What is crowdfunding real estate? It’s an alternative for businesses to raise venture capital and investors an easier way to access ventures using the internet. It finds many people willing to put in small amounts of money, quickly growing it into enough to finance large projects. It:
- Uses the internet to connect investors with projects
- Allows an investor to buy into a project and become a shareholder in a company or property
- Offers companies new access to capital
This is exciting for companies that gain access to new capital markets, and for small investors who could never get involved in large commercial projects before.1
How Does Crowdfunded Real Estate Work?
Crowdfunding real estate works by allowing people to invest small amounts of money in the equity or debt of a large project. Then, that person owns a proportional stake in the venture and receives dividends. There are two types:
- Equity – investors own a proportional share and earn rental income and proceeds from the property’s sale
- Debt – investors do not own a share of the project and earn interest income from the property’s mortgage payments
Online brokers pool the money and offer people investment opportunities in many projects. Most sites charge 1%-2% to investors for their services. Some sites only allow accredited investors, but other sites also allow access for non-accredited people.2
Accreditation for Unregulated Investments
The Securities and Exchange Commission (SEC) defines the criteria for an accredited investor. The requirement is that a person meets one of the following:
- Have assets of $1 million dollars excluding primary residence
- Have an income of $200,000 for an individual or $300,000 for a married couple for each of the last two years or $400,000 and $600,000 in the current year
- Employed as the director, general partner, or executive officer of the issuer of unregistered securities
- Be a registered broker or investment advisor
Unregistered securities are risky, and a person needs to have sufficient financial knowledge and financial strength. Accreditation is the vehicle the SEC uses to determine if a person is knowledgeable enough and has sufficient capital resources to invest in unregistered securities.2
How Does Crowdfunding Make Money?
Real estate crowdfunding makes money either renting and eventually selling or renovating and selling the property. Here is how most are structured:
- A sponsor proposes a project, negotiates the deal, hires contractors, and manages the project
- He/she lists the project on a platform, which advertises, deals with regulatory issues, and collects investors’ money
- Investors search the platform for opportunities and then commit capital to the projects they like
The platform provides the investment details for each project, which you should read carefully and ask about anything you need to be clarified before you commit. Most projects fall into one of two broad categories:
- Rental income and proceeds from the eventual sale
- Renovation and sale
The first generates an ongoing income stream and the project may last an extended period. The second has a shorter horizon. Because there are many investors, the sponsor needs to define the length of the projects for either case.
The sponsor is critical to the project because he/she does most of the work to develop and execute the plan. They collect a 1%-2% acquisition fee when the property closes and the project begins. Investors take a 6%-10% preferred return, and then the sponsor gets 25%-30% of profits beyond that.4
Is Crowdfunding Real Estate a Good Investment?
Whether real estate crowdfunding is a good investment all depends on your personal situation. It has a big upside, but the downside is just as large. Here are some of the advantages to think about:
- High potential returns
- Low investment minimums, sometimes as little as $500
- No landlord hassles that usually come with rental property ownership
- Easy experience
Diversifying your investments is always a good idea, but these projects often have high returns as well. Also, because these platforms use new technology the process is usually streamlined and easy for new investors. But before you decided this is too good to pass up, remember there are significant disadvantages as well. They include:
- Commercial property is illiquid
- High platform fees
- Untested platforms
Once you commit to a project you can’t change your mind. If you need a short-term investment, this is not for you. In addition platform fees can be high, and taxes include ordinary and qualified dividends together with capital gains. These projects are risky, and in the past, the SEC required accreditation to invest because they are so risky. Today, they have eased those restrictions, but it is still a risky business. Finally, the downside of new technology is that its untested. None of them have been through a financial downturn until right now. We will see how they hold up.
The bottom line is this, it all comes back to risk and reward. Can you tolerate high risk? If you can and are able to keep your money tied up in one investment for an extended period, then this may be a good deal for you. If not, there are other real estate investment alternatives, like REITs.5
Final Thoughts on What is Crowdfunding Real Estate
Crowdfunding may be a great investment if you can tolerate high risks and long investment horizons. Low investment thresholds allow many new and small investors access to large commercial projects. Anyone can invest in crowdfunded projects today, but you should remember that historically the SEC restricted this to accredited investors for a reason.