Performing due diligence on a potential real estate investment is one of the most important parts of the process. It ensures that you assess the investment risk soberly rather than rely on unreliable methods such as “gut feeling” or taking the borrower at his word.
With real estate crowdfunding, due diligence begins with verifying the trustworthiness of the platform.
Step by Step Guide to Performing Due Diligence on a Real Estate Crowdfunding Platform
At a minimum, you’ll want to check the following on any real estate crowdfunding platform you are considering investing through:
- Depending on whether the platform accepts non-accredited investors as well as accredited, or accredited only, and based on the platform’s business structure, you’ll want to make sure they have registered property with the Securities and Exchange Commission and filed all the required documents by checking the EDGAR database.
- Next, look at how many successful deals the platform has listed and whether those deals have returned positive returns for their investors.
- Check the background of the company’s leadership. Do they have experience and a track record in the types of real estate deals you want to invest in?
- Examine the platform’s underwriting practices. Do they do their own underwriting or partner with a firm that has experience in underwriting real estate loans of the type you want to invest in?
- Finally, if possible, speak to other investors who have used the platform and see what they have to say. Were they satisfied with their experience, have good things to say about the platform’s customer service and technology, and were they able to find solid deals on the platform?
Performing Due Diligence on Individual Real Estate Investments
If you perform the proper due diligence on each real estate crowdfunding platform you intend to invest in, then that will go a long way to ensuring that individual investments you find on the platform are solid deals with good potential. Still, you’ll want to look at each individual investment even if the platform performs due diligence—and it should. Not only should you trust the investment property itself, but you should be able to trust the borrower as well as the platform that makes the offer available.
- Begin with your own loan-to-value (LTV) assessment. Before investing in any deal on any real estate crowdfunding platform, know your threshold for LTV. After deciding your maximum LTV, make sure you only invest in properties that meet your criteria.
- If you’re investing in rehabs, check the after repair value. Like LTV, you’ll want to establish a criteria and stick with it.
- After LTV, check the annual net return, also called Net Annualized Return (NAR). This is the expected return on investment throughout the life of the investment. If the deal matures after 12 months and the platform estimates a 10% NAR, weigh that estimate against other known NARs of investments you have access to. But don’t rely on NAR completely. It is just an estimate.
- Where does the investment fall in the capital stack? Ideally, you want to be in a first lien position. If you are higher on the capital stack, you’ll want your potential return to reflect the amount of risk. For instance, if NAR for a first lien position is 9%, then you’ll want your estimated NAR for mezzenine debt more than that, and for private and common equity investments even higher.
- Another consideration is borrower, or borrower, experience. Not only do you want to ensure the borrower has experience with the type of deals on offer, but you’d also like to know if that borrower has had other successful deals on offer through the platform you are investing in. Background, experience, and track record of the borrower should always be a part of your due diligence assessment.
All due diligence is an assessment of the risk factors pertaining to your investment. Keep a cool head and walk away from any deal that doesn’t make sense or has you scratching your head.