Crowdfunding real estate investing is taking over the way investments are made on the internet. In 2014 alone, crowdfunding investors injected $1 billion into the U.S. real estate market, and that number was projected to climb to $2.5 billion by the end of 2015. Real estate investments in the space are growing in popularity because of their low barriers to entry, and ability for investors to diversify their real estate holdings easily. For many, investing in real estate lending through crowdfunding platforms offer the highest risk adjusted return in market.
The constant flow of deals across a variety of platforms increases the necessity for strong due diligence on the part of the investor. In order to make sure you’re getting the best rate of return on your money, you need to be sure you’re investing in the right places, on the right projects, and with the right types of people. Let’s take a look at a few important steps all investors should take in their due diligence process:
1. Know Your Platform
As an investor, you need to be comfortable with the platform(s) you’re investing on. Do they have experience underwriting previous deals, and if so, have those deals performed well? Do they have an experienced team in real estate and financial services? You want the platforms you invest with to be around for the long haul. It’s a good sign if they’re able to fund a majority of the projects they list and constantly bring new deal flow to the platform. To protect your investments, make sure they have a plan in place to continue distributions on loans if they have to wind down their business.
Once you’re comfortable with the platform, understand what level of scrutiny the company performs its own due diligence. For those that have strict guidelines, make sure you know and are comfortable with the criteria used for underwriting loans. For those that have no requirements, be sure they are providing enough information for you to do your own due diligence.
2. Know Your Fees
A basic rule is: if a crowdfunding site is not being completely transparent about their fees, stay away. Almost all of the platforms out there today base their companies on ease, trust, and transparency, so if you don’t get that feeling from the company you’re researching it is probably cause for concern.
When fee structures are available for you, try and stay away from deals with high fees, as these are generally detrimental to your longer term returns. Keep in mind, however, that sometimes the fees are tied in with other services on the site, like the level of overall due diligence done on potential properties.
3. The Borrower
Once you’re comfortable with the platform and their fee structure, you can start digging into individual deals. When looking at projects on crowdfunding sites, probably the most important piece of the due diligence puzzle is getting a feel for the borrower. Are they experienced? How many similar deals have they successfully (and unsuccessfully) completed? Have they successfully funded and repaid other deals on this particular platform? Do they have a good overall track record and a decent credit rating? If you can answer these questions satisfactorily, you should feel a lot more positive about the deal.
4. Deal Specifics
The next step is to study the individual deal you’ll be investing in. Look at the absolute numbers, ratios, and estimates provided to you by the platform you’re investing with. How much is the borrower buying the property for and how does that compare to the current appraisal? Buying properties at a discount help protect your downside. What is the estimated after repair value (ARV) of the house, and how does that compare to the size of the loan? A good rule of thumb is to stay away from projects with a loan to ARV ratio greater than 65%. If possible, have a look at other properties for sale in the same area, and make sure the ARV of your project is in the range of other properties in the immediate vicinity. Do some more research on the neighborhood and make sure that real estate values are not trending down.
For real estate investing, it’s also important to find out where you stand in bankruptcy scenario. This is also referred to as where you are in the capital stack. Depending on what platform you’re investing in, you may have the option to invest in first or second lien positions, or equity and mezzanine positions. As an investor, you’ll have a lot more downside protection if you invest in the first lien positions of real estate assets, as you’ll have first claim to the property if a borrower fails to pay off their loan.
5. Diversification
If all of the above meets your standards, you’re ready to invest. It’s important to extend your diligence process one extra step and make sure you diversify where you’re investing your money. The beauty of real estate crowdfunding is the ability to invest much smaller amounts of capital into a larger swath of potential projects. Use this to your advantage and make sure you’re not over-investing yourself into one specific deal, borrower, geographic location, or maturity range. Diversifying across these categories helps protect your portfolio from massive losses on individual deals and will lead to better long term returns on your investments overall.
