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Is Real Estate Crowdfunding a Solid Investment?

December 27, 2021

Real estate crowdfunding has allowed investors to tap into a market that otherwise would have remained unreachable.

Despite being a relatively new concept in real estate investing, crowdfunding is rising in popularity among investors who want to get into pricier commercial real estate investments, such as office buildings in major cities, but lack the millionaire status to make it happen.

To determine if real estate crowdfunding is right for you, you must understand what it is, how it works, and the advantages and disadvantages of this type of investment.

What is crowdfunding?

Real estate crowdfunding allows investors to combine money from different sources to take advantage of commercial real estate (CRE) opportunities.

It allows investors to participate in opportunities historically restricted to those with millions available to invest, such as remodeling a 600-room hotel.

When investors think of partially investing in real estate, they usually think of real estate investment trusts (REITs), but these differ from crowdfunding. In a REIT, your money is divided among various properties, whereas in crowdfunding, the money you invest is in one property.

How does crowdfunding in real estate work?

Crowdfunded real estate investments usually have a targeted timeframe and income level for investors.

Investment opportunities get presented by experienced real estate developers or investors known as the "sponsor".

The sponsor is responsible for most of the work that goes into the investment, including negotiating prices, hiring contractors, and overseeing the project. Once the property is ready for sale, the sponsor is also responsible for selling the property and distributing profits to the investors. The sponsor receives a percentage of the deal's profits in return for overseeing its completion.

The crowdfunding platform connects the project sponsor to investors, acting as an intermediary and handling any legal regulations pertaining to the project.

The crowdfunding platform gives the sponsor a place to pitch their investment opportunity and be upfront to investors about what their return on investment will likely be, along with how long they plan to hold the property before selling.

Investors can search for opportunities that meet their investing goals and the amount of risk they are comfortable with, and they fund a portion of the deal on the investment they choose.

The sponsor then pools the funds from the investors to fund the deal.

Investment limits for crowdfunding

As mentioned above, the SEC set limitations on how much non-accredited investors can invest in crowdfunding opportunities.

For those with less than an annual salary or net worth of $107,000, you cannot invest more than the greater of either $2,200 or 5% of your annual income during a 12-month period.

If your annual income or net worth exceeds $107,000, you are permitted to invest up to 10% of the lesser of your annual income or net worth during a 12-month period, but you cannot invest more than $107,000.

Advantages of real estate crowdfunding

  • CRE deals can yield significant returns on investment: It is not unheard of for crowdfunded CRE deals to reach annualized returns of 15%, and some even go higher than that. The crowdfunding platform lists a targeted Internal Rate of Return, or IRR, to give investors a reasonable expectation of the projected return.
  • Diversify investment portfolio: Crowdfunding allows investors to take on a new type of investment, and valuable addition to a portfolio of residential rental properties, stocks, and mutual funds.
  • No property ownership hassles: Since all aspects of the project, including renovations, are overseen by the sponsor, so the investors have little cause for concern. Investors simply pay their portion of the deal and let the sponsor take care of everything else.
  • Don't need a large amount of money to invest: Investors can contribute as little as $1,000 to a CRE crowdfunding deal. Any contribution could yield significant investment gains if the company eventually goes public and issue new stock.

Disadvantages of real estate crowdfunding

  • Single-asset investments can limit your spread of funds: Investing in one asset can yield high returns, but you are also putting all your funds into one investment, hoping to earn a profit. For instance, if you invest in a REIT where your funds get distributed among 50 properties, and one property takes longer to sell than anticipated, you will likely not experience any changes to your profitability. However, if you invest in one property and some unexpected delays occur, it may impact your profit.
  • High execution risk: With crowdfunding, investors typically invest in a value-adding project, which gives CRE deals their high earning potential. However, this causes the investors to become reliant on the sponsor executing the project according to plan.
  • Illiquidity: All real estate investments are illiquid, but CREs are especially so. The investors are bound to a hold period before they can cash out of the investment, and a three-to-seven-year period is standard. Also, the stated holding period initially pitched in the crowdfunding platform is not binding. If a property has a holding period of five years, but a recession happens at the end of the five years, the sponsor may decide to hold onto the property for the benefit of the investors.
  • The company you invest in is unknown: Investors are investing in a new or emerging company, so there is always the possibility the business fails, and investors lose their money.

As an investor, you should not invest in crowdfunded CRE without considering how the advantages and disadvantages affect you and your investing goals.

Your investment goals, desire for risk, and the crowdfunding platform you select will help determine if crowdfunding is a good fit for you.

All in all crowdfunded real estate could be a great opportunity and yield significant returns for those who desire to add a solid long-term investment to their portfolio.

 

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