Before I share more about my real-estate crowdfunding experiments, I wanted to take a quick step back in order to provide better context. Just as ETFs and mutual funds are separated into stocks and bonds, real estate can be separated into two general types of investments:

• Equity = an ownership interest in the asset.
• Debt = a loan, typically collateralized by the asset itself or other assets of the equity owner.

In the business world, I could buy a piece of Amazon or Apple and participate in the ups and down of the business value, or I could invest in bonds issued by Amazon or Apple and get a fixed return as long as Amazon and Google keep making their interest payments within the stated period of time.

This is called the “capital stack”. In residential real estate, the stack can be quite simple. There is one homeowner and one mortgage-holder (debt). If they ever sell the house, any proceeds must first go towards the mortgage-holder. Anything left over goes to the homeowners. If the house gets sold for $400,000 and had a $300,000 mortgage, the homeowner would get $100,000. When you see the image below (source), imagine water filling up a container. The bottom layer gets paid first. If there isn’t enough “water”, the next layer doesn’t get paid. If there is excess “water”, that goes to the equity owner. (image source)

In commercial real estate, here are the four most common layers of the capital stack: common equity, preferred equity, mezzanine debt, and senior debt. Preferred equity, as its location suggests, is in between common equity and debt in terms of cashflow priority and return upside potential. It has a more senior position to cashflow than common equity, but it still junior to mezzanine and senior debt. Mezzanine debt can be explained as similar to when a homeowner might also take out a “home equity loan” that junior to the first mortgage (and thus usually at a higher interest rate). Both of these intermediate stacks are more complex in terms of how much extra return are you getting for how much extra risk, and thus I tend to avoid them. (image source)

The expected return of each layer is then adjusted based on its position in the stack. Keep in mind that as your expected return increases, so does the possibility that your actual return is zero or negative. (image source)

My equity investments. My initial feeling was that publicly-traded REITs do a pretty good job on the equity side. The big REITs hold big apartment complexes, hundreds of public storage facilities, etc. Is there an opportunity for higher returns from smaller properties? Perhaps, but the problem is that it takes years for equity investments to pan out. My plan is to invest another $1,000 into Fundrise eREITs and hold on to them for 5 years as a long-term experiment. As the dividends are paid and the net asset value is updated, I can compare side-by-side with the dividends and net asset value of the low-cost Vanguard REIT ETF (VNQ).

My debt investments. I prefer the idea of providing short-term, 7%-9% loans backed by a hard asset like real estate. This is an area traditional referred to as “hard money loans”. I can’t replicate this type of deal with an ETF or mutual fund. I plan to increase my investment in PeerStreet to roughly $25,000 total as they focus 100% on the debt side and I like their platform so far. I invest only in notes with a term under 12 months, and in the first position (most senior). This remains under my “5% Speculative Portfolio” and will track my returns regularly.

I finally got around to reading an academic paper that looked a bit dry but had a great title: The Rate of Return on Everything, 1870–2015 [pdf] by Jorda, Knoll, Kuvshinov, Schularick, and Taylor. I wonder which of the authors came up with that.

One of the major findings that was residential housing – when you add up the returns from both price change and imputed rent – had a higher overall average return than stocks (equities). Not only did housing have higher returns, but it also had lower volatility (standard deviation). Here’s a chart that compares housing and equities:

When the paper was released, places like the Financial Times discussed the paper’s conclusions but none of them addressed my two immediate questions.

Did they account for the maintenance and management costs of rental real estate? If you own a rental property, you may still have to pay for lawn maintenance, replacing roofs, HVAC units, interior and exterior painting, replacing carpets, and various other issues. To be fairly compared with equities, you should also account for property management costs. Here’s are excerpts that deal with maintenance and repairs:

To the best of the authors’ knowledge, this study is the first to present long-run returns on residential real estate. We combine the long-run house price series presented by Knoll, Schularick, and Steger (2016) with a novel dataset on rents from Knoll (2016). For most countries, the rent series rely on the rent components of the cost of living of consumer price indices as constructed by national statistical offices and combines them with information from other sources to create long-run series reaching back to the late 19th century.

A number of additional issues have to be considered when constructing returns on housing. First, any homeowner incurs costs for maintenance and repairs which lower the rental yield and thus the effective return on housing. We deal with this issue by the choice of the benchmark rent-price ratios. Specifically, in the Investment Property Database (IPD) the rental yields reflect net income (i.e., net of property management costs, ground rent, and other irrecoverable expenditure) received for residential real estate as percentage of the capital employed.

Did they account for the annual property taxes required on residential real estate? In many US states, the annual property tax bill can exceed 1% of the value of the house. Some are closer to 2% annually, and these are owner-occupied numbers. Rental properties may be higher. That’s on top of any potential capital gains you’d owe upon sale of the house, and any taxes you’d owe on rent received. Here’s are excerpts that deal with taxes:

Although the extent of real estate taxation varies widely across countries, real estate is taxed nearly everywhere in the developed world. International comparisons of housing taxation levels are, however, difficult since tax laws, tax rates, assessment rules vary over time and within countries. Typically, real estate is subject to four different kinds of taxes. First, in most countries, transfer taxes or stamp duties are levied when real estate is purchased. Second, in some cases capital gains from property sales are taxed. Often, the tax rates depend on the holding period. Third, income taxes typically also apply to rental income. Fourth, owners’ of real estate may be subject to property taxes and/or wealth taxes where the tax is based upon the (assessed) value of the property.
This section briefly describes the current property tax regimes by country and provides estimates of the tax impact on real estate returns.

With few exceptions, the tax impact on real estate returns can be considered to be less than 1 percentage point per annum.

This is an interesting paper that tries to cover a huge amount of stuff. Estimating the return of all businesses from all countries for the last 150 years? Estimating the return of all residential real estate from all countries for the last 150 years? They mix together a bunch of different datasets, so it’s hard to know exactly the quality level of each and how well they accounted for things like taxes and maintenance.

I’m not sure why they prefer to use arithmetic averages instead of geometric averages, but even if you shave off 1% for additional property taxes and another 1% because you don’t think they account for maintenance costs adequately, housing returns are still at least comparable to equity returns.

Here is the most recent update of the Case/Shiller home price index from Multpl, which tracks US housing prices on an inflation-adjusted basis:

Some people use this to argue that housing returns only keep up with inflation, but home prices ignore the value of rent. The fact that most housing purchases involve a mortgage loan does complicate things a bit.

Bottom line. An interesting paper that compares the long-term returns (last 150 years!) of residential housing and equities. In the long run, some may be surprised that residential housing returns at least matched equity returns, and housing returns had lower volatility. This is a reminder that you can also build wealth via residential real estate, taking into account that rent makes up half of the total return. Stocks are not the only game in town. (Just like with stocks, can is not the same as will.) New services like AirBNB provide an alternate path to monetize residential real estate.

While the number of real estate crowdfunding sites keeps growing, most marketplaces still require you to be an accredited investor with high income and/or net worth requirements. However, options for non-accredited investors should improve shortly due to the expanded Regulation A+ per the JOBS Act, which allows the general public to invest in private companies under certain circumstances.

RealtyMogul.com just announced their offering called the MogulREIT I. Instead of being able to buy part of a specific shopping center or providing a loan against a specific apartment complex, these REITs take your money and the sponsors get to pick out a diversified pool of commercial estate. The investor has much less control, but easier diversification. Instead of putting $2,500 into one building, you can spread $2,500 across 20 or 30 properties. Here are more details from their website:

• Fund intends to be diversified across property types, investment types, and geographies.
• The Fund expects to pay quarterly distributions starting the second full quarter of operation.
• The Fund will provide certain redemption opportunities, quarterly.
• MogulREIT I is audited by Cohn Reznick and administered by Opus Fund Services.
• $2,500 Minimum Investment.

Here’s what they have to say regarding expenses:

Investors in MogulREIT I will not be charged any sales commissions and the organization and offering expenses are anticipated to be approximately 3% of the target total raise of amount. Traditional non-traded REITs typically charge an average sales commission of 7% and organization and offering expenses of up to 15%**.

There are more details in the full SEC offering circular. Please do your own due diligence.

As I’ve said before, I would tell my family to invest in a low-cost, diversified, publicly-traded REIT fund before investing in any of these non-traded REITs with limited liquidity. For example, buying shares of the Vanguard REIT Index ETF (VNQ) will give you commercial real estate exposure with rock-bottom expenses and daily liquidity. VNQ and its mutual fund equivalents are where the vast majority of my commercial real estate exposure remains.

That said, I find this area of investing to be interesting. I like the idea of focused real estate but don’t enjoy being a landlord. I have invested $2,000 of “experimental money” into the similar Fundrise Income eREIT, as I prefer high-interest loans backed by real estate as collateral. Fundrise also has a Growth REIT which focuses more on real estate equity. The MogulREIT I is supposed to target both income and growth. I currently have no plans to invest in either the Fundrise Growth REIT or the MogulREIT.

Professer Robert Shiller has a new NY Times article entitled Why Land and Homes Actually Tend to Be Disappointing Investments. He computes the historical, long-term inflation-adjusted returns for both farmland and housing:

Over the century from 1915 to 2015, though, the real value of American farmland (deflated by the Consumer Price Index) increased only 3.1 times, according to the Department of Agriculture. That comes to an average increase of only 1.1 percent a year — and with a growing population, that’s barely enough to keep per capita real land value unchanged.

According to my own data (relying on the S&P/Case-Shiller U.S. National Home Price Index, which I helped create), real home prices rose even more slowly over the same period — a total increase of 1.8 times, which comes to an average of only 0.6 percent a year.

Over the same time period (1915 to 2015), the total inflation-adjsuted return of the S&P 500 index including dividends is roughly 6.7% annualized. Here is a recent version of his famous Home Price chart:

Shiller is a smart guy and so I’m sure he knows this, but he always seems to leave out the fact that most people don’t just buy a chunk of land and let it sit there idle until they are ready to sell it again.

• People use farmland to grow stuff. You know, things like apples and corn and cows. Or you could charge rent to farmers.
• People either charge rent to others or avoid paying rent themselves on residential housing.

These are all additional sources of investment return beyond just price. Therefore, even if you assume your home’s price will only rise between 0% and 1% above inflation over time, you are still getting more “return” from it in the form of either rent or imputed rent.

Rent will rise roughly with inflation. Indeed, the biggest portion of the Consumer Price Index is housing as shown in the graphic below (source). The great majority of the Housing component is “rent of primary residence” and “Owners’ equivalent rent of primary residence”.

From FRED, here’s the rent part of CPI divided by overall CPI for as far back as the data series goes (1947). Sometimes rent grows faster than CPI, sometimes rent grows more slowly than CPI. Mostly, it evens out, as one might expect.

For most of the last 20 years, rent has increased faster than CPI inflation:

Estimating your “rental dividend” return. If you have a house that costs $200,000 that would otherwise be rented for $1,000 a month, that is a price-to-annual-rent ratio of 16.7. The inverse of that number is a rough idea of the annual “rental dividend” you could get from the house. That is, $12,000 divided by $200,000 is 6%. Now, a proper real estate investor would take out things like property taxes, insurance, repairs and maintenance. Let’s continue to be very rough and call that 3%. Now, if you assume both rent and expenses will rise roughly in step with inflation, that is an additional 3% real return.

Adding the two parts together, and you’re getting a very rough 3% to 4% real (inflation-adjusted) return. Now, most people acknowledge that housing is local and your specific return can vary widely. Your housing price return if you bought a house in Detroit in 1985 and a house in Mountain View, California is quite different. At the same time, your current housing rental dividend return is going to be a lot higher in Detroit than in Mountain View, California.

(I’m not nearly as familiar with farmland, but I do know people who rent out their property to farmers and ranchers. They seem satisfied with the arrangement. I’m also not including all the psychic rewards of owning your home like being able to remodel and customize things as you wish, nor am I including the costs of doing that remodel.)

If you look at various broad estimates of future stock and bond returns, they are not forecasting much more than 3% to 4% real returns on a diversified and balanced 60/40 stock/bond portfolio. Do housing prices only go up? No. Is every house a good investment? No. However, I also don’t agree with the broad statement that land and homes are disappointing investments.

I’ve explored my own situation and income tax effects more in the previous post Mortgages, Imputed Rent, and Early Retirement.

Updated with Q2 2016 performance results. My second real estate crowdfunding investment is $2,000 into the Fundrise Income eREIT. (REIT = Real Estate Investment Trust.) Their investment claim is being the “first ever low-fee, diversified commercial real estate investment available directly online to anyone in the United States, no matter their net worth.”

Fundrise is one of the first real estate companies taking advantage of the recent JOBS Act that allow certain crowdfunding investments to be offered to everyone, as previously it was limited only to accredited investors. You must be a US resident and your investment cannot exceed the greater of 10% of your gross annual income or net worth.

Here’s a quick overview of the features:

• Low investment minimum ($1,000)
• Quarterly cash distributions
• Quarterly liquidity (you can request to sell shares quarterly, but liquidity is not always guaranteed)
• Low Fees (claimed to be roughly 1/10th the fees of similar non-traded REITs). Until Dec 31, 2017, you pay $0 in asset management fees unless you earn a 15% annualized return.
• Transparency (you get to see exactly what properties are held)

Essentially, instead of investing in a single condo building, I am now putting my money into a pot of money that will invest in a basket of different commercial real estate properties.

Why not just invest in the Vanguard REIT index fund? Well, I happen to think most everyone should invest in VNQ if they want commercial real estate exposure. I own a lot more of VNQ than this Fundrise investment. VNQ invests in publicly-traded REITs, huge companies worth up to tens of billions of dollars. VNQ offers wide diversification and you have daily liquidity. But as publicly-traded REITs have grown in popularity (and price), their income yields have gone down.

As with other crowdfunding sites, Fundrise deals with specific, smaller deals with (hopefully) higher risk-adjusted returns. This eREIT diversifies your money across multiple properties, but we’re still talking examples like a $2 million townhouse complex, or a $2 million boutique hotel. An analogy might be made with “micro-cap” investing. From their FAQ:

Specifically, we believe the market for smaller real estate transactions (“small balance commercial market or SBC”) is underserved by conventional capital sources and that lending in the market is fragmented, reducing the availability and overall efficiency for real estate owners raising funds. This inefficiency and fragmentation of the SBC market has resulted in a relatively favorable pricing dynamic which the eREIT intends to capitalize on using efficiencies created through our technology platform.

A positive feature is the ability to request liquidity on a quarterly basis, but it is not guaranteed that you can withdraw all that you request (similar to some hedge funds). Here’s a comparison chart taken from the Fundrise site:

Why Fundrise? It can be hard to differentiate between the various crowdfunding websites. One way that I feel that Fundrise differs is they are more picky about the deals they choose to fund. Talk about higher standards is one thing, but I’ve been tracking them for a while and Fundrise really does offer far fewer deals than the other competitor sites I have signed up with. For about a year now, every deal that I’d been interested in filled up within 24 hours. Even this eREIT had a waitlist. Will this selectivity last? I don’t know, I hope so. Will their selectivity produce higher, safer returns? I don’t know, I hope so.

Dividend income updates.

• 1st Quarter 2016. 4.5% annualized dividend was announced. This is the first complete quarter of activity, so the dividend size is expected to increase once funds are fully invested. The portfolio included 13 commercial real estate assets from 8 different metropolitan areas, with approximately $31.5 million committed as of March 31, 2016.
• 2nd Quarter 2016. 10% annualized dividend announced, to be paid mid-July. Portfolio now includes 15 assets totaling roughly $47.25M in committed capital.

Screenshot from my account:

I think the Fundrise Income eREIT is an interesting concept. There may be a waitlist to join, but they do work through it. I am simply sharing my own results, not making an investment recommendation as I don’t know your situation. This is a higher-risk, speculative investment.

• Open up a Fundrise Account