With the passage of the JOBS Act in late 2012, crowdfunding has caught fire and is being used to raise money for everything from startups to small businesses. In fact, by the end of 2014, crowdfunding, which includes debt, equity, rewards and donation based crowdfunding has injected $65 billion into the global economy. And by the end of this year, some predict that crowdfunders will have injected $2.5 billion into real estate alone.
CircleUp and AngelList have made the crowdfunding value proposition possible for startups. The basic premise for real estate crowdfunding is very similar. An investor can access individual real estate properties through an online platform and pool money with other investors to invest as little as $1,000 into that specific property. Because of the complexity of real estate and because the industry is still very nascent, there are still misconceptions about the basic structure (both legal and otherwise) of a crowdfunded real estate investment. And as the Founder and CEO of real estate crowdfunding platform, RealtyShares, I’ve encountered these misconceptions firsthand.
The Investments Results are not Tied to the Success of the Platform Itself
Security is very important in any investing decision. Layer in the risk of making investments through a startup and one might think they’re playing with fire. However, most crowdfunding platforms take supreme precautions to make sure that investments are safely annexed from other entities and corporate considerations. For example, in order to make this possible, RealtyShares, Inc. provides the platform for listing investment opportunities–but a separate entity, RealtyShares Manager, LLC, acts as the manager of each deal. Each deal is also structured through a separate single purpose LLC so debts and obligations of the platform/startup do not effect the performance of the underlying real estate investment. So remember, you are investing in real estate not in the platform itself.
It’s not a REIT
Real estate investment trusts (REITs) are very popular instruments to get exposure to real estate. REITs are an important piece of a diversified portfolio, but they do not give the same flexibility and transparency as crowdfunded real estate investments. When you own a REIT, you are investing in a company that owns and operates many real estate investments. You do not choose the specific properties. Real estate crowdfunding offers an additional layer of transparency in that you can choose your specific properties and learn about the owner/borrower. They are also a nice hedge against the stock market, while REITs tend to have closer correlation with stocks. Of course, REITs offer instant liquidity whereas with crowdfunded real estate you’re locked in until an exit event such as loan maturity or the sale of the property (which can range from six months to ten years).
Debt v. Equity – They Aren’t the Same
Real estate crowdfunding has two primary subgroups – debt and equity. In the case of debt, the investor is entitled to monthly interest as well as a return of any unpaid principal at maturity but does not receive the benefit of property appreciation. The investment is also secured by the property and if the borrower fails to pay interest and principal when due, the investor has recourse and can recover his/her investment through a foreclosure. Equity investments allow the investor to “own” a piece of real estate. A savvy investor will invest in an equity deal with hopes of the property value appreciating. If/when the property appreciates in value and sells, the investor is entitled to an outsized return on their investment. Of course, there is always the chance the investment underperforms in which case the investor bears the risk of loss of their investment to a greater degree than if they were investing in a loan.
It’s Not Really Crowdfunding
Crowdfunding for real estate has been praised as a way to democratize the real estate investment market by giving mom and pop investors an opportunity to invest. Unlike Kickstarter or other donation and rewards based crowdfunding v, however, real estate crowdfunding has thus far largely been available only to Accredited Investors—generally, high net worth individuals. However ,that could change with the passage of the final rules for Title III of the JOBS Act which would allow platforms like RealtyShares to offer investments to all investors.
Investors are constantly looking for new ways to diversify. Investor confidence in real estate is back and crowdfunding has opened up new doors. Accordingly, it is now more important than ever for investors to understand exactly what they are purchasing when participating in a crowdfunded real estate investment.