What is real estate crowdfunding?
JOBS Act was adopted in 2012, making the real estate crowdfunding possible. The act aimed to encourage small business, in particular, using the power of crowdfunding.
Crowdfunding is pooling money from the number of investors to further investment. Crowdfunding is attractive for investors because it allows non accredited investors to invest in private real estate deals. Each platform offers a minimum investment which ranges from $5,000 to $10,000, giving the small investors a chance to diversify their portfolio.
Initially, business owners had to invest money into the development companies or via REIT. Mainly wealthy investors could afford using such type of financial instruments.
Nowadays, business owners can reach the pool of unaccredited investors to raise money. According to the Securities and Exchange Commission, a non-accredited investor has an annual income of less than $200,000 annually. If you want to become an accredited investor, you need to earn at least $200,000 or $300,000 together with a spouse.
How does real estate crowdfunding work?
The main difference between the traditional methods of raising money and crowdfunding is that now it is done via online platforms. There is a Sponsor, and he has not enough money to fund the entire project. He needs to raise money. But how? He already asked family and friends but is still not enough. He needs crowdfunding, and he creates a platform. Now, the investors and look at the deal and invest if interest. A Sponsor is ready to negotiate with a developer to make a downpayment and receive the right of ownership. Then, the ownership will be divided among all the investors.
A Sponsor is responsible for searching for financial resources, developing, and operating of real estate projects while the investor has to choose the right deal and invest.
How to start?
You can create an account at one of the platforms and get access to private real estate deals. The modern market has many different online platforms like Realty Shares, Realty Mogul, Fund Rise, Equity Multiple, Alphaflow, and many others. Some platforms welcome net worth investors only, but most of them are open for everyone.
We can advise putting your attention to those platforms having their “skin in the game.” For example, Equity Multiple personally co-invest in each project. This guarantees that a Sponsor will do his best to make a deal successful.
Study what each platform offers you, in the end, to know how much you are risking. Also, study how many successful deals a platform have closed. We cannot advise you to start working with a brand new platform as it can be too unpredictable and risky. When you found the right platform, choose the deal you like the most, and you are ready to invest.
Most online platforms offer equity and debt investment. Like any financial instrument, both these investment types have advantages and disadvantages.
Equity investment means that investor invests in real estate, and in return, he holds a stake in the equity capital. An investor share in the profits when a property is developed, sold, or rented.
- You are not just crediting to fund a deal. You are an investor who owns shares and has a right to profit split. The earning potential is not limited;
- An equity investor has tax benefits. You are a property owner so that you can reduce taxes thanks to depreciation costs;
- Equity investments offer lower fees. You can pay an annual fee that runs between 1% to 2% of the total invested amount.
- Equity investment considered to be riskier than debt investment; A seasoned Sponsor is the key to success. It may not be a problem to raise money. This is just the first step. However, if a Sponsor fails to have a solid business plan, the risk of failure increases.
- As a rule, debt investments are secured by property, while equity investments are considered to be unsecured. So, you are not the first one who will receive money in case of bankruptcy.
- The holding period is much longer. It can be five or even ten years. This factor should be considered if you want to maintain the liquidity of your portfolio.
When investing in debt financial instruments, an investor plays the role of a lender to a property owner or sponsor. The biggest plus is that the property itself always backs debt investment. An investor is sure to receive his money if something went wrong.
- The very first advantage is pretty distinct – the debt instruments are less risky;
- The holding time is shorter. As a rule, it takes six months to a year before you start receiving income;
- An investor gets a fixed return limited by the interest rate; An investor will receive a steady income on a quarter or annually basis.
- An online platform does not take anything for creating an account. However, when you are a part of a deal, be ready that a platform will charge a fee before paying you interest.
- When the deal generates some profit, you do not take part in a profit split. An interest rate limits your income. So, your income potential is limited.
- A debt investor has no tax benefits. He has no right to claim depreciation deduction because he is a lender, not an owner.