Regular reviewing and sticking to your investment plan (and we hope you have one) remains ever-important in the current fast-changing economic environment.
The overwhelming increase in the money supply has brought down the general level of interest rates, which has also affected the real estate crowdfunding market.
The first charge mortgage secured loans, that used to pay double-digit interest rates, are rarely available now, and the new interest rate level for secured real estate loans is settling down at 7-8% per annum. While this rate is still much higher than the interest rate provided to the same type of projects by the commercial banks, this decrease has ignited vivid discussions amongst the real estate crowdfunding investors about the riskiness of crowdfunded real estate projects and the fairness of the single-digit interest rate.
The ca 20% returning, riskier real estate equity projects, where the crowdfunding investors acquired an equity stake and shared the profits with the Project Owner, have become rare as the long positive real estate cycle has allowed the real estate developers to become so well-capitalized, that they are not looking for equity investors any more.
It is not surprising that the lower return rates encourage real estate crowdfunding investors to look for alternative investment opportunities that might provide higher returns. The global stock market has been performing very well in the past years, and we have seen investors reducing the size of their real estate crowdfunding portfolio to acquire more stocks. We have also heard of investors liquidating their global index portfolios to buy cryptocurrencies. There is nothing wrong with being greedy, but such reallocations seem to be driven solely by the hunt for yield, and they completely ignore the increased risk arising from such reallocation decisions.
An excellent example of risk ignorance is the recent discussion we saw on the discussion group of real estate crowdfunding investors. The discussion started from the concern about falling interest rates of mortgage secured real estate loans, then moved on to better alternatives being available at 7-8% per annum yield and then surprisingly ended in the conclusion that buying S&P500 or MSCI World Index ETFs would be a much better choice for investors due to equal expected return, lower risk and higher liquidity.
There is no doubt that S&P500 or MSCI World Index ETFs are great investments – in fact, there is a lot of scientific evidence supporting investing in ETFs and making them the kings of your portfolio. At the same time, investors should keep in mind that the above mentioned ETFs are composed of equities and investing in those ETFs equals investing in equity.
Comparing secured real estate loans to global equity investments is like comparing apples to oranges. From the asset allocation perspective (please see our previous post on asset allocation here), secured real estate loans should be treated as fixed income instruments or secured real estate investments, and as such, they fit in a completely different bucket than the equity investments. Reducing the share of secured real estate loans in one’s portfolio or swapping a global ETF portfolio for cryptocurrency investments means a significant change in strategic asset allocation, and such a change has to be justified by a good reason (a short-term hunt for yield is not a good enough excuse).
To highlight the differences between the secured real estate loans and ETF are outlined in the table below, we have outlined the key characteristics of both investments below:
|Characteristic||Secured real estate loans||ETF|
|Risk||Low (lenders get paid before shareholders)||High (shareholders are paid last)|
|Collateral||Yes (LTV < 70%)||No (LTV > 60%)|
|Return||Low (fixed interest rate)||High (participation in profit sharing)|
|Return components||Interest||Capital gains (stock price change) and income (dividends)|
|Return volatility||No volatility (interest rate is fixed)||High volatility (returns depend on company profitability and market movements)|
|Sensitivity to the economic cycle||Low (loans are very short and have fixed return rates)||High|
|Liquidity||Medium (loans can be bought and sold via secondary markets if they exist)||High (ETFs can be bought and sold as stocks, with immediate liquidity)|
|Diversification potential||High (as each investment into an individual loan is very small, the total secured real estate loans portfolio cab be diversified easily, without any concentration risk)||High (one ETF consists of a large number of individual stocks, although there might be some concentrations risk – for instance, top 5 stocks in S&P500 make up about 20% of the ETF)|
- Strategic asset allocation (eg establishing a mix of stock, bond and real estate allocations in your portfolio) is the most important factor determining the long-term return and riskiness of your portfolio. Work out the asset allocation that suits your needs and stick to it until the next annual review. Do not fail to prepare; otherwise, you are preparing to fail;
- Do not give in to temptations to jump to the next investment opportunity offering attractive returns without analysing the effects of such change in advance.
- Conduct a careful analysis of any changes affecting your strategic asset allocation to avoid ending up with unacceptable risks and incoherent returns. Changes within the same strategic asset class have much less impact and can be made more easily.
Crowdestate provides its investors with a wide range of real estate investments across Europe.