With the proliferation of real estate crowdfunding websites over the past years, investors can now invest all over Europe and the UK from the comfort of their homes.
Not all platforms and investments are equally good, however, and while it is good practice to diversify and thus spread the risk, it still makes a lot of sense to have a basic skill set in evaluating real estate investments, before you hit the Invest button.
In general, from my experience, investing in loans tends to be riskier, however, it is the format favored by many projects on these crowdfunding websites, as it is much more straightforward to structure. The alternative is to set up a company that owns the property, but that incurs more costs and is harder to manage. The advantage for an investor, however, is that he would own shares in a property and thus not be at the sole mercy of the developer.
If the deal involves giving a loan to a property developer to build or refurbish a property, a very important metric to look at is loan-to-value, or LTV in short.
The lower the loan amount compared to the value of the property, the safer you are as an investor, as it means that in case of any problems, the chances of recouping the investment are higher.
You have to be extra cautious with this one, and take a close look at what value figure is being taken into consideration.
This can easily be explained by an example. Let’s say the developer puts up a project that involves buying an old and dilapidated building at 500,000 Euro, refurbishing it completely to luxury standard, and selling it off within a year for 1,000,000 Euro. He asks for a loan of 250,000 Euro for the project.
Now, here’s the trick some platforms use. Instead of listing the project as having a loan-to-value figure of 50 (250,000 divided by 500,000), they will use the anticipated value of the finished project, giving a loan-to-value figure of 25 (250,000 divided by 1,000,000).
I would advise staying away from these kinds of projects, as they tend to be much riskier. The price that the project is eventually sold at depends on many factors, including how good of a job the developer does, prevailing market conditions, the buyers’ profile, etc. As investors, we should concentrate on the facts, and therefore look at the value of the property right now, and that is 500,000 Euro in our example.
The fantastical figures that developers provide can lead to investors getting burned, as happened with the Lendy platform, which eventually went bust.
First or Second Rank Mortgage
A mortgage is the collateral of real estate which is pledged against borrowed capital. It is divided into primary and secondary ranks, which indicate which investor or institution is the first to recover the money. Typically, a first-rank mortgage holder in large projects is a bank or other large financial institution, while the second-rank mortgage is held by crowdfunding platforms or other institutions.
In general, you should prefer first rank mortgages. Platforms like LendSecured only do first rank mortgages, for example. Other platforms might offer the riskier (but potentially more profitable) second-rank mortgages.
Secondary rank mortgages are quite popular on the German and British real estate crowdfunding platforms, such as Property Partner.
There are nuances, of course.
For example, if the property is already built and has tenants that generate rental income the risk is naturally lower. When assessing the risk in such a scenario, one should look at the property’s profitability.
Consider the case of a €5M property that is generating a net rental income of €350,000 or a 7% annual return, You can check what would be the return for primary and secondary mortgage holders. You can do this with a simple formula: €350,000 (rental profit) / €3,600,000 (sum of primary and secondary mortgages loan values) * 100 = 9.72% net yield.
This step is important to assess the liquidity of the real estate, which helps to understand whether after a takeover of the asset it would be difficult to find a buyer and repay both mortgages to the investors. In this scenario, selling a property that is generating a yield above 9% shouldn’t be complicated.
Apply Financial Ratios
I’ve written a separate article about ratios and shortcuts you can use when evaluating real estate investments, so check that one out.
Consider the Platform’s History
Take a look at the history of the platform you plan to invest in. Ideally, it should have been operating for a number of years already with no significant issues. If it’s been through a sideways or downward market and emerge unscathed that’s even better. Everybody can perform well when the market is up, but when the market is not helping many platforms cease to make updates and run into problems.
Property Partner are a good example of how to keep things professional and take care of your investors in a bad market, such as that of the UK during and after Brexit and the COVID crisis.
While you should always assume that the reviews you read online are biased in some way or another, I still recommend checking out blogs, forums and specialist review websites to get a general feel of whether a platform is trustworthy or not.
Do you use any other criteria when evaluating real estate crowdfunding platforms? Let me know in the comments section.