What is real estate syndication and how does real estate crowdfunding work? This post takes an in-depth look at what real estate crowdfunding is, its purpose, structure, profitability, and more.
Since 2016, I've personally invested in 18 different real estate crowdfunding projects. My total capital investment has been $810,000 so far. Therefore, I'm confident to say Financial Samurai is one of the best sources to discuss how does real estate crowdfunding work.
Financial Started in 2009 and is one of the largest independently-owned personal finance sites with over 1 million organic visitors a month. Everything is written from firsthand experience.
What Is Real Estate Crowdfunding?
Real estate crowdfunding is abbreviated REC and is also known as real estate syndication. REC is an effective way for investors to pool their financial and intellectual resources.
The purpose of real estate crowdfunding is to invest in properties much bigger than investors could individually afford or manage. Real estate crowdfunding exploded onto the scene after the passage of the 2012 JOBS Act.
Increased Accessibility
Real estate syndication has been around for decades. However, 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.
Now, real estate syndication is accessible to everyone.
Two of the best real estate crowdfunding companies are Fundrise (for non-accredited investors) and CrowdStreet (mainly for accredited investors). They gives access to mid-market, commercial real estate deals that have provided above average real estate returns for decades.
I've met people from both platforms. Not only do they have the most robust offerings, they also have the largest number of clients and longest histories.
This is why so many investors, including myself, are excited about the growing real estate crowdfunding space.
How Does Real Estate Crowdfunding Work?
Now you understand the purpose of real estate syndication. So just how does real estate crowdfunding work? Real estate crowdfunding (syndication) is a transaction between a Sponsor and investors like you and me.
The Sponsor sources, develops, and managers a real estate project and a group of investors. Check out this graphic below that explains the process visually.
Investors Pool Financial And Intellectual Resources
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. The Sponsor is the manager and operator of the deal.
In other words, the Sponsor invests the sweat equity. This includes scouting out properties, raising funds, and managing the investment property’s day-to-day operations. On the other hand, 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. Conversely, investors put in between 80-95% of the total. Obviously, the more the Sponsor can invest in the property, the better for investors. Investors want Sponsors with as much “skin in the game” as possible.
Related reading: The Real Estate Investing Rule To Follow – Buy Utility, Rent Luxury
Real Estate Syndication Structures
Let's dive even further into REC as we answer how does real estate crowdfunding work.
Real estate syndications are simple to set up and come with built-in protections for all parties. The structure is usually a Limited Liability Company or a Limited Partnership. The Sponsor is generally participating as the General Partner or Manager. And the investors are participating as limited partners or passive members.
These LLCs can also be Special Purpose Vehicles (SPVs). The real estate crowdfunding platform and the investors in the platform have NO claim on these SPVs or LLCs.
What about the rights of the Sponsor and Investors? Everything is set forth in the LLC Operating Agreement or LP Partnership Agreement. This includes rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment.
Real Estate Crowdfunding Profits
How does real estate crowdfunding work in regards to profitability? Profits are from rental income and property appreciation and sale.
Rental income from a syndicated property is distributed to investors from the Sponsor. This is typically on a monthly or quarterly basis according to preset terms. A property’s value usually appreciates over time. Thus, 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.
Target Dates
The Sponsor will propose a Target Date for exit, but such target dates are just rough estimates. What if the target date so happens to be in the middle of a bear market? In those cases, it may be prudent to hold on and collect 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. It is usually about 5-10% annually of the initial money invested.
Below is my real estate crowdfunding dashboard where I hold $810,000.
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 2020, over 60,000 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.” 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 $1 million in assets under management, has 150,000+ active investors, and 100+ employees as of 2021. 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:
CrowdStreet
Founded in 2014, 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.
Fundrise
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.
Best Real Estate Crowdfunding Platforms
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. 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 $250,000 a year in passive income. He spends time playing tennis, hanging out with family, and writing online to help others achieve financial freedom.