As accredited investors we’re always searching for the best returns on our investment dollar. How can we find residential and commercial investment projects that have been professionally vetted, and promise minimal risk and excellent returns? The field of online real estate investment offers an excellent vehicle to achieve these goals.
Debt and Equity Investment Structures for Accredited Investors
What is the best investment structure for your goals? Crowdfunding platforms offer a combination of debt and equity. Each has unique benefits and offers associated risks and returns.
Equity investment is a long-term strategy that earns returns through dividends on the income the property generates, either on an ongoing basis, or when the property is resold. Equity shares offer the promise of the greatest returns when the project has an extremely successful outcome. Since the returns are based on the percentage of ownership in the project, high-margin projects yield the greatest returns for the accredited investor, compared to debt investments which are limited contractually to the interest-rate specified. When an investor holds an equity share, and the investment fails, there is little recourse to recover invested funds.
In contrast, debt investment is typically shorter term, based on a fixed period and interest-rate. Debt investments are generally the safer strategy of the two, as you are promised a pay back within a specific period time, at a set interest rate. Debt investments are typically backed by notes collateralized by the subject property. When the debt holder is in a first lien position, the lender has an excellent potential to recover the funds in the event of default. Another option is a hybrid form of investment where debt is converted to common shares in the project. This allows the accredited investor to earn a stable return, and the potential to participate in the long-term growth of the project.
Assessment of Risk for Accredited Investors
Whether debt or equity interest is selected in a crowdfunding platform, it’s vital that the fund managers, and the accredited investor, engage in careful due diligence. You should ask questions about the financial strength of the borrower, experience level of the project managers, and various risk factors specific to the subject property. When considering the solvency of the borrower, it’s important to see documentation to verify and analyze credit scores, assets, and the track-record of success in similar projects. The level of risk associated with the borrower is the basis of establishing a risk-adjusted interest rate. The platform you choose to work with should offer complete transparency and a willingness to share all due diligence documents with you. This allows you to make an informed decision when considering making a debt or equity investment in a crowd funded project as an accredited investor.
You’ll also need to ask questions about the project itself: what is the occupancy rate, loan-to-value ratio, lien position, stage of development, and type of market the property is in? The answers to each of these determine the risk profile of the project and property. Occupancy rate is important because it indicates the stability of the property. Higher occupancy rates indicate that the property is further along in the development process and will produce greater income. When the occupancy rate is low, it can signify an excellent value-add opportunity. As the value of multi-family and commercial properties is directly related to the income they produce, occupancy rate generally indicates either the strength, or the room for potential improvement, in value based on income.
Additional Risk Factors for Accredited Investors
In general, projects that are further along in the development process represent less risk. Variables such as cost and tenancy become more stable with progress. New projects also require more advisement and oversight than those that are already established. When other investors have already invested significant funds in the project’s design and implementation phases, it indicates their willingness to bear the initial risk to start the project. Investors have substantial incentive to ensure that the project is completed successfully and profitably. While prior investment is an important sign, it’s prudent to ask about the loan-to-value ratio. Debt financing should typically not exceed 70-85% of the property’s projected value. Exceeding this figure creates extra risk as the invested funds may not be recoverable in the event of default or market depreciation.
Larger Projects for Accredited Investors
Unless you’re willing to invest huge amounts of capital in a single investment, it can be difficult to find larger commercial and residential investment projects that will yield the highest returns and provide the most stability. When you invest directly as a private investor or business angel, you bare much greater risk and are typically limited to smaller investments. Smaller investments tend to receive less scrutiny, compared to that conducted for high-value real estate undertakings. Investing in a shared risk model through a crowdfunding platform allows the greatest access to quality investments that offer the risk profile, diversification, and returns needed to maximize the growth of your investment portfolio.