By NerdWallet, Want to invest in an income producing, multi-family property in Indianapolis? How about helping fund a brand new shopping center in California? Thanks to real estate crowdfunding, ordinary investors may now be able to invest in real estate projects that were once available only to deep-pocketed real estate developers.As with any investment, real estate crowdfunding presents some risks. Therefore, potential investors are wise to perform their own due diligence before making any decisions.
What is real estate crowdfunding?
Most people have heard about crowdfunding through Kickstarter, an online platform that allows the public to fund projects such as movies, new products or trips. In the past, crowdfunding was donation-based. But when Congress passed the JOBS Act, lawmakers legalized equity crowdfunding, which gives investors a small ownership stake in the projects they fund.
When it comes to real estate crowdfunding, the money is raised to purchase either commercial or residential real estate investments, including office buildings, retail shopping centers, and single-family or multi-family homes.
Entrepreneurs or real estate companies seek to raise money from investors to fund these projects. The company gets capital to complete the projects, while the investor hopefully gets a solid income on their investment when the project is finished, and then a share of the proceeds when the project is sold.
What are the advantages to real estate crowdfunding?
Real estate crowdfunding gives investors access to privately held real estate, an asset class they might not have been able to invest in previously, whether it’s due to a lack of capital or the difficulty of getting started. This can be an easy, attractive way for investors to gain diversification into the real estate sector.
Traditionally, purchasing a real estate property for investment often requires a great deal of money upfront. For example, an investor purchasing a $200,000 investment property is likely required to put at least 20% down or $40,000 to close on the property. Factor in closing costs, the amount of money to close jumps to at least $45,000 for a single property. With real estate crowdfunding, however, you might be able to spread out your $45,000 over four or five different properties in different markets across the country.
With real estate crowdfunding, the investment you make is directly in a property through a real estate company, which takes care of all the work. You can invest in properties across the country – something you might not have been able to do on your own.
For example, Fundrise.com, a real estate crowdfunding platform, offers a number of public and private real estate investments across the country. The choices range from a New York multifamily rehab in Harlem, which comes with a projected annual return of 23%, to a single-family home construction in Berkley, Michigan, a suburb of Detroit, with a projected return of 12%.
Fundrise.com boasts average returns of 12-14% annually. You can choose individual properties to invest in with minimum investments starting as low as $100.
Groundfloor.com is also open to non-accredited investors, requiring as little as $100 to get started. Projected investment returns range from 8% for a single-family home in Atlanta, to 11% for a multi-family development in Powder Springs, Georgia.
However, other websites such as RealtyMogul and iFunding require you to be an accredited investor, which means you have to make at least $200,000 a year or have a net worth of more than $1 million to invest.
Also keep in mind that the returns listed on these websites are just projections based on past performance, and are by no means guaranteed returns. The actual amount of money you earn could end up being far lower than expected, or worse, you could end up losing money.
How does real estate crowdfunding comply with the law? Investments are structured as private placements under SEC Rule 506c of regulation D, which allows investors to raise capital through the sale of equity or debt, but only to accredited investors. Therefore, any offer on a real estate crowdfunding site through regulation D must meet certain conditions, which can be found at the SEC website.
Other sites that don’t require accredited investor status, such as Fundrise and GroundFloor, uses Regulation A, which is an exemption for public offerings less than $5 million in a 12-month period.
How can I invest?
To invest, you are required to sign up at the company’s website (it’s usually free to do so). From there, you can use the website to pick and choose from a variety of investment opportunities.
You can complete the entire process online – from signing documents and transferring funds, to receiving dividends and tracking your investment performance.
You should understand the length of each investment and the exit strategy. Some investments may be “buy-and-hold” investments with terms of 5 years, meaning you will receive income up to that point, but won’t be able to receive your entire principal back until the fifth year. Other investments might be more like “flips” that only come with an investment term of one year, allowing you to get your money back much faster.
Understanding your investment strategy and your individual needs and goals is important, as with any investment.
Why not REITs?
Previously, investors’ next best option to gain exposure to the real estate market has been investing in real estate investment trusts, or REITs, which are companies that own real estate. REITs can be bought on major stock exchanges. However, there are a few advantages to investing in real estate through crowdfunding over REITs.
First, with crowdfunding, you know exactly what property or building you are investing in, giving you more control over your investments. You know exactly where your money is going. When you invest in a REIT, it’s possible you are investing in a company with a bunch of properties that you know little about.
The price of REITs tends to be driven by market sentiment, rather than the actual value of the company’s assets. REITs are vulnerable to a market downturn, just like other stocks. For these reasons, real estate crowdfunding could make for a better investment than REITs.
What are the risks to real estate crowdfunding?
As with any investment, real estate crowdfunding comes with some risks, including the potential loss of your money.
First, you must keep in mind that these investments are not insured by the FDIC or any other federal agency. The projected returns listed on each crowdfunding website are based on past performance, which is no guarantee of future results.
Many things can go wrong with real estate investing in particular – whether it’s an issue with the tenants not paying rent, an accident at one of the properties resulting in a lawsuit, an unknown defect in the property that was not found during the inspection, or a property not performing up to expectations.
For these reasons and more, it is important to carefully choose which company you do business with. You may want to choose an experienced real estate developer over one with less experience.