Successful accredited investors have the analytical skills to select real estate development projects that represent low risk and healthy returns. Identifying projects with a low-risk and high-return profile can be a time-consuming, tedious, and an inherently complicated task. With this article, we’ll answer the questions that most accredited investors ask when it comes to selecting projects that have strong return potential and a low-risk profile.
What are the Best Real Estate Development Markets to Focus on?
Real estate development markets are evaluated on key indicators such as demographics, tax rates, regulatory environment, population, and industry growth.
Real estate development market demographics reveal the nature of the target audience, the trajectory of the market, and the viability of real estate products and services over the long-term. Real estate markets with rising commercial lease rates, improving industry growth, and increasing populations are favorable to real estate developers, with few exceptions. Additionally, impending changes in regulations, emerging regulatory issues, and zoning law amendments have a direct impact on the direction of real estate markets.
What Makes Real Estate Development Projects low Risk for Accredited Investors?
Factors that influence the risk profile of a real estate development project include Loan-to-Value (LTV) ratio, lien position, occupancy rate, and the development phase. The LTV ratio and lien position have the most bearing on the risk profile of any real estate development project. The LTV ratio indicates the extent to which the project has been leveraged. Higher leverage makes the project prone to higher debt servicing requirements and liquidity challenges in situations where occupancy percentage drops, interest rates rise, or the market contracts.
Why is Crowdfunding less Risky than Direct Investment/Private Lending?
The primary objective of crowdfunding and direct investment/private lending is the same: generate profits; however, these investment types are distinct in the returns they provide, the risks the investor is expected to bear, and the way profits are administered. While private lending may offer the highest returns, it also requires investors to accept the maximum risk. Private lending requires larger contributions and more involvement from investors. If market dynamics put pressure on the real estate development project leading to default, private lenders must independently seek recovery via various foreclosure options.
In crowdfunding investment models, the opposite is true. Contributions required are smaller, allowing for diversification and hedging. The management of the project is handled by experienced and highly-qualified professionals trained to mitigate risk.
What Financial Documents and Statements should I Request from Borrowers/Sponsors (Real Estate Developers)?
You should ask the borrowers/sponsors for documents that will give you access to key indicators of solvency, liquidity, market conditions, and the probable profitability of the project. This means you need to calculate performance metrics such as the debt to equity ratio, the internal rate of return (IRR), and capitalization rate, among others. Financial documents you should request include:
- Construction budget
- Appraisal report
- Title report
- Series note listing/Loan details report
If you do not have a financial background, you may need to get financial assistance from an expert to decipher these documents. Considering credit scores, state of liquidity, and experience in the market is also prudent.
How Much Time Does It Take to Complete Proper Due Diligence and Manage a Direct Investment as a Private Lender and Accredited Investor?
If you plan to use a real estate crowdfunding (marketplace lending) platform to source your investments, you will only need a few hours at most to perform due diligence. If you were to privately fund a real estate project – independent of a marketplace platform – you could spend anywhere from 30 to 120 days performing adequate due diligence. Marketplace lending platforms have teams dedicated to processing investments, underwriting loans, and confirming the quality of an investment before making it available to accredited investors online. To learn more about how Sharestates performs due diligence, visit sharestates.com.
The exact time taken will depend on project size as well as the extent of its features. You may need to be quicker with your due diligence if there is competition for the project and the risk of losing it to a competing investor. Further investigation might be necessary if there are additional revenue generating facilities on the premises such as a laundry, parking, recreation, and fitness amenities. The due diligence period is part of the agreement between the development and investment parties.
The time it takes to manage a direct investment as a private lender also varies on the basis of the project size and inherent facilities. On average, it is not only time-consuming to manage commercial assets directly, but also extremely tedious. It involves managing a wide variety of tasks including payroll, maintenance, tenants, insurance, mortgages, and taxes. Managing direct investments is time-consuming enough that most investors opt to employ third-party management agencies.
Reliable crowdfunding platforms, such as Sharestates, render both financial assessors and management agencies redundant. They eliminate the need for a real estate investor to conduct excessive due diligence or deal with daily management activities. Every project/sponsor is fully vetted before recommendations are made, and issues such as maintenance, borrower defaults, and solvency determination are all handled internally.
While the process of selecting real estate development projects with low risk and high return is time-consuming and complex, it is critical to the success of accredited investors seeking higher performing opportunities. Consider the benefits of crowdfunding platforms as an alternative to going through the complicated due diligence involved in managing direct investments.
Sharestates offers a diverse range of investments within real estate markets nationwide. All open investment opportunities can be viewed on sharestates.com/investments.