Real Estate CrowdFunding VS Traditional Real Estate Investment

By Anthony J. Zeoli, Ever find yourself dreaming of being the next Donald Trump and building a huge residential tower? Or better yet, putting up a luxury hotel in Vegas? Well now you can … sort of. With the introduction of real estate crowdfunding (i.e. “RECfunds” or “RECfunding”), ordinary investors now have the opportunity to invest in the types of real estate projects that have traditionally been reserved for professional real estate developers and highly connected, ultra-wealthy, real estate investors.

 

RECfunding is set to redefine how we invest in real estate and it’s taking off across the country and around the world. This two-part article will give you a brief introduction to investing in real estate through RECFunds versus more traditional methods as well as the benefits that RECFunds bring to today’s real estate investors (for part 2, click HERE).

TRADITIONAL REAL ESTATE INVESTMENTS.

Traditionally, those who wanted to invest in real estate and real estate related projects had very few options. Here are the main three:

  • Approach 1 – the Direct Approach.

Under the direct approach, the investordeed(alone or with a group) will find purchase a particular investment property directly. This option, however, is NOT for the casual investor. First, selecting and acquiring a profitable piece of real estate requires a great deal of experience and skill that a casual investor lacks. Even more important, under this approach, the investor has to have (or have access to) the full amount of capital needed to purchase the property, and it doesn’t end there. Under the direct approach, the investor would be directly responsible for the time, energy, and costs of holding and operating the property until it can be sold/rented, not to mention any expected or unexpected repairs that might arise after a purchase (think, Tom Hanks in Money Pit). Even from this simplified description you can see that the direct purchase of real estate requires a significant amount of knowledge, capital and time which most investors just do not have or do not want to commit to one investment.

  • Approach 2 – the Network Approach.

red_network [Converted]Rather than finding and purchasing a property directly, highly connected investors have often relied on word of mouth through their own networks to access quality real estate investments. These investments can range anywhere from investing in the acquisition/development of a particular property to investing money in a real estate development company that expects to handle multiple projects. This approach holds several advantages over the direct approach for investors. First, they can rely on the skill of others to both identify quality properties and to operate/develop them after acquisition. Second, the investor’s maximum capital commitment is generally limited to the amount of their initial investment. This is a significant benefit over the direct approach where the investor, as the owner of the property, would be on the hook for any and all costs associated with the acquisition and carrying of the property.

While this approach has many advantages over the direct approach, it is not a viable option for the ordinary investor. The “network” approach (sometimes called the “country club” approach) requires just that, a network (and a good one at that). Most ordinary investors do not have the types of connections necessary to have access to these almost insider types of quality real estate investments. Moreover, these types of investments often require a substantial amount of capital to participate. The minimum amount would be significantly less than under the direct approach but it would still most likely be more than today’s ordinary investor might have access to, or again be willing to commit to a single asset.

  • Approach 3 – Real Estate Investment Trusts (REITs)

Pixelated REITA REIT is an entity that raises capital from investors in order to seek out, acquire and hold a portfolio of real estate investments. These investments range from income-producing real estate (e.g. apartment complexes, hotels, malls etc.; sometimes called an “Equity REIT” or an “EREIT”), to debt secured by real estate (sometimes called a “Mortgage REIT” or a “MREIT”), or some combination of the two (sometimes called a “Hybrid REIT”). In a REIT, an investor typically has no say in what assets are acquired by the entity. Similar to the certain “network” deals, an investor essentially hands their money over to an entity and relies on the expertise of management to select, acquire, hold and operate profitable real estate assets.

The minimum amount necessary to invest in most REITs will be less than the capital needed under the direct approach and, most often, less than under the network approach, as well. That being said, you typically need to invest at least $50,000 to $100,000 to participate in a REIT. For the ordinary investor, this may be a big nut to crack, let alone risking the diversification of their portfolio by allocating that amount of capital to a single investment. Another aspect of REITs that makes them less attractive to the ordinary investor is that the investor does not know upfront what they are really investing in (i.e. what property). The managers will pick the properties/investments as they go along using the capital from investors and pre-determined selection criteria but many of today’s investors want to know upfront what they are buying a piece of.

RECFUNDS AND RECFUNDING.

All hail the coming of RECfunds! RECfunding involves raising the necessary capital for a  particular real estate purchase/project from a “crowd” of investors rather than one or a select few as with traditional approaches. This crowd-based approach to real estate investment combines many of the favorable aspects of the above traditional approaches but in a way that everyday investors can access.

Since the JOBS Act was passed in April 2012, we’ve seen a proliferation of web-based fundraising platforms that cater to a variety of interest groups and industries,” says Joe Elias, co-founder and COO of Michigan-based real estate investment platform Loquidity. “The real estate industry is set to be majorly disrupted for several reasons, including the new general solicitation rules, which allow companies to advertise their investment opportunities, and the fact that people areLoquidity Transparentincreasingly comfortable making substantial investments online. Additionally, a whole new class of investor can now participate since platforms like Loquidity have dramatically lowered investment minimums per deal.”

Like the traditional direct approach, RECfund investors know exactly what property/project they are investing in as opposed to the REIT structure or some network deals as discussed above. This is a significant draw for today’s investors who value knowing exactly what their money is going to buy, not to mention being able to see the actual investment property is often a source of investor confidence. Additionally, with RECfunds, investors can enjoy the economic benefits of “direct” ownership of real estate (e.g. Impressioncash flow income, market appreciation, depreciation deductions, etc.) without the substantial capital and time requirements associated with owning the property directly.

While the network and REIT structures above also involve the pooling of assets from investors, there are two (2) distinct benefits of the RECfund approach to the everyday investor. First, the out-of-pocket investment cost is often significantly less than under either the network or the REIT approach (with minimum investments beginning as low as $5,000 in many cases, and even $100 in some cases). This not only makes such investments more accessible to the everyday investor but allows them to both limit their overall exposure and more easily diversify their investments. Second, RECfunds provide access to private real estate transactions that were traditionally only reserved to high net worth individuals and/or those with an expansive network. Put more simply, with RECfunds “who you know” (or more apt “who you don’t know”) is no longer a barrier to investing in real estate.

Part 2 of this article explores the benefits of RECfunds over traditional approaches in more detail and provide some insight as to the future of real estate investment (for part 2, click HERE).

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