How many projects you need to diversify in real estate crowdfunding so that one default doesn't ruin your year
The investor who has the hardest time is not the one who has suffered a default. It is the one who has suffered a default while holding only four projects.
IN THIS ARTICLE 6 sections
It is the same bad news in both cases, but in one it takes out a small part of the portfolio and in the other it takes out the whole year. The difference is not luck or having chosen better: it is how much that deal weighed in the total.
Here is what spreading your money well means, with the numbers in front of you.
Each project is a specific case, not an average
When you buy a stock market index you are buying hundreds of companies at once, and the result is an average. Here, that average does not exist.
Each real estate crowdfunding deal is a specific development, by a specific developer, in a specific city, with a specific permit and specific buyers. Either it goes ahead or it doesn't, and nothing softens whatever happens to that development: if the developer cannot pay, there aren't forty other developments inside the same product to cushion the blow.
That is the underlying reason why, here, diversification is not a textbook recommendation but the only way to make sure an isolated failure remains an isolated failure.
The maths, which is very simple
Imagine €5,000 spread across four projects of €1,250 each. One of them ends in a total loss, and with it goes 25% of your capital: a hole that will take you years to fill with what the other three earn.
Now take the same €5,000 spread across twenty projects of €250. The same failure, just as painful on a personal level, amounts to 5% of your capital, and that 5% does fall within what the return on the rest of the portfolio may be able to absorb over time.
There is nothing more sophisticated behind diversification than this division. That is why the useful question is not "how many projects should I invest in?" but "what percentage of my capital am I prepared to see lost in a single deal?". If the answer is 5%, you already have your number: twenty. If it is 2%, it is fifty.
Spreading by number is not enough
You can have twenty projects and be far less diversified than you think.
Twenty deals from the same developer are, in practice, a single bet: if that company runs into trouble, they all fall at once. The same goes for twenty projects in the same city if that local market cools, or for twenty deals signed in the same quarter, which will also all mature at the same time and leave you with all your capital sitting idle and waiting at once.
Beyond the number, the dimensions worth looking at are the developer, the platform, the geographical area, the asset type (housing, land, commercial premises, hotel), whether it is a loan or equity and, above all, the timing of your investment. Staggering maturities means your money comes back in instalments rather than all at once.
The floor and the ceiling of all this
There are two practical limits that set how far you can go.
At the lower end, the deciding factor is the minimum investment. If a platform asks for €500 per deal, reaching twenty projects on that platform means €10,000 of capital, there is no way round it. With €250 minimums the same portfolio costs half as much, and that is one of the reasons why investors who are starting out should find out what minimum each platform asks for before choosing it.
At the upper end, the deciding factor is your time. Each project has its own page, its own developer to look into, its own payment schedule and its own possible delay to keep track of. There comes a point where adding deals stops adding protection and starts adding admin work, and that point depends on how involved you want to be.
So, how many?
There is no magic number, and anyone who gives you one without asking you anything first is selling you something.
What there is, though, is a sensible way to work it out: first decide the maximum percentage of your capital you want a single deal to take up, divide, and that is your number of projects. Then check that those projects are not all from the same developer, the same city or the same month. And bear in mind that a diversified portfolio is not built in an afternoon, but by gradually investing in the opportunities that come up over the months.
