Real estate crowdfunding gives individual investors direct access to participate in larger, often long-term real estate projects. These opportunities, typically facilitated online, allow developers or property owners to connect with many investors in order to fund their real estate project, and share the returns to that same investor group over time.
Unlike traditional real estate investment, which usually requires significant capital, crowdfunding enables investors to access the benefits of real estate investing with only a small amount of initial money. Even $100 will get you access to many real estate crowdfunding opportunities, providing you an entryway into the real estate investment arena. Real estate crowdfunding continues to gain popularity, especially after the 2012 JOBS Act modified federal regulations around crowdfunding investments. Advances in technology have also increased accessibility and transparency for investors of all types. This article gives a high-level overview of real estate crowdfunding and how investors can get started.
How real estate crowdfunding works
For real estate crowdfunding to be successful, a project developer or sponsor must raise adequate funds to finance the project. Using online real estate crowdfunding platforms, real estate developers or project managers (called “sponsors”) pitch their investments. These sponsors are typically individuals or companies that will find, organize, and manage a real estate crowdfunding investment. These investments include purchasing rental properties, developing land, or making loans to real estate-related parties.Real estate crowdfunding platforms provide the necessary infrastructure for sponsors to seek investment, while ensuring regulatory compliance. Investors can be individuals or entities. For example, some platforms are limited to accredited investors. To be an accredited investor, you must generally have an annual income of over $200,000 or a net worth of over $1 million. Other crowdfunding opportunities are open to everyday investors, with investment minimums as low as $100.There are two main types of real estate crowdfunding: equity crowdfunding and debt crowdfunding. Each type has a different risk profile and different potential investment returns.
Equity crowdfunding
In the real estate equity crowdfunding space, investors purchase shares of a property directly, or they buy part of a business that will buy properties or operate a business that earns income from real estate. Like traditional real estate ownership, equity crowdfunding investors may benefit from property appreciation, rental revenue, and other streams of income produced by the property. However, just like any real estate investment, equity crowdfunding investors also assume their share of the risk if the project is unsuccessful. Equity crowdfunding gives investors a slice of ownership, and the success of the investment is tied to the success of the property or project. With this investment strategy, there is a chance of larger returns, because the property or project may exceed expectations and produce significantly more income than anticipated. Because the investor owns equity, they get their piece of the income as it is passed on directly to investors after other expenses are paid. Overall, you can think of equity crowdfunding as owning a stake in a property or business.
Debt crowdfunding
Debt crowdfunding is slightly different from equity crowdfunding. In debt crowdfunding, investors usually lend money to the sponsor in exchange for a fixed return, typically in the form of an interest payment. Investors can think of debt crowdfunding as similar to a loan. For example, a sponsor may want to raise $10 million in debt in order to purchase rental properties. In equity crowdfunding, the investor would either own shares in the sponsor, or own shares of the properties themselves. In debt crowdfunding, the sponsor simply promises to give a certain return, but investors do not own shares of the sponsor or property. For example, an investor might invest $1,000 in a debt crowdfunding project and receive a 10% return for five years. Each year, the investor will receive $100 from the sponsor. At the end of the five years, the sponsor must return the initial $1,000 to the investor. Returns for debt investments may be lower than equity investments, but debt crowdfunding is considered less risky, as investment returns tend to be more predictable.
Benefits of real estate crowdfunding
For individual investors who may not have the expertise or capital to fully fund a standalone real estate investment (such as buying a rental property outright), crowdfunding offers a range of benefits.
Accessibility
One of the biggest advantages of real estate crowdfunding is accessibility. Many platforms have low minimum investment requirements, leveling the playing field for investors interested in investing as little as $100. Since the crowdfunding platforms are accessible online, it is easy for investors to get started, without the need for an investment advisor, industry connections, or prior real estate investing experience.
Portfolio diversification
Only a small amount of money is typically required per investment, making it possible to diversify investments. Investors can spread their money across property types, geographic locations, and projects, reducing overall risk. For example, an investor using any one of the top real estate crowdfunding can invest in a single-family rental home in Georgia, a vacation rental in Phoenix and a real estate debt fund, all on the same platform.
Passive income opportunities
Many real estate investments give investors the opportunity to earn passive income through rental earnings or interest payments. This is a key benefit to real estate crowdfunding; investors do not have to be involved in the day-to-day management of the property. For example, investors in a rental property might earn money every month as rent comes in, the expenses for the home are paid, and the profit is distributed to investors.
Potential for high returns
Like any investment, real estate crowdfunding does not guarantee any level of returns. However, given the reputation of real estate for strong returns over time, it can be a strong, risk-adjusted investment. That is why you will see many real estate crowdfunding projects with timelines of five years or more. Industry experts know that the greatest returns often come to those who are invested for a longer time period.
Risks and challenges
While there are many potential benefits to real estate crowdfunding as an investment avenue, there are some risks and challenges that all investors should be aware of.
Market risks and economic factors
Macro, or large-scale, factors like economic downturns can disrupt the real estate market, which also includes real estate crowdfunding investments. When real estate values drop, investors may experience losses or diminishing returns. However, some findings show that the real estate market is generally more stable than the stock market during periods of economic uncertainty.
Lack of liquidity
When you invest in a real estate project, your money may be tied up for quite a while. Unlike publicly traded stock, which you can buy and sell within moments, real estate investors may not be able to easily sell shares or withdraw funds before the project is completed. For example, in a development project, investments may be used to build the project, so funds won’t be available until the project starts to receive a return on investment. This is a key reason to do your research and understand the details of your investment. Some investment opportunities include the ability to sell your investment after a certain time period, so keep an eye out for those details.Many crowdfunding platforms have sprung up over the last decade, but not all platforms are created equal. Some platforms may have different levels of vetting processes for projects, leading to different levels of risk for investors. It is important to always research the platform itself before moving forward with a project-specific investment. Also, every real estate project will have a different risk profile, so it is best to dig into the details before diving in.
Regulatory and legal considerations
As the real estate crowdfunding industry is relatively new, laws and regulations continue to evolve. The legality and custom of today’s practices may change with new regulations and innovations. Investors must accept potential regulatory uncertainty and the risk associated with it.
Getting started with real estate crowdfunding
Ready to get involved with real estate crowdfunding? Take an approach that prioritizes careful planning and informed decision-making. Here are a few steps to follow:
1. Choose the right platform
Seek out an online investment platform that is reputable, well-regulated, and transparent. Be sure they outline any and all fees, and get a good understanding of what exactly you are buying (for example, equity or debt). Check that the platform has a strong track record of successful projects, and review their vetting process for projects and sponsors. If you know other people who invest in real estate crowdfunding, ask for recommendations. There are many websites that go over real estate crowdfunding opportunities in depth, such as BiggerPockets and NerdWallet. Some real estate crowdfunding platforms to consider are Arrived, Fundrise, Yieldstreet, RealtyMogul and EquityMultiple.
2. Know the investment limits
The federal Securities and Exchange Commission sets investment limits for non-accredited investors, based on annual income or net worth. According to the SEC: “If either your annual income or your net worth is less than $124,000, then during any 12-month period, you can invest up to the greater of either $2,500 or 5% of the greater of your annual income or net worth. If both your annual income and your net worth are equal to or more than $124,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is greater, but not to exceed $124,000.”
3. Carefully evaluate each investment opportunity
Do not jump in without doing your research. Take time to review the details of each project, including property type, location, expected returns, and investment timeline. You should also review the sponsor’s experience and take a deep dive into the financial details of the project. Within the context of each opportunity, be sure to evaluate market conditions and potential risks.
4. Follow the step-by-step investment process
After you have decided on an investment, you will need to first create an account on your selected platform. Review and sign all necessary documents, and transfer funds. Then track your project’s progress on the platform throughout the life of your investment.
Future trends in real estate crowdfunding
It is an exciting time to be a real estate crowdfunding investor, as many industry experts expect the market to continue to grow, for a few key reasons. First, technological advancements are widening the investor pool and making it easier for individual investors to participate. These innovations include new blockchain technologies and smart contracts, as well as improved online investment portals. All are poised to streamline transactions, boost transparency and increase investment efficiency.Second, the growing popularity of real estate crowdfunding is seen as a democratization of real estate investing. Because the entry point is lower than traditional real estate investments, it’s a vehicle available to a more diverse set of individual investors, which opens new pathways for wealth creation. These reasons outline a case for the future continued growth of real estate crowdfunding, and it is definitely worth exploring as an investment strategy.
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