Crowdfunding has found real estate. More than a handful of outfits have sprung up to collect small amounts of capital from a large number of individuals to finance their deals. One New York company is even selling stock in a single building in the nation's capital.
Until the JOBS Act of 2012, which loosened rules on how firms seek capital, real estate investing was mainly the province of high-net-worth individuals: "accredited investors" who earn more than $200,000 a year and were protected somewhat by the Securities and Exchange Commission.
Large-scale investors can, and sometimes do, put their money into losing propositions. But at least the SEC requires full disclosure, so investors won't be tripped up by undisclosed details.
But with little or no SEC oversight for crowdfunding investments, how do small, mom-and-pop investors with only a few hundred or thousand dollars to risk determine which deals are shrewd and which are lewd — that is, which are destined to be financial successes and which are failures from the get-go?
"The key to successfully investing in real estate is performing a thorough due-diligence analysis," says David Manshoory, founder of AssetAvenue. The company is just one of several crowdfunding real estate platforms that seek to connect investors with real estate professionals offering access to high-yield deals.
Seasoned investors know the importance of investigating all aspects of a transaction. But Manshoory says novices often "get excited about acquiring part of an investment property and lose sight of the mechanics of knowing what they are buying."
Here, from AssetAvenue, are some tips for rookies to spot a lousy real estate deal:
•Market conditions. Two major factors are the keys to underwriting an investment in income-producing property: the market and the property. But of the two, local market conditions trump everything else.
Put simply, a great property in a declining market is generally a bad investment because no matter how you try, you can't change the market. But a poor property in a good market can be improved, becoming a good property in a good market.
"Analyzing the demographic trends of population growth, income and employment in the local market will tell you whether opportunity or risk lies ahead," Manshoory says. "It will also show which property types are in demand or oversupplied."
•Misleading financials. The bottom line can be manipulated into whatever will make the deal work. So investor beware. Many sellers will overestimate revenue and/or underestimate expenses, making the property appear more profitable than it really is.
According to the AssetAvenue founder, it is crucial to get the real operating numbers, not a projection of potential rent and estimated expenses. "Confirm and verify every element of income and expense," he says, "and make sure your offer is based on the actual financial performance of the property."
•Poor-quality tenants. Leases are the most important documents attached to an income property. They produce the income, so it is crucial to review every lease and understand the financial strength of the tenant behind each lease.
In an apartment building, tenant files with poor or nonexistent credit reports and a lack of references are a red flag. If the building is filled with tenants who have a history of making late payments or being evicted, your vacancy, management and legal expenses will be higher than anticipated.
The same screening mechanism takes place with tenants in shopping centers or office buildings, where examining rent rolls, payment histories and credit files of existing tenants can be enlightening.
•Hidden property conditions. The seller always knows more about the property than the buyer. So to make an intelligent investment decision, the buyer's job is to dig for the information the seller may not want to volunteer, or perhaps isn't aware of.
Part of your due-diligence checklist involves inspecting the property's condition, including physical items such as building systems, environmental matters and structural components. Hire the right professionals to give you estimates on the maintenance costs of these items, their life spans, and how much it will cost to replace them when needed.
The condition of the property will determine how efficiently you will be able to manage it, Manshoory says.
•Legal challenges. Intangible items, such as title, survey, zoning and land-use regulations, are important too.
Sellers sometimes market their property indicating that it can be zoned for another use and has the development potential for additional square footage. The burden is on you, the buyer, to make sure what the seller is saying is true. Do not assume that the proposed use of the site will be permitted as advertised.
•Investing online. When it comes to facilitating your investment activities online, be sure to choose a credible platform that only does real estate deals, is backed by a team with years of deep experience in real estate investing, and has people available to answer your questions.
The team should strongly vet their deals, set realistic expectations and have a consistent track record of delivering solid returns.