Institutional Investors and Crowdfunding Are Coming

  • Institutional investors have been under fire lately for eating up real estate market share.
  • Meanwhile, crowdfunding platforms have promised to democratize housing markets for retail investors.
  • Two industry experts shared their thoughts on what’s really going on behind the scenes.

Real estate has been a red-hot commodity over the past two years, in no small part due to the massive influx of institutional investors into the housing market. Alongside the rise of these deep-pocketed investors has come a surge in popularity for real estate crowdfunding platforms, which allow smaller and non-accredited investors to get in on the action as well.

But as investors and wealthier work-from-home transplants from metropolitan areas have swooped into suburban housing markets, fear that market locals are being priced out have risen. These investors may also be contributing to the housing shortage the US currently faces, postponing the dream of homeownership for many Americans.

Insider asked two real estate experts to share their thoughts on how the combination of institutional investors and crowdfunding investment platforms have affected the housing market — and what the consequences will be for potential homeowners.

“Investors gone wild”

According to independent real estate market analyst John Wake, the pandemic-induced era of easy money brewed the perfect storm for a land grab in the housing market. The catch, however, was that instead of the average Joe buying their first home, the floodgates were opened for a massive deluge of investors who were seeking new assets after the stock market sold off in early 2020.

“My impression of the whole thing is sort of like investors gone wild,” Wake told Insider in a recent interview. He believes that the most important trend in today’s housing market is the sheer amount of capital chasing new homes.

The influx of these institutional investors has only exacerbated the massive supply-demand imbalance the real estate market currently faces, Wake said.

“The supply of increases more slowly than the supply of gold in the world. So when you get a little bit of an increased demand from investors, it has a disproportionate impact on prices, and then prices people out,” he explained.

Wake also believes that institutional investors are more inclined to hold on to their properties, which is why he isn’t optimism that supply will catch up to demand anytime soon. In previous housing market booms, such as the growing market bubble in 2005, the mom and pop investors would sell out of their properties as soon as prices peaked, which created a glut of inventory over the next two years.

“I don’t think we’re going to have those foreclosures this time, unless there’s some bomb buried in the financing of these institutional investors,” he said.

A new entry into a crowded housing market

While institutional investors have certainly increased their foothold in recent years, retail investors have still been able to enter the housing market through a new investing strategy: crowdfunding.

Crowdfunding platforms like Fundrise have soared in popularity based on their promises that with just a few dollars investors can capture big returns in one of the hottest asset classes of today’s market. Wake believes that it’s certainly opportunistic — with people tending to take action whenever there’s good news — but he worries about the long-term effects of this trend, particularly if it continues to destabilize housing markets like Phoenix.

The financing with institutional investors can also sometimes be muddled, with Fundrise seemingly overpaying for its build-to-rent communities. But when calculating the value of these neighborhoods as a de-facto apartment complex rather than as individual homes, the math works in the platform’s favor.

Wake says there’s also a lot of room for error, since this method of valuing assets is so new. For instance, there’s a lot of risk in rent calculations if investors simply extrapolated rent increases under the assumption that rents would continue to rise indefinitely.

“But what happens if they don’t? That’s a totally different scenario than we had last time, because rents didn’t go up at all in 2005 and 2006,” he said. “So now to have them skyrocket — it makes this time different. That changes the calculations.”

Retail investors might be taking on more risk than they realize

Tomasz Piskorski, a professor of real estate at Columbia University Business School, is more optimism regarding investors — including crowdfunding platforms — and their impact on the housing market.

“There’s this thing going around of blaming institutional investors for pushing prices up,” he told Insider in a recent interview. “They buy single family homes and convert them to rentals, pushing the dream of homeownership away from some people.”

“I don’t think institutional investors or crowdfunding platforms have a big, meaningful impact on prices … not when compared to low interest rates, migration trends, work-from-home impacts on prices,” Piskorski continued. “It all depends on acquisition price.”

Piskorski says that institutional investors might value a home more highly than a single-family owner because they can create more value for these properties through professional management.

For instance, homeowners who own multiple properties might not find as much value in their vacation homes if they don’t spend the majority of their time there. But if a professional real estate firm can instead buy that property and rent it out the majority of the time, the asset’s efficiency could be maximized, Piskorski pointed out.

“Professional rental companies in some ways bring more efficiency and they might help solve affordability problems because of very high mortgage rates right now. A lot of people simply cannot afford to buy a home; they might have a lot of financing costs,” he explained . “It’s great that there are companies offering single-family rentals.”

In fact, Piskorski believes that an influx of professional management may be just what housing markets need right now, considering that the over 10 million single-family units currently offered for rent in the US are “usually very inefficiently managed” in terms of maintenance requests and other factors. “I think the single-family rental businesses are useful responses to markets’ needs,” he said.

Piskorski said that rentals also help mitigate some of the potential risks of home ownership, like property devaluation in the case of an economic recession. In addition, he views crowdfunding as an alternative option for retail investors who might not be able to invest in the real estate market using traditional methods, which may include barriers to entry like requiring investor accreditation.

To understand why, Piskorski dived into the history behind crowdfunding. “In 2012, investing in real estate prices were still very depressed, and it was not easy to get a lot of institutional capital to invest. So the idea was to provide an alternative source of funding to encourage public investments in real estate,” he explained.

Crowdfunding has a plethora of benefits, including the fact that it’s both a cheaper and easier source of funding for real estate projects, and allows these platforms to buy and operate properties at lower costs than a single investor. And on paper, it’s meant to provide a public service by democratizing access to private equity.

But historically, private equity and crowdfunding returns on average have underperformed the public REIT market, especially when accounting for fees, Piskorski said. He’s also concerned about the so-called “lemons market” — essentially, that some crowdfunding platforms will get the bottom-of-the-barrel deals that institutional buyers won’t invest in.

Crowdfunding platforms could potentially place a lot of risk on a small investor, who might not have the financial sophistication to fully understand and monitor their investments, according to Piskorski. The industry itself also lacks regulation, so that companies are able to promise high returns while disclosing very little information.

“Just to be very clear, I wouldn’t want to come across as someone who is against crowdfunding … I think there are very legit companies out there,” Piskorski said. “But again, if you would honestly ask me as an economist what the problem is, I wouldn’t say it’s on the asset side. It’s more about if these companies are offering a fair return to a diversified retail base of investors given there is a very limited oversight and disclosure regarding the quality of the deals they do.”

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