How will a real estate market downturn affect Crowdfunding?

13 Replies

Hello BiggerPockets! I'm interest in starting my REI by putting money into a Fundrise account. Does anyone have knowledge or speculation of what might happen to Fundrise or other crowdfunding sites if the real estate market has a downturn? How are these sites exposed or protected from this? Any opinion is welcome. Thanks!

You need to read the prospectus and see who gets paid first. Also what types of assets are they invested in? If its apartments those are not as effected if their objective is to hold them. If the objective is to develop and flip then there could be major problems during a downturn. I know one of the largest multi family builders on the east coast went under on that business plan due to the economy.

As with any REI you need to evaluate the individual investment or fund for what the risk points are and what are the mitigating factors for the risk. In my view one of the biggest risks in the case of a downturn is the amount of leveraging. While leveraging with loans can raise the potential IRR, it also creates additional risks. I believe that FUNDRISE uses leveraging extensively but it has been awhile since I have reviewed their investments. In syndications, crowdfunding or otherwise, I mostly favor cash investments (using investor capital) that minimize the long term risk of a loan, but have made 1 or 2 crowdfunding investments that have leveraged with commercial loans. I am not sure I will do any more of those for a while.

There are other things I don't like about Fundrise, which includes the lack of transparency.  That is, an investor puts their money in the fund, then the managers decide how to invest it.  I like knowing what I am investing in upfront.  I also prefer that the managers share the risk alongside me - via skin in the game and/or profiting only after I have my capital returned along with a preferred return before the manager/developer makes any profit.  But that's just me.

@Larry F., thank you for your input. So you think Fundrise being heavily leveraged could be what hurts them in a downturn? Good point about wanting them to be transparent. I’d prefer they let me know what the fund is invested in before hand as well. Do you know any crowdfunding platforms that do pay back capital and interest to investors before making their profit?

@Account Closed , crowdfunding is essentially the real-estate syndication online. So yes, every single crowdfunding deal is potentially susceptible to a downturn (just like every real-estate investment), with some more than others.

The first thing to look at is the capital stack. If you are investing in equity and recession hits and for some reason the deal blows up and can't make its loan payments, most likely you will lose all your money. However, if you are invested in debt in the same deal (especially conservatively underwritten debt) then you can foreclose on the property, and then resell it to recoup your losses… and often get back some or all of your principal.

And all equity investments are not the same. A big importance is how much leverage are they using, and how conservative or aggressive is it? What asset classes is it? In past recessions for example, self storage and mobile home parks did much better than for example hotels. Another important thing to look at is the strategy. Something with high execution risk like ground up construction or heavy value add, is going to be much more susceptible to a downturn than something like a core real estate investment that has much lower execution risk.

As a conservative investor, at this stage of the cycle, I don't invest in anything unless I can run a recession stress test on it. Then I look and see if I could live with the results or not.

Originally posted by :

As a conservative investor, at this stage of the cycle, I don't invest in anything unless I can run a recession stress test on it. Then I look and see if I could live with the results or not.

What kind of recession stress test do you run. I would be interested in learning more about this. Thanks,

@Account Closed what was the outcome of your decision?  Did you ever invest in the company?  I'd not heard of them until your mention and now I'm doing my research into their website.

@Lee Burns , I did not end up investing through Fundrise. I found out that as an investor with Fundrise, the investor is not the 1st lein holder against the properties invested in, so if they go sideways then the investor may not get their money back. A company like Grounfloor on the other hand makes the investor a 1st lein holder, so the investor is the first to get money if they have to foreclose. Hope that helps, what are you looking to do?

I signed up for Fundrise too, but I ended up skipping it after getting deeper into the program.  I am still pissed I gave them my social security number to open the account without seeing the interface.

I personally like peerstreet for debt.  FOr equity, I prefer Crowdstreet and Equitymultiple.  I have 3 invests with them, they are pretty much going according to plan.  I do stay away from the new construction due to the constant delays and I tend to stay with something that is making money.  I have invested in hotels and apartment complexes.  There is a senior home that is coming that seems very interesting.  The return is projected to be 22% in about 4 years.  

I've been toying with the idea of investing in a crowdfund, but at the same time I'm looking to move and my capital's not where I want it to be yet.  I'll probably just hold off on the idea for now, but it does sound interesting.

If I was going to invest in crowdfunding type investments I would rather buy a REIT. Nothing like having more control of your money. If things go south you can hit your stop loss and be out in seconds. If you were in a crowdfunding investment you could be bag holding and watch everything go to zero. Know your risk and know your exit plan.

Originally posted by @Andres Osorno :
Originally posted by :

As a conservative investor, at this stage of the cycle, I don't invest in anything unless I can run a recession stress test on it. Then I look and see if I could live with the results or not.

What kind of recession stress test do you run. I would be interested in learning more about this. Thanks,

First, I find the historical performance data for the geography and asset type of the deal. I can usually find this on Google from brokers like Marcus & Millichap or data providers like Axiometrics. Occasionally, it may require contacting a local/county property appraiser office. Typically that can be done by phone, but occasionally it can be handy to belong to an investor club where someone local can drop by to squeeze the information out of a difficult source.

The critical data for equity investments is primarily vacancy increases and rental income drops. And to be safe, I go back a couple of recessions and make sure I pick the absolute worst. (For example, commercial real estate did worse in the S&L crisis while residential real estate did worse in the Great Recession). Then I find the most difficult year in the pro forma (where cash flow is lowest), and pretend the recession hit that year by running the numbers through it and watching what happens. I keep a close eye on the final result: the cash flow at the end. If that goes below $0 on a leveraged equity deal, then the deal would have blown up. And a blowup means the fund would have defaulted on debt and investors would have lost 100% of their investment. If I see this, I breathe a sigh of a relief that I'm not the one exposing myself to this risk, and move on to the next deal.

If it passes, some people might be perfectly fine with that, but in my case I'm still not done. Every recession is different and the next recession has a good chance of being worse in some ways than previous ones. So I actually want an additional cushion in case that happens. To check for this, I will overstress the investment (for example, 2x the worst vacancies, 3x the worst rental income drops). If I do this and it still doesn't default on its debt, then I'm very happy.

Debt deals are similar, but focused on different data: historical default rates. So if I'm looking at a hard money loan first position debt fund that does construction loans on multi family properties in California, I look for the worst recession for that (S&L crisis recession). Then I create a spreadsheet that calculates the return of the fund, and run the numbers through and watch what happens. If I start seeing huge losses of principal, then I move on. Again, I will also overstress the investment (1.5x worse default rate, 2x, etc) to make sure the investment has a cushion in case things next time are worse.

The stress testing is just one part of the overall due diligence that I do on every deal. If you want more information on that PM me.