Real Estate Crowdfunding: What is It? How does It Work? Who Should Use It?

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August 21, 2022

Adam K. |

5 Minute Read

What is Real Estate Crowdfunding?

In its simplest form, a real estate crowdfunding platform helps a sponsor (the company or team managing the investment property) raise capital from individual investors. With the help of the crowdfunding platform, the money raised is then pooled together to fund some, or all of a real estate project.

The types of real estate projects can vary from individual properties to a large multi-family apartment complexes.

How Does Real Estate CrowdFunding Work?

A Real Estate Crowdfunding platform is often comprised of an experienced team of professionals with extensive experience working with or managing a real estate portfolio.

This team often is responsible for sourcing potential real estate deals. Most teams often perform vigorous due diligence before opening an investment opportunity on their platform.

Due diligence may include: vetting the sponsor’s experience in the said real estate market, performing background checks on the management team, and does an analysis of the location, size, and strategy of the real estate investment.

Once an opportunity passes due diligence, it is open on the platform for potential investors. All the metrics about the real estate projects are available for review by potential investors.

Most crowdfunded real estate investments allow individuals to invest with just a few hundred dollars, sometimes much less.

Once you invest in a project, many real estate crowdfunding platforms provide in-house investor support, including project updates, performance, and even tax reporting.

A Brief History of Real Estate Crowdfunding

The Real estate crowdfunding framework resulted from the 2012 Passage of the JOBS Act, which was intended to encourage private funding for small US businesses.

The JOBs Act made raising money for small businesses simpler, cheaper, and faster.

However, when the JOBS Act first went into law, many of the laws’ exemptions only targeted accredited investors (individuals with an annual income over $200,000 per year) and left everyday investors like you and me on the sideline.

Then in 2015, there was an amendment to the JOBs Act known as Regulation A+.

Reg A+ allowed all accredited and non-accredited investors to invest in commercial real estate.

The critical feature of Reg A+ was that private companies could now raise up to $50 million in capital from the general public without the same legal and administrative burden typically required for such activities.

And since then, hundreds of crowdfunding platforms have come into business, making real estate investing relatively seamless for everyday individuals like you and me.

What Are The Types of Real Estate Investments Available?

Depending on the company, many real estate crowdfunding platforms may sell shares in Private REITs (Real Estate Investment Trusts), Individual properties, or both.

But whether you invest through a private REIT or an individual property, the investment can fall anywhere with the capital stack.

The capital stack comprises debt investments at the bottom, which are the least risky and often secured by collateral such as the actual property.

However, debt investments also tend to have the lowest returns.

Capital Stack

And at the top of the Capital Stack are equity investments, which are the riskiest but also have the potential for the greatest returns.

Some real estate crowdfunding sites like Groundfloor focus only on debt investments, while crowdfunding platforms focus on equity investments.

And depending on the property, some real estate investments may focus on capital appreciation e.g., the total value of the property when it is sold for a profit, while others may focus on income generation e.g., constant cash distributions to investors.

There are PROs and CONs to investments across the entire capital stack. What type of property you add to your investment portfolio depends on your goals, strategy, and risk tolerance.

Why Do Real Estate Companies Raise Money Through Crowdfunding?

If the investment opportunities were so great, wouldn’t all the wealthy investors quickly jump on the opportunity first and not wait for individuals to invest $1,000 at a time?

It’s a valid question, and there are valid answers.

Diverse Investor Base. Firms could spend months working with one investor/small group of investors to invest in the deal, and if they back out for some reason, the company could be back at square one from the capital raising perspective. But if they deal with hundreds of individual investors, the chances of a mass exodus of investment are less likely.

Leveraging Technology. Companies that raise money through crowdfunding often only deal with the investing platform, and the platform, in turn, manages the hundreds of individual investors. That means the company can spend more time doing what they’re good at and less time on administrative work.

Smaller deals require a different investor base. Many times there are smaller investment opportunities, but banks or ultra-wealthy individuals may not be interested in funding the project due to the size of the deal. With crowdfunding, firms can fill that gap by leveraging investments from individual investors.

What Are The Benefits of Investing in Real Estate Crowdfunding?

Some of the main benefits of real estate crowdfunding is that it can provide non-correlated returns to the stock market, in general, has higher returns than publicly-traded REITs, and can serve as an inflation hedge.

  1. Non-Correlated Returns to the Stock Market. Private real estate has a correlation of 0.14 and -0.12 with publicly traded stocks and bonds, as noted in a TIAA study on private real estate investing.

  2. Source: TIAA Cref

    So, in the case of extreme market downturns, private real estate projects are less likely to suffer losses to the same extent or at the same time as publicly traded securities.

  3. Higher Returns. Private real estate has higher returns than publicly-traded REITs. Over the past 20 years, NPI (the index that tracks private real estate performance) has averaged a higher rate than the yields of other major asset classes such as publicly-traded REITs, Bonds, and Stocks. The main reason for higher returns is the liquidity premium because investors cannot easily buy or sell private real estate, so they must be compensated accordingly.

  4. Real Estate serves as an Inflation Hedge. When inflation rises, real estate tends to increase at or exceed CPI. The Net Operating Income based on the NCREIF Fund Index highlights that real estate operating income closely matches or exceeds the Consumer Price Index (CPI).

  5. Less Volatility. Due to the illiquidity of private real estate investments, non-traded real estate will not fluctuate in value compared to publicly traded REITs and securities.

What Risks Are The Risks of Investing in Real Estate Crowdfunding?

While real estate crowdfunding may sound like an excellent way to add real estate to your investment portfolio, any crowdfunding investment comes with risks.

Liquidity Risk. Unlike publicly-traded REITs, many crowdfunding platforms have limited liquidity options once you invest. In other words, you should generally expect to have your money locked up for 3 -5 years or pay an early redemption fee, usually between 1% – 3% of your invested amount.

However, redemption features and the associated cost can vary between firms, so read the fine print before investing.

Externally Managed. Most real estate crowdfunding platforms serve as a “middleman” connecting real estate investors with sponsors (the company that manages the project). The crowdfunding platform collects a fee for every user they sign-up. This could potentially create conflicts of interest.

No Independent or Public Source of Performance Data. Because real estate crowdfunding offerings are private investments, they do not provide the same level of information as you commonly see for publicly traded REITs.

Lack of Understanding. Real estate investing can get complicated. Understanding where in the Capital Stack your investment falls, How and When you get paid can be somewhat confusing for your average real estate investor.

High Fees. Private real estate investments tend to have higher fees compared publicly traded REITs.

What Are The Best Real Estate Crowdfunding Sites?

As of this writing, there are over 100 active real estate crowdfunding companies.

Some companies have a long track record with a large investor base and diverse investment strategies, while others have only been around a few years.

But by far, the biggest name in real estate crowdfunding is Fundrise, which has been around since 2010 and has over 300,000 active users.

With Fundrise, you can start investing in real estate with a minimum investment of just $10, making it easy for aspiring investors to invest in real estate without buying property.

How Much Money Can You Make With Real Estate Crowdfunding?

Depending on where in the capital stack your investment lies, investments in collateralized real estate debt can expect to earn around 6% on the low end, with the average around 10%. But if you invest in high-risk equity projects, targeted returns can range from 18% – 24%.

For context, from 2000 to 2020, private real estate exhibited slightly lower absolute returns than publicly-traded REITs, 8.1% vs. 11.6%, but with lower volatility, so private real estate had better risk-adjusted returns according to a TIAA White Paper.

Real World Investor.com

Adam

Adam is the founder of realworldinvestor.com, an investing website dedicated to helping discerning individuals make the best investment decisions.

Before starting Real World Investor, he was a Vice President at the 3rd largest investment bank in the US. He also spent time at prestigious firms like J.P. Morgan and Deloitte Consulting. He has over 10 years of experience working in financial services. His experience includes working with complex derivatives while spending many years working on a trading floor.

He has a bachelor's degree in Business Administration, majoring in finance. Adam is married and resides in New Jersey with his wife.