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So, you’re interested in building your own real estate portfolio? Great. Now, the fun part begins—assessing whether the investment opportunity meets your investment objectives. Here’s an overview of what you should look for when evaluating real estate crowdinvestments, and some important questions you should ask when reviewing a deal. We’ll break it down into three primary categories: the deal, the sponsor, and the platform.
1. The deal
When it comes to evaluating the deal itself, there are a number of factors to consider, and a handful of questions you should ask.
What type of investment is it?
From a capital structure perspective, there are two main types of investments: equity and debt.
With equity, you earn a return by holding an interest in the property’s profits, which can be generated through rental income payments and/or price appreciation when the property is sold.
With debt, you are acting as the lender by providing some of the financing for the property. You are entitled to receive regular interest payments. With debt investments, one of the most important factors to consider is where the investment is in the capital stack. Senior debt is generally less risky than junior debt, as it gets paid off first. However, this means senior debt investments generally yield a lower return.
What is the valuation?
The price of the asset must make sense, especially when considering the total exposure and the type of property—is it a hotel? An apartment? A house? The square footage has to be taken into account, as well as comparables in the market, both in the present day and historically.
This can get tricky because in real estate, the price can be different from the cost which can be different from the value. If your head is spinning... fear not! We explain below.
The price is what the seller of a property is asking.
The cost is how much the buyer of a property is willing to pay.
The value is a bit more nuanced, because although it is informed by concrete information (such as surrounding market data, comparable sales, etc), it is an opinion of worth.
There are a few ways in which property valuations can be determined, which we’ll simplify into three methodologies:
The income approach: oftentimes, properties are valued on the basis of income. In this method, the value of the property is determined by dividing its net operating income by the capitalization rate (or cap rate—a metric that shows the potential rate of return of a real estate investment). This is popular for income-generating assets, such as rental properties.
The cost approach: This method estimates that the price a buyer should pay for a property equals the cost to build an equivalent building. This approach says that the property's value is equal to the cost of land, plus total costs of construction, less depreciation.
The sales comp approach: This method determines property values by comparing them to similar comps that have recently been sold, by using market data to estimate the valuation.
Where is the project?
The first rule of real estate is location, location, location. Is the property well-located? Is it near public transportation or a highly trafficked area? Is the property desirable from a leasability perspective? If the business model depends on acquiring strong tenants, leasability is crucial.
What is the risk profile?
It is important to consider what state the property is in. Is the project a new development? Is it an older building that requires renovations? Is the property stabilized with tenants, and are those tenants high quality? New development is typically associated with greater risk, and in turn, potentially greater reward.
How does the deal make money?
Returns in real estate are typically derived from two sources: 1) dividends from rental payments and 2) capital appreciation. If the focus is on capital appreciation, is the market on the upswing or about to have a correction? Since real estate cycles typically run about 17 years, timing is important.
What are the returns?
Be wary of promises of sky-high returns. While real estate crowdinvesting deals can make solid investments, if it sounds too good to be true, it probably is.
2. The sponsor
It’s equally as important to consider the sponsor of the deal, and to determine whether you believe that sponsor is capable of executing their investment strategy and business plan. Since the sponsor is responsible for managing the project, some important questions to ask are:
How much experience does the sponsor have?
Have they done similar investments in the past?
What is their track record?
How is their reputation, and have they raised capital for other deals?
Promising sponsors have strong reputations, and if they have raised significant investor equity in the past, they will be reluctant to sacrifice their reputation on subpar deals, even if there is a short-term profit to be made.
Another important aspect to consider when evaluating the sponsor is whether they are aligned with you, the investor. Does the sponsor have skin in the game? Or, in other words, are they contributing some of their own capital to the deal, so that they have a vested interest in its success? Typically, the more capital a sponsor is willing to commit, the more motivated they are to make sure the project is a success.
Managing real estate is no small feat, which is why real estate owners and developers charge fees. You should do some digging here—is there an acquisition fee once the deal closes? What percentage of the deal’s profits are they taking? What is the preferred return, when does the sponsor get paid out, and what is the split between the sponsor and the investors? Be sure to read the fine print.
3. The platform
Lastly, as a potential investor it is important to thoroughly research the platform on which the estate investment is hosted. Is it reputable? How long have they been in the industry? Do they have a user-friendly website and good infrastructure? Are they compliant with securities law? After all, we are talking about financial products. Due diligence is key: read reviews about the platform. Make sure the platform is transparent and posts necessary legal documents, has informative deal pages, and good customer service.
Next, make sure that your choice of platform aligns with your needs and what you can afford to invest. For example, if you’re investing $1,000, don’t set your heart on a platform that has a $10,000 minimum. Reputable platforms will provide all the information you need, so shop around to find what’s best for you.
Putting it all together
In all, real estate crowdinvestments are a solid option for investors who don’t want the hassle of traditional ownership, but still want exposure to the asset class. By taking a holistic look at the offering, including the deal, the sponsor, and the hosting platform, you will be able to determine whether the opportunity aligns with your personal investment goals and risk tolerance. As with all investments, diversification is key—you shouldn’t make one big bet on one deal. Rather, consider allocating to a variety of deals so that you have a more balanced portfolio.
Republic is focused on sourcing a broad range of real estate investment opportunities so that you can build your own personal portfolio. Now that you have the tools to review real estate opportunities, check out the latest deals on Republic.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.
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