The idea of dividing large assets into fractional investment units is gaining momentum. From investing in small plots of shares through platforms like Stake, to real estate crowdfunding solutions like DomaCom or BrickX, fractionation has opened the door to new opportunities.
And this has important implications for strategic asset allocation. Advances in automation, artificial intelligence and the Internet of Things are opening up access to what has traditionally been considered “private market” investments.
For investors, allocating funds to private debt as an asset class means that you are effectively acting as a bank. Like any lender, they get a return on principal in the form of monthly interest payments made by borrowers.
ALTERNATIVE TO REAL ESTATE FUNDS
With expectations that residential property prices in Australia will rise by as much as 18.5% in 2021, pent-up domestic investment demand has fueled a booming real estate market. And property has long been viewed as a ‘safe as a home’ investment in Australia, supporting 51% of household wealth, according to 2018 data from the Australian Bureau of Statistics.
But there are downsides to investing directly in real estate. It is capital intensive and difficult to diversify your asset allocation between retail, commercial and residential assets in order to mitigate the impact of real estate cycles. It can also be difficult to get a decent rental yield in a heated market, as the growth in purchase prices outpaces the rise in rents – in July 2021, gross rental yields were only 3.4% to l. nationwide.
And of course, it’s not the most liquid asset either – if investors need to free up cash quickly, settlement alone can take at least six weeks and you will incur high transaction costs in the process. process.
Fractional investments in real estate can solve some of these problems – but until recently, real estate investment trusts (REITs) and real estate funds were the only real options for doing so.
REITs have certainly proven to be a popular option for investors looking for yield in a low interest rate market. Inflows in Australian unlisted real estate funds increased 28% in the first three months of 2021, compared to the previous quarter. With over $ 676 million in net inflows, it’s clear that the spread of yield over other forms of fixed income or cash has made a compelling case.
However, investing in private real estate debt can offer a similar benefit – with the potential for attractive returns.
For example, a new growth fund leveraging rental yields from residential properties is targeting yields between 3% and 4.45% per year. AltX investors, although they do not participate in capital appreciation, receive stable returns of between 4% and 8%.
Private debt investors benefit from an investment backed by real estate security, with a predictable monthly return. They can start with a single investment or constitute a diversified portfolio according to the available capital and the risk profile.
DEMOCRATIZATION OF ACCESS TO INSTO-SIZE INVESTMENTS
Technology platforms have changed this in two ways: fractionation and distribution.
Not so long ago, private investment started and ended with the stock market. Investors could quite easily buy a diversified portfolio of listed stocks, but not much more. Unlisted investment opportunities were reserved for the privileged few – primarily institutional investors with large checkbooks and multi-billion dollar investment portfolios.
In the smaller end of town, access to syndicated private investment was network-based and by invitation only. This meant that both sides of the market had missed out: demand for capital was not adequately matching pockets of limited supply – think ultra-high net worth and family offices. At the same time, investors with capital to implement did not know how to access quality opportunities.
Access to fractional investing disrupts this traditional status quo by harnessing the power of digital platforms for distribution. By dividing unlisted investments into smaller lots, a much larger universe of investors suddenly has the size of the check to stake. And, by seamlessly distributing the offers through the platform to thousands of investors at the same time, everyone can participate on an equal footing.
Previously, a private offer may have been taken over by a small number of private investors who personally knew the main sponsor of the transaction. A private club, if you will. Now, bite-sized pieces are open to an infinitely larger investment universe. Farmer in Wagga or retired on the Sunshine Coast, they now all have the same access to opportunities as the networks in Sydney and Melbourne.
This larger pool of investors will continue to grow as our platform is able to open up to retail investors, beyond its existing pool of wholesale investors.
A new generation of investors are already drawn to the accessibility and affordability of fractional investing. BrickX, for example, operates as a “stock exchange” for fractional residential real estate investments, with a minimum investment of just $ 250 in units (or “bricks”) and the BrickX real estate trust. Most of its investors are under 35. And fintechs like Stake, which allows Wall St shares to be traded in minutes on a mobile app, meet the needs of this new generation of investors. Australian property
Stake recently announced Self-Directed Pension Fund (SMSF) set-up and administration services, and has already launched in New Zealand, the UK and Brazil.
MORE CHOICES OF FINANCIAL ADVICE
For financial advisers, this democratization of investment can appear to be a double-edged sword: it gives their clients direct access to an ever-widening range of opportunities.
However, it is also an important opportunity to help clients make smarter decisions, reallocate funds for better portfolio diversification and access real-time reports to help clients understand exactly what they are investing in. .
With the 10-year Australian government bond yield of just 1.57% and the official treasury rate approaching negative yields, private real estate debt rates of 4% to 8% look pretty attractive. And since transactions are generally short term – averaging 12-18 months – they are a solid alternative for investors who cannot achieve target income with fixed income investments, including SMSF.
These returns also make private debt more attractive to older clients who value a reliable income stream in retirement.
Age, it seems, is not a barrier to adopting fintech. A significant portion of our investor base is made up of retirees who access the technology platform daily to invest in real estate-backed transactions. This generation of investors are more comfortable than you might think using a platform to access investments, and this is extremely encouraging – it shows that the path to investing through platforms is becoming mainstream. .
For financial advisers, this is another sign that client expectations have changed, demanding more transparency, accessibility and control. Instead of seeing it as a threat, it can turn into an advantage.
Because the real beauty of this model is how it connects investors with opportunities they might not have known otherwise. And because it’s secured by a registered first mortgage, there’s a tangible asset backing.
Rethinking the composition of asset allocation
Fractional investing is a game-changer in terms of risk and return, so it’s worth thinking about what it does to the makeup of the target portfolio.
As a fractional owner, investors have a smaller down payment, better diversification, and the benefit of detailed due diligence. For example, at AltX, we get a 360-degree view of the true valuation of the asset underlying a private debt transaction. Clients tell us they look at the Loan to Value Ratio (LVR) to assess risk. They value transparency – they know exactly where their investment is going, where the underlying security asset is located, and who they are dealing with.
If you are new to private debt investing, there are a few things to consider. Check how the risk is isolated, for example, AltX uses separate Special Purpose Vehicles (SPVs), so transactions are separate from each other. Make sure you have access to the underlying documentation and know your rights in the event of a defect. And check that the interests of the people managing the loan match yours: are they also prepared to invest on the same terms?
As technology continues to advance, investors will have access to more options than ever before. However, the fundamentals of investing remain the same: know your risk profile, figure out who is behind the trade, and diversify your portfolio to mitigate downside risks.
Nick Raphaely is co-founder and co-CEO of AltX.