What is crowdfunding for real estate investing?
Crowdfunding for real estate investing is the same as any other crowdfunding venture: Investors pool their money to fund a project, a product or a company in the hopes that there will be a future profit.
Real estate crowdfunding is a way of raising money for a real estate project. As any crowdfunding can be done via an equity or debt model so can crowdfunding for real estate investing.
Equity crowdfunding will allow investors to receive shares in return for their investment, while debt crowdfunding will not give any shares in return and instead offer investors a loan that the company can repay upon completion of the project.
Traditionally, real estate crowdfunding had a high barrier to entry, with investors requiring a down payment saved up for investment.
But with real estate crowdfunding platforms, the thresholds have been worked, so you can invest with as little as $500.
In most cases, real estate crowdfunding platforms direct investors' money into real estate investment trusts or similar investments.
REITs are companies that own, and sometimes operate, real estate, such as apartments, warehouses, malls and hotels. Shares of some REITs are publicly traded on stock exchanges, while eREITs are privately owned.
How does crowdfunding real estate work?
While investing in a real estate crowdfund you work with a developer or a syndicator.
There are two ways you can invest in property crowdfunding: 1) by buying shares in properties or 2) by lending money to developers and earning interest.
Developers raise funds either in stock or a loan. A loan is for a specific time period.
If you buy shares in the property, you invest in property equity, and when you lend money you are buying bonds. In both cases each are made via a Special Purpose Vehicle (SPV).
When you lend money for real estate investing through a crowdfunding platform, your investment is not disbursed to the developers till their total requirement of funds has been raised.
Once fully funded, the property is bought using your investment.
What’s in it for the investors?
Investors start earning rental income or interest from their investment – without having to worry about managing property or its maintenance.
If you’re a lender you earn interest on the funds you lend. This is generally paid yearly, but can also be paid at the end of the loan term.
What are the ways of exiting your investment?
You can exit your investment by selling your shares to other investors at any time.
Since these are not traded shares you can choose the price at which to list your shares and wait for a buyer to match your sell price, or you can negotiate a mutually acceptable price and complete the deal.
A bond, for a lender, has a specific time duration after which you automatically exit your investment.
What is the minimum investment you can make in crowdfunding for real estate?
Investment Limits for Crowdfunding
The SEC has imposed investment limits to protect non-accredited investors from the high risk associated with investing. Below are the SEC's guidelines.
Annual Income Less than $107,000
Suppose your annual income or your net worth is less than $107,000. Then, during any 12-month period, you can only invest up to either $2,200 or 5% of the lesser of your annual income or net worth, whichever is greater.
Annual Income More than $107,000
Now, if both your annual income and your net worth are equal to, or more than, $107,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser. But your investment may not exceed $107,000 in any 12-month period.
These are broad guidelines for the upper limit. You can start with investing as low as $ 500.
Is crowdfunding in real estate a wise choice?
Real state crowdfunding is a great way to fund real estate projects for those who don't have the capital otherwise. For the investors, it is a way to diversify your investment portfolio.
It's important to be cautious when choosing a real estate crowdfunding platform. You want to make sure that you are getting the best terms and most reliable service.
In order to find the best real estate crowdfunding platform, it's important to do your research and look for one that offers the following: 1) Low-risk investments 2) Good returns on investment 3) A variety of projects 4) Good customer service 5) Reasonable fees
Once you are sure you know what you are getting into, real estate crowdfunding might be a worthwhile addition to your portfolio.
What that means is real estate has unique set of nuances, risks and rewards. At times, real estate deals can be complex. And you need to be extra careful in order to understand and navigate them to invest successfully in private deals like those offered by crowdfunding platforms.
So, is real estate crowdfunding a good investment? Let’s look at the pros and cons.
Pros of real estate crowdfunding
The Access to Deal argument is the most compelling argument for real estate crowdfunding. Investors can access deals that an individual investor may not be able to do on their own. This provides the investor with a potential return that a bank would not offer, and it also allows them to invest in areas of the country they may not otherwise have access too.
A major benefit of investing in real estate through crowdfunding is the increased access to investments. Investing in real estate requires an initial deposit, but it also provides investors with a potential return that traditional banks would not offer them, as well as allowing them to invest outside of their local area.
Traditionally, real estate investment trusts (REITs) were the only way for small investors to add real estate to their portfolios. The minimum investment for most private real estate deals is $250,000 and investors were required to be accredited.
Crowdfunding platforms changed all that. The platforms give investors direct access to pre-vetted deals with much lower minimum investments.
And, unlike REITs, crowdfunding platforms let investors participate in specific properties and projects without having direct ownership.
Traditional real estate investing — like owning a rental or fixing and flipping — requires large sums of money. When all your the money goes only into one property deal it increases the level of risk. This is where crowdfunding for real estate investing helps. Because it lets investors mitigate their risk because they own a small part of a big project.
So, instead of putting down $200,000 to buy one property in one location, you could spread your risk over eight different locations and types of property with a minimum investment of $25,000 each through a crowdfunding platform.
You don't have to put all your eggs in one basket when it comes to real estate investment. It could be really risky, especially if you are new to real estate investments.
So, instead of investing $ 250,000 in one project, where you may not fully know the area or the property you're investing in. Investing through an online crowdfunding platform can make a lot more sense. You can invest $25,000 in a project and spread your risk across, say, 10 different opportunities for the same $250,000.
Anyone who invests in stock markets will vouch for the fact that they are among the most volatile of investments. This isn’t the case with real estate. Real estate is among the more stable investments. Real estate is a longer-term investment.
However, direct investments in real estate, whether through crowdfunding or through direct purchases — are often affected by economic shifts. But these are macro-economic shifts and not related to the fluctuations in the stock market.
But REITs are a different story, because they're traded on the stock market.
The values of the REITs spike and fall according to the stock market fluctuations even when the inherent value of the properties held by them remain the same.
Regular cash flow
Usually, real estate crowdfunding investments provide a regular monthly or quarterly inflow of funds based on rental income or project profitability.
The crowdfunding company, Fundrise, just announced that in the second quarter of 2019 their investors earned $9.4 mn in dividends a marked increase compared with their quarter 1 figure, which was $6.1 mn.
These payouts are an addition to the return you get from investing in a project and seeing it through to completion. Not everyone will see these payouts, but they are definitely possible.
Low Barriers to Entry
It's easy to invest in real estate via crowdfunding. You set up an account on a platform, select your investment, and send money to fund the deal. You can research the deal and complete due diligence online. There are no closing papers to sign or ongoing costs to hold a real property. You can track the investment's performance and monitor it with a few clicks.
Investing in a property or real estate development is not as daunting as it may seem. There are a number of platforms that allow you to invest in short-term deals or long-term projects with low minimum investments.
You can even do all your due-diligence online and select the investment that makes sense to you. You transfer the amount to the fund and you are done! There’s no lengthy paper-work to complete nor any on-going maintenance and holding cost for the property to incur.
There’s a small hitch, though. Many real estate crowdfunding platforms are meant for only accredited investors.
There are three types of real estate crowdfunding: commercial, residential, and small business funding. Crowdfunding platforms have also emerged in all three sectors, but each is specialized into a specific type of property.
Commercial property crowdfunding targets commercial buildings and developments that have large sums of money associated with them. Residential property crowdfunding is geared towards smaller-scale projects like renovations or home improvements that don't need as much initial capital as commercial ones do. Finally, small business funding focuses on lending or investing in start-ups.
And within those broad categories, there are two more sub-categories of equity and debt options.
Both these options come with their own nuances. Equity investments are more risky compare to debt, but they offer higher returns. Debt investments are more predictable and steady but provide lower rate of returns.
As an investor it is advisable to have a healthy mix of debt-equity investments. And with crowdfunding allowing lower minimum investments, you don’t need a lot of capital to diversify than in traditional real estate deals.
Higher return on investment (ROI) potential
The debate over which delivers a higher return on investment, stocks or real estate, continues with staunch proponents of both sides. It’s difficult to directly compare the two because they are inherently different on so many aspects.
Stocks are liquid assets whereas real estate is sort of fixed. Stocks are affected by global and national trends, while real estate is affected more by local trends.
In spite of these differences, I have found that real estate delivers a much better return on investment than stocks. That’s because there are more opportunities to buy at low rates and resell for more in real estate than in stocks where one can't take advantage of market anomalies more often.
Let’s look at it from a different perspective. Real estate has an advantage over stocks, because land is a finite resource. The total landmass is fixed. And people are always going to need a place to live. So the demand for real estate is going to grow with growing population.
Cons of real estate crowdfunding
Crowdfunding for real estate investing is still a new, untested phenomenon
Let’s admit it, crowdfunding in real estate is relatively new. Nobody has a demonstrable track record yet.
After the JOBS Act, many real estate crowdfunding sites popped trying to cash-in on the new opportunity. But we all know what happens once any industry matures. Many of them will not survive. And you can't predict with reasonable certainty which ones will bite the dust.
Things might look promising with several platforms show encouraging initial results and investor money is flooding in.
But the opposite can also happened and it did for… RealtyShares, who just closed its doors to new investors and the status of current deals is unclear. What makes it even more suspect is that the company downsized from 100 to 15 employees.
To safeguard against such incidents, real estate crowdfunding investments are made using Special Purpose Vehicles
Investors have no management control
In traditional real estate investing, you buy equity. You own the property. You’re free do with it what you will. Need to add another room? Get the permissions and you are free to build one. But it is not so in a crowdfunded investment.
Because you own a portion of the property and you aren’t the sole owner you are relying on the property management team to make sure they get the returns for you on your investment.
You have no option but to trust operators to meet their targets and successfully manage the project for you.
Research and look at the experience of the crowdfunding companies in managing real estate projects. It’s easy to put up a crowdfunding website and collect money. But who are the people who are going to actually work on the project?
Earning distributions aren’t guaranteed.
The SEC has made it mandatory for REITs to distribute 90% of their profits to investors. And you might have also seen crowdfunded real estate projects advertise monthly or quarterly distributions. But the thing to note is that these earnings are not guaranteed. But what if the project doesn’t go according to plan? Well, there may be no profits to distribute.
Due diligence can be difficult
The ability to reach out and invest in traditionally inaccessible deals which was an advantage can also be a disadvantage. Because distances make it difficult to carry out proper due-diligence. Because real estates are driven by the local market conditions, it may be difficult to properly vet a deal as one may not have the local information.
In such conditions you’re left with no choice but to trust in the ability of the sponsor to present an accurate picture. And hope that they have vetted the deal thoroughly and trust the management team to do everything possible to mitigate risk and increase ROI.
It may shock you to know that your investment is not guaranteed.
Also, if the platform goes under (and we’ve seen that a shake-up is surely to place since so many platforms have sprung up suddenly after the passage of the JOBs Act), there’s a possibility you will lose all your investments.
Next is the project itself. If the project you’re invested in is mismanaged or poorly maintained, you could end up losing not only the cash-flow you were counting on, but also your initial capital.
Crowdfunding in Real Estate Provides Less liquidity
Let’s suppose you are in need of capital and fast. What are your options when it comes to real estate investments?
We know that REITs are traded on the stock exchange. That means if you need your money fast, you can easily sell your shares and raise the capital you want.
But that’s not the case with a crowdfunded deal. In such deals your money is tied up and not easily to cash out.
Longer holding time required
Let’s be realistic (pun unintended), real estate needs a long-term commitment to build wealth. A typical investment duration ranges from a few years to a decade.
And rightly so. Because in real estate deals the transaction costs are high and investors aren’t likely trade in and out of real estate assets.
Is crowdfunding real estate legal?
The short answer is, yes. Crowdfunding for real estate investing is perfectly legal. And there are laws to protect the interests of the investors and sponsors. Some of them are:
SEC regulations on crowdfunding
Initially crowdfunding real estate deals were limited to only Accredited investors. But that changed in 2012 with the passing of the Jumpstart Our Business Start-ups (JOBS) Act.
This act allows even non-accredited investors to invest in these types of projects. According to the JOBS Act companies can raise up to $1 million via crowdfunding, and to offer stock without having to go through federal securities law via the Securities and Exchanges Commission (SEC).
This Act sort of democratized crowdfunding in real estate investing and gave retail and small investors, who represent that vast majority of investors in the U.S., access to deals that would have only been available to accredited investors before.
How does that change for Accredited Investors? The next regulation explains that.
Regulation D: Private placement
Regulation D gives us some insight into this. Regulation D allows real estate developers or syndicators can solicit unlimited amounts of funds from accredited investors and non-accredited investors, but with a small limit. The non-accredited investors cannot be more than 35 in number and, must be considered “sophisticated investors.”
Also, the real estate developers or syndicators cannot openly solicit investments, nor can they advertise.
Regulation of 2016: Title III and Crowdfunding Regulation A (Reg A+): Securities
It became possible for companies to raise capital without the need for an underwriter in 2016 when Title III and Reg A+ were introduced as part of the JOBS Act. Companies could sell their securities to an unlimited number of investors and charge a commission up to 1%
Title III, also referred to as Regulation Crowdfunding (Reg CF), allows an issuer a maximum fundraising of $1 million from an unlimited number of investors. This can be limiting for many real estate developers and syndicators who typically need to raise higher amounts.
Regulation A+ offers a bit more flexibility. Yet, they do put in a few restrictions. They can offer stock according to the following tiers…
“Regulation A has offerings in two levels- Level 1 which represents up to $20 million in a 12-month period, and Tier 2 with an allowance of up to $50 million. Companies that want to raise up to $20 million can choose to proceed under Regulation A.”
This is why Reg. A+ offerings is sometimes called the “Mini-IPO”.
Crowdfunding regulations: Investors
Who is an Accredited Investor?
These are some guidelines by the SEC for crowdfunding for real estate investing…