Fundrise notes that the belief that a very real and potentially significant downturn still lies ahead has necessarily “been the foundation for all their decisions across the portfolio over the past six months.”
As Fundrise noted at the beginning of the year and again in their Q1 letter, they have focused their efforts simultaneously “on defensive preparation, continuing to build what they believe to be an extremely resilient portfolio, while also taking advantage of the growing number of opportunities created by further distress in the markets.”
Fundrise also mentioned that since the beginning of the year they have “acquired or invested in more than $400 million of real estate assets.”
Fundrise pointed out that they are aiming “to simultaneously protect against a more severe downside while putting investors in the position to take advantage of current and future buying opportunities as the downturn continues to unfold.”
Fundrise added that they’ve “continued to shift a larger and larger percentage of efforts (and investors’ portfolios) towards income-focused investments and their income-focused funds (i.e., those that invest primarily in private credit and other forms of debt), which have performed remarkably well so far.”
Fundrise revealed that their largest income-focused fund, the Income Interval Fund, has “paid an approximate 8% annualized distribution through the first six months of the year.”
Fundrise further noted that they “see a once in a decade opportunity for private credit investments that has arisen out of what they’ve termed ‘The Great Deleveraging’ and accordingly anticipate allocating a greater percentage of new dollars invested onto the platform towards those strategies.”
And despite the growing headwinds brought on by further interest rate hikes, their equity-focused funds, “such as the Flagship Fund, continue to hold up better than most of the broader public market real estate benchmarks when compared over the past 12+ months.”
As noted in a blog post, the Flagship Fund, as well as several of the other equity-focused funds, “did see net negative returns for the 2nd quarter.”
As most of their investors understand, the value of a cash-flowing real estate asset, “like an apartment building or industrial warehouse, is primarily derived from two key inputs: (i) The net income stream produced from the property (think revenue from rents, minus operating expenses); and (ii) The market discount rate, or, in other words, the rate of return someone would want to earn on that income stream.”
In real estate this is called the cap rate (think P/E ratio in stocks), the team at Fundrise explained.
They added that cap rates (and market discount rates) are inextricably “linked to interest rates. As the latter rises or falls, so does the former.”
As a result, property values can “move significantly in connection with changes in interest rates, despite the income stream from those properties remaining constant.”
As noted in the update from Fundrise, this phenomenon is what has been occurring “across all asset types, including all real estate and consequently the Fundrise portfolio, for the past 12+ months.”
As interest rates have risen, Fundrise has “continuously increased the cap rates that they are using to determine the values of the properties within the portfolio, which in turn has had the impact of lowering total returns (all else being equal).”
For those investors who appreciate this level of detail, it’s worth noting that “as of the end of Q2, they believe that the cap rates they are concluding to are in line with or, in some instances, higher than the implied cap rates of the public REITs, which have generally been trading at roughly 20% below their peaks from earlier last year.”
Their portfolio managed to perform better than many of these REITs primarily because of “the types of assets that the portfolio is concentrated in, along with seeing continued actual income growth at the properties themselves.”
Specifically, the portfolio is almost entirely “weighted to residential and industrial properties located in the Sunbelt region, which have proven to be the most resilient asset types within the broader real estate industry and are continuing to see increasing rents.”
Notably, Fundrise also “do not have a single high-rise office asset in the entire portfolio, having shunned the asset class for nearly the entirety of the history of the company.”
Despite what some may now believe after the past 15 years, markets “don’t always go up.”
And as sure as night follows day, economic downturns “have followed every major period of monetary tightening since WWII.” And they cannot today “see how this time is poised to be any different.”
The Fundrise team concluded:
“The bottom line is that in this environment the potential risks on the downside far outweigh any near term missed upside that may come from a surprisingly soft landing. As managers, it is therefore our job to do what is necessary to prepare and position our investors to be as well protected as possible ahead of a coming recession.”