Why Real Estate Crowdfunding May Fit Your Portfolio
Why Real Estate Crowdfunding May Fit Your Portfolio
(Todays guest post if from Soren Godbersen a sponsor of Diversefi.com.)
Nevertheless, “real estate crowdfunding” (usually shorthand for online platforms offering placement in private commercial real estate investments at relatively low minimums) is a gamechanger for investors, allowing individuals to play in a space that’s historically been the province of institutional investors. Let’s take a look at some of the major benefits of this new mode of real estate investing.
Lower Correlation to Public Markets (These Are Not REITs)
Real estate crowdfunding (or online private real estate investing, or whatever you want to call it) is often confused with REIT investing. REITs and real estate crowdfunding are different – shares of a real estate investment trust (REIT) provide built-in diversification, liquidity, and low minimums, but they are publicly traded, and so exhibit much greater correlation with public equity markets than do private-market investments made through platforms like EQUITYMULTIPLE.
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. This correlation undercuts the diversification and inflation-hedging benefits of other forms of real estate investing. Private real estate investments show a low correlation to the public debt and equity markets (between -0.03 and +0.25) and thus have strong diversification benefits in portfolios that also feature stocks and bonds.
Furthermore, REITs offer no opportunity to direct one’s own asset allocation. Real estate crowdfunding allows individual investors to participate in discrete projects and project types that align with their strategy and complement assets already held in a portfolio.
Real Estate Provides Downside Protection
Public markets fluctuate – sometimes wildly – based on perception and anticipation: stock prices may dip in response to expectations of inflation, economic policy that hasn’t been signed into law yet, or perception of overvalue. Conversely, real estate markets are driven by demand and demographic trends. Since real estate is a tangible, essential good, the asset tends to weather economic downturns better than equities. This is particularly true of multifamily properties: above all else, people still need a place to live.
Holding 20% or more of a portfolio in private real estate can protect your portfolio against systemic risk and yield better performance through market cycles. With relatively low minimums, and the opportunity to invest in specific properties within markets exhibiting strong fundamentals, real estate crowdfunding platforms can help reduce your portfolio’s overall exposure to risk.
Access to Private, Alternative Investments
Related to the first two points: real estate crowdfunding platforms provide access to private-market real estate, an alternative asset class that individuals are typically underallocated to. Unlike public-market 
investments, which are highly liquid and characterized by volatility, private real estate markets are typically less efficient, with opportunities for yield where skilled real estate firms identify opportunities to acquire properties at a favorable basis, add value, and improve operations.
In other words, while public-market investing affords exposure to “beta” – tapping into the broad performance of the economy or sectors of the economy – private real estate investments afford access to “alpha”, or yield driven by skill of management and exploitation of slower-moving, less-efficient markets. Indeed, pensions and other institutional investors have long devoted a sizable share of their portfolios to private-market investments, with individual investors severely underallocated. Real estate crowdfunding platforms present an opportunity to close this gap.
(for further reading on the topic, check out Blackstone’s great report on allocating to alternative investments.)
Fewer Headaches, Lower Barrier to Entry
So why not just buy an apartment building? Indeed some investors do, and with the right skillset and ample time to devote, direct ownership of property can yield outsized returns. However, most of us aren’t lucky enough to have the time to manage commercial property, and the capital to acquire, improve, and maintain a property through tenancy cycles.
Alternatively, online platforms allow for investing $10k or less in an institutional-grade property, alongside a real estate firm that typically has an extensive track record and operational experience. What’s more, online platforms allow for much more rapid diversification of a commercial real estate portfolio: instead of deploying $500k to take part in a multifamily acquisition directly, you could invest $10k in 50 different commercial real estate projects across the country, avoid putting all eggs in one basket, and reduce exposure to risk.
Conclusion
Real estate crowdfunding provides individual investors a nice middle ground between REITs and direct ownership of property, and allows for participation in the kinds of institutional commercial real estate projects that were inaccessible prior to the JOBS Act.
Not every online investing platform may be a fit for your investing strategy, however. Fortunately, the online platform mode of investing allows for full transparency: any platform worth its salt should make the investment thesis and underwriting assumptions clear, and be willing to answer questions from investors (unwillingness or inability to do so should raise a big red flag). And, low minimums allow you to get comfortable with one or several platforms without a large capital commitment.
Some info about our sponsor:
These are all key reasons why I invest in commercial real estate. It’s a good way to diversify your assets into alternative investments and I write about this a lot. But there are risks so investors need to do their own due diligence. I haven’t invested through Equity Multiple yet but I’ve heard good things.
Hey MD. I’m excited to hear your opinions since I know you have a lot of experience in this field!
I would like to hear also This post is largely marketing boilerplate (not a knock just a fact) and it really doesn’t explain in any granularity the risk involved and how to analyze the risk, and the special risks involved when you invest in real estate while the investment company and the property may be thousands of miles apart.
Hey Gasem. I’m hoping Soren from Equity Multiple will chime in on your thoughts.
Hi Gasem, that’s a fair point and I’d be happy to provide more perspective. It’s worth considering risk at the asset-class level (that is to say these real estate investing platforms) and with respect to specific assets/securities offered through the platforms.
– Asset-class/Platform level: In general, the investments offered through EquityMultiple, RealtyShares, PeerStreet, etc. are illiquid. This is probably the most glaring risk associated with this kind of investing. Public REITs can be traded relatively quickly, whereas with an investment made through a crowdfunding platform, your money may be tied up for anywhere between 6 months and 7+ years. The liquidity risk inherent in these investments is basically equivalent to the projected term of the individual investments, but RECF platforms to tend to have some focus in that regard: some offer debt and/or preferred equity investments, which are more secure (by virtue of seniority of repayment) that tend to be only 6 months to 2 years in term, whereas others focus on common equity investments that offer more upside potential but tend to carry a longer projected term and could be hung up by construction delays, permitting, or other unforeseen challenges. Liquidity and upside potential are inversely related, of course: the risk inherent in longer-dated projects is priced in, and those common equity investments carry greater potential for overall profitability. The soundness of the platform itself is also a potential risk factor: are the principals experienced and connected to solid deal flow? Is the fee structure such that the interests of the platform are aligned with investors? Is there a remoteness plan for if the platform goes out of business? And of course, what does the platform’s historical track record look like? These things can be less-than-obvious (with the Vanguard REIT, for example, historical performance is readily available), but platforms should be willing and able to address these questions.
-Asset/specific investment-level: all real estate investing involves risk, and depending on the specific investment, the market may present risks (as a function of supply or demand factors in the local CRE market, or labor force and demographic trends and how robust those trends are); the project plan could present risks (such as the threat of rising development costs in the area, or a thorny process in securing necessary permits); the tenancy situation could present risks (are there super long-term leases on the books, are there stringent rent control laws to consider); the specifics of the property location could present risks that might be hard to see on paper or even on a map (it may be close to downtown or transit as the crow flies, but there are railroad tracks in between and it’s next to a superfund site). Much of this, again, all comes down to transparency – all of these risk factors should be presented comprehensively for investors to see. The platform should present realistic sales and rental comps in the neighborhood of the property; all facets of the business plan should be spelled out in detail; detailed pro formas and rent rolls should be available upon request.
You are correct in noting that the distance between the property+sponsor (the firm originating the investment) and the investing platform can present risk. We make a point of touring every property. This is also part of the benefit of this investing paradigm, though: you can invest in markets across the country alongside an institutional real estate investor who knows the market intimately, and often has experience with a specific property type and/or business plan. The job of the platform is to a) make sure that the sponsor truly knows the market and the property b) do diligence on the sponsor and the specific investment and c) present the investment to you in a detailed, transparent, yet digestible way.
I hope that helps and doesn’t read too much like more marketing fluff. I’d be happy to keep the discussion going and answer any further questions you have.
Best,
Soren
Quite thorough and thought provoking. Much of what I’ve read doesn’t come close to this level of granularity. You should figure a way to link to some white papers on risk and what you provide in terms of service. I’m a bit more inclined than I was 5 minutes ago
Thanks
This is a very interesting and useful information. Actually, I think crowdfunding will be the mainstream for next years for every industry.
Thanks Amy. I think it is a really interesting platform and a good way to uncorrelate from the stock market without having to be a landlord!