In 2012, Warren Buffett appeared on CNBC’s Squawk Box with host Becky Quick.
Warren Buffett told Quick that if it were practical, he’d buy up a couple hundred thousand single-family homes. It’s a very attractive asset class.
Real estate is itself an attractive asset class, in part, because it hasn’t experienced the same massive increase that other assets have. Stocks have experienced tremendous growth, with the CAPE ratio (Cyclically Adjusted PE Ratio) at over 30. Bonds are looking less attractive in a rising interest rate environment and flattening yield curve.
Real estate is attractive. It still is attractive.
What I find less attractive are the mechanics of investing in real estate property. If Warren Buffett found it impractical to buy up a couple hundred thousand single-family homes, I find it too much of a headache to buy one investment property. I don’t want to be a landlord. I also don’t want to sink a huge sum of money into one property.
I want diversification. I want real estate. I don’t want to stick it in a massive REIT and I don’t want to be a landlord.
Fortunately, there are crowdfunded real estate investing platforms and they’re changing the way people are investing in real estate. There are even options for folk
Here are 8 reasons (and one caveat!) why they’re going to change how people invest in real estate:
Table of Contents
- REITs are too big, too general
- Diversify small investment amounts across projects
- Many options for Non-Accredited Investors
- No hands-on work, phone calls, headaches
- Platforms curate real estate deals
- Leverage geographic arbitrage
- Short term investment periods, options
- Low / reasonable fee structure
- Big Caveats: They are not perfect
REITs are too big, too general
A REIT, short for real estate investment trust, is a company that owns, and sometimes operates, income-producing real estate. These can be anything from office parks to hospitals to shopping malls to storage facilities to everything in between. They’re popular because you get exposure to real estate while being able to buy and sell shares in those companies on the public market. REITs, like any other company, can pay out dividends, making it a great income producing asset.
Anyone can invest in a real estate investment trust and Vanguard’s REIT ETF (VNQ) has no minimum with an expense ratio of just 0.12%.
If these options exist, why would anyone consider crowdfunding real estate projects?
When you invest in a REIT, you get everything they invest in. You can’t pick and choose. A REIT fund invests in other REITs. VNQ’s top holdings are in companies you probably would only recognize if you looked at commercial real estate listings or knew the names of mall holding companies. The top 10 are Vanguard Real Estate II Index Fund, Simon Property Group Inc., Prologis Inc., Equinix Inc., Public Storage, AvalonBay Communities Inc., Equity Residential, Digital Realty Trust Inc., American Tower Corp., and Welltower Inc.
With crowdfunding real estate sites, you have options. You can invest in individual properties, such as with RealtyMogul, or you can pick very tightly focused eREITs, like with Fundrise. The publicly-traded REITs are massive and have huge geographic footprints, so you can’t find inefficiencies and take advantage of them.
REITs are a solid set and forget strategy for real estate investing but you lose the advantage of your flexibility and speed. Crowdfunding real estate investing gives you the opportunity to invest in properties the larger REITs just aren’t dealing with because they’re too small. These small projects may be bad if you have millions to deploy but they can offer higher returns for those who only have a few thousand.
Diversify small investment amounts across projects
Speaking of those who only have a few thousand, that’s all you need.
If you want to flip a house, you have to come up with the money to buy the house and pay for the renovations. Even if you were to buy a house to live in, so you qualify for a regular home mortgage, you still need to come up with the funds for a down payment plus the renovation. Each investment is going to be relatively large. A few thousand dollars is not going to cut it in most areas.
Crowdfunded real estate will let you invest as little as a thousand dollars in a variety of projects. You can diversify your risk across borrower, asset types, geographic location, and project type. Whether you want an NNN (triple net) retail lease or a single family investment, you’ll find it on a crowdfunded real estate platforms.
Many options for Non-Accredited Investors
If you are an accredited investor, with $1mm net worth or earned six figures the last few years, the whole universe is available to you. You can invest in any crowdfunding real estate platform and pick and choose your properties.
If you are not an accredited investor, the options are limited to “eREITs.” These are similar to the large REITs we mentioned earlier except these are usually more focused.
Fundrise is one of the leaders is the non-accredited real estate investing space and for $1,000 you can invest in their eREITs. They have five eREITs with tighter approaches – there are the Growth and Income eREITs plus three regionally-focused eREITs.
They also have “ePlans” with $500 minimums. You pick whether you want income or appreciation, your level of risk, and they put you in a fund that finds properties that meet your needs. These are typically residential properties and a mixture of debt and equity deals.
No hands-on work, phone calls, headaches
If you flip a house, you need to do the work or oversee the renovations.
If you are a landlord, you need to hire a property manager or handle finding, billing, collecting, and potentially evicting tenants.
When you invest in crowdfunding real estate, you do no work after the investment closes. You still have all the up front work of analyzing the investment and seeing whether it’s a good fir for your overall plan. After the funds are transferred, it’s managed just like a REIT.
You just collect checks and read correspondence; no 2 AM phone calls about a leaking water heater.
Platforms curate real estate deals
As for the upfront research, the crowdfunded platforms do a tremendous amount of due diligence and deal curation. Many of the projects they get pitched never get passed on to investors. This is because there’s a tremendous demand for capital but very few deal worthy partners. Many of the platforms pre-fund deals to help facilitate the close and when these deals are for millions, they will only pre-fund deals they know will get investment.
It’s a lot like syndication deals except you have professionals doing the vetting. If you are capable, you could do it yourself but most people (myself included) are NOT.
The platforms aren’t perfect, but when the platform curates deals then it ensures you miss the truly bad ones. You probably don’t even see the borderline deals. You don’t waste your time and that’s worth money.
They can also conduct a lot of the grunt work research into the property, the local area, the partner, and all the other details you’d want to know about a deal. That can save you a tremendous amount of time, even if you knew where to look in the first place!
For example, at RealtyShares, there was a senior debt deal on a franchise location in a midwestern state. The information they collected on a million dollar 12-month note was extensive. It included every detail about the property (you could visit the vacant lot if you wanted to), the local market (population density, household income, DOT estimates of daily traffic, neighboring retailers), management (borrower details and history), plus sales data from the franchise itself. I did not know this but it only takes 125 days to build this franchise store!
(I use RealtyShares as my example because I’ve invested on a property through them and so I’m familiar with their platform but they’ve since shut down)
Leverage geographic arbitrage
When I was younger, I invested in property in Kansas City, MO while living in Maryland because the property was cheaper in Missouri. The properties in Howard County, MD were too expensive. Property in Kansas City was far cheaper, owing in part to a far lower cost of living.
With crowdfunding real estate platforms, you can invest anywhere. There’s a heavier emphasis on a property on the two coasts but you can still find plenty of opportunities in the middle of the country.
You can invest in Manhatten projects, where the cost of living is astronomical, or you can invest in Alabama, often cited as one of the most affordable states to live in. You earn an income in one cost of living area while investing in another, lower cost of living area, thus making your dollars go even further.
Short term investment periods, options
Finally, these investments are typically very short. The equity deals are usually 5-7 years whereas the debt deals are 12-36 months.
As of this writing, there are six available investments on RealtyShares – 3 equity, 3 debt. The target hold of the equity deals are 7 years, 5 years and 5 years. The maturity on the debt deals are 24-months, 12-months, and 12-months.
If you go with a company that offers eREITs, your holding period can be as short as you want. There are sometimes rules about redeeming / cashing out shares because real estate is meant for a longer hold period. For example, Fundrise allows you to redeem shares but makes you wait for 60-days. RealtyMogul permits quarterly redemptions too.
Low / reasonable fee structure
The fees for using many of the platforms are usually billed against the borrower rather than the investor. While this can be passed on in a way that’s similar to realtor transaction fees, you can always analyze the ROI on an investment independent on that.
For example, a property on RealtyShares may offer a return of 9.50% over 12 months. RealtyShares collects 10.50% from the borrower, takes 1% for themselves, and passes on the 9.50% to you. The borrower’s financial may indicate the property can support a 10.50% payout and the “fee” RealtyShares collects seems to be a 9.5% on each payment, but if it makes sense for you to invest in this note for 9.50% then it doesn’t matter what the other numbers are. (RealtyShares also collects an origination fee on the loan)
Alternatively, some of the eREIT platforms will charge the equivalent of an expense ratio. I am not aware of any platform that charges a fee to join (and if they did, I would never join it). Fundrise charges a 0.85% annual fee and RealtyMogul charges a 1.00% annual fee, but those are on assets under management in the REITs.
Big Caveats: They are not perfect
These platforms solve a lot of the problems I have with direct real estate investing… but they’re not perfect. Investing carries risk and real estate carries a lot of risk. The platforms curate the deals but you still need to review the borrower and the property. It’ll be hard to visit the properties unless you’re nearby (then you are giving up geographic arbitrage) so you rely on much of their research for the hard numbers.
No hands-on work means any expertise you have in this area goes to waste. There’s no way to convert sweat equity into real equity. You’re completely passive.
They’re illiquid investments. You can’t sell these notes or your equity. If you opt for a fund, you can redeem them on their schedule. The lack of liquidity means you shouldn’t treat these like a short term investment. Heck, you can’t even take a penalty to get your money.
Finally, they’re new. When peer to peer lending like Prosper and Lending Club first started, everyone loved them. Then there were the defaults. The various other pitfalls. Real estate itself is not new, so chances are any problems we face will be relatively new ones, but these platforms are. Some have done hundreds of millions in deals. Others haven’t – so do your due diligence on the platform as much as you would on any investment.
The platforms themselves carry risk because they’re startups and startups can fail. Realtyshares shut down because they couldn’t secure venture funding to fuel growth. All my investments there are still paying for the time being, they’re secured by the underlying real estate, but now I’m waiting to see who will manage those assets after the transition.
You can mitigate this risk by working with a platform that is not backed by venture funding. EquityMultiple is an example of a platform that is backed by Mission Capital, a national real estate capital markets firm. To succeed, they don’t need grow the platform as quickly as possible and exit. They just see it as another channel for generating investment capital and while they would it to grow, they don’t need it to grow fast.
They may feel pressure to grow at all costs, including not being as diligent as they need to be. A recent Wall Street Journal article highlighted some glaring errors in due diligence. “A Wall Street Journal review of 104 completed deals and other deals that were aborted or still in process found that many failed to meet returns suggested in sales pitches. When developers fell short of funds, they asked investors to pony up more cash or risk losing their investments. CrowdStreet also helped raise cash for a firm that lied about its track record to investors, according to the Securities and Exchange Commission and the Justice Department, andwhose chief executive was later sentenced to prison for fraud for the fundraising.” Not good.
Even with these caveats, I can’t think of a better way to get into real estate investing given the sizing.