Updated August 2022. It has now been nearly 5 years for my experiment comparing a Fundrise Real Estate portfolio and the Vanguard Real Estate ETF. In Fundrise, we have a start-up with “crowdfunding” beginnings that offers users a share of a concentrated basket of properties actively chosen from the private market. In Vanguard, we have a one of the largest real estate ETFs in the world – users own a tiny passive slice of 170 public-traded REITs. I invested $1,000 into both in October 2017 and the plan is to let them run for at least 5 years.

Fundrise Starter Portfolio background. When I bought in, the Fundrise Starter Portfolio was a simple 50/50 mix of two eREITs: the Fundrise Income eREIT and the Fundrise Growth eREIT*. Since these are finite baskets of entire properties, over time they will close one fund and start another similar basket. What new investors are buying today will be different apartment complexes and office buildings than what I bought in 2017. Here is what I hold now:

Each private eREIT works within recent crowdfunding legislation that allows all investors to own a basket of individual real estate properties (not just accredited investors with high net worth). The minimum deposit is now just $10. You must buy shares directly from Fundrise, and there are only limited quarterly liquidity windows as this is meant to be a long-term investment. There are also additional options available with higher investments:

Vanguard REIT ETF background. The Vanguard REIT ETF (VNQ) is the ETF share class of a $70 billion index fund that invests in publicly-traded real estate investment trusts (REITs). You can purchase it via any brokerage account. You have the liquidity of being to sell on any day the stock market is open. A single share currently costs about $100, but many brokers offer fractional dollar-based trades if you want. All shareholders are holding the same ratio of (tens of?) thousands of office buildings, hotels, storage centers, nursing homes, shopping centers, apartment complexes, timber REITs, mortgage REITs, and so on. Here are the recent top 10 holdings:

Expenses. The Fundrise Starter Portfolio has an 0.85% annual asset management fee and a 0.15% annual investment advisory fee (1% “all-in” total). The Vanguard REIT ETF has an expense ratio of 0.12% on top, but each public REIT also has their own internal costs like employee salaries to manage their properties. In each case, investors are paying for real estate management, office space for those employees, etc. REITs may also use debt to increase their real estate exposure (leverage). Is the technology offered by Fundrise a more efficient way to invest in real estate?

Performance update. Based on an initial $1,000 investment in October 2017 and immediately reinvestment of all dividends, here are the monthly balances of my Fundrise portfolio vs. the Vanguard REIT ETF.

Commentary. The main issue with this comparison is that this chart uses two different types of NAVs (net asset values). Vanguard updates the NAV daily based on the combined agreement of millions of investors. Every trading day, there is a price where you can liquidate your VNQ shares. Meanwhile, Fundrise NAVs are only estimates as there is no daily market value available since they hold entire apartment complexes, office buildings, and so on (similar to your house, but with even fewer comps). Your liquidity from Fundrise is limited to quarterly windows that are not guaranteed.

This is not to say that the Fundrise NAV is not truthful, especially over longer periods, but it’s simply not going to move around as much as the VNQ NAV. If you own farmland, office building, or a 100-unit apartment complex, does anyone really know the value at any given moment?

This makes Fundrise similar to a rental property that looks more stable over time because you don’t get daily price quotes on your rental property. You’re really just guessing until something actually sells. Meanwhile, that physical piece of property is something you can visit and see people using (and paying rent). For example, I own part of the The Ridley Apartments in Jacksonville, Florida (picture below). Here is a recent Bloomberg article about a Fundrise property in Los Angeles. That feeling of stability and tangibility is a “pro” of private real estate. However, the “pro” of REITs is exposure to investment growth with zero ongoing management concerns. Fundrise tries to give you a bit of both – you get pictures and updates from the properties but zero management responsibility.

However, this also means that I am not convinced that the performance of Fundrise is that much better than the Vanguard REIT after the effect of the bear market of early 2022. Right now, based on report NAVs, Fundrise is up +86% since October 2017 while the Vanguard REIT ETF is only up +32% as of June 30, 2022. That’s a big difference! I feel that if Fundrise really had to liquidate its real estate portfolio, the true net values would be much closer. Therefore, I’m going to keep the experiment going to see how it works out.

Bottom line. I’m nearly 5 years into my buy-and-hold-and-watch experiment where I compare investing in real estate via Fundrise direct active investment and the passive REIT index ETF from Vanguard. Right now, based on report NAVs, Fundrise is up +86% since October 2017 while the Vanguard REIT ETF is only up +32% as of June 30, 2022. However, due to the limited liquidity of Fundrise REITs and the current bear market, I wish to see how things work out after another year or more.

You can learn more about all Fundrise Real Estate options here. Anyone can invest with Fundrise; you don’t need to be an accredited investor.

There are many ways to access real estate as an asset class – publicly-traded REITs like Realty Income, diversified REIT ETFs, private funds that hold baskets of individual properties, and many new fintech varieties. This Institutional Investor article discusses a new research article comparing public REITs and closed-end private equity real estate (PERE) funds:

In a new study published in the Journal of Portfolio Management’s real estate issue, authors Thomas Arnold, David Ling, and Andy Naranjo found that, when compared side-by-side, real estate investment trusts outperformed U.S. closed-end private equity real estate, or PERE, funds by 165 basis points annually.

Here is another Nareit article about the study, where I noticed that the research was actually sponsored by Nareit. Here is a direct link to the study itself.

This other Institutional Investor article points out one of the “benefits” of private real estate funds – namely the fact that they don’t offer accurate daily pricing. You should also consider this a “benefit” of personal homeownership – when things are scary, houses simply don’t sell (instead of giving you a shockingly low price at that moment).

REITs, like any public security, are priced in real time. At the depth of the economic shutdown in March and early April, REIT investors imagined doomsday scenarios as commercial property and hotels sat empty and analysts forecasted that individuals would be unable to make rent payments for the foreseeable future. The price of REITs fell in line with that outlook.

In contrast, private real estate funds use other valuation methods, including appraisals — which depend on property transactions. Back in March and April, no real estate was changing hands to inform these valuations. As a result, the net asset values of private portfolios didn’t reflect the carnage.

Real estate continues to intrigue me, but I’ve always stopped short of directly investing in a rental property because I want to avoid any management responsibility (or even the responsibility hiring a good property manager). To me, rentals are best considered a potentially-lucrative part-time self-employed business opportunity, with the greater upside and downside involved. I also love that I can completely ignore my portfolio for months at a time, and the dividends and interest payments still keep coming in.

I’ve experimented with other options like PeerStreet, Fundrise and others, but the vast majority of my real estate investments are still in the low-cost index ETF VNQ (Vanguard Real Estate ETF). As long as you are good at ignoring the price drops during the scary times, it has been a solid long-term holding. Per Morningstar, here is the growth of $10,000 invested in VNQ since inception 25 years ago (with dividends reinvested!):

Bloomberg has an interview transcript with investor John Paulson, and it has the catchy headline Billionaire Paulson Who Shorted Subprime Calls Crypto ‘Worthless’ Bubble. He does say that, but the interview also includes some insights on many other topics like asymmetrical trades, gold, the highly-limited supply of crypto leading to high volatility, interest rates, and controlling how you spend your time.

If you are having trouble getting around the paywall, let me include this quote:

If somebody came to you and asked how they should invest $100,000, what would you tell them?

I always say the best investment for an average individual is to buy their own home. So if you take that $100,000, put 10% down, get a $900,000 mortgage, you can buy a home for a $1 million. It was just reported that home prices were up 20% in the last month. So if you bought a home for a $1 million with $100,000 down and the home was up 20%, that’s $200,000 on a $100,000 investment. The longer you wait, the more the house is going to appreciate and the greater return you’ll have on your equity investment. So I think the single best investment for anyone with that type of money would be to buy their own house or apartment.

Basically, mortgages offer cheap leverage on an asset that he believe will keep going up for a while. A person can take $50,000 and control a $500,000 asset. If it goes up 10%, you just made another $50,000 and doubled your initial $50,000.

Yes, we learned that leverage works both ways in the 2008 Financial Crisis, meaning that if that $500,000 drops by 10%, you just lost your $50,000 downpayment. That’s what Paulson is most well-known for – making $20 billion betting against subprime mortgages during that crisis. In fact, I recall Paulson saying something very similar back in 2014 or so, that housing prices are going to keep going up. Here is the S&P/Case-Shiller U.S. National Home Price Index chart from Calculated Risk:

With this interview, I guess he doesn’t see this trend ending soon. I’m not saying I necessarily agree with this answer, but it is an interesting one when you consider all of the possible options.

I’ve invested over $50,000 of my “alternative” money into PeerStreet real estate notes because of the ability to diversify into 50+ different high-interest loans backed by physical real estate. Here is a case study of a $10 million mansion that bounced in and out of late status for years, only to suddenly get paid back in full. You can find additional case study links and the most recent update to my overall portfolio performance in my Peerstreet review.

I called this property “90210” as it was located in a prime spot in Beverly Hills. The loan photo on the Peerstreet listing was quite drab:

Here’s what it looked like on the MLS page when they listed it for over $10 million:

Initial investment details.

• Property: Single-family residential property in California.
• Target Net Investor Rate/Term: 8.25% APR for 31 months.
• Appraised at $8.75M = 60% LTV.
• Cash-out/Bridge loan secured by the property in first position.
• Loan originator retained 13% “skin in the game”.

Timeline.

• June 2018. Loan originated. Original maturity date was January 2020.
• June 2019. Payments are now late.
• August to September 2019. Payments are still late. Demand letters are sent.
• October 2019 to January 2020. Intermittent payments are made, but still behind and late.
• February 2020. Peerstreet approves a loan extension to April 2020.
• April 2020. Late again.
• May 2020. Loan brought current!
• July 2020. Guess whose late again?
• August 2020. Another extension is approved, but does it really matter?
• September 2020 to January 2021. Still… late.
• February 2021. Loan is suddenly paid off in full.

Final numbers. As the loan was paid off in full, I earned the full promised 8.25% annualized return but for 31 months instead of the original 18 months. I guess that worked out to my benefit, given the current low interest rate environment. My overall annualized return across my entire Peerstreet portfolio is currently 6.9%. These numbers are net of all PeerStreet fees.

My commentary. This loan is an example where for nearly three years, I stared at the same loan that with a late/default status every time I logged into Peerstreet. It spent more time late than current, yet one day it suddenly became paid off in full and actually improved my overall return numbers. The originator appears to be juggling many different loans, but the property remained valuable enough that they really had to eventually pay off this loan despite having to pay me 8.25% interest while I waited.

It was good to see (and rare these days) to see the originator keep an interest in the loan, as that is usually taken as a sign of confidence. I wish I could only invest in loans with such “skin in the game”, but the reality is that Peerstreet inventory is currently in such great demand that nearly all of their notes sell out instantly to automated investors.

Again, the lesson is to diversify, ignore the late status, and invest money with which you can be patient. Let Peerstreet do the due diligence and manage the late payments and possibly the foreclosure process.

Bottom line. At the moment, out of the $50,000+ I’ve now invested into 66 loans at PeerStreet over 4+ years, 55 were paid back, 8 are current, and 3 are late. However, many of those paid-off loans were late at some point in time. This is one example of a single-family residential loan that was constantly late for years, but ended up being paid in full. The annualized return for this loan was 8.25%, while my overall annualized return across my entire portfolio is 6.9%.

If you are interested, you can sign up and browse investments at PeerStreet for free before depositing any funds or making any investments. You must qualify as an accredited investor (either via income or net worth) to invest. If you already invest with them, they now sync with Mint.com.

I’ve invested over $50,000 of my “alternative” money into PeerStreet real estate notes because of the ability to diversify into 50+ different high-interest loans backed by physical real estate. Here is a case study shared by a helpful reader about a “disaster” loan with multiple bad factors – bankrupt building owner, bankrupt tenant, a charitable donation, poorly-aligned incentives, COVID-19 pandemic, civil unrest, and forced selling. You can find additional case study links and the most recent update to my overall portfolio performance in my Peerstreet review.

Initial investment details.

• Property: Office building in Springfield, Ohio.
• Target Net Investor Rate/Term: 8.75% APR for 31 months.
• Amount: $3,600,404 loan.
• 60% LTV based on 3rd-party appraisal of $7.76 million.
• Loan secured by the property in first position.
• Cash-out refinance.

Timeline.

• February 2018. Loan is originated.
• December 2018. Payments stop.
• January 2019. Payments are over 30 days late, demand letters are sent, etc.
• April 2019. Foreclosure complaint filed.
• April 2020. A year has passed. Foreclosure process drags on, but now all foreclosures are halted due to COVID-19.
• August 2020. Foreclosure auction date set for October 2020.
• October 2020. PeerStreet abruptly decides to sell to a third-party for net proceeds to investors of $573,281.31 for a final return (including interest paid to date) of 18% of the original investment.

How did a $3.6 million loan backed by a building that was appraised for $7.8 million in 2018 end up only giving back investors $580,000 less than two years later? How did a loan with a supposedly 60% loan-to-value ratio end up paying back only 18 cents on the dollar? After reading all the screenshots and documentation provided along with some poking around online, here’s what happened in the background.

A wealthy couple donates what might be the most prestigious commercial address in downtown Springfield, Ohio. The address is literally “1 Main Street.” Look at the building entrance from Google Maps Streetview. The lucky nonprofit recipient immediately agrees to sell it to EF Hutton, which renames it EF Hutton Tower. The nonprofit is happy, but they are on a payment plan and also get paid partially in EF Hutton stock. (Cue ominous music…)

EF Hutton is now both the building owner and the anchor tenant. So the same company that owns the building is also the source of most of the rental income. They now want a cash-out refinance, and obtain an appraisal of $7.78 million in January 2018. Now, if there was an independent buyer for this property, the appraisal might have been done with more skepticism. But it was appraised as a charitable donation (i.e tax write-off) for a needy non-profit! Many people potentially benefited from a high appraisal. The building owner gets more money from the cash-out refi, the donor get a bigger tax break, the recipient gets a high-publicity donation, even Peerstreet got a note with a great LTV%. Everyone except the person holding the bag at the end.

Okay, so time moves on. EF Hutton is quickly in financial trouble and being investigated by the SEC, somehow pivoting from stock trading to mobile phones to cryptocurrencies on its way to bankruptcy. Check out this Springfield News Sun article about their $12 million in debt. The anchor tenant is broke. There is no rent being paid. The nonprofit is owed money. Property insurance and property taxes are not being paid. The building is no longer being maintained. From a Peerstreet letter to noteholders:

As the foreclosure proceedings were ongoing, PeerStreet made repeated efforts to gain access to the property and assess its condition. After the court granted PeerStreet partial access to the property, we discovered water damage, deferred maintenance on the elevators and other maintenance issues caused by the borrower’s failure to maintain the property, which inspectors estimated would cost over $1M to remedy.

In addition to this, the borrower stopped making property insurance payments, which PeerStreet then advanced to protect investors’ interests in the collateral. The borrower also defaulted on property taxes in excess of $700,000.00.

COVID-19 crushes the local economy. Nobody is there to protect the building during civil unrest. There is no anchor tenant. $1m in property damage. $700,000 in property taxes. Even so, I don’t understand why Peerstreet didn’t just wait for the foreclosure auction. I’d personally feel more confident if there was an open auction. Could they have held out until after the pandemic passes? That’s what I would have done if I was the sole owner. However, Peerstreet might simply value a fast resolution over absolute final return.

Final numbers. As noted above, the final return (including interest paid to date) was 18% of the original investment. (As in, you put in $100 originally and get $18 back.)

My commentary. Both bad luck and bad incentives lined up for such a bad result. The appraisal was obviously too high in retrospect. Whenever someone donates something big, even though it is a charitable act, the donor still wants it to be valued as highly as possible while the nonprofit also benefits. The tax deduction here was worth millions. EF Hutton also wanted the highest valuation possible as it was a cash-out refi. COVID and economic factors only made it worse. Once it was clear that they had no more skin in the game (equity), EF Hutton let the property fall into ruin.

A cynic might wonder if EF Hutton knew this would happen and wanted to walk away with as much money in its pockets as possible? Where did all the money from their $12 million in debt go? Highly suspicious.

Getting back 18 cents on the dollar really hurts, and makes me wonder how this might happen on a more commonplace residential property (and how to avoid it). You would still need an inflated appraisal (avoid cash-out refis?). You would also need the owner to stop caring about the property and let it get totally trashed (maintain equity?). You would need a severe economic downturn and a forced sale (more skin in the game from Peerstreet to encourage more patience?).

Finally, this is another lesson in the importance of diversification. If this was a $1,000 loan amongst 50 different loans, your loss would be 1.6% of your total $50,000 portfolio.

Bottom line. Even though I’ve now invested and reinvesting $60,000+ into 63 loans at PeerStreet over 4+ years, I haven’t had one (knock on wood) completely “blow up”. I’ve had several spend several months in default, only to be paid back in full with interest. Thanks to a helpful reader, I was able to share this story and hopefully provide some educational value. Most importantly, this should teach you to diversify even if the loan looks solid, as even if you replaced any one of my $1,000 loans with this “worst-case scenario”, thanks to diversification my overall portfolio return would still be positive.

If you are interested, you can sign up and browse investments at PeerStreet for free before depositing any funds or making any investments. You must qualify as an accredited investor (either via income or net worth) to invest. If you already invest with them, they now sync with Mint.com.