What is Real Estate Crowdfunding?
Real Estate Crowdfunding is a method used by real estate businesses to raise funds for real estate ventures. Instead of relying on one or a few investors to invest large sums of money, crowdfunding combines and uses smaller investments from a pool of individual investors.
Crowdfunding through social media is a way of marketing to a broader audience. Facebook and Instagram are a few platforms that real estate companies use, as well as real estate crowdfunding websites, to draw the attention of interested and potential independent investors.
Real estate crowdfunding allows investors to invest capital in the mortgage or equity of a real estate venture. As a result, investors then have the right to a percentage share, or in other words, become shareholders, in either the real estate project or the mortgage and receive profits monthly or quarterly from the rent or interest rates applied to the loan for the mortgage.
Real estate crowdfunding investing can be broken down into two categories:
- What is equity crowdfunding? Equity crowdfunding commonly includes profits that arise from a share of the monthly rent. The investors then own a percentage share of the real estate and collect dividends from rental payments and the sale of the property.
- What is debt crowdfunding? Debt crowdfunding means an investor makes a living from the interest collected from a property’s mortgage. However, unlike equity crowdfunding, investors do not own a percentage share of the real estate and do not acquire a share of the sale of the property.
As an alternative, real estate crowdfunding is mainly done through the internet. It offers real estate investors the opportunity to invest in a real estate project or portfolio of projects that they wouldn’t have been able to without the support of crowdfunding. A wide variety of websites facilitate real estate crowdfunding by gathering investments from a crowd of real estate investors to help with the funding of a real estate project. Crowdfunding can involve both certified and uncertified investors, depending on the individual crowdfunding company’s terms and conditions.
Whether you choose equity or debt crowdfunding, the investment usually lasts for a specified period, and the capital funds are collected when the agreement expires.
What are the criteria for an accredited investor?
“The regulations for accredited investors vary from one jurisdiction to the other and are often defined by the local market regulator or competent authority. In the United States, the definition of accredited investor is put forth by SEC in Rule 501 of Regulation D.”
An accredited investor is categorized, by the Securities and Exchange Commission (SEC), as:
- Earning an income of at least $200,000 for a minimum of 2 years.
- Having a net worth of more than 1 million dollars.
- Being a “general partner, executive officer, director, or a related combination thereof for the issuer of unregistered securities.”
Equity vs Debt Crowdfunding
Real estate crowdfunding can be broken down into two categories: equity and debt crowdfunding. Debt crowdfunding occurs when an investor invests in the mortgage of a property or portfolio of properties. On the other hand, equity crowdfunding occurs when an investor invests in the actual real estate property. Investments in real estate equities are the most popular choice amongst investors as they are a long-term investment and can often bring in greater profits.
A breakdown of equity crowdfunding
By investing in real estate equities investors could:
- Earn an income from monthly rental payments.
- Make a profit from the increase in the value of the property over time.
Most crowdfunding agreements consist of investments in equity. With equity investments, the investor owns a share in a property, and their claim depends on the total capital that was initially invested. Profits come from a cut of the rental payments. They can also arise from the appreciation and/or sale of the property.
The following list of advantages and disadvantages has been sourced from Investopedia.com
- No cap on returns – Equity investments offer a broader horizon in terms of earning potential. It’s possible to see annualized returns ranging from 18% to 25%. Since there’s no cap, however, the sky is the limit from an investor’s perspective.
- Tax benefits – One perk of owning an investment property can deduct certain expenses associated with its ownership, such as depreciation and the cost of repairs. With equity crowdfunding, deals are typically structured through an LLC, which is treated as a flow-through entity for tax purposes. That means that investors can reap the benefits of the depreciation deduction without having to own property directly.
- Lower fees – Equity investments have the potential to be cheaper where fees are concerned. Rather than paying upfront fees and monthly service fees, investors may pay a single annual fee to maintain their position in the property. The fee is calculated as a percentage of the total amount invested and often runs between 1% and 2%.
- More risk – Equity crowdfunding may put more money in investors’ pockets, but it means taking a bigger gamble. Investors are second in line when it comes to receiving a payback on their investment, and if the property fails to live up to its performance expectations, that can easily translate to a loss.
- Longer hold period – Equity investors are looking at a much longer time frame compared to debt investors. Hold times can stretch out over five or even ten years, which is an essential consideration if you’re interested in maintaining a high degree of liquidity in your portfolio.”
A breakdown of debt crowdfunding
By investing in real estate debt crowdfunding initiatives, the investor funds the mortgage of a property or portfolio of properties. Capital return is received through the interest rate on the mortgage and the sum of the initial investment.
The following list of advantages and disadvantages is sourced from Investopedia.com
- Shorter hold time-Debt investments are most often associated with development projects. As a result, they typically have a shorter holding period compared to equity investments. Depending on the nature of the deal, the hold time may last between six and 24 months. That’s a plus for investors who aren’t comfortable tying up assets for the long-term.
- Lower risk- Because of the way deals are structured, investors take on less risk with debt investments. The loan is secured by the property, which acts as an insurance policy against repayment of the loan. In the event the property owner or sponsor defaults, investors can recoup the loss of their investment through a foreclosure action.
- Steady income- Debt investments are more predictable in terms of the amount and frequency of return payouts. While every deal is different, it’s not unusual for investors to earn yields ranging from 8% to 12% annually. These returns are typically paid on a monthly or quarterly basis.
- Capped returns – Debt investments entail less risk, but one major downside is the fact that the interest rate on the loan limits returns. Investors have to be clear about whether they’re willing to sacrifice the potential to earn higher yields in exchange for a safer bet.
- Higher fees – While most real estate crowdfunding platforms don’t charge investors anything to create an account and research debt investments, there’s usually some fee involved to participate in a deal. The crowdfunding platform usually takes a percentage off the top before any interest is paid out, which can eat into your returns. There may also be a separate loan origination fee that’s passed on to investors.”
Crowdfunding opens a passage for individual investors to make profits without the headache of a bank loan. It offers smaller companies the opportunity to boost startups and gives independent, individual investors a way of taking part in real estate investments.
Crowdfunding can be a powerful way of marketing, especially for companies that are trying to endorse their business to a broader audience. Real estate companies often advertise their project or portfolio of projects on social media and webpages that promote and offer crowdfunding investing opportunities. A great way a crowdfunding business can illustrate their credibility to potential investors is by publishing records of previous projects.
What type of investor is best suited for real estate crowdfunding?
Real estate crowdfunding is best suited for the individual investor who would otherwise not be able to access the investment due to the scale and financial burden that real estate investments pose. Moreover, real estate crowdfunding offers a passive form of investment, in the sense that you do not have to undertake the responsibilities and costs associated with property maintenance and development.
Real estate crowdfunding is most appropriate for:
- Investors who want to invest in the real estate markets but don’t have enough money to invest in a project on their own.
- And investors who want a hands-off and passive style investment scheme that saves them the hassle of keeping up with maintenance costs and general landlord duties.
- Because real estate crowdfunding is done online, it means that investors from across the globe can get involved, which consequently expands the scope and variety of potential investors.
A brief history of Jumpstart Our Business Startups (JOBS) Act
On April 5th, 2012, the President of the United States of America, Barack Obama, signed the Jumpstart Our Business Startups Act, putting it into full legislative effect. The JOBS Act allows businesses to get the ball rolling without the hurdles set by strict regulations.
“However, given the loosening of restrictions, along with allowing for new sources of capital raising, it comes with new provisions protecting potential small investors, such as requiring startups utilizing crowdfunding to register with the SEC and provide information on their financial health and risks. Others have suggested that small individual investors are not financially sophisticated enough or lack the financial education or knowledge needed to invest in early-stage companies.”
“Crowdfunding is a way for companies or individuals to raise money by accumulating relatively small amounts from many individual contributors. The JOBS Act specifically is concerned with equity (or investment) crowdfunding, whereby ownership shares are sold – sometimes on a fractional share basis. This is different from donation-based crowdfunding platforms (which Kickstarter and GoFundMe tend to feature), whereby companies do not offer any debt or equity stake in return for contributions. Rather contributors may receive discounts on certain items or receive early access to a company’s new products.”