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Real Estate Crowdfunding: What Is It, How Does It Work, & Investing

crowdfunding Apr 24, 2019

Crowdfunding is not just a buzzword in the contemporary world. It’s an exciting, new way to raise capital for real estate investments. But how does is it differ from the other means of raising real estate investment capital? How does it fund real estate projects and what should you know before you use it to raise capital?

This article answers these and other questions you may have in mind when thinking about funding for your next real estate project with crowdfunding money.

What is Real Estate Crowdfunding?

Real estate crowdfunding is a way of investing in real estate with other investors through platforms that propose deals in real estate while taking care of all the involved works that may include listing deals, doing the legal work, and managing properties. As such, real estate crowdfunding enables you to invest with a little amount, diversify properties, and have a passive portfolio in the industry.

Crowdfunding differs from the traditional ways of raising money for real estate investment because it is done online. In addition to crowdfunding websites, investors use social media networks like Twitter and Facebook to directly market ventures to more interested investors.

To some investors, crowdfunding is an alternative to the traditional ways of financing their investments. A large developer for instance can use a crowdfunding platform to get investments from accredited investors. A small business person can launch a campaign with an aim of raising money for a small investment deal.

How Does Real Estate Crowdfunding Work?

At the core, crowdfunding entails pooling money for an investment project from an investors’ group. Essentially, crowdfunding in real estate has existed for centuries. Multiple institutions have also come together to buy properties collectively, whether they buy single family homes, or different types of commercial assets.

Modern real estate crowdfunding differs from collective real estate investment of the past because transactions are now being done via online mediums. Investors also have access to unparalleled deals and cash flowing assets using the internet as a distribution platform.

Basically, real estate crowdfunding enables you to invest money in low amounts in terms of equity or debt. This approach makes you a proportional stake owner in either the portfolio/property or the underlying mortgage to receive payments in monthly or quarterly dividends. 

The two major types of investments in real estate crowdfunding are:

  1. Equity Crowdfunding - In this investment, dividends comprise of rental income. Investors in equity crowdfunding own a portfolio’s or property’s proportional share and earn rental profits as income and also when or if they sell the property.
  2. Debt Crowdfunding - The interest income that is earned off the mortgage payments of a portfolio or property comprises of the dividends in this investment. Investors do not own any property’s proportional share and if/after the sale of the property.

It’s easy to find many crowdfunding websites online allowing you to pursue any of these investments. Some allow the participation of both non-accredited and accredited investors while others allow investments by accredited investors only. It’s however important that you do your due diligence before you decide to invest with any platform.  

Is Real Estate Crowdfunding Legal?

Yes, real estate crowdfunding is legal. Pooling investors’ money with an aim of investing in real estate is a concept that has legally existed for many years. In the past, it was known as syndication. Before 2012, this concept was limited to families and friends and it wasn’t allowed to be done online.

However, the Jumpstart Our Business Startups Act of 2012 changed this. Title III of the JOBS Act made equity crowdfunding legal when done by licensed broker-dealer or through a funding platform that is registered. Using crowdfunding, companies raise up to one million dollars within a year from non-accredited and accredited investors.

Since it involves commercial enterprises investments, crowdfunding is generally subject to the regulations of the Securities and Exchange Commission (SEC). It also attracts more investors, particularly those yet to be accredited. JOBS Act allows for general solicitation in some ways. It allows companies to give direct notice of an offering’s existence to the public.

However, debate on the legality of real estate crowdfunding is not over yet. According to some legislators, crowdfunding regulations by Securities and Exchange Commission, especially the registration and compliance requirements, are time-consuming and too onerous to make it profitable. These can hobble the practice even before its take off.

On the other side, some legislators argue that SEC is yet to do enough in protecting investors, especially the unaccredited ones. Because the JOBS Act became a law some years ago, there are many bills that have already been introduced with an aim of addressing conflicting issues. However, a majority of them are yet to become laws.

Do I Need to be an Accredited Investor for Crowdfunding?

In some cases, you don’t need to be an accredited investor for crowdfunding, and in others you do. Different states have adopted different versions of crowdfunding regulations in addition to the efforts made by congress to improve laws that govern and regulate it. However, all states have laws that permit participation of both accredited and non-accredited investors though with strict limitations in some cases.

What is an Accredited Investor?

An accredited investor is an entity or a person that is permitted to invest in the securities that have not been registered with the SEC. Investing in all types of securities has a risk. However, unregistered securities have an additional risk because information about them is not available to the public.

A company can decide to use the existing regulation when issuing securities in order to avoid the expensive and timely process of registering with SEC and a full-blown IPO. Companies that issue securities under exemptions are restrained to sell securities to accredited investors only.

Most real estate crowdfunding websites cater for the needs of both non-accredited and accredited investors. That means the investment opportunities you will be eligible for will to some extent be determined by the website you choose. Qualifications of an accredited investor are determined by SEC.

To be an accredited investor, you should meet these criteria:

  • Have a joint income of $300,000 or individual income of $200,000 for the last 2 years.
  • Have a joint or individual net worth of $1,000,000, exclusive of the primary residence value.
  • Be an executive officer, director, general partner for a non-regulated securities issuer.

A non-accredited investor is the one that does not meet these accredited investor’s financial qualifications.

How to Get Crowdfunding for Real Estate?

The main purpose of real estate crowdfunding is to enable investors to invest in projects or properties bigger than what they could manage or afford on their own. Investments are marketed via investment pages after going through an approval process.

Investment pages feature every project’s overview. This overview includes the sponsor’s description and local market details. It also features the business plan summary details and possible cash flows. It also features a review of the legal structures, fees, and risks.

To get crowdfunding for real estate, you need to visit the online marketplace then browse the available opportunities. These opportunities vary by geography, investment type, and target returns. Once you choose an investment depending on your goals, your funds will be pooled with those of other investors and the investment will be closed.

After that, you will collect your passive income as you monitor the performance of the investment till it exits. The most important thing is to do your due diligence with what you want in mind. Also make sure that transaction of the actual investment will be fairly simple.

The major steps of investing in real estate crowdfunding are generally as follows:

  • Select your preferred investment and sign a subscription or legal document.
  • Your bank account will be debited with the funds.
  • The funds will be pooled with other investors’ funds.  
  • The investment will be closed after pooling enough money.  
  • You start receiving distribution payments as per the investment offering materials’ outline if all goes according to plan.

Just like with other investments, there are no guaranteed returns with real estate crowdfunding. Therefore, you need to make careful considerations when it comes to the risk profile of your preferred investment and your goals.

Crowdfunding Real Estate Loans

Since the recession, there has been a decline in the rate at which banks lend to developers in the real estate industry. In addition to crowdfunding, personal loans and P2P (Peer-to-Peer) loans have facilitated bridging of the gap. This can be attributed to the fact that banks will most likely not consider you if you have a poor credit score.

Essentially, crowdfunding real estate loans fill the financing gap that exists between hard-money loans and conventional loans. When compared to conventional loans, crowd funding loans are more flexible. Their terms are usually also better than those of hard money loans.

Financiers enjoy the benefits of diversifying risks. A financier is not required to fund an entire real estate project. Thus, they can spread money over different projects. They also benefit from the involvement of other financiers. Therefore, the projects undergo extensive scrutiny.

Capital conservation is the pillar of any smart strategy in real estate investment. However, hefty down payments limit the growth of investors when buying properties. Traditional lenders tend to ask for 20 to 30% down payment.

Real estate loans from crowdfunding can make things much easier. They allow investors to avoid hefty down payments and have more cash as their working capital. In some cases, lenders offer up to 100% financing to keep cash flowing for investors and allow them access it where and when they need it.

Crowdfunding Real Estate Development

Real estate development has usually been an investment source for private equity companies or real estate investment trusts. For most people, real estate development has not been a feasible direct investment. This is because a real estate development venture is a finite and registration of the products as securities, or under Regulation D filings, tend to be inefficient.

Additionally, the Securities and Exchange Commission did not allow real estate developers to actively solicit or market investments for these projects. Crowdfunding led to the modification of Regulation D rules. The modification opened a solicitation and direct marketing door to investors.

Real estate developers can now depend on crowdfunding websites to invest in the market. Crowdfunding websites classify investors to make sure that they qualify for private real estate developments. Investors hope that this online real estate investment market will keep flourishing to allow them a better alternative in the future.

Top Real Estate Crowdfunding Platforms

A major challenge that most investors have is that a crowdfunded real estate investment tends to be an illiquid investment. This implies that in case of an emergency, cashing out the investment before its sale is almost impossible. It’s easy to enter an investment online. However, you may not have control of the exit process.

As such, it’s important to choose your real estate crowdfunding platform carefully. Today, there are many platforms with varying features and options. It’s important that you select a platform on the basis of the credibility, functionality, quality of customer service and documentation. As a starter, it might be wise to avoid a website that functions like a listing service. Instead, choose a platform that acts like a broker-dealer. It’s also important that you pick a platform that depicts experience in handling your preferred investment type.

A website with a solid capital backing for its venture is the best. An investment can be locked up for some time. It’s therefore important to ensure that the platform you use is credible. It should be a platform that will keep running properly for a longer duration. Also inspect the way your chosen platform does due diligence.

When signing up, ask crucial questions. For instance, what documentation type does your preferred platform collects for the potential deals? Are companies required to provide indemnities or liabilities to the investors? What happens if things fail to go according to plan?

Finally, check the customer service of the platform. Come up with a list of questions that will enable you to understand the quality of the customer service provided by the platform. Find out if the platform provides all the assurance and information you need to decide whether to sign up or not.

Here are the top crowdfunding platforms you may want to consider:

These platforms list different projects and the funds required for every project vary. In some of these platforms, you will be allowed to pick where and what you wish to invest in. With others, your investment will be diversified across different projects. These may include both residential and commercial real estate.

Real Estate Crowdfunding Reviews

Choosing a wrong real estate crowdfunding website can be a very expensive mistake. As such, you need to be careful when picking the platform to invest with. A better way to choose a real estate crowdfunding website is by reading deep real estate crowdfunding reviews.

Currently, there are many websites that feature comprehensive reviews of different crowdfunding platforms. These sites use different criteria to review crowdfunding websites for real estate. However, the basic functionality level is a major factor that is considered by these reviews.

According to most real estate crowdfunding reviews, a good platform should be functional without fake investments. It should also have a minimum of one open investment with an exclusive focus on real estate. Additionally, most reviews focus on platforms that provide all the information investors need on their websites. Alternatively, if you are curious about any of the reviews of a crowdfunding company, then email them directly to inquire about them.  

When reading real estate crowdfunding reviews, it’s important to note that though reviewers do their best to verify information accuracy, they do not guarantee 100% accuracy of all the information. There are also times when the information is not made public and is not readily available. In some cases, the information can change after some time.

Therefore, prospective investors should be very careful and do their own research. Find out more about a platform before you make the decision to invest with it.

Best Real Estate Crowdfunding Sites

With so many real estate crowdfunding sites to choose from, you definitely want to know how to choose the best platform. It’s important to note that there are many factors that you should consider when choosing the right website.

Bear in mind the fact that each real estate crowdfunding website is different. Some are better than others in some ways. Therefore, take time to research different platforms in order to identify their weaknesses and strengths.

Consider factors like the time a site has been operational, its track record, return performance, deals, management information, and company funding.

Effective criteria for choosing the best real estate crowdfunding sites entail consideration of the following:

  • Ease of using the crowdfunding website or portal
  • Presence of a solid list of closed and active listings showing a proven track record
  • A clear, interesting investment niche

Take time to investigate the niches and merits as well as the downfalls of each website. Also find out whether the site allows you to invest only when you are an accredited investor and/or if you are not accredited.

Real Estate Crowdfunding for Non-Accredited Investors

Title III of the Jumpstart Our Business Startups Act makes raising capital for small businesses possible with an aim of spurring economic growth by making job creation easier. It has provisions that permit non-accredited investors to take part in real estate crowdfunding.

The crowdfunding platforms for non-accredited investors have been expanding over the years with an increasing demand due to Title III.

Some of the platforms that provide real estate crowdfunding for non-accredited investors include:

Although Title III regulations permit non-accredited investors to take part in crowdfunded investments, it also limits them. SEC has placed restrictions on the amount a non-accredited investor is allowed to invest over a year. The individual limit is generally based on income and net worth of a person.

The major reason to impose these limits is to reduce the risk of non-accredited investors that may not know much about general investing or crowdfunding in particular. Also, the limit is there to decrease the amount of money a non-accredited investor can lose in the event of a failed investment.

Is Real Estate Crowdfunding Safe?

If you’re a cautious investor (and wisely so), you want to know if real estate crowdfunding is safe. Most crowdfunding sites claim that they are highly uncorrelated with markets and that they are based on their offerings. Basically, real estate crowdfunding does not have same risks with traditional lending markets. However, it has its risks too.

Some of the major real estate crowdfunding risks include: 

  • A borrower can default on a loan
  • The company you decide to back can go bust
  • The crowdfunding platform can face legal challenges
  • Your chosen crowdfunding platform can go bankrupt

However, real estate crowdfunding may be safe in the sense that they are legitimate investment options and businesses. Generally, it is to be expected that a borrower can default, and a startup investment can also fail. Additionally, there are major issues that crowdfunding sites face such as restructuring.

Most real estate crowdfunding platforms solely advertise their successful returns & deals and, for obvious reasons, don’t really tout the deals they’ve had defaults with. However, this does not mean you won’t have issues like late payments and investments that may perform differently as advertised. The most important thing is for you, as a prospective investor, is to conduct extensive research upfront.

Commercial Real Estate Crowdfunding Investing

Investing in commercial real estate was a privilege for the wealthy before the introduction of the commercial real estate crowdfunding concept. In the past, only institutional investors and ultra-high-net-worth individuals could invest in commercial real estate.

However, commercial real estate crowdfunding introduced a new paradigm. This concept differs from real estate investment trusts substantially. It allows the common investor to passively invest in commercial real estate.

With commercial real estate crowdfunding, investors can diversify their portfolio with little time invested. As always, he most important thing is to make informed decisions on the basis of historical data to enjoy long-term profitability. Essentially, commercial real estate investment data is crucial in making effective decisions to invest in crowdfunded commercial deals.

Real Estate Crowdfunding vs. REIT

Both real estate crowdfunding and REITs offer the options of diversification and balance from the bond markets and traditional stock. They also offer value from rental income and appreciation of the existing real estate assets. The two investments allow investors to pool capital and therefore provide a less intensive way of investing in different real estate properties.

You also invest passively with these approaches. That means you don’t have to worry about daily management and operation of the asset because this is done by reputable teams of managers.

However, real estate crowdfunding differs from a REIT because crowdfunding enables you to invest into tangible real estate directly. With REITs, you invest in corporations that invest money in real estate on your behalf.

Actually, a significant percentage of total investments in REIT can be assets rather than real estate. As such, real estate crowdfunding allows you more transparency and control than REITs. With crowdfunding, you also take part in the vetting process of investments.

More & more, we’re starting to see that real estate crowdfunding can provide higher returns, higher leverage, and less volatility than REITs.

Real Estate Crowdfunding Statistics

In addition to being popular for the opportunities it provides to new investors, real estate crowdfunding is known for delivering high returns. With crowdfunding, you invest in properties situated in prime locations all over the world while diversifying your investments across different properties.

Here are some of the real estate crowdfunding statistics that demonstrates why it is so popular:

How to Start Real Estate Crowdfunding Today

Although exciting times are here, the real estate crowdfunding sector is in the early stages with a long way to go.

If you want to start a Real estate crowdfunding platform or site for yourself, then consider these tips:

  • Decide what you want to sell - The real estate crowdfunding industry has many products that you can offer, such as: equity financing, debt securities, and non-traded, & private REITs.
  • Invest in the right technology - You need experts to create a website with the right technology and provide ongoing maintenance. You also need programmers, project managers, & acquisition specialists to acquire the real estate investments.
  • Build up an investor list - Build up a list and network of investors. Your success here will largely depend on the quality of your investment opportunities and investor strength within the marketplace.
  • Get funding for the venture - Get money for your real estate crowdfunding startup. Scale, growth, and being different than the competition will be key to the next successful real estate

Obviously, building a successful real estate crowdfunding company requires interest, diligence, hard work, and a top-notch team. A strict legal team will necessary, as well, to verify documents, investors’ information, and create the necessary investment paperwork to make the right moves.

 

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