Real estate crowdfunding is an effective way for investors to pool their financial and intellectual resources to invest in properties and projects much bigger than they could afford or manage on their own. Real estate crowdfunding exploded onto the scene after the passage of the 2012 JOBS Act.
Although real estate syndication has been around for decades, until recently and before the advent of crowdfunding, syndicated investments were difficult for individual investors to access. Only ultra high net worth investors or institutional investors with hundreds of millions, if not billions in capital could partake and profit.
Real estate crowdfunding companies like Fundrise (for non-accredited investors) and RealtyMogul (mainly for accredited investors), gives access to such mid market, commercial real estate deals that have provided above average real estate returns for decades.
This is why so many investors, including myself, are excited about the growing real estate crowdfunding space. I’ve personally invested $810,000 in real estate crowdfunding as of 2019.
How Does Real Estate Crowdfunding Work?
Real estate crowdfunding (syndication) is a transaction between a Sponsor, who sources, develops, and managers a real estate project and a group of investors, you and I. Check out this graphic below that explains the process.
Real estate crowdfunding is an effective way for investors to pool their financial and intellectual resources to invest in properties and projects much bigger than they could afford or manage on their own.
The basics of real estate crowdfunding aren’t all that different from two guys opening a bar together. As the manager and operator of the deal, the Sponsor invests the sweat equity, including scouting out the property, raising funds and acquiring and managing the investment property’s day-to-day operations, while the investors provide most of the financial equity.
The Sponsor is usually responsible for investing anywhere from 5-20% of the total required equity capital, while investors put in between 80-95% of the total. Obviously, the more the Sponsor can invest in the property, the better for investors since investors want to see as much “skin in the game” as possible.
Syndications are simple to set up and come with built-in protections for all parties. They’re usually structured as a Limited Liability Company or a Limited Partnership with the Sponsor participating as the General Partner or Manager and the investors participating as limited partners or passive members. These LLCs are also sometimes called Special Purpose Vehicles where the real estate crowdfunding platform and the investors in the platform have NO claim on these SPVs or LLCs.
The rights of the Sponsor and Investors, including rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment, are set forth in the LLC Operating Agreement or LP Partnership Agreement.
Real Estate Crowdfunding Profits
Profits are made through rental income and property appreciation and sale.
Rental income from a syndicated property is distributed to investors from the Sponsor on a monthly or quarterly basis according to preset terms. A property’s value usually appreciates over time, so investors can net higher rents and earn larger profits when the property is sold.
Payment depends upon the time the investment needs to mature; some types of syndications are over within 6-12 months while others can take 7-10 years. Everyone who invests receives some share of the profits.
The Sponsor will propose a Target Date for exit, but such target dates are just rough estimates. If the target date so happens to be in the middle of a bear market, it may be prudent to keep holding on and collecting rent until the cycle turns.
At the deal’s beginning, the Sponsor may earn an average acquisition fee of 1% (although it can be anywhere from .5 to 2% depending upon the transaction). Before a Sponsor shares in the profits for their work as manager and promoter, all investors receive what is called a ‘preferred return.’ The preferred return is a benchmark payment distributed to all investors that is usually about 5-10% annually of the initial money invested.
Below is my real estate crowdfunding dashboard where I hold $810,000 on the RealtyMogul platform.
An Example Of A Real Estate Crowdfunding Investment
Real estate crowdfunding investments are structured so that the sponsor is motivated to ensure the investment performs well for everyone. Let’s look at an example of a preferred return.
If you’re a passive investor who invests $100,000 in a deal with a 10% preferred return, you could take home $10,000 each year once the property earns enough money to make payouts possible.
After each investor receives a preferred return, the remaining money is distributed between the Sponsor and the investors based on the syndication’s profit split structure.
If, for example, the profit split structure is 70/30 — investors net 70% of the profits after receiving their preferred returns and the sponsor nets 30% after the preferred return.
For example, after everyone receives their preferred return in a 70/30 deal, and there is 1 million remaining, the investors would receive 700k and the Sponsor would receive 300k.
Real Estate Crowdfunding Statistics
* In 2012, over 47,000 investors participated in syndications.
* The average size of a real estate offering was 2.3 million.
* Passive investors came up with 80-95% of the initial capital investment
* Sponsors came up with 5-20% of the initial capital investment
* Investors received a preferred return ranging from 5-10%.
* The average preferred return was 8%.
* Sponsors netted an acquisition fee of .5 to 2%. The average acquisition fee was 1%.
* Sponsors netted a property management fee between 2 and 9%.
Real Estate Crowdfunding Progress
Before the internet, real estate syndication required that interested investors have an established network of syndicate partners to find trustworthy, profitable deals to buy shares of.
Like the two guys opening up a bar together, the guy with the bar experience had to somehow meet the guy with the money, and vice versa. Fast forward a few years and things have really changed for real estate syndications, with the help of the internet and the advent of crowdfunding.
Real estate crowdfunding gives access to the financial fundamentals of a deal and makes it easy for accredited investors to purchase shares without using the old model of country-club small talk and caddy fees.
Crowdfunding is a way to raise money through the internet for a big project with the help of a ‘crowd’ of investors; if a project gets enough funding, it’s a “go”, and if not, the money is returned to investors.
Crowdfunded real estate syndications are more accessible, have lower investment minimums and offer a wealth of online project information available to potential investors.
Fundrise Growth And Performance
According to the latest public offering documents by Fundrise for its IPO, the firm manages roughly $488 million in assets under management, has 63,271 active investors, and 76 employees. Their AUM grow and investor signups have been very promising.
Fundrise’s five-year average platform portfolio has also done quite well, yielding a 10.79% return versus 7.92% for the Vanguard Total Stock Market ETF and 7.4% for the Vanguard Real Estate ETF. Their massive 14%+ outperformance in 2018 versus the Vanguard Total Stock Market ETF is particularly impressive.
By generating a strong 5-year return, Fundrise has taken a huge step forward in proving out what they have believed for so long: that a model of individuals diversifying into real estate through a direct, low-cost technology platform is a superior investment alternative to owning only publicly traded stocks and bonds.
Invest On The Best Platforms
With real estate crowdfunding, you don’t need to risk $100,000 or more to invest in commercial real estate. Instead, you can invest for much lower amounts such as $5,000. The best real estate crowdfunding platforms today are:
1) RealtyMogul, founded in 2012 and primarily for accredited investors. So far, RealtyMogul has distributed over $100M, have 170K members, and have funded over $2B in property deals. I’ve spoken to their CEO, Jilliene Helman at length, and she is focused on building a multi-decade long business with the highest quality commercial real estate deals.
2) Fundrise, founded in 2012 and available for accredited investors and non-accredited investors. I’ve worked with Fundrise since the beginning, and they’ve consistently impressed me with their innovation. They are pioneers of the eREIT product. Most recently, they were the first ones to launch an Opportunity Fund in the real estate crowdfunding space to take advantage of new tax laws.
Both of these platforms are the oldest and largest real estate crowdfunding platforms today. They have the best marketplaces and the strongest underwriting of deals. Investors should carefully consider their own investment objectives when assessing the gamut of real estate opportunities that are available.
Remember, too, that real estate investments have many risk factors, so it is important to review the full offering materials for any investment that is being evaluated.
About the Author: Sam has $810,000 invested in real estate crowdfunding to take advantage of lower valuations and higher net rental yields in non-coastal city real estate. He believes there will be a multi-decade migration away from expensive coastal cities due to technology and the emergency of real estate crowdfunding platforms In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $220,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.