In the new industry, scaling, insufficient investments, and high minimums bring diversification issues.
Recap
Part one of this series discussed the limitations of real estate crowdfunding sites, which overcomes with the right tools and effort.
Part two of this article will discuss limitations that sites will need to address as the industry matures:
• Accredited investors only
• Inadequate investment to diversify
• Insufficient core investments to diversify
• Excessive minimums
When the market catches up, you’ll be able to scale and diversify your investments effectively, and the sites will be able to handle your substantial core real estate investments. For the time being, they are best suited to smaller, speculative investments.
Let’s look at the problems.
Only reputable investors (for now)
Updated in April 2018: There are 14 options for the typical, everyday non-accredited investor due to the industry’s significant maturation since the written article. If non-accredited investors had as many options as credited investors, that would be nice. However, this is an essential first step in the right direction. As a result, this is less of a problem now than it was in 2015.
Insufficient investment to diversify.
They were updated on April 26, 2018. Since the publication of this article, many platforms have begun to offer funds with multiple properties. So, an investor could own five, twenty-five, or more possessions with a single investment. So things have improved significantly. However, because there are still many single-property funds where this can be an issue, I’m leaving the section in place.
Diversify your holdings to protect your portfolio from geographic, regional, tenant, and property risk. It would be best to have at least 100 properties (and probably many more). There are only 42 available investments in the industry in our current new investment feed, with a new investment opening every 3 to 4 days. Because not all investments are suitable for every investor (by far), deploying a diversified portfolio currently takes months or years.
A crowdfunded consumer loan is a consumer loan crowdfunding site that currently has 600 – 700 new investments open daily. An investor can diversify into The Lending Club’s minimum of 100 loans in a single day.
It increases the risk of investing in real estate sites. In conclusion, I discuss a strategy for dealing with this risk.
There aren’t enough core investments to diversify.
Update for 2018! There are now primary options! Not much, but better than before. I’ve looked into it. See the best core investments by clicking here. (This is a private investor club article; membership is free, but verification is required.)
There are four methods for investing in real estate. If you want the security of diversification, you must properly allocate your investments across the four strategies.
If you don’t, you put yourself at unnecessary risk, which could quickly result in losing all your profits (plus some additional ones)—especially as the economy shifts.
One of the strategies, known as “core,” requires that 40 to 70% of a diversified portfolio be made up of it. (For more information, see “What are the four investment strategies?”)
However, there are currently very few core investments, and most websites have none. Currently, only two of the 42 assets in our investment feed are core investments. A 40% to 70% diversified portfolio would require years to accumulate at the current rate.
I’ve reported this problem to several websites. The staff has told me that selling value-added and opportunistic investments is much easier in today’s low-interest environment because they have higher returns.
It is a very short-sighted approach, in my opinion. We’re in a good place right now because the real estate cycle is on the upswing. But we’re closer to the end of the process than the beginning, and it will inevitably fall. When this occurs, investors will suffer significant losses on riskier assets. The impact on a portfolio without the ability to diversify can be disastrous. Furthermore, the industry will unnecessarily damage its reputation with the general public.
I anticipate that this will improve over time. However, it is now a serious issue. It makes investing far riskier than it should be. Finally, I discuss a strategy for dealing with this risk.
The inability to diversify due to low minimums
April 26, 2018. Since the publication of this article, many platforms have begun to offer funds with multiple properties. So, an investor can own five, twenty-five, or more possessions with a single investment. So things have improved significantly. But since there are still many single property funds and high minimum offerings where this might be a problem, I’m leaving the section here.
As I detailed in this article, the current site minimums put diversity out of reach for the average investor.
- Required Cash:
To diversify into 100 properties, you need to have $500,000 in cash because low-end accredited investor minimum sites only require $5,000. (It is a bare minimum for diversification and perhaps too low). The minimum high-end sites demand $2.5 million in cash.
- Size of the Overall portfolio:
Investing the entire portfolio in real estate is not advisable for safety reasons. Because real estate is typically limited to 10% of a portfolio, a person should not participate in low-end minimum sites unless they have a portfolio of $5 million. They should not join high-end minimum sites unless they have a portfolio worth $25 million.
Many accredited investors and 99.99 percent of individual investors cannot afford this.
It is a critical issue that the sites must address in the coming years. I fully expect the minimums to be drastically reduced. With the average investor only having $100,000 in a 401(k), minimums should be lowered to $50, similar to the $25 minimum of consumer loan crowdfunding sites.
I will notify sites about this problem and post their responses.
Conclusion
Due to the industry’s youth, I predict that there will be significant advancements over the coming years.
There are solutions for many of them in the interim. I’ve also developed a few tools to help solve some of these issues, which I discussed in part one of this article. Some of them are unsolvable with tools and will require time for the industry to address.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.