest additional capital? There typically will be dilution.
  2. What are the fees paid to the sponsor and how is the sponsor incentivized?
    • Acquisition, sourcing, debt, asset management, property management, leasing, construction, disposition etc.
  3. How can I exit my investment? Who can I sell it to and how is my share valued?

The image of private real estate investment is marred in late-night “get-rich-quick” schemes. In reality, it’s an extremely complex asset class that requires professional management, experience, and a little luck in order to be successful. If you’re not careful it’s easy to get burned. If you’re interested in investing in private real estate deals, use this checklist as a starting point.

What would you add to this list?

Disclaimer: This information is provided for informational purposes only, and should not be viewed or construed as investment advice.