The Ultimate Guide to Real Estate Crowdfunding: Mastering the Art of High-Yield Investment Opportunities.
Real estate crowdfunding is a great way to generate passive income and diversify your portfolio. Before you start investing, here’s a primer on the ins and outs of real estate crowdfunding.
What is Real Estate Crowdfunding?
Real estate crowdfunding is when investors pool their money together through a crowdfunding platform to fund some or all of a real estate project.
The types of crowdfunded real estate projects can vary from individual properties to large multi-family apartment complexes and retail spaces.
Crowdfunded deals generally have a long investment horizon of at least 3 years. However, some platforms specialize in deals that can be as short as 6 months.
Crowdfunded real estate investments are private investments. They do not trade on an exchange like the NYSE. Instead, the investments are structured as a private REIT, an LLC, or a debt note, like a Limited Recourse Obligation.
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.
When the JOBS Act first became law, many of the laws’ exemptions only targeted accredited investors (individuals with an annual income over $200,000 per year) and left all other investors on the sideline.
Then in 2015, there was an amendment to the JOBS Act known as Regulation A+, which removed onerous restrictions and allowed accredited and non-accredited investors alike to invest in commercial real estate.
Regulation A+ was a game-changer for the real estate crowdfunding industry.
The key feature of Reg A+ allowed private companies to raise up to $50 million in capital from the general public without the legal and administrative burden typically required for such activities, thus paving the exponential growth in this nascent market.
Since then, hundreds of real estate crowdfunding platforms have come into the business, creating a new way for individuals to invest in real estate without buying a property.
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 and executing the front-to-back process of a crowdfunded real estate project.
A typical crowdfunded real estate deal usually goes as follows:
1. Source the deal
Potential opportunities are typically brought in by brokers or from the firms marketing techniques. Brokers usually receive a commission for sourcing deals that go live on the crowdfunding platform.
2. Pre-Screening
Once a potential opportunity makes it in the door, they are pre-screened based on criteria set by the crowdfunding platform.
3. Due Diligence
Most teams often perform vigorous due Diligence before opening an investment opportunity on their platform. Due Diligence can include the following:
- Experience. All assets the company previously acquired are examined and compared to the proposed project to check if the sponsor has had similar experiences in the past.-References. References from lenders, investors, and business associates to ensure there are no red flags.
- Background Checks. On the management team, including criminal checks and identifying any pending lawsuits.
- Property Analysis. Analysis of strategy, size, and location of the potential investment. Making sure the property is what they say it is. Only once a potential opportunity passes due Diligence does it receive funding.
4. Pre-Funding
Once due diligence is completed, but before the loan is fully funded, many platforms provide pre-funding for real estate deals. Otherwise, a deal can sit dormant, waiting for funding, which in some cases, can be 30 – 90 days, which can be lost revenue for the borrower, and it is also a way for the platform to earn revenue before an investment is fully allocated to investors.
5. Open To Investors
After an opportunity passes due Diligence, it is listed on the platform for potential investors. The platform often provides details like The investment strategy, targeted returns, LTV (Loan-To-Value) Financial Metrics such as purchase price, expected holding time, investment thesis, and property pictures.Some deals are fully funded in a couple of hours, others in days. It largely depends on how desirable the opportunity is and the size of the offering.
6. Asset Management
Once you invest in a project, many real estate crowdfunding platforms provide in-house investor support, including project updates, performance, and even tax reporting.
Most crowdfunded real estate investments allow individuals to invest with just a few hundred dollars, sometimes much less.
Investment Options & Strategies
The types of investment options can vary greatly depending on the crowdfunding platform’s real estate strategy, target market, and type of investment property. There is no one-size-fits-all in real estate investing.
Common types of crowdfunded properties include:
- Apartments/Multi-family
- Retail spaces (clothing stores)
- Industrial
- Single-Family
A crowdfunded real estate investment usually falls into 1 of 4 investing strategies: Core, Core Plus, Value-Add, and Opportunistic.
Core
It is a buy-and-hold strategy when purchasing a high-quality property that generates stable revenue. Core strategies include lower risk but also have lower returns. Expected returns generally hover sub 10% IRR.
A core strategy is ideal for investors looking for passive income, and since core properties are relatively stable, they don’t tend to generate capital appreciation.
Core Plus
Core-plus investors create value by renovating and increasing the property’s appeal, allowing an investor to charge higher rent.
This strategy builds long-term wealth through increased property value and increased passive income.
Core Plus strategies typically generate an internal rate of return of around 10-14%.
Value-Add
Investors with a higher appetite for risk and reward might pursue value-add strategies. Value-add investments focus on properties that require capital and day-to-day management to achieve profitability.
Investments in value-add properties include renovations to attract a new type of tenant or to fill tenant vacancies. Pursuing value-add opportunities may also provide a way for investors to enter an otherwise too-expensive market.
Value-add investments usually have a 5 – 7 year investment horizon and target an internal rate of return of around 15 – 19%.
Opportunistic
Opportunistic real estate strategies are the riskiest types of investments but also have the potential for the most reward. Most investments require considerable leverage, and properties may not provide income for years.
Examples of opportunistic investments may include ground-up developments, acquiring an empty building, or land development.
Only seasoned teams of real estate professionals typically execute opportunistic real estate projects.
Opportunistic investment can have returns over 20%.
Targeted Returns
The types of returns you can expect in real estate investments vary greatly depending on where in the capital stack the investment lies. The capital stack comprises debt investments at the bottom, which are the least risky and often secured by collateral such as the actual property.
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. At the top of the Capital Stack are equity investments, which are the riskiest but also have the potential for the most significant returns.
At the bottom of the capital stack are debt investments, which are the least risky but offer lower 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 in real estate were so great, wouldn’t all wealthy investors quickly jump on the opportunity first and not wait for individuals to invest $10 at a time?
There is a wide range of reasons why companies use real estate crowdfunding to raise money. Still, the most common rationale includes a diverse investor base, the use of technology, and smaller deals requiring a different investor base.
Some companies may raise all their funding through real estate crowdfunding, or only a portion of it, or perhaps only on specific deals.
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 investments 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.
Benefits of Real Estate Crowdfunding
Some of the main benefits of real estate crowdfunding are 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.
No Property Management
When you invest in real estate crowdfunding, you get the benefits of investing in real estate without the stress of property maintenance, tenant management, and insurance, to name a few.
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.
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.
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).
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 or stocks, making them a great alternative for those who cannot stomach wild market gyrations.
Passive Income
One of the most common reasons people invest in real estate crowdfunding is passive income. Unlike buying a physical rental property, the income & capital appreciation earned is truly passive. The sponsor or platform handles all operational aspects of the investments and passes gains (or losses) to investors.
What Are The Risks?
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. Most crowdfunding platforms have a 1% asset management fee, while the average publicly-traded REIT ETF has an expense ratio of 0.41%. In comparison, REIT mutual funds have an average expense ratio of 0.85%, according to the Motley Fool.
- Crowdfunding Fee: 1%
- REIT Mutual Fund Fee: 0.85%
- REIT ETF Fee: 0.41%
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 massive investor base and diverse investing strategies, while others have only been around for a few years and target particular investment strategies.
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.
Popular real estate crowdfunding platforms:
Is Real Estate Crowdfunding Right For Me?
Real Estate Crowdfunding is good for…
- Investors who have a long investment horizon (greater than 3 years)
Real Estate Crowdfunding is not good for…
- Individuals with a short investment horizon (less than 3 years)
- If you may need to sell your investment for cash
Is Real Estate Crowdfunding Safe?
Like any investment, there is always the risk of losing your investment, despite the advertised risk.
Before investing with a real estate crowdfunding platform, be sure to perform some basic due diligence.
With countless crowdfunding sites, be weary of any sites promising guaranteed returns, no loss of capital, or even incredibly high returns.
Also, check the SEC website to ensure that the companies offering circulars are registered with the SEC.
Essential Tips To Ask Before Getting Started
Real estate crowdfunding is just one way to build wealth with real estate. Should you decide crowdfunding is right for you, consider the key points you should know before investing in a real estate crowdfunding deal:
- Risk. Always understand how much risk you are taking. Most people look at returns, but with many terms in real estate lexicon, it’s easy to be sold upfront and for a deal to underdeliver later.
- Minimum Investment e.g. $100 or $10,000
- Holding Period(3 – 7 years)
- Fees: (1% asset management fee)
- Early Redemptions (if yes, are there any fees)
- Expected returns
- Investment Strategy (Core, Core Plus, etc)
- Type of Investment (Equity, Debt, Preferred)
Frequently Asked Questions
How Do Real Estate Crowdfunding Platforms Make Money?
There are numerous ways Crowdfunding sites generate revenue, but the most common way is through a management fee, usually between 1 -3% of the amount of money invested. Other sources of revenue include origination fees (usually charged to the borrower) and co-investing in properties, also known as ‘skin-in the game’.
Do I have to pay taxes?
Yes. The most common form of tax document you will receive is a K-1 form. The type of tax documents you receive depends on how the real estate deal is structured.
How Much Money Can You Make?
Depending on where in the capital stack your investment lies, you can earn between 6% and 24% through a crowdfunded real estate deal.
Investments in collateralized real estate debt can expect to earn around 6% on the low end, with an average of approximately 10%. But if you invest in high-risk equity projects, targeted returns can range from 18% – 24%.
On an absolute basis, private real estate had slightly lower returns than publicly-traded REITs, 8.1% vs 11.6%. However, private real had lower volatility, so private real estate had better risk-adjusted returns, according to a TIAA White Paper.
Total returns are just one aspect you should consider when considering real estate or stocks.
