This is a comprehensive beginners guide to real estate crowdfunding, my favorite way to invest in real estate and take advantage of demographic trends towards lower cost areas of the country.
The work from home trend has blown up thanks to the pandemic and to months of sheltering-in-place. As residents first look to cheaper areas of their own city to save money first, some will expand towards different parts of the country.
Real estate investing is a strategic way to diversify your portfolio while creating a secondary income stream in a passive manner. Historically, investors bought real estate by acquiring 100% of a particular property with leverage or by buying a Real Estate Investment Trusts (REITs), which acts like a mutual fund of real estate properties.
With the passage of the JOBS Act and the SEC’s recent Title III ruling, accredited and non-accredited investors now have a new way to gain entry to specific real estate properties without having to borrow or come up with all the funds in cash.
Instead, investors can now invest as little as $1,000 to participate in a piece of a larger real estate deal such as a 200-room hotel or a 30,000 sqft commercial property.
Real Estate Crowdfunding Basics
Real estate crowdfunding involves the pooling of funds by multiple investors in a real estate project. There are two main investment types to choose from:
- Equity investments
Investors make investments in commercial or residential properties and in exchange, they hold an equity stake in the property. Each investor shares in a portion of the rental income the property generates. - Debt investments
Specifically, this means investing in a mortgage loan associated with a particular property. As the loan is repaid, the investor receives a share of the interest.
Between the two, equity investments offer the potential for bigger returns because the profitability of debt investments is limited by the loan’s interest rate. On the other hand, equity investments are riskier and they typically require a longer holding period.
Debt investors generally get their interest on a quarterly, semi-annual, or yearly basis. Equity investors might get their return 3 – 5 years in the future, and things might drastically change by then e.g. a recession.
Therefore, it's important for equity investors to take a longer term horizon view and diversify.
What Investors Actually Own
Real estate crowdfunding platforms can vary widely in terms of how investments are structured and that affects what an investor owns.
Some real estate crowdfunding platform, for example, create a separated limited liability company (LLC) for each equity investment opportunity. The LLC holds an interest in the entity that owns the real estate at the center of the investment. Investors own shares in the LLC, giving them limited liability as well as certain tax benefits associated with pass-through entities.
With debt and certain preferred equity investments, the investment is made in payment dependent notes belonging to the real estate crowdfunding subsidiary. The notes are tied to the performance of a real estate loan or project investment made by an individual subsidiary. Investors have ownership in the note itself.
Benefits for Investors
Compared to investing in a real estate investment trust (REIT) or purchasing a rental property, real estate crowdfunding offers certain advantages, including:
- Increased transparency
With a REIT, information about the underlying investment may be limited which can make it more difficult to gauge whether the deal is sound. CrowdStreet thoroughly vets each deal beforehand so that investors have as much information as possible to aid in decision-making. - Accessibility
Traditionally, investing in private real estate mean bringing tens of thousands of dollars to the table to participate. With real estate crowdfunding the bar is much lower. CrowdStreet, for example, offers deals with a $10,000 minimum. - Diversification
Between debt and equity investments in both commercial and residential properties and real estate funds, investors have the opportunity to gain exposure to a new asset class. - Tax benefits
Real estate crowdfunding allows investors to benefit from certain tax breaks, such as depreciation, that normally apply to owning an investment property.
Investing in Real Estate Crowdfunding Best Practices
Here are some practical tips for making sure that your real estate crowdfunding experience goes as smoothly as possible:
- Choose your platform carefully
Every real estate crowdfunding platform is different and some may be a better fit than others. Researching the various platforms to identify their strengths and weaknesses is an important first step for investors. Important considerations include track record, length of operation, number of deals, return performance, company funding, and management credentials. - Review investments yourself
Real estate crowdfunding platforms are not investment advisors and while many platforms vet deals before offering them to investors, not all of them do. Talking over the details of a specific deal with a financial advisor or fiduciary can help you pinpoint any potential issues. - Keep an eye on liquidity
Real estate has very different liquidity schedules as well as unique return profiles for each individual investment. Understanding how long you stand to be locked into a deal is vital when making investment decisions. - Don’t overlook risk
Investing in real estate is a good way to diversify your holdings but it’s also necessary to diversify your risk as well. Weighing the potential returns against the projected risk can help you determine whether debt or equity investments are more appropriate.
Top Platforms for Real Estate Crowdfunding
One of the most important factors that borrowers and investors should consider when choosing a real estate crowdfunding platform is the quality of the overall experience it provides. Here are three real estate crowdfunding platforms investors should consider:
Fundrise is the largest real estate crowdfunding platform based in Washington DC for non-accredited investors. They have a unique offering with their eREITs, which allows non-accredited investors to participate in real estate crowdfunding deals. The returns are in the 8% – 10% range because the funds are more diversified.
CrowdStreet is based in Portland and connects accredited investors with a broad range of debt and equity commercial real estate investments. CrowdStreet is great because they focus primarily on 18-hour cities (secondary cities) with lower valuations, higher net rental yields, and potentially higher growth.
Both platforms are free to sign up and explore.
Real estate crowdfunding has established itself as a major game changer where the larger real estate industry is concerned. By introducing tech-based solutions and removing some of the most challenging barriers to real estate investing, crowdfunding is opening new doors for investors and borrowers alike.
Related: A Real Estate Investment Rule To Follow: Rent Luxury, Buy Utility
About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
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