Crowdfunded Real Estate Limitations

The crowdfunding phenomenon is now taking on real estate investing.  Sites like RealtyShares and iFunding are enabling small-time retail investors to become silent partners in projects they could not otherwise afford.  Passive investments in real estate have been around forever in the form of limited partnerships.  Crowdfunding things like trust deeds just lowers the entry barrier.  It does not change the threshold for due diligence.

The key to success in real estate has always been location, location, location.  A crowdfunding investor can only perform a minimal assessment of a property’s value without physically visiting the property. Anyone can log on to Zillow and view the most recent valuations of neighboring properties, or check a parcel’s assessed value at the county assessor-recorder’s office.  Those are beginning steps.  The next steps involve property appraisals, traffic analysis, and other checks on the track record of property managers.  Those things can be crowdsourced to some extent but there’s no complete substitute for traditional on-site legwork.

Investing in residential property since the housing bust poses additional challenges.  Getting clear title is a problem if a home mortgage was bundled and changed hands several times.  I can’t know whether a given trust deed on a crowdfunding portal has title problems without checking with a title search company first.

I am concerned that novice investors could be hurt by a severe downturn in the housing market just as they were hurt in the housing crash that started in 2006.  Buying a share of a note secured by a trust deed is like becoming a hard money lender rather than a title owner.  The investor owns a share of a syndicated loan, denominated in dollars as a fixed-income instrument that pays a predetermined yield.  If the US economy experiences high inflation, those note owners will see the value of their note evaporate as the dollar loses its value.  Meanwhile, the actual property owner (either through an LLP, private REIT, or whatever) laughs all the way to the bank at the stupidity of those crowdfunding note holders.  That doesn’t happen in normal times but these aren’t normal times.

I think crowdfunding would work best for small projects that members of a community can see firsthand.  Urban farmers could form a land trust, for example, and crowdfund it to establish community gardens in a blighted urban neighborhood. Charities like Habitat for Humanity could crowdfund a housing project for a low-income buyer and hand them title when the project is done.  The valuation for such projects would have fewer variables to calculate because they’re brand new and presumably unencumbered with the problems of previous owners. Crowdfunding portals can eventually be useful for conventional real estate investors once the housing market stabilizes, with the median property value for a given metropolitan area at somewhere between 2x and 3x of the area’s median income. I am looking forward to seeing miscellaneous real estate investments like liens and rights-of-way traded on crowdfunding portals.

Investors who have neither the time nor skill to evaluate a crowdfunded real estate project can always choose a publicly traded REIT or real estate index fund (or ETF) instead.  A widely held fund has two advantages over a single property. It has no entry barriers or limitations for non-accredited investors and it arbitrages away the location problem by holding a large number of properties.  Maybe some sharp investment manager will crowdfund a private REIT.

About Anthony Alfidi 128 Articles

Affiliation: Alfidi Capital LLC

Anthony Alfidi is the Founder and CEO of Alfidi Capital. His firm publishes free investment research with honesty and humor.

Mr. Alfidi holds a Bachelor's degree in human resource management from the University of Notre Dame (cum laude) and an MBA in finance from the University of San Francisco. He is a life member of Beta Gamma Sigma, the academic honor society for business majors. He has been a private investor since the 1990s.

1 Comment on Crowdfunded Real Estate Limitations

  1. Anthony,

    You make some valid points in your post and you are 100% correct that crowdfunding does not change the threshold for due diligence. At RealtyShares, protecting our investors and only focusing on very high quality exclusive investments is our priority. We thoroughly curate and underwrite every investment as well as the market. This process includes reviewing appraisals and valuation statements, reviewing title, reviewing local (often not publicly available) sales data, reviewing historical data to understand trends and even negotiating better deals terms on behalf of our investors if we see fit. As a result of this vetting process, we agree to list only a small fraction of the investments that are in our pipeline.

    Also, we aren’t solely focused on Trust Deed investments (although trust deed investments do have various benefits including annual yields as high as 9-12%). Rather we are focused on a range of opportunities with the caveat that these opportunities have to make sense for our investors.

    In the end, our goal is to make real estate investing simple and secure so our investors can access quality deal flow and invest efficiently across a broader range of investments. However, we are also very much focused on guarding our brand and reputation as an investment platform that focuses on only the highest quality. Thanks for your coverage here and for raising issues that I think any real estate investor (whether participating through crowdfunding or not) should be aware of.

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