It’s tempting for investors to hear about 8%-12% returns that real estate crowdfunding has been delivering and rush in to get their piece of the action. However, it is important for investors to take the steps necessary to ensure their investment is solid.
Real estate crowdfunding (RECF) platforms have changed the way people can invest in real estate. The opaque world of private real estate deals has been upended by a digital transformation that brings with it a deluge of data and its own set of issues. RECF platforms perform investment due diligence before offering it to the crowd of investors, but who is vetting the platform?
The following is a list of three due diligence questions for real estate crowdfunding investors to ask before making an investment decision.
1) How Does the Real Estate Platform vet Their Borrowers?
Every platform is different. Firms will generally perform a FINRA broker check, which, among other things, offers intelligence on the borrower’s credentials, affiliations, and registrations. Some firms consider organizational structure in their vetting process as well as online research. Some of the pertinent information that a firm will usually seek on a borrower is:
- What is their borrowing history, including total volume and rate of success?
- How much experience does the borrower have?
- What is their credit score?
- Do they offer a personal guarantee?
2) How Does the Real Estate Platform vet the Properties?
A lot of what goes into vetting a property is the vetting of a borrower, but factors concerning the actual structure of the deal and the property are considered as well. Some of those considerations are:
- Loan-to-value (LTV) ratio: Traditional bank lenders may not service a loan with an LTV above 59 percent, whereas private non-bank lenders have more flexibility to lend with an LTV of 80 percent.
- Lien position: A property with a first lien might be as attractive to the underwriting process as a large borrower with an impeccable track record, while a second lien is less attractive in the event of foreclosure.
- Location and occupancy: Core urban markets with high occupancy score more favorably than suburban markets with moderate occupancy, which fare better still than rural properties or emerging markets with lower occupancy.
- Phase of development: Stabilized properties, which are existing assets with leases and cash flow, measure more favorably than value-added properties, which are existing properties that are being improved upon. The lowest rated of the three development phases is the ground up phase, where a completely new asset is being built without a rent roll to support the balance sheet, yet.
3) How do Investors vet the Platform?
To start, investors should only work with a firm that has good leadership. How long has the platform been in business? Who are its main players? How successful have they been, and what are their notable associations or accomplishments? One of the biggest considerations for the investor when vetting any RECF platform is whether deals are debt-based or equity-based investments. Debt-based investments mature after a shorter hold time and offer steadier income at lower risk while equity-based investments charge lower fees and offer better tax benefits, but they also have longer hold periods and pose more risks.
Investors should also find a platform with a proven track record. What is the value of the firm’s underwriting history, and what percent of those loans have defaulted? Have investors lost money as a result? What percent of the firm’s transactions is senior debt vs. mezzanine or lower positions on the capital stack? What origination terms does the platform tend to seek? Is the platform only available to accredited investors? What is the required investment minimum?
Investment Due Diligence for Safe Returns
There is money to be made in real estate crowdfunding in the current investment market, but that money is there for those investors who perform the necessary due diligence on the platforms in which they wish to entrust their money. Don’t assume that all real estate crowdfunding platforms were created equally. They vary greatly in terms of the types of deals they offer, their management teams and their track record of success.