The benefits of real estate crowdfunding can help build a portfolio for smoother returns and less risk
Your robo-advisor may practice a more advanced version of what you may hear from your father-in-law at a cocktail party: “devote 100 minus your age to stocks – as a percentage of your portfolio allocation – and the remainder to bonds”. This bromide works just fine as a general guide for simple portfolio allocation.
However, it leaves quite a bit on the table as far as the risk-adjusted return potential of one’s portfolio, especially given the universe of alternative investments and online investing platforms now available to individual investors.
This article takes a look at how private commercial real estate – now available via real estate crowdfunding platforms – can reduce a portfolio’s exposure to risk, tap into modern portfolio theory, and help an individual investors mirror the allocation strategies of institutional investors like the Yale Endowment.
What Is Real Estate Crowdfunding?
Before discussing how this new paradigm for real estate investing can benefit individual investors, let’s touch on what it is. “Real estate crowdfunding” evolved from the JOBS Act of 2012 – a piece of federal legislation that made it legally feasible for individual investors to participate in commercial real estate and startup equity ventures.
Though the term “crowdfunding” may make you think of Kickstarter and fundraising for a wide array of causes – from disaster relief to album recording costs, many real estate and equity crowdfunding companies are headed by industry veterans, practicing sophisticated underwriting measures.
In short, “real estate crowdfunding” refers to an online platform that offers fractional ownership of a private real estate investment, often a commercial project with an overall capitalization of tens of millions of dollars. The minimum investment, at the deal level, could be as low as $5k.
These investment vehicles are often confused with real estate investment trusts (REITs), but behave differently in two key ways:
- Non-traded: While publicly-traded REITs offer liquidity, the private real estate investments offered through crowdfunding platforms provide better downside protection precisely because they are not traded, we’ll get further into this in a moment.
- More transparent: While REITs offer a blind pool of real estate assets, real estate crowdfunding allows investors to participate in specific projects.
How Private, Platform-Based Real Estate Investment Can Help Build a Stronger Portfolio
Again, the assets offered through real estate crowdfunding platforms are non-traded, and the underlying properties are acquired by experienced real estate firms, typically at a discount to market value.
Return is thus driven by “alpha” – the skill of management and incisive acquisitions of institutional real estate firms, which individual investors can now tap into at low minimums. Conversely, index funds that track to the S&P 500 offer exposure to “beta” – or the broad strength of the economy.
Real Estate Crowdfunding Uncorrelated Returns
Because these private real estate assets are not traded and are illiquid, they do not correlate highly with public markets. While traded REITs do not perfectly correlate with the stock market, they do move more closely with public markets.
In other words, if an economic downturn occurs, private real estate is generally better positioned to weather the storm. This has generally held true over time.
Real Estate Crowdfunding as Downside Protection
Related to the last point – non-traded private real estate tends to retain value better in mild economic downturns and experience less volatility than public equities markets due to inherent value: while corporate scandals or geopolitical concerns may have adverse and unpredictable impact on stocks, people will still need places to live and work.
Multifamily in particular tends to hold up well during economic downturns; economic pessimism can create incentive for would-be homeowners to keep on renting, and operators can engineer downside protection by incentivizing long-term leases and rolling lease expirations.
Other niche property types – such as self-storage or student housing – may be counter-cyclic and offer further downside protection. Individual investors can reduce their portfolio’s overall exposure to risk by participating in such assets, and do so at relatively low minimums.
Real Estate Crowdfunding, Private Assets, and Modern Portfolio Theory
As mentioned previously, The JOBS Act ushered in a new universe of private, alternative investments for individual investors. These assets are characterized by a high degree of alpha (or returns driven by skilled management) and a low degree of correlation with public markets, which most individual investors are already substantially exposed to.
Modern portfolio theory holds that a portfolio with the lowest degree of cross-asset correlation will perform best over time.
Hence, many institutional investors have long held 20% or more in alternative assets, and with good reason – a Blackstone study showed that for each level of annualized return, a portfolio with 20% allocated to alternatives exhibited a lower degree of volatility for each level of aggregate annualized returns over a 20 year period.
While endowments and pensions have historically held over 25% of their portfolios in alternatives, individuals remain underallocated – averaging just 5%. Real estate crowdfunding platforms make it feasible to bridge this gap. Browse available investments on EquityMultiple to see how you can benefit from real estate crowdfunding.