Evaluate Real Estate Investment Opportunities Using: Who, What, When

Real estate investment opportunities are available in all types of markets. It just so happens we are in one of the strongest real estate bull markets ever. As someone who believes the housing market will continue to stay strong for several more years, I’ve purposefully positioned ~40% of my net worth in real estate.

However, with all investments that carry risk, there are no guarantees. All of us must do as much due diligence as possible before making any investment decision. The greater the capital outlay, the more time we should spend evaluating various investment scenarios.

As someone who has been through several economic downcycles before, my worry goes up the better the market gets. During a bull market, it’s easy to lose our discipline. The last thing I want is for all of us to think we’re the next Warren Buffet of real estate investing.

Therefore, I’ve invited CrowdStreet, a leading real estate crowdfunding platform and FS partner, to share with us a logical real estate evaluation framework they use.

How To Evaluate Real Estate Investment Opportunities

If you’re an accredited investor, you have the opportunity to hand-select the individual deals that make up your real estate portfolio with platforms like CrowdStreet. But as the old adage goes, with great power comes great responsibility. Sorting through five, ten, or even 15 opportunities can be a little overwhelming, especially with deadlines to invest looming. 

So what are some of the first things you should look at in order to find the right deal for you and your financial goals? Let’s look at how to evaluate real estate investment opportunities using a WHO, WHAT, WHEN framework.

There are many ways to properly evaluate real estate crowdfunding opportunities. Let us share an easy-to-remember framework. From this framework, you can then dig even deeper.

1) WHO Is The Sponsor?

With more than 500 funded and closed deals behind him – not to mention the thousands that didn’t make it to their Marketplace – CrowdStreet’s Chief Investment Officer Ian Formigle has one key piece of advice for investors: learn as much as you can about the sponsor behind the project.

Even if we at CrowdStreet love a deal, we need to like the sponsor behind it just as much. As an investor, you don’t need to know anything about the deal until you know about the operator.

CrowdStreet believes in this so much that we publish the track record of all the sponsors who have deals on our Marketplace. Below is an example.

Just about anyone can do well when times are good. However, true leaders differentiate themselves when things start to go off the rails. We saw it happen during the Great Recession and we’re seeing it again with COVID.

Sponsor Experience Matters

Experienced sponsors who had strong relationships with their banking institutions were able to more easily navigate their loans or take advantage of the federal PPE program. Those sponsors have been able to keep their projects afloat, even if they did have to hold a capital call. They know how to manage the pitfalls of a downturn. Ultimately, they are more likely to position themselves for success when the market rebounds.

So if a particular opportunity seems interesting, spend a little more time also looking at the firm behind the project. Here are some questions to ask about the sponsor.

  • Are they experts in this asset class? They’ll be less surprised by common pitfalls that might plague someone new to that space. Carefully evaluate the management of each sponsor. Make sure they have the relevant education and investment experience before participating in their real estate investment opportunities.
  • How many times have they successfully brought a project like this to a sale? There is a big difference between building a luxury apartment building from the ground up versus operating and improving a 20-year-old property.
  • Have they been tested by a downturn? Whether it’s was local (maybe supply outstripped demand) or national, sponsors who have survived through tough times understand how to move through the entire real estate cycle and win. If a sponsor has never done business during a downturn, then it’s probably best to stay away until they have.
  • Does the sponsor have skin in the game? The more the sponsor has invested in a project, usually the better. You want the sponsor to be completely aligned with investors.

2) WHAT Does The Local Market Look Like?

Austin Metro's expected population growth

CrowdStreet has long believed in the power of 18-hour cities. These growing markets aren’t big enough to be dominated by institutional investors. But they can provide a substantial upswing for individual investors who are able to get into a deal.

Formigle adds, “Over the last few years, we’ve been gravitating towards a macrotrend thesis. When you catch a market on the upswing, you really catch it. For instance, we liked Austin three years ago, but we didn’t realize how much more we should have liked it. There’s a reason it’s part of our Best Places to Invest report across multiple asset classes. Looking back, it should have been less of a surprise to our team just how successful Austin has been.

According to U.S. Census Bureau figures released May 4, Austin’s multi-county metro population increased by 3% increase, making it the fastest population growth among metros with at least 1 million residents.

Here are some of the best states to invest in real estate based on migration trends and valuations that Financial Samurai put together. The “spreading out of America” is a long-term trend worth paying attention to thanks to technology and the greater acceptance of working from home.

Top states to invest in real estate by migration and valuation rankings

Be Very Attentive Of Micro-Markets

The flip side is when you’re looking at a super sensitive micro-market.

A few years ago, CrowdStreet had the opportunity to publish a student housing deal near a good, growing university that. By all accounts, it should have been a really successful project.

But everyone else had the same thought about this college town. Therefore, supply outstripped demand and rents actually went down as vacancies went up. College town markets are micro-markets. A few too many projects and it’s ruined, even at the biggest universities.

After all, there are only so many students each year and once there are too many beds there is no demand for new projects. Below shows how the supply of beds surged around five big colleges in 2020 when fewer students were coming to campus. Micro-markets are more susceptible to supply and demand shocks.

How To Evaluate Real Estate Investment Opportunities - Supply of beds between 2019 and 2020 for five major state universities

3) WHEN Will The Project Hit The Market?

When evaluating real estate investment opportunities, the final question you must ask yourself is when will the project hit the market. It takes time to build. Not only must you estimate when the project will finish being remodeled or built, you must also determine where the market will be once the project is complete.

As mentioned in a previous post on Financial Samurai, knowing where your investment sits in the real estate cycle really matters. As we come out of the pandemic, the real estate market is strong as demand outstrips supply. But this will not always be the case.

Real estate market cycles - Four phases

COVID definitely plunged the U.S. into a recession, albeit a slightly skewed one depending on where you sat. For multifamily properties, there was immediate concern regarding the prospect of spikes in vacancy rates and lease defaults given how unemployment numbers skyrocketed practically overnight.

But government intervention played a significant role in propping up this sector by providing significant fiscal and monetary stimulus, as well as by implementing an eviction moratorium. Consequently, rent collections never dropped below 93% in any month in 2020. Final collection rates are below, but still close, to 2019.

Multifamily Supply Declined As Well

On the flip side, fewer than 300 new multifamily projects broke ground last year, the lowest velocity witnessed since 2012. Urban construction saw the largest pullback in 2020 at around 50% below the three-year average. That means there will be a gap when projects hit the market.

This gap will likely lead to a tighter rental market in various cities, which is one of the main reasons why rents are also going up in addition to property prices.

Development projects that were able to keep moving during COVID will likely lease up quickly as we enter the recovery phase, especially in growing metros. There will likely be a slowdown in new deliveries beginning later this year and extending into 2022. This should keep the multifamily market tight.

However, eventually, new multifamily supply will come online. Imagine what would happen if one new building opened up in your town every month for a year. Now compare 12 new buildings all looking for all their tenants in the same month. It’s entirely possible those laggard deals will force the expansion phase and push us into hypersupply. 

Therefore, when evaluating a real estate investment opportunity, estimating the WHEN is crucial. Real estate development tends to move in boom-bust cycles.

Hospitality Properties Making A Comeback

Hospitality properties were undoubtedly the hardest hit by COVID. Many hotels were permanently shuttered or taken offline and the new demand pipeline essentially ground to a halt.

But it is also likely to be the distressed asset class with the strongest bounce coming out of the pandemic. We’re already seeing travel numbers grow. More than 37 million Americans were projected to travel 50 miles or more over Memorial Day. This is an increase of 60 percent compared to 2020, the lowest number of Memorial Day travelers on record.

One AAA spokesman called it “revenge travel.” The combination of a substantial drop-off in new deliveries plus the removal of existing keys from popular tourist markets makes the 2023-2024 recovery period look very interesting. We expect to see new product and development opportunities.

Real Estate Investment Opportunities Are Everywhere

Thanks to CrowdStreet for providing a memorable framework when evaluating real estate investment opportunities. Who, What, and When is a good framework to follow.

The main criteria I focus on is evaluating the sponsor and its management team. The more experience the sponsor has, the better. Ideally, I want to invest with a sponsor who has experience navigating through prior recessions. A sponsor should have experienced at least one prior loss as well. We tend to learn much more from our losses than our wins.

I also want a sponsor to invest a reasonable amount of their own capital in the deal. For example, if a sponsor is trying to raise $2 million to purchase a $10 million property, I’d like to see 25% or more of the capital come from the sponsor, i.e. $500K. Like with most things, skin in the game is important. It’s why I’ve personally invested $810,000 in 18 real estate investment opportunities since late-2016.

To attract capital, the natural tendency is to shine a spotlight on your wins. But if you have invested as long as I have, you will have plenty of losses as well. Therefore, I encourage all potential investors to ask a sponsor about their previous suboptimal investments and share what they have learned. It’s hard for me to trust people who only talk about their wins.

If you’d like to explore various real estate investment opportunities on CrowdStreet, feel free to sign up here.

Readers, what other criteria do you use to evaluate real estate opportunities? What real estate asset classes and markets are you looking most carefully at today?

Evaluate Real Estate Investment Opportunities Using: Who, What, When is written by Financial Samurai for

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