Real estate crowdfunding has grown exponentially over the past few years. Many crowdfunding platforms are thriving as the industry has ballooned into a multibillion-dollar market. Consequently, crowdfunding companies are disrupting the traditional real estate sector by allowing everyone — not just those with real estate connections and institutional capital — to invest in quality opportunities.
This success should come as no surprise since real estate crowdfunding was born during a near decadelong market upcycle. History, however, has taught us that what goes up must come down.
No one knows the exact timing of the next downturn, but the market is certainly nearing the end of its current cycle. By examining historical trends, we can discern a few likely scenarios that may affect real estate crowdfunding and the industry as a whole during a downcycle.
A Reduction In Values Can Lead To More Opportunity
Economic slowdowns are typically accompanied by fear and uncertainty, causing investors to move from riskier and illiquid investments to more stable and liquid vehicles, such as savings accounts and bonds.
Real estate is an illiquid asset, so if the market begins to decline, demand is likely to fall. Additionally, fewer jobs and lower wage growth can lead to slower rent growth. Less demand and rental income can ultimately result in lower property valuations, yielding reduced potential capital gains for investors.
That said, real estate investments are widely considered less volatile than stocks for many reasons. Real estate is a physical asset with inherent value and transactions occur at a much slower pace than trading equities. Also, real estate can hedge against inflation thanks to fixed mortgage interest rates and rising rent payments (even if rents rise at a slower pace). These attributes typically make for safer investments in the face of a significant economic downturn.
In addition, market downturns usually present an opportunity for savvy real estate investors that have access to cash to acquire properties at a discount to prior values as the market cycle resets and more inventory comes online.
Real estate companies (including crowdfunding platforms) that have exercised restraint in acquiring overvalued assets over the past few years will likely be in a good position to ride out any potential storm. If a property is not overleveraged with debt and exhibits sound fundamentals, it can continue to perform as expected. Many sophisticated real estate players have been anticipating a market dip and have underwritten their deals with this in mind. Investors should expect that investment hold periods may lengthen in order for a sale to occur once the market strengthens and values increase.
Financing Challenges May Ultimately Lead To Lower Interest Rates
Leverage, such as a mortgage, is a great tool for real estate investors. It allows them to borrow money to buy properties with less upfront capital and participate in larger deals with more upside potential.
But when the economy slows, traditional banks and other lenders enforce stricter guidelines and terms for borrowing money and even reduce the amount they are willing to lend. These institutions may assign low valuations to properties, making it more challenging to obtain financing.
Without loans, many projects just aren’t feasible. Additionally, aggressive sponsors with deals that are overleveraged will find it difficult to refinance maturing loans. This atmosphere will result in more loan defaults and an overall slowdown of real estate investment projects.
On a positive note, as economic activity slows, the Federal Reserve typically reduces interest rates to help reenergize the market, which also results in reduced mortgage interest rates.
As a case in point, in response to the Great Recession, the Fed reduced interest rates to virtually zero, clearing the way for historically low borrowing costs for the next decade. This created opportunities for well-capitalized investors to expand their portfolios by buying properties with exceedingly low-cost debt.
Demand For Luxury Fades As Focus Shifts To Lower-Priced Products
Investors value luxury real estate such as glassy condominiums, five-star hotels and Class A high-rise rentals because the potential returns can be outstanding. However, these investments have a downside; demand often decreases dramatically when the economy is shrinking.
People are more financially conscious during downcycles, so many buyers and tenants can’t afford (or simply don’t want) to spend top dollar for real estate. Therefore, it becomes more difficult for investors to successfully operate and complete luxury projects. High-end real estate crowdfunded investments may receive less demand from tenants and buyers, which could result in the crowdfunding platform failing to meet initial projections.
In contrast, as more people and companies look for more affordable real estate options, investments in multifamily workforce housing become more attractive. It is an asset class that typically stays resilient throughout a downturn because people will still need to live somewhere.
The Takeaway
While the future is unpredictable, at some point the real estate market will slow down. However, fear should not get in the way of opportunity. At the end of the day, a downturn doesn’t mean all doom and gloom. A patient real estate crowdfunding platform with cash on hand can secure excellent real estate opportunities for investors, as prices will be lower and there will be less competition and lower interest rates. Of course, crowdfunding investors need to be more careful with the investments they make. They need to do their due diligence to ensure that the deals they are considering make sense. And they should only look to invest with trusted platforms that have experienced leaders who have navigated through and succeeded in prior downturns.