Since the JOBS Act of 2012 opened the door for equity crowdfunding, dozens of startups have taken up the mantel of “real esate crowdfunding” – depending on your definition, there are now dozens to well over 100 platforms offering some form of real estate micro-investing, affording retail investors unprecedented access to real estate investments. For individual investors managing their own portfolios, the vast array of options can be overwhelming. Discerning investors are right to evaluate the landscape critically, and only pursue those investments and investing platforms that align with their strategy.
While each offers a unique focus and value proposition to investors, platforms have now consolidated into several main categories of business model:
- eREITs: Fundrise, one of the original players in the real estate crowdfunding space, has pivoted to offering semi-blind funds that aggregate properties throughout the country. These investments offer built-in diversity and very low minimums, making them appropriate for less experienced investors.
- Commercial equity investing: probably the closest to the original ideal of real estate crowdfunding, these platforms offer CRE equity opportunities to accredited investors, allowing them to participate in high-upside, larger commercial projects. While the return potential is often great, these tend to be the longer term and riskier than other RECF investments. Thus, these kinds of investments are most appropriate for investors who have time to really understand the risk factors in play, and who have at least a working knowledge of real estate equity investing
- Debt investing: Some platforms take some or all of an existing real estate loan, secured by a deed on the underlying property, and syndicate it out to a network of individual investors at a fixed rate of return. Other platforms act as the lender, issuing a loan to a real estate developer or flipper. In either case, the platform’s network of investors are offered a flat annual rate of return – typically between 7% and 12% – over a relatively short term – generally 6 to 18 months. Since these investments are secured by the property and short in term, they tend to be a good fit for more risk-averse investors.
Note: EquityMultiple offers a combination of the second and third models, and several other platforms offer some hybrid.
Understanding the spectrum of models can help investors prioritize those offerings that best fit their portfolio objectives, whether that be stable cash flow, preserving wealth for retirement, or opportunistic pursuit of high upside. Given the relatively low minimums many platforms offer, there may be room in an individual’s portfolio to invest through several platforms and achieve further diversification.
Regardless of what model a platform operates under, investors are advised to take a close look at the track record and experience of the people behind the platform. Attentive customer service is a must – platforms should practice transparency and be willing and able to answer any questions investors have.
Individual Deals – What to Look For
Some platforms (like EquityMultiple, see below) perform their own diligence on investments, which should give you some comfort as an investor. Even so, you’ll want to understand some key components of any deal you consider, and be sure it aligns with your investing objectives before pulling the trigger. Here are some of the main things to consider:
- Risk Factors – No investment is without risk, even fixed-rate, short-term debt investments. Examples of risk factors are tight construction timelines, a precarious labor market in the area, an unsubstantial track record or aggressive leverage on the part of the Sponsor who originated the deal. Again, if risk factors aren’t presented transparently, or the platform is unable or unwilling to field questions about risk factors, this should raise a red flag.
- Payout Structure – While debt deals are mostly straightforward, equity investments can be much more complex. Be sure to understand where your investments fits in the capital stack, and what order you will be repaid principal and profits relative to the Sponsor and other LP investors.
- Cash Flow and Liquidity – Simply looking at how many dollars you’re expected to receive over the lifetime of a deal (the simple return) or even a time-weighted return (IRR – internal rate of return), won’t give a complete picture of the timing and magnitude of returns. Depending on the business plan for the project and how the platform has negotiated and deal, you may receive distributions monthly or quarterly, and you may begin receiving cash flow from rent immediately, at some point partway through the term, or not at all in the case of a ground-up development or rehab. Similarly, repayment of principal may be projected for the end of the term, partway through the term, or piecemeal in the case of partial sales or a refinance. Be sure that the schedule of distributions and principal repayment is palatable to you given your liquidity needs.
Once again, if any aspect of the deal is unclear or doesn’t pass the sniff test, don’t hesitate to ask questions of the platform offering it.
Platform Diligence: What to Expect
While some platforms merely act as posting platforms, others perform substantial diligence on potential investment opportunities, and on the real estate companies that originate the investments.
Here are some of the standard items a platform may analyze when underwriting an offering. Any red flags along the way can remove the project from consideration entirely.
Deal-Level Underwriting Items
- Excel pro forma and financial model
- Senior and/or mezzanine loan documents
- Operating agreement
- Operating financials
- Rent rolls
- Purchase & sale agreement
- Org. Chart / Proposed Deal Structure
- CapEx History & Budget
- Certification of Formation
- Tax & Utility Bills
- Property Photos
- Site / Floor Plan
- All Leases & Abstracts
- Estoppels (if necessary)
- Lease / Sale Comps
- Tax Returns for Borrowing Entity
- Operations and Maintenance Agreements
- Certificate of Occupancy
- Public and private permits
- Tenant stacking plan
- Tenant delinquency reports
- Property payroll schedule
- Third party reports
- Sponsor criminal background check and credit check
- 2-year sponsor personal tax returns
- AML KYC form
- Current sponsor banking relationships and contact info
- Pro Forma Title Policy
- Management Agreement
- Certificate of Good Standing
Company-Level Underwriting Items
Individual investors shouldn’t need in-depth knowledge of each of these items. Rather, it’s most important to establish that the platform offering investments is practicing rigorous diligence. If a platform is acting as a markteplace, i.e. acting as a posting vehicle for the real estate company that originated the investment, this layer of diligence is effectively missing. This doesn’t necessarily mean such platforms aren’t worth considering, but it does signal to indivdiual investors that they should be prepared to conduct such diligence on their own.