For individual, main-street investors, commercial real estate (CRE) investing has changed quite a bit over the past 5 years.
Not so long ago, private commercial real estate investing was the exclusive province of ultra-high-net-worth individuals and institutional investors (hedge funds, pensions, endowments, and family offices).
Some Background: The State of Modern Real Estate Investing
Thanks to regulatory changes and the harnessing of technology, platforms like EQUITYMULTIPLE have lowered the barrier to entry – allowing individuals to invest as little as $5k in private commercial real estate transactions through a secure online platform.
This new paradigm for commercial real estate investing – often referred to as “real estate crowdfunding” – differs substantially from REITs (real estate investment trusts), which have been around since the ‘70s, and are still what most people think of when they imagine an individual passively investing in commercial real estate.
Whereas REITs are liquid, traded, and constitute a blind pool of real estate assets, platforms like EQUITYMULTIPLE offer discrete investments into distinct properties, alongside experienced real estate firms.
Both asset classes have their merits – while REITs offer built-in diversification and liquidity, the fact that they are publicly-traded means that REITs correlate with public equity markets more closely than do private commercial real estate assets.
On the other hand, the assets offered through EQUITYMULTIPLE and other real estate crowdfunding platforms typically carry a term of 1-5 years, and hence some liquidity risk.
Why Invest in Commercial Real Estate?
Let’s take a step back and consider why an individual investor may want to invest in CRE in the first place.
Portfolio Diversification
Ever since Harry Markowitz pioneered the elegant Modern Portfolio Theory in the 1950’s, the simple yet powerful concept has provided a useful framework for investors new and experienced: a portfolio with a low degree of cross-correlation among assets will perform better over time.
The real estate asset class has historically exhibited a low degree of correlation with the stock market, which stands to reason: though public markets may fluctuate based on perceived value or speculation, real estate remains a tangible and essential good. In other words, while Facebook’s share price may jump up and down with the news of the day, people will still need places to live, work, and congregate.
As mentioned above, this applies more to private commercial real estate investments (like those offered through crowdfunding platforms) than REITs, as REITs are publicly traded and hence to move more closely with the stock market.
Institutional investors (like hedge funds, pensions, and endowments) have long understood and capitalized on this benefit. Unfortunately, individual investors remain under-allocated. Now that online platforms offer passive, private CRE investments for as little as $5k, individual investors can more readily diversify into commercial real estate.
Private real estate investments (like those offered through modern real estate platforms) are often considered ‘alternative assets’
And, with minimum investments as low as $5k, individual investors can diversify not only into commercial real estate, but can rapidly build a diversified portfolio of real estate holdings.
Let’s say, for example, an investor has $50k in savings to deploy, and looking to get into real estate. One could put 20% down on a single rental home, in one market, with a single tenant.
Conversely, that investor could participate in 5-10 investments through platforms like EQUITYMULTIPLE, co-invest alongside experienced real estate firms, and further diversify across markets, property types, and even the platforms offering the investment, further reducing exposure to risk.
This new, passive form of real estate investing also allows individual investors to avoid managing the property and tenants, which can quickly become a full-time job.
Yield and Appreciation
Commercial real estate investments typically offer cash flow in the form of rental income, as well as appreciation in the form of market growth and added value, particularly in markets benefitting from job and population growth.
In the modern landscape of real estate investment, some platforms offer debt-based investments with attractive, flat annual rates of return, and others offer more opportunistic equity investments that allow individual investors to share in uncapped upside if the investment performs well.
With the low associated per-investment minimums, individuals can build a portfolio that generates significant annual return, as well as the potential for outsize returns when projects perform well. Combined with the lower degree of volatility as compared with the stock market (discussed above), real estate crowdfunding allows individual investors to access an asset class that has historically provided compelling risk-adjusted returns.
The National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index – which measures the performance of an broad pool of individual commercial real estate properties – reported an annual return of 12.7% in 2015, which bested other key indexes such as the S&P 500, Dow 30 and Russell 2000. In the period between 2000 and 2017, commercial real estate yielded an average annual return 67% higher than the S&P 500 over the same period.
Tax Advantages
U.S. tax law dictates that real estate investors may deduct the depreciation of a real estate asset as a passive loss, offsetting other passive income, on an annual schedule of 27.5 years for residential, and 39 years for other commercial properties.
The tax reform legislation that went into effect in 2018 shortens CRE depreciation schedules to 25 years across property types (meaning that an investor may use 1/25 the market value of an asset to offset other passive income) – in other words, this change was a boon to all real estate investors, but particularly non-residential commercial real estate investors.
This same accounting technique is available to passive investors who invest through online platforms. Additionally, income earned through pass-through entities – such as the LLC structures that most platforms employ – are entitled to a 20% deduction, per the new tax law. (Please note that EquityMultiple does not provide tax advice, and each individual’s tax situation will vary depending on numerous other factors – we advise all investors to consult a tax professional).
A Closing Word: How to Approach Real Estate Crowdfunding
This is an exciting time for investors, with the array of real estate and other alternative asset investing becoming more accessible by the day. However, all investments carry risk, and investors are advised to get as comfortable as possible with real estate investing platforms they consider, and people behind them, as well as the investments offered on those platforms.
In the long run, the aggregate track records of platforms will come into clearer focus, and can inform your investment decisions.
In the meantime, take a close look at the experience of the people behind the platform, the quality of transparency and customer service, and the robustness of underwriting standards.
This is a guest post from Soren Godbersen from the Real Estate Crowdfunding platform EQUITYMULTIPLE.
What a cool idea – and it makes me wonder what other sorts of things could take advantage of crowdfunding in this way. It’d seem you could open up all sorts of investments to people with less capital through crowdfunding. I suppose it’s only a matter of time until we see more things like this.