Part 2: 7 limitations of real estate crowdfunding sites.

New industry has too few investments and high minimums that cause diversification and scaling problems.

 

Originally written June 16, 2015 (Updated April 26, 2018) BY IAN IPPOLITO

 

 

Recap

 

In part one of this series, we talked about limitations of real estate crowdfunding sites, that can be overcome with tools or effort.

In part two of this article, we'll talk about limitations that the sites themselves will need to fix, as the industry matures:

  • Limited to accredited investors

  • Not enough investments to diversify

  • Not enough core investments to diversify

  • Too high minimums
     

Once the industry does, it will be possible to truly scale and diversify your investments, and the sites will accommodate your large, core real estate investments. For now, they're best suited for smaller, speculative investments.

Let's take a look at the issues.

Accredited investors only (for now)

Update April 2018: the industry has matured a lot since this was written and there are now 14 options for the average, everyday nonaccredited investor. It would be nice if there were thousands of options for nonaccredited investors, like there are for credited. But this is a huge first step in the right direction. So this is no longer as much of an issue as it was in 2015. 

Not enough investments to diversify

Update: April 26, 2018. Since this article was written, many platforms offer funds with multiple properties in them. So with a single investment an investor may be in five, 25 or more properties. So this has gotten a lot better. However, since there still are plenty of single property funds where this can be an issue, I'm leaving the section here.

You need at least 100+ properties, to diversify your portfolio against geographic, regional, tenant and property risk (and most likely many more). In our current new investment feed of all open investments in the industry, there are only 42, with a new investment opening every 3 to 4 days. Since not all investments will be suitable for every investor (by a long shot), it currently takes months or years to deploy a diversified portfolio.

In comparison, The Lendingclub is a consumer loan crowdfunding site, and currently has about 600 - 700 new investments open up every day. An investor can diversify into the required minimum of 100 loans on The Lendingclub, in a single day.

This makes investing real estate sites uncomfortably risky. In the conclusion I talk about a strategy to deal with this risk.

Not enough core investments to diversify

2018 Update! There are now core options available! Not a lot, but still better than before. I've explored the field. Click here to see the best core investments. (This is a private investor club-only article. Membership is free, but requires verification.)

There are four real estate investment strategies. If you want the protection of diversification, you have to allocate your investments properly across the 4 strategies.

If you don't, you expose yourself to unnecessary risk that can quickly wipe out all your profits (and then some): especially as economic conditions change.

One of the strategies is called "core", and needs to be between 40 to 70% of a diversified portfolio. (See "What are the 4 investment strategies?")

 

However, today there's only a handful of core investments, and most sites don't have any. In our current investment feed, only two out of 42 investments are core. At the current rate, it would take years to build a 40% to 70% diversified portfolio.


I've complained about this issue to several sites. Staff have told me that in today's low interest environment, it's much easier sell value-added, and opportunistic investments, because they have higher returns.

 

In my opinion, this is an extremely shortsighted strategy. Times are good now, because we're currently in the upswing of the real estate cycle. But we're closer to the end of the cycle than to the beginning, and inevitably it will go down. When it does, investors will experience significant losses on riskier assets. Without the ability to diversify, the effect on a portfolio can be catastrophic. And the industry will take an unnecessary black-eye with the public.

 

Over time, I expect this to improve. However, today it's a serious problem. This makes investing much riskier than it needs to be. In the conclusion, I talk about strategy to deal with this risk.

 

Minimums too high to diversify

 

Update: April 26, 2018. Since this article was written, many platforms offer funds with multiple properties in them. So with a single investment minimum an investor may be in five, 25 or more properties. So this has gotten a lot better. However, since there still are plenty of single property funds and also high minimum offerings where this can be an issue, I'm leaving the section here.

As I described in detail in this article, the current site minimums put diversity out of the reach of the average investor.  

 

  • Cash required:

    Low-end accredited investor minimum sites require $5000, which means you need $500,000 of cash to diversify into 100 properties (which itself is a bare minimum for diversification and perhaps too low). The high-end minimum sites require $2.5 million of cash.

     

  • Overall portfolio size:

    For safety reasons, it's not wise to invest the whole portfolio in real estate. Since real estate is typically confined to 10% of a portfolio, this means a person should not participate in low-end minimum sites without a portfolio of $5 million. They shouldn't participate in high-end minimum sites without a $25 million portfolio.

 

This is beyond the reach of many accredited investors, and 99.99% of the individual investors.

 

This is a key issue, that the sites will have to address in the coming years. I fully expect the minimums to come down drastically. With the average investor having only $100,000 dollars in a 401(k), minimums need to be brought down to the $50 range, similar to the $25 minimum of consumer loan crowdfunding sites. 

 

I will be informing sites about this issue, and posting their responses.

 

Conclusion

 

The industry is young, and I expect we will see vast improvements over the next few years.

 

In the meantime, there are workarounds to many of them. I've also created a few tools solve some of these problems, which I shared in part one of this article. A few of them can't be solved with tools, and will take time for the industry to resolve.

 

For now, these limitations cause significant scalability and diversification issues for some investors.

 

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About Ian Ippolito

Ian Ippolito is an investor and serial entrepreneur. He has been interviewed by the Wall Street Journal, Business Week, Forbes, TIME, Fast Company, TechCrunch, CBS News, FOX News and more.

 

Ian was impressed by the potential of real estate crowdfunding, but frustrated by the lack of quality site reviews and investment analysis. He created The Real Estate Crowdfunding Review to fill that gap.

   

 

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