So, you have made the decision you want to get into the real estate business, but not necessarily by becoming a landlord. It is no surprise that this is a popular choice when investing in property is a decision that is bringing financial freedom to many, but the first obstacle can be a tricky one.
How are you going to afford to finance your new business venture?
One creative route that is starting to be used for this very reason is real estate crowdfunding. As surprising as it may sound, this method of investment is redefining the world of real estate, and is proving to be a very lucrative method of earning a passive income.
Crowdfunding is rather different from the traditional route of investing in property, and has leveled the playing field to such an extent that people with a moderate budget are able to invest and diversify their portfolio, something that would be unheard of in recent years. Real estate investment via crowdfunding is quick and easy … it takes only minutes to sign up on a site that offers investment properties to choose from at your fingertips.
Justin Pierce from The Washington Post is passionate about the concept as we can see here:
“Through crowdfunding, iFunding has opened the opportunity to invest in private real estate to millions of individual investors by lowering the minimum investment to $5,000. Crowdfunding is the future!” [source]
The opportunity to invest and make money is easier than ever with this route, but there are some important points to understand in order to remain informed about just what you are financing and how to protect your investment.
What Exactly Is Crowdfunding for Real Estate?
Real estate crowdfunding is the pooling of finances in a real estate project by multiple investors. The types of property available to invest in are varied, with everything from family residences to commercial property on offer in a broad geographical region across the various platforms. It works in two ways:
- Equity Investment – Each investor holds a stake or shares in the property (commercial or residential), and in return, receives a portion of the rental income. This is typically paid out on a quarterly basis.
- Debt Investment – Each investor pays towards the mortgage loan for a particular property. The loans are paid over time with interest, and the investors receive a share of the interest as the loan is repaid. This may be received on a monthly or quarterly basis.
The two options vary in their degree of profitability and risk. Equity investments tend to result in bigger returns, but they can be riskier and take longer to pay off. On the other hand, debt investment is limited by the interest rate set on the loan.
What Are the Benefits of Real Estate Crowdfunding?
Real estate crowdfunding, using either of the two methods (debt or equity investment), is considered to be a lower risk investment compared to other methods of financing property. This is because it is possible to spread funds across a variety of options, rather than pooling all of your available resources into just one property. With a Real Estate Investment Trust, also known as REIT, for example, investors are required to pay 25% upfront of the property’s value. When compared with real estate crowdfunding, which often stipulates a minimum investment in each property of just $5,000, you can see that the scope for diversifying your portfolio is huge.
When compared with REITs, real estate crowdfunding brings greater benefits to investors in many ways:
- Crowdfunding deals are vetted thoroughly, offering increased transparency for investors. Take a look at what Patch of Land have to say about their due diligence in this regard: We ensure that borrowers and projects meet our stringent risk profiles and high underwriting standards using our technology, data analytics and vast real estate experience. [source]
- The financial barrier to entry is far lower with real estate crowdfunding.
- Through real estate crowdfunding, investors may enjoy certain tax benefits (including depreciation) that are not applicable to investors in REITs.
- Thanks to the affordability, investors can diversify their portfolio, combining equity and debt investment, across commercial and residential properties.
The following except from RealtyShares explains the benefits in further detail.
“Commercial real estate investing in other contexts often involves large investment amounts and limited regional opportunities. RealtyShares, on the other hand, allows accredited and institutional investors to invest for as little as $1,000, all from the convenience of an investor’s laptop or tablet computer. This means that investors have the ability to participate in opportunities that historically may have been available only to large institutions. You’ll also be investing “passively” — similar to stocks and bonds — so that you don’t need to directly be concerned with the management headaches associated with a property.” [source]
This is a good question, and the answer isn’t exactly straightforward. The truth is, investments are structured differently across the various crowdfunding platforms – and, therefore, what an investor actually owns, can differ, too.
In some circumstances, a crowdfunding site will create a separate limited liability company for each investment opportunity – and investors own shares within this, which reduces their liability and provides certain tax benefits too.
It is important to read the terms and conditions of any real estate crowdfunding site that you choose to be a part of, so that you are clear about what you are purchasing and how that will affect you, before you go ahead and invest your money.
How to Choose a Real Estate Crowdfunding Platform
As we always reiterate, it is vital to thoroughly research your options before investing in real estate, as there is always risk involved when it comes to money. While it is true that crowdfunding can offer a simple solution to becoming involved in real estate investment (without the need to become a full-fledged landlord with 100% responsibility for a mortgage), it is vital you know exactly what you are getting into, before you start financing a project.
You need to remember that each and every platform for real estate crowdfunding is different. They are individual companies, with differing terms and conditions. Some may suit your needs better than others, so take the time to find out the finer details and identify the strengths and weaknesses of each option.
Remember to call on expert advice for specific information on the viability of investments. The crowdfunding platforms themselves are there to offer you a service, and they want you to sign up, so don’t forget that they are not investment advisors.
Take note of the ‘lock in’ periods for each investment, this is a very important factor to take into account when deciding on deals to finance. The liquidity schedule can have a big impact on the profitability of a project for you.
Be aware that there is always risk involved in any investment, and while real estate crowdfunding may seem like a safe option, it is important to consider the options, and the benefits of diversifying with a combination of properties spread geographically, for example. Take a look at the following FAQ from Realty Mogul, to keep your feet on the ground.
“Are these investments risky?
Yes. Similar to investing in the stock market, there is no guarantee when you are investing in real estate. The real estate market has economic cycles and it is difficult to know how and when the economy will change.” [source]
In conclusion, real estate crowdfunding has opened the industry and leveled the playing field, allowing more and more people to invest in property than ever before. Yes, there are still risks involved, but the great news is that lower barriers to entry mean that investors can diversify their portfolio to such a degree that these risks are largely minimized.
The important points to remember are that each crowdfunding real estate platform comes with its own set of terms and conditions that you should read carefully to ensure you understand exactly what you will own, as well as how long you are committed to any deal.
Be sure to check out the particulars of any deal with a professionally qualified financial adviser, too, and don’t be swept up in the emotions of a “great deal.” The real estate crowdfunding platforms are offering a fantastic service, but we must remember they are there to sell investments. So, keep your head straight and don’t let emotions run wild.
Once you have your information straight and are ready to invest, you can celebrate the fact that investing in real estate crowdfunding offers more transparency than other options, allows greater diversification and, best of all, has been producing greater returns. It seems that this could be the answer many individuals have been waiting for to become involved!