The Pros & Cons of Real Estate Crowdfunding
May 2, 2022
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If you're looking for a way to get into real estate investing, but you don't want to physically own the real estate or be a landlord, real estate crowdfunding can be an option. With crowdfunding, you invest in real estate with many other investors. You don't physically own the property, but you have rights to the equity or debt, depending on your investment.
What Is Real Estate Crowdfunding?
Real estate crowdfunding platforms bring together real estate builders and developers with individual investors interested in investing in real estate without owning the physical properties themselves.
Investors can invest in residential properties and commercial real estate projects in either an equity or debt position. There are several ways to invest in real estate using real estate crowdfunding platforms, including the following types of investments.
Equity Crowdfunded Real Estate Investments
When you invest in a property's equity, you own a fraction of the property. This means you have access to the property's rental income, appreciation, and equity buildup. You might earn regular dividends, either quarterly or monthly from the income, and you'll get a full payout when the investment matures.
Equity investments are often long-term and don't have redemption programs, so make sure any money you invest can be tied up for a while. Like any investment, there are risks in investing in equity. The developers or builders could have roadblocks and give up on the real estate projects, or they could run out of money, and the investment could go upside down.
On the flip side, if you've invested in a commercial real estate project that's on track to earn money, you could earn money from rent and the property's appreciation if you can hold on for the duration of the investment. Investing in equity is like being a partial owner of the property even though you don't have any physical rights to it.
Debt Crowdfunded Real Estate Investments
Debt crowdfunded real estate investments are the funds builders and real estate developers need to complete their projects or buy commercial real estate deals. However, some builders or developers can't get financing from a traditional lender because they already have too many loans or don't have a good track record or credit.
When you use a real estate crowdfunding platform to invest in debt, you pool your funds with other investors, and the fund manager lends the fees to the borrower. There are various investment opportunities in debt investments, and each has a different risk factor.
The good news is that real estate acts as the collateral, so there's the hope that you'd get something if the borrower defaulted, but again, the risk of loss always exists. If the loan goes as planned and the real estate market cooperates for builders and developers, you'll earn interest monthly and be fully paid off by the end of the loan term.
Most real estate crowdfunding platforms have a strong due diligence process to measure the risk level of each loan, giving it a 'grade.' It's up to you to decide what grade loans you want. Since the minimum investment requirement for many debt investments is low, you could diversify your funds across several loans.
Crowdfunding vs REITs
Crowdfunded real estate projects and real estate investment trusts (REITs) both fund commercial real estate investments, but in a different way.
Crowdfunded real estate projects focus on one project. You don't diversify your portfolio. Instead, your funds are focused on one particular project. Depending on the type of investment, whether debt or equity, you might earn dividends monthly or quarterly. A crowdfunded real estate project is the closest thing you can get to physically investing and owning real estate.
Typically, crowdfunding is reserved for accredited investors only. You need a lot of capital and a high risk tolerance since the minimum investment is usually pretty high. You must do the legwork to determine if the real estate crowdfunding deals are a good deal or if they involve substantial risk.
REITs or real estate investment trusts, you don't invest directly in a piece of real estate. Instead, you buy shares of a company that invests in real estate. REITs fund managers usually invest in commercial real estate, such as multi-family units, retail properties, and office buildings.
Most REITs have a portfolio of several real estate investments, some debt, and some equity. All REITs must distribute at least 90% of their profits to their shareholders. If the investment goes as planned, you should receive regular dividends, but there's always the risk of loss like any investment.
Crowdfunding has its pros and cons. Understanding the 'good' sides can help you determine if it's right for you.
Crowdfunding often pays much higher dividends than REITs because you invest directly in the real estate development you want. You might earn interest if it's a debt investment or rental income if it's an equity investment. Because the risk is higher, there is usually a much higher payoff.
The dividends are what most investors call passive income. You don't have to do anything for the earnings, they just show up as the property appreciates or a mortgage is paid down.
Portfolio Diversification and Expansion
An investment portfolio should always be diversified, but that can be hard to do when you only invest in the stock market. Instead, a diversified portfolio should include alternative investments, including real estate and other commodities. Real estate investments also have the potential to expand your portfolio as it grows with equity build and capital gains.
Since investing directly in real estate can be expensive and risky, many people turn to crowdfunding to experience the returns real estate offers without the risk and hassle of owning it themselves.
Access to Unique Real Estate Projects and Opportunities
Real estate investors aren't just people that buy houses and rent them out. Instead, they can be investors behind the scenes, funding the debt or equity of real estate projects so builders and developers can fulfill their dreams while investors make passive income.
You might have access to unique real estate development opportunities that you otherwise wouldn't have access to. Real estate investors can get creative with their projects, and if you decide it's something you think is a good idea, you can jump in on the investment too.
Eliminates Typical Landlord/Property Owner Concerns
If being a landlord was never on your list of things I want to do when I grow up, crowdfunding gives you a way to be a real estate investor without the hassle of managing the property, finding tenants, and being on call 24/7 if something goes wrong.
Owning real estate yourself means you must be ready to handle any problems, be able to screen tenants, and know what to do when you have sudden vacancies that you weren't expecting. Even if you hired a property management company, there are still specific tasks that fall on you that some investors just don't want.
Lower Investment Minimums
Investing in real estate usually requires a lot of capital, but real estate crowdfunding sites offer low minimum investment requirements. You might even find platforms that provide minimum investments of just $500. Before this, you'd probably never guessed you could invest in real estate with such little capital. As a result, you get to enjoy the perks of investing in real estate without breaking the bank.
All investments can lose money, but there are a few other disadvantages of crowdfunding real estate investment opportunities that you should understand.
Management and Advisory Fees
Most investments have management fees, but crowdfunding platforms tend to have much higher fees than other investments. Therefore, it's important to do your due diligence and find out the costs, reading the fine print to know exactly what you're on the hook for when you invest with a crowdfunding platform. Some platforms have zero management fees, so shop around before you settle.
Can’t Easily Sell Assets
Real estate isn't liquid. Before you enter an investment, make sure you know the timeline. Not all programs have a redemption program which could mean you're on the hook for 5 - 10 years, depending on the timeframe of the investment.
Must Pay Taxes on Dividends Earned
Unless you open an IRA and invest in crowdfunded real estate investments, you'll pay taxes on your dividends as ordinary income. This could increase your tax liability and decrease your profits.
Relatively Little History
Since crowdfunding is a newer concept, we don't have a lot of past performance to determine the investment opportunities' stability and future performance.
Some Opportunities Are for Accredited Investors Only
Many crowdfunding platforms only allow accredited investors. This means you must have a net income of $200,000 for the last two years and/or a net worth of at least $1 million.
Popular Crowdfunding Options
Streitwise offers a private REIT. It's open to accredited and nonaccredited investors. It focuses on equity investments in large companies and has a minimum investment requirement of $10,000. The average rate of return is 8%, and they are very transparent about their fees. In other words, you won't sign up thinking you're paying a certain amount of management fees only to find out there are other fees too.
Diversyfund offers a multi-family REIT. The fund manager invests in multi-family properties that they buy and rent out, collecting rent as passive income for its investors. The minimum investment is just $500 for Diversyfund, and they charge zero management fees.
All Diversyfund portfolios are for five years, so you must make sure you can tie up your funds for that long. You also won't receive dividends during the investment period as Diversyfund reinvests all dividends back into the fund.
Fundrise is an investment platform with a low minimum investment requirement. You only need $10 to start investing, so you don't have to be an accredited investor to use Fundrise. However, if you have more money to invest, they have more complicated portfolios that require as much as $10,000 to invest.
Like most crowdfunded investments, Fundrise has a 5-year requirement for each investment.
Only accredited investors may invest at Crowdstreet, and you'll need at least $25,000 to invest. Crowdstreet offers the unique option to accredited investors to invest in individual properties or a portfolio of properties.
Groundfloor is an excellent platform for nonaccredited investors looking to jump into real estate investments. Its investment criteria is minimal as you invest in short-term real estate loans that last between 6 - 12 months.
It's up to you to vet the opportunities and ensure they are right for you, but Groundfloor can be a good option for everyday investors. Their ROI is often between 7% - 12%, but there's always the risk of loss.
Crowdfunding Alternative: Concreit
If you're looking for an alternative to crowdfunded investments, consider Concreit, a real estate investment app that offers private non-traded REITs. They invest in private loans for real estate projects. They can be commercial real estate such as retail buildings and office buildings or multi-family properties that earn rental income.
Concreit is simple and open to non-accredited investors, with investments starting at just $1. Your portfolio will consist of equity and debt investments, and there is a redemption program if you need to withdraw your funds early.
Concreit's focus is on private loans and multi-family projects. Concreit has a strong due diligence program, but you should always do your own diligence to ensure a portfolio is right for you.
Can You Crowdfund in Commercial Real Estate?
You can crowdfund in commercial real estate. It can be an excellent way to invest in rental properties and earn decent rental income. You don't need direct access to the properties, but you can enjoy the returns commercial real estate might offer.
Is Real Estate Crowdfunding Profitable?
No investment is foolproof. While real estate often has a great ROI, that doesn't mean crowdfunded investments will always be profitable. It's always a good idea to diversify your investments, so you aren't reliant on one industry and don't risk a total loss.
How Much Does Real Estate Crowdfunding Cost?
Every crowdfunding site has different management and administrative fees. Always read the fine print and know the bottom line before agreeing to an investment. Some platforms charge no management fees and others charge a percentage of the money invested.
Do You Have to Pay Taxes on Real Estate Crowdfunding Earnings?
You'll pay taxes on your earnings, just as you would for any other investment earnings. The only exception to the rule is if you have some of your portfolio invested in your IRA. This is a tax-deferred account which means you pay taxes when you withdraw them during retirementbut not when you earn them.
Real Estate Crowdfunding Bottom Line
Real estate crowdfunding sites can be an excellent way to diversify your portfolios and invest in real estate. But before you do, look at all of your options and decide if crowdfunded real estate is better or if you should consider a real estate app like Concreit to get your feet wet in real estate without paying too many fees or needing a lot of capital. Learn more by signing up and visiting our blog.
This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security which can only be made through official documents such as a private placement memorandum or a prospectus. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Neither Concreit nor any of its affiliates provides tax advice or investment recommendations and do not represent in any manner that the outcomes described herein or on the Site will result in any particular investment or tax consequence.Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Concreit does not guarantee its accuracy.