Crowdfunding For Real Estate Investors: An Opportunity or Misfortune?
You being a real estate investor; if I tell you that you can earn passive income from commercial real estate without the need to invest thousands and millions of dollars. Will you buy this idea? If not, then you are really missing on an opportunity known as Crowdfunding for real estate investors. With Crowdfunding real estate, it doesn`t matter whether you are an experienced investor with lots of money or a first time investor with just $10000 to start. You can start making passive income by investing in crowdfunding real estate.
Is this for real? Since when real estate investments become so approachable? Is this what you are thinking? Don`t believe me. Read this article yourself and find out how investing in crowdfunding real estate is a perfect opportunity? Or even if it is an awful misfortune, you can decide it?
What is Crowdfunding Real Estate?
Crowdfunding simply refers to raising capital from a large pool of investors when the motive of all the investors is to achieve a common goal. And when we apply this same principle to fund a real estate project, it becomes a crowdfunding real estate.
“In a Nutshell, Crowdfunding Real Estate provides a real estate investor direct access to real estate investing without the need of making a full purchase and managing it on their own.”
As an investor, you can take advantage of crowdfunding real estate by buying some interest in ongoing or upcoming crowdfunded real estate projects. There are various online platforms where you can invest in these crowdfunding real estate opportunities and earn passive income.
Types of Crowdfunding Real Estate
1. Equity Crowdfunding Investment
Investing in an Equity Crowdfunding Real Estate allows you to get a proportionate worth of interest in a property or a complete portfolio (depending on what you invest in). You get to share the profits when the property is sold through appreciation and cash flow benefits in the form of rents when the property is rented.
2. Debt Crowdfunding Investment
A Debt Crowdfunding Investment allows real estate investors to earn money in the form of interest received on the loan made by the investors. With debt crowdfunding, lots of investors raise the capital and write a loan for a real estate project. As a debt crowdfunding investor, you lend a loan to the property owner or the crowdfunding deal sponsor where either the property is a collateral or the LLC holding the property becomes a guarantor in event of default.
Debt Crowdfunding Equity Crowdfunding
Returns Capped (Limited to Interest Rates) Not Capped
Risk Low (Will anyway receive your return) Moderate (Will not receive returns if the project under performs)
Potential Fixed Returns Higher Returns
Benefits Preference Share Holder No Such Preference
“In this article, I`ll be primarily discussing Equity Crowdfunding Real Estate because in my opinion it is the equity crowdfunding that gives the actual benefits of owning a real estate. With debt crowdfunding, the returns are limited. You simply are earning interest on the loan made, unlike with Equity crowdfunding where you make money through cash flow and appreciation.”
How Does Crowdfunding For Real Estate Investors Works?
You might have already got a glimpse from the above on what crowdfunding real estate is and how it works for a real estate investor like you? Let me now break it in even more detail to help you better understand how crowdfunding for real estate investors works.
To understand this, you need to understand the pipeline of the Crowdfunding Deals.
- The Sponsor
A Sponsor is a real estate professional or a real estate company that identifies an opportunity to make money in the real estate market. This opportunity can be making money from constructing and selling real estate, buying real estate to rent out, and similar other kinds of opportunities.
The main task of a sponsor is to identify an opportunity and if this sponsor doesn`t have the required money to fund the deal. He can either obtain a mortgage or reach out to the crowdfunding platforms to raise the money.
- Crowdfunding Platforms
The Crowdfunding Platforms help the sponsors to find the investors for the deals. Each crowdfunding platform is specific in a way how they vet the deal and ensure that the deal meets certain standards. These Crowdfunding platforms are not only matchmakers between sponsors and investors. They are a regulated body under the Securities and Exchange Commission (SEC).
- The Investors
Investors like you and me who then sign up on these crowdfunding online platforms to invest in crowdfunding deals. The investors raise the capital and become entitled for shares in the profit the deal will make.
Is investing in crowdfunding real estate a good idea?
Now that you know how crowdfunding for real estate investors works. Let’s now shift our focus on whether investing in Crowdfunding is a good idea for you or not? Analyzing Crowdfunding real estate investment under the light of the pros and cons will give a perfect insight into this investment.
Pros of Investing in Crowdfunding Real Estate
1. Low Entry Barrier
The notion that investing in real estate is reserved for only the riches is taking a back seat with Crowdfunding Real Estate Investments. Buying an investment property in the US today anywhere requires you to put 20% down if you are to take a conventional loan. And, even 20% is not less considering the real estate prices today.
But, with crowdfunding real estate, even a mom and pop investor or an average joe with very little money in hand can also start to earn passive income from real estate. You really need not come up with thousands of dollars to start your real estate investing journey.
2. No Landlording Skills Required
When you own a Rental Property, there are a lot of things that go behind the curtain. A Rental business doesn’t mean just having rental property and collecting rents. Being a landlord is not easy and not every investor wants to deal with tenants and toilets either.
When you invest in crowdfunding real estate, you simply pay a very small asset management fee to earn the passive income from your portfolio. There is no need for you to take the pain of property management. Simply invest, relax, and earn passive income for life.
3. Risk Management
Real Estate is considered to be a safe investment compared to other investments. But, when you invest in crowdfunding real estate, the risk becomes even lesser. Crowdfunding Real Estate Investment is diversified by nature. This means you are not investing in just one property but your investment is diversified with having different properties under your portfolio.
Though if you consider individual traditional real estate investors, all of them start with a single property and it mostly works fine. But if you see there is a risk that the investment property may not perform well, maybe because of declining demand, major employers leaving the state, and a lot more such issues. With Crowdfunding real estate, your investment is diversified and you are much more protected.
4. Less Volatility
Real Estate investments by nature are not volatile as compared to stocks which depend a lot upon market fluctuations. Crowdfunding Real Estate Investments are no exception. When you invest in crowdfunded real estate, your investment is protected and market news has no direct impact unless the assets in your portfolio under perform or do not perform at all.
With every investment, the crowdfunding platform targets to meet the Internal Rate of Return (IRR). The IRR is the rate of return, a crowdfunding platform promises to deliver to its investors. So, the crowdfunding platforms work closely with the sponsor to ensure either they meet or beat the IRR as their platform reputation remains on stake.
Cons of Crowdfunding Real Estate Investment
1. Gap in Due Diligence
When you invest in crowdfunding real estate, there is a gap in due diligence that stays with your investment. The crowdfunding investments are mostly bouquet of various investment properties bundled in one portfolio. And this makes it difficult to analyze and perform due diligence on individual properties.
Though all the crowdfunding platforms ensure a thorough and perform strict due diligence on all the investments. But for an investor like me, I will always want to perform my own due diligence on each property, I`m investing in. After all, you are trusting a platform whose major business comes in the form of fees the sponsors pay to the platform to fund the project.
“Anyway, the investors who are just starting with real estate investing and have limited knowledge, these Crowdfunding platforms can be a great place to start with.”
2. Complex Exit Strategy
Liquidity is an issue and a little complex if you want to make an exit on your crowdfunding investment in the short term. Crowdfunding platforms levy exit load charges and most of the investments have a minimum investment time frame of three to five years.
Everything is written on the fine print of the investment you are making on a crowdfunding platform. Your investment stays locked unless it meets its time frame quoted by the sponsor or the sponsor ends the project. At the end of the term or after achieving the time, your initial investment funds plus the interest or the return earned are released.
Sometimes, there can be a chance that funds will take time to release even if the project has achieved its time frame. It can be a delay due to the sponsor taking time in selling the project or any such related issues. Though, the crowdfunding platforms closely work with the sponsor and ensure to complete the deal in referenced time.
3. Accredited Vs Non Accredited Investors
Your doors to crowdfunding real estate investment are open if you are an accredited investor. But if you are a non accredited investor, your options to invest in crowdfunding deals are limited. Not all crowdfunding platforms allow non accredited investors to invest in deals on their platform.
An Accredited investor is one whose net worth is either a minimum $1 million (Excluding Home Residence Equity) or has an annual salary of more than $200,000. Fundrise is one such crowdfunding platform where you can invest even If you are an non accredited investor.
Also, there is a limit on how much you can invest in crowdfunding real estate if you are not an accredited investor. The SEC puts this limit to such investments in order to protect the money and interests of new investors at such early stages of the projects.
- If your Annual Income or Net Worth is less than $107,000; you can invest only the greater of $2200 or 5% of your annual income in one financial year.
- And, if your annual income or net worth is more than $107,000; you can invest upto 10% of your annual income and investment not exceeding $107,000 in a financial year.
What Returns can You Expect with Crowdfunding Real Estate?
In terms of returns, Crowdfunding real estate has an upper hand. The crowdfunding platforms allow investors to earn double digit returns. An equity based crowdfunding real estate deal has a potential to even give a 14% annualized return plus quarterly dividend yields.
Unlike debt crowdfunding investments, where you invest for a small term and your returns are limited to just quarterly interest payments. An equity crowdfunding investment is locked for a longer period and has a higher potential of providing greater returns. With equity crowdfunding real estate, you are not loaning the money where you only get the interest. But you are having shares in the overall net profits.
Mostly, an investor profits when an equity crowdfunded deal is sold. However, you also get payouts in between different intervals if you have invested in a crowdfunding real estate that is rented.
What are the Risks of Crowdfunding Real Estate Investments?
I gotta be honest here. You can lose your money if you are not careful. Every investment you make has some risks associated with it. And a crowdfunding real estate investment is no different. Hence it is very important you understand all these risks and plan your investment carefully.
“While writing this article, I have carefully analyzed Fundrise which is among the top crowdfunding real estate platforms. During this course, I carefully read the Fundrise offering circular to Securities and Exchange Commission (SEC). In this circular, Fundrise has detailed about the risks that an investor must be aware of. In general, I believe, all crowdfunding investments possess similar kinds of risks.”
1. Real Estate Crowdfunding is a New Concept
Crowdfunding Real Estate is a pretty new concept in the market. It is in the year 2013 that the SEC has proposed the real estate crowdfunding under the Title III of the JOBS Act. It was the year 2015, the rules were adopted and further took another year to get these enacted rules live.
Before this, there were no other ways for investors to invest in institutional real estate other than REITs. In initial stages, only accredited investors were allowed to invest in crowdfunding real estate. But now, the SEC has allowed the non accredited investors for such investments with a certain limit.
In all, these crowdfunding platforms are new players and none has actually tested the deep waters of the market. So, there is no guarantee of your investment as there is a factor of risk and uncertainty.
2. Returns are not Guaranteed
There is a chance that you may not receive returns projected on the crowdfunding platforms. If for any reason the crowdfunding deal doesn’t perform or able to meet its investment goal, the company is not liable to pay dividends. And if the crowdfunding platform is unable to find or receive any suitable investment opportunity, they will liquidate the investments.
Something similar happened to Realtyshares which is a crowdfunding real estate platform that shut its operations for new investors in 2018. Their case was getting a lot of investments from the investors but not being able to find equal opportunities to invest that money.
3. Making a Bad Investment
When you invest in crowdfunding real estate, you are solely relying on the due diligence performed by the platform managers. And it is not likely that the managers will always vet a good deal.
There can be a possibility that the managers will not be able to secure a deal on suitable financial terms. Or the platform will over commit the equity for a project, causing them to overpay for a project. Overall this can affect the returns causing your investment to quickly turn to a bad investment.
4. Crowdfunding Platforms can Go Bankrupt
The Crowdfunding Platforms operate by raising capital from the investors and if somehow the investors stop investing with them. They can go bankrupt and can cease operations. If a crowdfunding platform has no significant assets and financial resources, you will come at a risk of losing your investment.
Also, when you invest in a common equity, you are on the last of the priority list to receive money from the proceeds of the company after a bankruptcy. It is better you invest on a crowdfunding platform that has some special purpose entities to mitigate the financial risks.
Also considering the risk, you can invest in a balanced portfolio which contains both debt and equity investments. Doing so, you are reducing your risk as debt investments are on a higher priority list of receiving money from proceeds.
Should You Invest in Crowdfunding Real Estate then?
The short answer is yes. You can invest in crowdfunding real estate. You are getting an opportunity to invest in real estate even with a very little money and experience in hand. And, if you feel the risks are unsettling you. Then remember, every investment comes with a risk. You should anyway take a discretion and your approach here should be to minimize the risk.
One thing I’m sure of is that the real estate crowdfunding platforms are investing in something which is truly a real asset that is real estate. And real estate always got an intrinsic value attached to it. So, even if something goes south, you are much better protected with a crowdfunding real estate investment than other market linked investments that have a very high volatility.
Though if you ask me, I would have a different opinion and personally I`m not a big fan of crowdfunding real estate. My investing strategy is different and the glimpse of which I will give you briefly in the article itself. Read till the end
But your case can be different from me. You should then invest in Crowdfunded Real Estate if
- Real Estate Investing is a side hustle for you.
- You wish to simply earn passive income from real estate and have no interest in dealing with tenants and managing your property.
- Diversifying your investment strategy.
- You want a safe approach to your investment strategy away from volatile investments such as stocks, bonds, ETF`s or other market linked products.
“In my opinion, you should not invest heavily in crowdfunding real estate. Instead use it to supplement your income and take investing benefits of an asset which is considered to be only reserved for riches earlier.”
How to Analyze a Crowdfunding Real Estate Deal?
Investing in the right deal is important. When you go on a crowdfunding platform, there are many portfolios and options available. So, before you invest try and analyse each property in the portfolio.
- Check what are the commitments of the crowdfunding platform to the sponsor.
- The Purchase Price of the property is as per the market trends or not. A purchase price higher than market prices can severely impact your returns.
- The portfolio or the property should not be over leveraged. If the loan to cost ratio is higher, there is a risk of foreclosure.
- Analyse the market in which the property is located. See if the market is improving or declining based on the objective of the investment.
- If it is a rental property, check whether the rents are at par with the market rates or not? What is the current occupancy and vacancy rate?
- The experience of the Sponsor and if the sponsor has co invested in the deal. If the sponsor also has some of his equity investment, it shows the interests of the sponsor is aligned with the interests of the investors.
Why I choose to Invest in Rental Property Directly and not in Crowdfunding Real Estate?
I told you, I will give you a glimpse of my investing strategy. So here it is.
As I mentioned above, I’m not a big fan of crowdfunding real estate. And rentals are my thing. But that doesn’t mean I ‘ m suggesting you to do the same. Certainly, if my case resembles the situations I have mentioned above, I won’t mind investing some of my dollars in crowdfunding real estate.
But, let me tell you, investing in real estate and buying rental properties is what excites me. I thoroughly enjoy being a landlord and love managing my own rentals. I keep looking for new opportunities to add more and more rentals to my portfolio. And, even this is the exit strategy that I’ve planned for myself in order to achieve financial independence.
The Ability to Use Leverage
Do you know that you can start to own rental properties by just putting 3.5% down and financing the rest with a FHA Loan. The first benefit of using leverage, where you come up with only 3.5%. But now you can control an asset worth thousands of dollars. Your money will not only give you returns on 3.5% but you will also get benefits of appreciation of the property.
Imagine a 2% annual appreciation on $300,000 property where you have only invested $10,500 from your own pocket. Yes, you are receiving $6000 free equity every year on a $10,500 investment.
Wait, ain’t you getting the same benefit with crowdfunding real estate also?
Well, yes! But, with crowdfunding real estate, there is a risk of losing money because you were the last to receive the money if the crowdfunding platform stops its operation. And with a rental property, it is your own property. And if something goes wrong, your equity is still safe.
And, you know what is the real ice on the cake here? When you buy a rental property using a leverage, you slowly build equity in it by paying down your mortgage. And, you can pull out this equity to buy even more cash flowing rental properties from it.
The biggest benefit of owning rental property is the ability to write off mostly all the expenses that occur on a rental property. Compare this with your active income sources. Suppose I might earn only $50,000 annually from my rental properties and you earn $60,000 from your job or from a crowdfunding investment before taxes.
But after paying taxes, I am able to keep $48,000 with me because of all the deductions available for a rental investor. And if, you’re taxed at 22% rate, you will only be able to keep $46,800.
Remember all the income you earn from Crowdfunding Real Estate is taxed at normal income tax rates. Taxes have a major hit on the returns. Even if you get a 12% return from your investment, your after tax return will be only 9.36% if you lie in a 22% tax slab rate.
“These are two biggest reasons for me to choose rental properties as an investment vehicle for my journey of financial freedom. But, I must say, being a landlord and dealing with tenants is not for everyone.“
And, if this is your case too. Crowdfunding real estate is a good opportunity for you to make money from real estate. However, you need to be very careful with this investment and choose wisely on which crowdfunding platform to invest with.