I recently started investing in commercial real estate through Fundrise and wanted to write a review of the platform. Diversifying investments
across domestic stocks, international stocks, and bonds helps ensure strong gains, and minimizes the effects of market volatility. But besides these “traditional” types of investments, real estate and other “alternative” investments provide additional diversification value and large potential returns.Fundrise offers a unique and easy way to invest in a Real Estate Investment Trust, or “REIT.” But it’s not perfect, so I wanted to evaluate the platform without glossing over the negatives. Read on to see why it gets my optimistic stamp of approval.
What is a REIT?
A REIT allows normal investors to pool resources and invest in real estate properties that one individual usually could not afford to buy alone. As long as it distributes at least 90% of its earnings to investors, a REIT is not taxed at the corporate level. For the individual, REIT distributions are taxed either as ordinary income, or at the capital gains rate.
REITs are generally either publicly traded, or non-traded. Investors buy publicly-traded REITs just like any other stock, so this type of REIT has the advantage of liquidity (i.e., you can buy and sell it at any time). However, there is also a “liquidity premium” built into the price, so an investor who does not take advantage of this liquidity (i.e., by holding the REIT for a relatively long period of time) may see no benefit from the liquidity, and in fact may see lower overall returns because of the liquidity premium. Publicly traded REITs also suffer from stock-market-like swings in share prices, even though the value of the underlying assets may be unaffected. For example, news of an oil spill might cause a panicked selloff in the stock market (including publicly-traded REITs), reducing share prices, even though the value of the real assets held by a REIT is virtually unaffected.
Non-traded REITs are not traded on a stock exchange, but usually involve large up-front fees from brokers, which may equal as much as 10% or more of the purchase price. These REITs likely won’t have the same volatility as a publicly-traded REIT, but those high fees can really eat away at returns. Non-traded REITs may also have a high minimum investment amount, putting them out of reach for “normal” investors.
Background on Fundrise
Fundrise’s “eREIT” tries to provide the best of both publicly-traded, and non-traded REITs. Fundrise’s products are not publicly traded, and are therefore not liquid. This could be a major drawback if an investor needs to access these funds within five years or so from the initial investment. However, because the shares are not traded, in theory, the price will not fluctuate nearly as much as a publicly-traded REIT (at least until the value of the underlying assets actually change). Fundrise’s fees and expenses are also cheaper than most non-traded REITs.
Fundrise currently offers three different commercial real estate eREITs focusing on the West Coast, the East Coast, and the “Heartland,” or central United States. Fundrise’s investments are managed by real estate professionals who have a long and successful track record. The general investment strategy is to use both debt and equity to invest in large multi-unit residential properties and development projects.
Fundrise focuses on projects at a middle price range that are too large for most individual investors, and too small for the huge publicly-traded REITs, which need to deploy tens of millions of dollars on every deal. Because there is less competition in this middle price range, Fundrise should theoretically be able to find more favorably priced investments. Every investment goes through a rigorous vetting process, and I like that their CEO has refused to lower his investment standards to pursue short-term gains.
The Good, the Bad, and the Buried
Fundrise provides a massive circular for each eREIT that explains some of the risks and strategy considerations for investors. Because it is several hundred pages long, I’m probably one of about three people to have read the entire thing. I definitely have some concerns with Fundrise, and I think it is a very risky investment. But on the whole, I think the company provides a high level of potential return to offset those risks. Fundrise makes it easy to get exposure to professionally-managed real estate investments, without the headaches and time commitment of investing yourself (even if you had the financial means to buy large multi-unit properties, which most of us don’t). Here is a summary of my thoughts after reading Fundrise’s circular:
- Low Minimum Investment. You only need $1,000 to invest with Fundrise. And, you don’t have to be an institutional investor with a $200,000 annual salary or a net worth of more than $1,000,000 to invest.
- Diversification. Fundrise makes it easy to diversify because each eREIT holds several properties. Also, because of the low investment minimum, you can hold multiple eREITs that focus on different geographical areas. This gives investors exposure to real estate across the United States, which is safer than concentrating your investment in, say, the geographic area where you live. That being said, in the West Coast eREIT, most of the current holdings are in the Los Angeles area, so keep an eye on how much diversification Fundrise actually provides. (As the eREITs are still in their “ramp-up” period, I expect the diversification to improve as new properties are acquired in different geographic areas.)
- Management. Fundrise investments are professionally managed by a company that seems a step above some in terms of integrity (with some caveats, they offered to waive their management fees on their initial offerings if the investments did not perform well).
- Low fees. Fundrise charges a management fee of about 1% per year, which is reasonable for this type of investment (but see below).
- Ease of use. Fundrise’s website is very easy to use, although the investments seem to take a while to register on the platform. After being debited from my bank account, the funds took over a week to show up in my Fundrise account.
Concerns with Fundrise
Buried in the circular are a few issues that investors should take careful note of—even if, in my opinion, they’re not deal breakers.
- High/hidden fees. The organizational fees alone are estimated to reach $1 million. That’s 2% of the $50 million maximum total investment for each of Fundrise’s eREITs. These fees are substantial, but the bigger issue in my mind is that each eREIT may not raise the maximum amount of $50 million, which would mean that the $1 million in fees would be a much larger percentage of the total funds invested (so far, each eREIT has raised less than $10 million in investments, and their prior two eREITs were closed to new investors at about $44 million and $47 million respectively). On top of the organizational fees and 1% management fees, Fundrise charges a variety of other acquisition and servicing fees. However, these fees are still lower than most non-traded REITs. (For example, another similar eREIT from RealtyMogul charged $1.5 million in organizational fees.)
- Conflicts of interest. Because some management fees are earned through transactions, Fundrise may be tempted to buy and sell properties simply to drum up fees, even if the transactions are not necessary, or in the best interest of investors. Fundrise’s managers also manage other investments, and will therefore have competing demands on their time and attention, and may need to decide which fund should pursue a particular investment opportunity.
- Track Record. It’s a little difficult to track Fundrise’s prior performance, although the company claims their eREITs returned approximately 13% in 2015, and issued nearly 7% in dividends in 2016. Regardless, the company has a very short track record.
- Liquidity. Fundrise plans to offer quarterly share redemption, but an investor should not count on any short-term liquidity, as a variety of circumstances might cause Fundrise to be short of cash. Also, redemptions carry a penalty of a few percentage points of the investment value.
- Share dilution. Fundrise can issue an “unlimited” number of additional shares, which will dilute the ownership interest of current shareholders. Further, instead of only paying dividends from earnings generated by the underlying properties, Fundrise can also use money from new investors to pay dividends to current investors. Because the new investment funds were used to provide short-term dividends, rather than buy new income-generating properties, investors would likely see decreased long-term returns. Also, those new investors (whose investments did not provide any long-term value) gain an ownership interest in the properties owned by the eREIT, diluting value for prior investors. As an investor, you basically have to trust that the Fundrise managers will not abuse this practice and substantially devalue your investment.
Is Fundrise Worth It?
After reviewing Fundrise’s website and offering circulars, and comparing the company to other available options, I decided to invest a small amount as an experiment to see if these eREITs could provide a viable income stream to fund a portion of our living costs after reaching financial independence. A 10% yearly return (which I think is a reasonable prediction if the real estate market stays out of major trouble) could provide a nice boost to post-retirement income, because it is significantly higher than the normal 4% safe withdrawal rate of a stock portfolio. Of course, if Fundrise manages to consistently make this type of return (which remains to be seen), it would not do so without substantial risk. Therefore, “alternative” investments of any kind, including Fundrise, should probably occupy no more than 10-20% of your early-retirement portfolio (always keep your income diversified over as many sources as possible to reduce your risk of exposure to any one type of investment).
If you’re interested in my Fundrise experiment, you can learn more on Fundrise’s website, and you can also follow the progress of my investment here. I’ll update that post every few months, or whenever there is something significant to report. Comment below and let me know if you have any other ideas for good alternative investments. I’ll be posting reviews of other “alternatives” soon!
Note: Fundrise just announced an “iPO,” or “internet Public Offering,” which allows investors to buy an interest in the company itself, rather than a basket of real estate holdings. Although I think Fundrise is doing innovative things, investing directly in a startup financial tech company does not match my current investment strategy. I’ll write a review of their iPO offering in the future if my opinion changes.