Crowdfunding of Real Estate: A New Way to Fund your investments

Real estate has always been one of the favorite routes taken for investment, either for the accumulation of wealth, diversification, or assured cash flow. Conventionally, real estate as an investment class demands huge capital and therefore is mainly reserved for high-net-worth individuals or institutional investors. Crowdfunding has drastically changed this real estate investment landscape, though, and made it more accessible to a wide swath of investors.

Real estate crowdfunding means many people contributing relatively small amounts of money to invest in or lend to the financing of a property. In this blog, we’ll talk about how crowdfunding in real estate is really done, the pros and cons, and what every potential investor needs to consider before getting involved with it. By the end of this post, you will know if real estate crowdfunding is truly a creative and innovative way to finance your real estate investments.

Understanding Real Estate Crowdfunding

In their simplest form, crowdfunding involves the process of raising small sums of capital from a large number of people, usually via the internet. Even though crowdfunding has been around for many years now, it found its first mainstream applications in the creative industries where artists, entrepreneurs, and inventors wished to raise funds for some project. Real estate crowdfunding, however, is relatively something new; it is rather a recent development where funds are brought together for property investment.

How Real Estate Crowdfunding Works

Real estate crowdfunding platforms serve as intermediaries, connecting real estate developers or operators with individual investors. Here’s a basic outline of how the process typically works:

• Listing Projects: Developers or operators in the real estate arena identify properties or projects they need funds to develop. They will then list the project on a crowdfunding platform, describing where the property is located, the kind of property that it is, financial projections, and how much capital is needed.
• Investor Participation: The interested investor can review several projects on the website. Investors can select to invest in one or more projects based on their preference by contributing as low as $500 to $10,000 per platform and per project.
• Pooling of Funds: Once the project attains its funding goal, the pooled capital is used by the developer in buying, renovating, or developing the property.
• Return on Investment: The return on investment made by investors in real estate is distributed based on the performance of the property. This may be given as a proportion of rental income, interest paid, or a direct share of profits when the sale of the property is finally made.

Real Estate Crowdfunding Types

Broadly, there are two kinds of crowdfunding available within real estate investment: equity crowdfunding and debt crowdfunding.

• Equity Crowdfunding: In this model, investors in equity crowdfunding receive shares or equity in real estate projects. That means each investor becomes a part of the ownership of the property and is entitled to the profits accrued from it in the form of rental income or appreciation when sold. Equity investments promise higher returns, but all risks are higher too since returns are tied to property performance.
• Debt Crowdfunding: On the other hand, debt-based crowdfunding is a form of financing wherein investors actually lend money to the developer or operator in return for fixed-interest payments. These loans are typically secured by the property, which lowers risk to the investor. Debt investments generally have lower returns compared to equity investments but offer more predictable income in the form of regular interest payments.

Advantages of Real Estate Crowdfunding

Real estate crowdfunding has garnered attention for a number of reasons. Here are some of the key advantages that make it appealing to investors:

• Accessible and Affordable: One of the most significant real estate crowdfunding advantages is that real estate investment barriers to entry are decreased. Generally, investing in real estate is rather capital-intensive, with large sums of money-hundreds of thousands, or even millions of dollars-required for investment in properties. Crowdfunding websites allow investors to invest with much more modest sums and thus make real estate investment more accessible.For example, other platforms, such as Fundrise or RealtyMogul, allow an investor to create a portfolio of properties with as little as $500-$1,000. That makes them affordable enough that those who could never afford to purchase a whole property can have exposure to the market nonetheless.

•  Diversification: The concept is one of the founding theories in investment, and it works on the principle of spreading the risk over different classes of assets. Real estate crowdfunding offers diversification in the asset class by enabling investment in several properties from a few geographic locations, property types, and markets.It is for instance possible to invest in residential, commercial, and industrial properties spread across a number of regions to dampen the effects of a trough in one particular market. This level of diversification might be too ambitious through direct property ownership whereby the total cost of such diversified investment would be prohibitively costly.

•  Passive Income: Real estate crowdfunding will provide a source of passive income, especially for investors who deal in properties that generate income. They may make regular returns through rental income or even interest payments without the responsibilities pertaining to property management.Where equity crowdfunding would share the rental income with the investors coming from tenants, debt crowdfunding would give investors fixed interest. In fact, this passive income is going to prove most appealing for those looking to supplement an income stream to create liquidity flow that is stable.

•  Professional Management: One of the headaches of directly owning real estate is active management, including tenant issues, property maintenance, and possible legal problems. Properties are managed by experienced developers or property management firms in the case of real estate crowdfunding.These professionals undertake the daily operations of the property, thereby affording investors the fruits of their expertise without necessarily engaging in active management. This is an ideal hands-off type of investment for those needing to invest in real estate but are unable to because of lack of time, knowledge, or simply plain disinterest in doing so.

• Transparency and Information: Generally, crowdfunding platforms give extensive information on each investment opportunity, including financial projections, property details, and market analysis, in addition to the mention of risks. This would enable them to make an informed decision by researching in depth.Also, many investing platforms provide their investors with access to documents like offering memorandums, appraisals, and legal agreements-which may be very relevant for their specific investment. Further, many investing platforms provide regular updates on the project so that investors remain updated through the term of their investment.

Risks and Considerations

While real estate crowdfunding offers an amazing number of benefits, it is essential to understand the associated risks and challenges, too. Every investment has some kind of risk that the investor should consider when making decisions about real estate crowdfunding.

•  Market Risk: Real estate markets can go up or down depending on economic factors, interest rates, and other events. If the real estate market should slump, that might affect the value of the property in which you have invested, which could lead to lesser returns or even losses.For example, property values may decrease in a recession, rental income may decrease due to vacancy rates, and developers may face problems selling the property. All this may affect equity investment as well as debt investment since the investor needs to consider market risks during the selection of projects.

•  Illiquidity: Real estate crowdfunding investments are basically unliquid; they cannot be easily sold or otherwise converted to cash. Unlike stocks or bonds, which can be publicly traded, real estate crowdfunding investment usually has a lock-in period wherein the investors cannot withdraw their funds.This could be a weakness for investors who may want their cash within a relatively short time. You need to consider your financial situation and ensure you can afford to lock up your funds for the investment term, which is anything from several years to more than ten years.

•  Platform Risk: Crowdfunding investment success is not only inextricably linked to the particular real estate investment project itself but also to the platform through which the investment in the project was transacted. For example, if the platform happens to fail or goes out of business, investors might face the problem of accessing their funds or returns.Due diligence on the crowdfunding platform before investment is paramount. A platform which has an excellent track record, encouraging reviews, and operational transparency will be the best option to choose from. Also, see if the platform separates the investor funds from its operating funds, as that may lend added security.

• Sponsor Risk: In crowdfunding for real estate, the management of the project is vested in the sponsor or developer. The success of your investment will largely depend on the experience, competence, and integrity of the sponsor. Poor execution of the project by the sponsor may result in delays, cost overruns, or project failures for the investor.Do your research on the history, performance record, and other projects of the sponsor you will be investing in. Most platforms provide this kind of background information on the sponsor history and performance to help you determine how credible or proficient they may be.

•  Lack of Control: Unlike direct ownership of property, where you hold the reins over critical decisions affecting it, real estate crowdfunding gives you little or no control over the management and major decisions around the investment. Major decisions are usually left to the sponsor or developer, in whom investors simply have to trust.This is a drawback to some investors who might prefer to enjoy the liberty of controlling their investments more. For your investment, it is critical to feel comfortable that it would be left in the hands of a third-party manager.

•  Regulatory and Legal Risks: Regulations regarding crowdfunding of real estate vary, but even so, they even change from country to country, sometimes from region to region. Changes in laws or regulations have the potential to make crowdfunding platforms or investments themselves non-viable. Also, the legal structure of an investment will affect your rights as an investor.The bottom line is, it’s nice to go in knowing what type of legal exposure you’ll have with your investment-how the investment is going to be structured: limited partnership or LLC. What kind of legal rights would you have as an investor? It is preferred that you should consult with an attorney or a financial advisor who can help you understand such complexity.

How to Choose the Right Real Estate Crowdfunding Platform

Selection of the right real estate crowdfunding platform is, in fact, a very critical part of the investment process. Various factors to be considered are as follows:

•  Platform Reputation and Track Record: Research the history of the platform, including how many years it has been in operation and its success rate regarding projects. Amongst others, those that have a very good reputation within the industry, excellent reviews by investors, and follow a continuous track record of returns will come into play.

•  Investment Opportunities: Consider the types of investment opportunities a certain platform provides. Certain platforms deal in specific property types, like residential or commercial, while others offer a wide array of options. Choose a platform that aligns with your investment goals and risk tolerance.

• Fees and Costs: Most crowdfunding platforms take a cut in the form of management fees, origination fees, or performance fees from your investment. Understand the complete process of fees and exactly how it will eat into your returns. Some charge high fees that may eat into your profits. Therefore, fee comparison is important across different platforms.

• Transparency and Communication: Transparency is majorly welcome in real estate crowdfunding. Employ the use of a platform that will provide as much information as possible on each investment opportunity, including financial projections, associated risks, and legal documentation. Also, consider platforms that update investors with fresh information on the status of their investments. Accessibility to your account information is very important.

•  Investor Requirements: The requirements for investors include being an accredited investor, among other financial thresholds, depending on the site. Ensure you meet the eligibility requirements of the platform with which you will be working before you create your account.

Conclusion

Crowdfunding completely revolutionized the way one thinks about investing in real estate, making it way more accessible, flexible, and diversified than ever before. Be you a sophisticated investor or just starting out, crowdfunding offers that unique opportunity to be part of projects in real estate beyond the reach of most people.

Like any investment, there are a variety of risks associated with real estate crowdfunding that have to be weighed. If you understand how crowdfunding works, perform due diligence on potential deals, and select the right platform, you may be able to benefit from this innovative new way to invest.

As with any financial decision, it’s always wise to consult with a financial advisor or professional before making investment decisions. With the right approach and strategy, real estate crowdfunding can be an excellent addition to your investment portfolio and give you an entry into probably the most lucrative market sector of them all: real estate.