FundRise Launches Diversified Portfolio Option
3 steps forward, 1 back; but ultimately 5 steps short.
June 17, 2015 BY IAN IPPOLITO
Fundrise is one of the leading sites in the industry. It has a substantial investment inventory and significantly lower than average fees (0.3-0.5% versus 1.1% average). It also boasts an industry-leading rating system, and $35 million in funding, which lets investors sleep more soundly at night.
So, when I got an email from them a few days ago about a new product they’ve created that allows investors to diversify with lower minimums, it got my attention. Inadequate diversification, and too high minimums are the biggest frustration I have with the industry (and severely limits the amount I can safely invest at present).
As I dug into the details, I saw some positive features. But ultimately I was let down. This new fund does take some significant steps in the right direction. At the same time, it’s structured in a way that negates some of the benefits it could have provided. And ultimately, it falls significantly short of solving the diversification problem.
For those not familiar, here's a recap of the diversification issue.
Ouch! Why are my fingers burning?
Direct real estate has produced stable 9.2% returns over time, with bond-like safety (See “Why invest in direct real estate”). But individual investments can be much more volatile, so investing in just a few properties is like playing with fire. You might get away with it for a while, but eventually something will happen (change in economic cycle, loss of tenants, legal issue, bad luck etc.), and you'll get burned. Just one default can be very painful and wipe out several years of profits in a small portfolio (and then some).
Thankfully, you can eliminate this risk by diversifying into 120+ properties (See “How many properties do I need to properly diversify?”)
But, currently, the minimums on sites are too high to allow many investors to do this. The cheapest require $500,000 in cash and a $5 million overall portfolio to do safely. The most expensive require $2.5 million in cash and $25 million in assets. (See "Site minimums put diversification out of reach for investors").
Obviously this is a problem. Site minimums need to come down by a factor of 10, to fix things. Until they do, the sites are only suitable for small, speculative investing instead of large-scale, core investing.
It’s possible that Fundrise, may be aware of this issue, because they said they created their newest product in response to "investor demand". So let’s take a look at it.
Fundrise Diversified Portfolio 1, is Fundrise's diversification solution, and does have some good features.
Rather than 1 property/investment, it's a basket of five specific investments, which makes it much less risky. The individual investments range from B-C (using Fundrise's proprietary rating system), giving the overall investment a B rating, which adds up and make sense.
The investments are spread across multiple regions of the country, which is nice because it reduces geographic risk, without any extra effort.
The transparency of the offering is a huge plus, and fairly unique in the industry. Unlike some of the diversified offerings on other sites (like RealCrowd.com), you are given full details on each of the investments before you choose to invest or not. On other sites, you typically have no control over the investments, and instead turn over investment selection to a manager, who you hope and pray will do a good job.
This is a significant innovation, and step forward for the industry, and Fundrise deserves credit for doing this.
Disappointingly, Fundrise chose to double their typical minimum investment for this fund (from $5000-$10,000). This negates 50% of the benefit they could have provided!
If they had kept the normal $5000 minimum, it would allow investing at $1000 a property (a 4X drop). This allows investing at $2000 a property (just a 2X+ drop).
A 2X plus drop is only a tiny step closer to the 10X drop necessary to allow true diversification to take place. While a step in the right direction, it’s still a long, long way from solving the problem.
Not only does it fall short, but it doesn’t even move FundRise into competition with existing competitors. Many of them already at $1000 a property (versus $2000 in this fund).
Placing multiple investments in a basket is an awkward and expensive diversification kludge, compared to the elegant solution of simply dropping minimums.
With a pre-chosen basket of investments, it’s very unlikely that every single one of them fits the holes in your portfolio (matches the exact risk/reward ratio, investment strategy, geographic location, asset class, etc. that you’re looking for). This forces you to compromise and waste money on investments that don’t fit.
On the other hand, simply lowering the site minimum on all investments, allows you to pick the best individual investments to fill the holes in your portfolio perfectly. No money is wasted on compromises.
The new diversified fund is a small step in the right direction. At the same time it’s a far cry from solving the diversification problem.
When I asked Jordan Sale, Press Relations at Fundrise, about future plans to solve this diversification issue, he responded:
“As Fundrise Portfolio I is live on the site, I am unable to discuss specifics. However, giving our investors opportunities to diversify is a central focus for us as we scale”.
Hopefully, Fundrise will move significantly further in that direction in the future.
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.