Want to make intelligent real estate crowdfuning investments? At a minimum, you’ll need to understand the relationship between risk and return as it relates to deal type. Otherwise you might assume that all things are equal (they’re not) and just pick the deals with the highest projected returns. This strategy would not end well. It’s the equivalent of exclusingly picking racehorses with the highest odds. You’ll hit it big on one or twice, but eventually you’re going to be the sad guy at the track with a pocket full of worthless tickets and a boring story about how you almost made it rich.
Don’t be that guy. Learn the risk / return relationship in real estate, starting with deal type.
There are four main investment types into which commercial real estate investments are catergorized: Core, Core-Plus, Value-Add and Opportunistic. The category a RE crowdfunding deal falls into depends on where that asset fits on the spectrum of risk vs. return. Here is a quick overview.
Core assets are (typically) considered the lowest risk investments. These properties are higher quality, in top-tier locations in large markets with stable (perhaps credit tenants). Consquently, investors in Core assets can usually count on stable cash flows with a significant proportion of an investment’s return stemming from income vs appreciation.
An example of a Core deal is a beautiful, towering skyscraper located on Market Street in downtown San Francisco. The tenants are name brand tech companies, large consulting fims, and established law firms. In all but the worst economic times, investors expect such tenants to adhere to their contractual lease terms.
Next up are Core-Plus properties, which offer investors additional return potential (and additional risk) relative to Core deals. Core Plus properties are high quality, but need some additional capital, perhaps for a remodel or redevelopment to achieve maximum returns.
An example of a Core-Plus deal might be that same San Francisco office building on Market Street, but perhaps the lobby is tired, looking more like , CA, where adding amenities such as a gym could allow the complex to command even higher rents. That need for rehabilitation creates a little more risk and might require more financing than the traditional Core assets, but at the same time, it’s like to increase the potential return.
Properties that require sizable capital improvements or repositioning involve significantly more risk than the prior two deal types. Of course, invesors are usually “compensated” for this additional risk with larger potential returns.
These properties tend to need some combination or redevelopment, rehabilitation, or remarketing, which can boost cash flow and and overall value. An example might be a large 25 year old, apartment building complex in Dallas Texas where the apartments all need kitchen upgrades and hardwood flooring.
High risk, high return deals. Opportunistic real estate crowdfuding deals might include developments, redevelopments, or vacant properties, all of which need large capital budgets to impove and lease. Think of an empty wharehouse in an up-and-coming submarket of Seattle that can be converted into tech space (open floorplan, exposed brick, etc.) and leased to promising startups at top market. Taking a building from negative income to fully leased can result in huge profits. Of course, the sponsor could also time the market wrong, fail to get the property fully entitled, under-estimate the capital budget, or fail miserably in just about any number of ways.
So, while constructing a diversified real estate crowdfunding portfolio is a topic on it’s own, it certainly helps to undestand the basic risk / return characteristics of the deals you’re investing in.