Soren brings some clarity that should help you ensure you’re comparing apples to apples and enable you to recognize an orange when it comes along.
I am an investor with EquityMultiple, and I do have an affiliate relationship with them, which means investing with them via a link on my site could result in me receiving a payment, furthering my charitable mission. I was not paid for this post, however.
“I’m thinking about diversifying into real estate… I’m not sure if I should buy a rental property or just focus on REITs”.
This sentiment is all-too-prevalent in online real estate investing forums and backyard barbeques alike, and it doesn’t take an MD to see why: REITs and full, active ownership of property, as the incumbent modes of real estate investing, receive the most attention and are often presented as the only ways of diversifying into real estate for individual investors with little exposure to the asset class. Indeed, entire forums like BiggerPockets are devoted to the practice of buying, managing, and selling rental properties.
Fortunately, sites like this one have been giving more due to “real estate crowdfunding,” loosely defined as co-investing alongside experienced real estate companies in distinct properties and projects through online platforms, with investment minimums a small fraction of what it would take to acquire a commercial property.
Unlike REITs – which are publicly traded – these investments exhibit low correlation to public markets, and so offer downside protection in a portfolio when included alongside stocks and bonds. Unlike direct ownership of real estate, these investments do not force you to take on a second job managing physical property, and the low investment minimums allow for diversification across markets and property types.
Types of Crowdfunded Real Estate Investments
While “real estate crowdfunding” is getting more attention in investing circles, it’s important to realize that, like REITs (or any other asset class), there’s a fair amount of variety among individual real estate crowdfunding assets and the platforms that offer them. The risk-return profiles and quality of offerings vary substantially. Here’s a quick look at the most prominent forms of “real estate crowdfunding”
- Platform-based debt: In this case, the site / platform raises capital in order to issue a loan to a developer or real estate investment firm (a ‘Sponsor’). Individuals who invest in these offerings – typically issued as notes – are effectively mini-lenders on a real estate project. In some cases, these are single-family homes, and the borrower is a “fix-and-flip” investor.
- Syndicated Debt: In this case, the site / platform syndicates some or all of an existing loan from a private lender. PeerStreet, for example, exclusively offers this kind of investment, and focuses on syndicated loans secured by single-family homes. EquityMultiple offers this kind of investment (among others), while focusing on institutional commercial real estate projects.
- Preferred Equity: Preferred equity investments offer a happy medium between debt (the safest part of the capital stack) and higher-upside equity investments; preferred equity is subordinate to debt, but preferred equity investors are entitled to payment before common equity investors receive returns. This structure is exclusive to commercial real estate, and only a few platforms operating in the space offer preferred equity.
- Common Equity: The highest upside, but most risky variety of commercial real estate investments, these investments offer individuals the chance to co-invest alongside real estate firms that pursue opportunities for high yield based on micro and macroeconomic factors. Within this subset, there are different strategies that further vary the array of risk/return profiles available to individual investors.
- Ground-Up Development: The construction, marketing, and sale of a new property on a shovel-ready piece of land.
- Opportunistic Value-Add Plays: The acquisition, improvement, and sale of existing assets with opportunities for upgrading. Real estate firms that engage in such projects are banking on their ability to raise rents significantly (often to market rates) through capital improvements.
- Cash-flowing Repositionings: The acquisition, hold, and sale of existing properties that already have stable rent rolls. Real estate firms that engage in such projects are banking on their ability to improve rental income via operational efficiency and/or better marketing.
Here is a brief rundown of relative strengths and weaknesses of these kinds of real estate crowdfunding assets, from lowest-risk/lowest-return-potential to highest-risk/highest-return potential:
|Type of Asset/Project||Pros||Cons||Typical Range of Returns|
|Syndicated Debt||● Typically guaranteed by the underlying property
● Short terms mean less liquidity risk
● Predictable cash flow
● Since an experienced lender sourced the loan, there is another layer of underwriting in place → more protection for the investor
|● Limited upside vs. equity investments
● Since the platform is taking a small cut of a pre-existing loan, returns are typically 0.5-1% lower annually than platform-based debt
|6%-12% flat annual rate of return|
|Platform-Based Debt||● Typically guaranteed by the underlying property
● Short terms mean less liquidity risk
● Predictable cash flow
|● Limited upside vs. equity investments
● With the platform operating as the lender, there’s one less layer of diligence vs. syndicated debt
|6.5%-12.5% flat annual rate of return|
|Preferred Equity||● Entitled to returns before equity investors receive principal or returns, i.e. more secure than common equity
● Short terms mean less liquidity risk
● Predictable cash flow
● Opportunity to share in some of the upside (as compared to debt)
|● Capped upside (as opposed to common equity)
● Subordinate to debt, i.e. less secure
|● 6%-12% current return (like debt)
● 10%-16% total return (entitlement to some of the upside boosts overall return)
|Common Equity – Ground-Up Development||● Looking to capitalize on favorable market conditions and competitive advantages in building, can offer very compelling projected returns
● Investors can often tap into economies of scale realized by an experienced developer/real estate investment firm who is managing the project from start to finish
● Allows investors to tap into demand and demographic drivers in markets where purchasing property on their own might not be possible
|● Typically little to no cash flow during the term of the project (returns are dependent on sale of completed units)
● Since projects entail many moving parts and phases (permitting, construction, marketing, etc.) there’s a broad array of things that could delay repayment of principal or compromise returns
● Bottom line: the riskiest variety CRE crowdfunding assets, but the highest return potential
|● 20%-40% IRRs
● 2-7 year term
|Common Equity – Opportunistic Value-Add||● Investors can tap into the real estate firm’s acumen in operations and renovation
● Typically more upside than repositionings of stable properties, as the Sponsor is able to raise rents after material improvements to property
● Typically less risky than development, since the building already exists and there are fewer phases to the project
|● Less total return potential than development
● Depends on assumptions regarding how far and how quickly the Sponsor can raise rents after improvements. These assumptions should be examined closely.
|● Total projected IRRs of 18%-30%
● Often a “stabilized return on cost” phase where investors can earn 5%-10% annualized
|Common Equity – Cash-Flowing Repositionings||● Investors typically receive some degree of cash flow throughout the lifetime of the investment
● More upside potential than preferred equity or debt investments
● Since material upgrades to the property do not need to be made to realize returns, typically the safest form of common equity investing
● Generally safer than more opportunistic value-add or development investments, as stable rental income is already established
|● Less total return potential than value-add or development investments
● Cash flow is subordinate to debt and preferred equity investors, i.e. less secure
|● Projected annual cash returns of 5%-12%
● Total projected IRRs of 14%-25%
So, while real estate crowdfunding provides a real and viable alternative to REITs and direct ownership of property, this new asset class is hardly uniform in its own regard. Diversification is the hallmark of a strong portfolio, and it’s indeed possible that a sound portfolio might contain REITs and real estate crowdfunding investments, and perhaps individually-owned rental properties as well.
For investors seeking greater exposure to private real estate deals via online investing platforms, it’s important to consider these varieties, and which are viable given your appetite for risk. Above all, it’s important to do your own diligence on the platforms themselves: return projections are only as good as the people doing the projecting.
Interested in learning more about crowdfunded real estate investing? Check out these posts:
Have you invested in Crowdfunded Real Estate? Do you prefer debt or equity deals? What do you look for in a crowdfunding investment opportunity?
19 thoughts on “Debt, Equity, Development & More: Types of Crowdfunded Real Estate Investments”
Is there any crowdfunding. real estate platform that does not deal in debt and buys real estate on cash
Tnx for the article. I’m not sure how to evaluate the risk of these crowdfunded investments.
Enjoyed reading this. I don’t see how the returns can beat the scale of a REIT if cap rates start rising vs falling. A lot of the value in these investments is returned at exit and not based on on-going cash flow. I’ll stick with $EPR at a 7.6% yield and built in rent increases at or above the rate of inflation.
You may feel differently if the broad market takes a downturn. REIT’s are highly correlated with the market.
There are distinct advantages to owning real estate and non correlated assets, but to each his own.
As you know, EPR invests heavily in entertainment complexes, an interesting asset type in the real estate world. Morningstar states their trailing total returns at: -14.61 for 1 yr, 2.79 5yr. Current yield at 7.46%.
Tell me how that is better than a non correlated 8-10% pref, with IRR’s of 14-18%?? Not trying to talk you out of your REIT’s just making a point that they are not the same as direct ownership.
Lastly, there are a few high level sponsors that allow 1031’s via TIC’s. Nice if you can find it.
I appreciate the feedback. I guess I view “non-correlated 8-10% return” and a synonym for “illiquid 8-10% return”. A REIT provides a market price every day that you can get in 24 hours and avoids single project risk. You don’t actually realize the loss unless you sell under either scenario, but it does hurt more to see a REIT reprice daily. A syndicated real estate deal isn’t liquid, as an investor you can just say to yourself its worth “book value”, or what you’ve paid.
I’m in finance and I’ve watched this game on the other side, I had debt (loans) I made as a banker to commercial real estate properties in 2005-2007 go down between 2008 and 2010. Equity was wiped out and we either foreclosed and sold or just sold our debt at a discount. My concern isn’t the 7-10% returns I think a solid apartment complex investment can bring, my concern is all of the people bragging about 14%+ IRRs that are based on a snapshot of a real estate cycle. This will lead to over promising and under delivering for investors because those rates are based on high rent growth, contracting cap rates, and very low cost of financing or low-cap exits to REITs. Real estate historically returns a nice high single digit return in annual cash flow with a couple percent kicker that’s similar to inflation. 14% is not sustainable.
I’m not against the concept at all, but I’ll probably invest $25,000 – $100,000 chunks with people I already have a relationship with in a combination of real estate and private business deals. I have certain restrictions in my employment preventing me from doing that today. I will just have lower return expectations and carefully watch the debt position in each deal.
Got it. I pretty much agree with most of what you said. I understand that you being in finance precludes you from certain deals. I have a few friends in the same boat.
Illiquid- yep totally agree, but that is a given and occupies a component of my portfolio designated as such. I lived through the whole real estate craziness, in fact I syndicated a deal back then, and it’s still going strong. Illiquid – yep, cash flowing – yep.
I also agree that there are a lot of inexperienced syndicators that are stating very high projected returns, many based on cap rate compression, which may not come to fruition. On the other hand there are larger firms with 30yr of experience that have lived through the cycles. That’s where my money goes. As far as achieving 14% IRR, I believe it is doable with the right sponsor, the right asset class and the right deal/fund. Value add, new construction, and land development deals can achieve that even without cap rate compression.
Interestingly, my best deals have been quiet local deals with known local investors. But that is very sporadic so my bucks go to the larger firms. Nothing wrong with the whole crowd funded approach, it just makes me nervous given the large number of new sponsors competing for investment dollars. I’m sure there are good honest sponsors out there and some will rise to the top and move forward.
We’re not that far off at all. Your last point is spot on! The local real estate investors with a smaller / close knit pool of reliable funding just gets better pricing. Many of these crowd sourced deals require the buyer to pay a higher price in exchange for an extended contract period while they source the funds. I know a few of these individuals and can hopefully exchange deal advice (been able to look at 2500+ and finance 500 or so in my career) for an invitation into the investor pool post retirement.
Which longer-term, successful syndicators, who have been through a few cycles, do you prefer – both larger funds and also individual asset syndicators?
I have invested in syndicated debt via PeerStreet and Realty Shares and two preferred equity deals at RealtyShares. I currently have two properties in foreclosure, one on each platform, and am interested ti see how they work out.
I am going to check out the offerings at EquityMultiple (ca-ching!) as I was hoping to get more into commercial with these investments. Currently, almost all of my investments are in single family home projects.
Have you invested in any private placement syndicators (i.e. the ones that you have to be an accredited investor?).
I originally started on a crowdfunding platform (RealtyShares) and stuck with debt offerings. To avoid the hassle of out of state income tax filing etc, I only have invested in states with no state income tax (mainly Texas) or my own state (TN). Haven’t had any issues at all with the returns promised and have only 1 still open out of the 3 that I originally invested in (which returned capital as promised).
However, I have recently concentrated heavily into the private placement offerings because 1) they seem to have a much longer timeframe (on crowdsharing sites, I think the typical is 3-5 yr hold on equity) which is what I want (hoping to carry these investments well into retirement and provide a pretty stable source of passive income and I don’t want to have to be continuously looking to deploy returned capital); 2) A lot of the offerings on the crowdfunding sites are not preferred equity (i.e. you’re the last to be paid of what remains if things go south) whereas in these private placement deals I have an actual owner’s stake in the property.
There are private placement offerings in all sorts of sectors of real estate, the one I have solely gone in on is the commercial multifamily apartments (typically > 150 apt complexes). These properties have things going for them (basic need for housing, favorable commercial non-recourse loans (can’t come after individual investors by lender), etc. And by doing this I have access to properties I would never been able to look at individually (properties typically $8-30 million)
The downside is that these private placement investments typically require a much larger buy in (typically $50k minimum).
I’ve looked at what you’re speaking of. I actually think those are a decent place to invest in (I haven’t yet due to job restrictions preventing it). Find a syndicated deal with little to no debt and can capture a stable annual cash flow. Where you have to be cautious is many of the “historical performance” is based the economics of buying a property for an 8% cap rate and selling it for a 6% cap rate are over with and that’s driving some of the sites. Think of it this way, if a property generates $500,000 in Net Operating Income, it is worth $6.25mil at an 8% “Cap Rate”. If interest rates fall investors are willing to pay more for a real estate stream of cash flow, the market “Cap Rate” drops to 6% and the property is worth $8.33mil.
Buy based on cash flow, not based on appreciation and value at exit. A trained monkey can make money buying stabilized properties in a falling cap rate environment. I fear people are seeing returns based on exit values and chasing this asset class because of the higher than market returns over the past few years
That is a great point to consider.
What would you consider a good cash flow on a particular project? I have just invested in my 4th property with this particular syndicator (oldest investment is still under a yr) and have been getting quarterly payments that indicate about a 4.5-6% annual return on my money. According to their PPM typically first yr is the lowest cash flow and then it starts getting even more profitable in years 2-5 etc, so this % may increase in subsequent years.
This particular syndicator states that at sometime in future (probably yr 7 or later) they typically do a harvesting of “lazy equity” by doing a refinance. The additional money gained from refinance is then returned to investor where can be deployed again creating a cascade from original money. It is at this point that they get rewarded with equity share if certain milestones met (i.e. they really get paid if they achieve this goals).
I would benchmark this against a REIT in a similar property class. You get monthly/quarterly cash flows and the investment is more liquid, even though you have to stomach your investment’s market price being adjusted daily. Imagine if you had to see what any buyer would pay for your direct investment on a daily basis, it’s not always 100%.
Example: If I were investing in an industrial building, I would want it to exceed the cash on cash return of a similar REIT, Stag Industrial. I can get a more diversified 6% annual return with embedded 3-6% cash flow increases annually based on their rents.
The premium that you demand over that benchmark is up to you.
This sounds like a value-add deal. Initial years are for repositioning (rehab and lease-up) then later years have better cash flow. When investing in a multifamily, I like 8% pref then a 70/30 waterfall split. The 8% will be lumpy and possibly paid in the backend of the hold, but it does accrue and carry over year to year.
In the underwriting, a good sponsor should not count on a compressing CAP rate. They should be conservative and allow it to expand a certain amount for each year of hold. If they count on appreciation, I run away.
Now I do a mix of funds and individual deals. The fund may have 10-20 properties in it. Spread risk across multiple sponsors, geography, and asset types. Lots of new, inexperienced operators out there putting out rosy proformas.
I do the same, I have money with several large funds as well as in single asset projects. I am very picky about the sponsor and their track record and as such steer away from most of the crowd funded sites where the sponsors are often inexperienced. Just my take on it, I invested back in 2007 where everybody was a real estate super star and they got burned.
Diversify by asset class, sponsors and geographic location. Do your due diligence and be cautious.
I have a growing proportion of real estate but haven’t yet gotten into the crowdsourcing method. I’m waiting to see how things go for you early adopters. #Laggard
Can you describe the basic tax implications of investing in each investment when investing in a taxable account? Are you receiving a K-1 for all of these or only those that are equity related? Thanks!
Thanks for explaining these different types of investments. As someone who hasn’t invested in real estate yet, this was quite helpful.
Definitely glad to have this resource. I’ll start looking into more real estate investing when I am done paying off my debt in a couple of years and have the cash flow to do that.
Love the idea of diversifying in this way. Appreciate the post!