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Real Estate Crowdfunding - Definition, Risks, And Advantages

Real estate crowdfunding is an innovative new approach to investing in property. Real estate opportunities that were once reserved for the wealthy are now accessible to non-accredited investors thanks to this novel strategy.

William Willis
Jan 08, 20244377 Shares61650 Views
Real estate crowdfundingis an innovative new approach to investing in property. Real estate opportunities that were once reserved for the wealthy are now accessible to non-accredited investors, thanks to this novel strategy. In real estate crowdfunding, the introduction step is crucial since it lays the groundwork for the whole investment process.

What Is Real Estate Crowdfunding?

Crowdfunding is a method of raising capital that involves gathering small contributions from a large number of individuals. Initially used primarily for donation-based initiatives, crowdfunding has evolved, particularly in the realm of real estate, where technological advancements have facilitated its adoption for business purposes.
Real estate crowdfunding brings together multiple investors to collectively finance a specific real estate project. This approach allows individual investors to enter the real estate market with a significantly lower investment than they would need if pursuing a solo real estate venture. The expectation is that these investors can earn passive income from their contributions.
Typically, real estate crowdfunding involves three main parties:
  • Project initiator -Often a developer, this party proposes the real estate project and seeks funding.
  • Investors -Individuals who contribute funds to support the project.
  • Crowdfunding platform -This platform facilitates the crowdfunding process. Specialized platforms exist to assist project initiators in raising capital for their real estate ventures. These platforms typically vet projects, providing individuals with opportunities for passive investment.
Unlike traditional real estate investing, where significant capital is often required, real estate crowdfunding platforms enable investors to participate with amounts as low as $1,000 and, in some cases, even as low as $10, depending on the specific platform. Importantly, investors in real estate crowdfunding generally do not play a hands-on role in business decisions, making it more accessible for a broader range of individuals.

How Real Estate Crowdfunding Works

Crowdfunding is the practice of raising capital from a diverse group of investors through online platforms or social media channels. Traditionally associated with charitable donations, crowdfunding has expanded to include equity transactions, empowering small and medium-sized enterprises to pool funds for various purposes, like acquiring equipment or constructing manufacturing facilities.
The emergence of crowdfunding for investments can be traced back to the enactment of the Jumpstart Our Business Startups Act (JOBS)in 2012. This legislation facilitated crowdfunding for small and mid-sized companies by reducing reporting requirements and easing Securities and Exchange Commission (SEC) regulations, broadening the scope of crowdfunded investing. However, it imposed restrictions on the amount an investor could contribute based on their net worth and income.
In response, the SEC introduced Rule 506(c) under Regulation D, allowing public advertisements for securities with the condition that all investors were verified as accredited. Additionally, the introduction of Regulation A+ in 2015 enabled companies to raise $75 million annually from public investors. These regulatory developments have paved the way for a more accessible and expansive landscape for crowdfunding in the realm of investments.
In 2020, the Securities and Exchange Commission (SEC) implemented Regulation Crowdfunding (CF), introducing the option for entities to adopt a "common owner CF" model for fundraising. This regulatory framework extends to various ventures, including real estate and small business initiatives. A year later, the SEC raised the investment ceiling under Regulation CF from $1.07 million to $5 million, significantly broadening the scope of opportunities available for nonaccredited investors.
Real estate crowdfunding closely resembles its equity counterpart, allowing investors to purchase a stake in a property and become shareholders. Unlike traditional real estate investments, investors are not required to buy entire properties; instead, they can invest an amount of their choosing and earn a portion of the profits generated by the investment.
This could include a share in the revenue generated from a rental property or the proceeds from a property sale. Top real estate crowdfunding platforms provide investors with a low entry point, enabling them to participate with as little as approximately $1,000.

Benefits Of Real Estate Crowdfunding

Real estate crowdfunding presents a significant advantage by allowing both individuals and businesses to attract a wide array of investors for their projects. Investors, in turn, benefit from acquiring a small ownership stake in the property or venture.
One of the key advantages for investors in real estate crowdfunding is the considerably lower capital requirements compared to other methods of gaining exposure to real estate. Large-scale property investments, such as apartment buildings, offices, or hotels, often involve costs in the millions or tens of millions of dollars. Through crowdfunding, investors can access these opportunities without committing a substantial amount of capital, with minimum investments as modest as $1,000.
A noteworthy development is the Securities and Exchange Commission (SEC) lifting the ban on non-accredited individuals participating in crowdfunding activities. Previously, investors had to meet specific income or net worth criteria to be considered accredited. This regulatory change opens up crowdfunding for equity and real estate transactions to a broader audience, allowing non-accredited investors to engage in these investment opportunities.
Real estate written on a gold gear and crowfunding written on a silver gear in each other
Real estate written on a gold gear and crowfunding written on a silver gear in each other

Risks Of Real Estate Crowdfunding

Real estate crowdfunding has become a popular avenue for investors seeking entry into real estate projects, but, like any investment, it comes with inherent risks. This section will delve into the risks associated with real estate crowdfunding and strategies for mitigating them.

Lack Of Liquidity

A significant risk in real estate crowdfunding is the lack of liquidity. Once invested in a project, selling your investment may prove challenging. In contrast to stocks, which can be swiftly bought and sold, real estate investments often entail a lengthy selling process, spanning months or even years. This lack of liquidity poses a potential issue if there is a need for quick access to invested funds.

Lack Of Control

Investing in a real estate crowdfunding project implies minimal to no control over the venture. Decision-making authority rests with the sponsor, who manages aspects ranging from property selection to day-to-day operations. While investors can scrutinize a sponsor's track record and investment strategy beforehand, they have limited influence over project management decisions.

Risk Of Default

Real estate projects are not exempt from default risk. If a project fails to generate sufficient income to repay investors, there's a risk of default on the loan by the sponsor. In such instances, investors may face the possibility of losing a portion or the entirety of their investment. Mitigating this risk involves a thorough examination of the sponsor's financials and past performance before committing to an investment.

Market Risk

Real estate values are subject to fluctuations based on market conditions. A downturn in the real estate market can lead to a decrease in the value of your investment. To mitigate this risk, it's crucial to thoroughly assess the sponsor's investment strategy and understand the dynamics of the local real estate market before committing to an investment.

Fees

Real estate crowdfunding platforms often impose fees for their services, including annual management fees or a percentage of profits. These fees can impact your returns and diminish the overall profitability of the investment. Carefully reviewing the platform's fee structure before investing is essential to ensure that it aligns with reasonable expectations.

Diversification

Investing solely in a single real estate project carries inherent risks. If the project underperforms, there's a potential for losing the entire investment. Diversifying across multiple projects is a key strategy to reduce overall risk. Some real estate crowdfunding platforms provide diversified investment options, such as funds or portfolios encompassing multiple projects.

REIT Vs. Crowdfunding

A Real Estate Investment Trust (REIT) is a company that owns and manages income-generating properties, providing individuals with the chance to invest. Comparable to real estate crowdfunding, investing in REITs allows anyone to participate with a modest upfront investment by acquiring shares in the REIT company.
At a glance, real estate crowdfunding and REIT investment seem quite similar, and indeed, they share some key similarities. Both options enable investors to get involved with a minimal initial investment, and the investment typically yields passive income for the individual. However, there are notable distinctions worth highlighting:
Real Estate CrowdfundingREITs
Investors can choose which projects to invest inInvesting in an REIT gives you broad exposure to a portfolio of assets
People can invest with as little as $1,000Individuals can invest with as little as the cost of one share
Real estate crowdfunding is a private equity investmentREITs are a public equity investment
Real estate crowdfunding is illiquid, and investors generally must keep their money in for a minimum termREITs are liquid and investors can generally sell their shares anytime
Determining which option is suitable for you depends on your preferences. Both real estate crowdfunding and REITs offer opportunities for individuals to passively invest in real estate with a low minimum investment.
However, if you desire hands-on experience in the real estate industry or wish to be more actively involved, real estate crowdfunding might be the preferable choice. This avenue allows you to select your investments and often provides the chance to collaborate with developers, offering your input throughout the process.

How To Get Into Crowdfunding

Before venturing into real estate crowdfunding, it's essential to consider the type of real estate that aligns with your investment goals. Whether your interest lies in single-family homes or commercial real estate, this decision sets the foundation for your investment strategy.
Once you've determined the preferred property type, the next step is to identify the most suitable crowdfunding platform. Platforms like CrowdStreet specialize in commercial properties, while others, such as PeerStreet, focus on providing opportunities for investment in single-family homes.
It's crucial to be aware that various platforms have distinct investor requirements. For instance, CrowdStreet caters exclusively to accredited investors, whereas many other platforms have more inclusive criteria.
An advantage of real estate crowdfunding platforms is the ability to select specific projects for investment. Consequently, after choosing the property type and the appropriate platform, you can initiate your search for the ideal investment opportunity.
Two people shaking on a real estate crowdfunding deal
Two people shaking on a real estate crowdfunding deal

Investment Limits For Crowdfunding

Investing in any form of crowdfunding carries inherent risks, and the SEC has implemented investment limits for non-accredited investors.
For individuals with an annual income or net worth less than $124,000, the investment limit within any 12 months is either $2,500 or up to 5% of the lesser of their annual income or net worth.
For those with an annual income and net worth equal to or exceeding $124,000, the investment limit within any 12 months is up to 10% of their annual income or net worth, whichever is lower. However, the maximum allowed investment in this case is capped at $124,000.

Who Can Invest In Real Estate Crowdfunding?

Real estate crowdfunding has emerged as a popular investment option, allowing investors to collaboratively fund real estate projects without substantial capital commitments. The key question revolves around the eligibility of investors for real estate crowdfunding. In this blog section, we will delve into the different categories of investors who can participate in real estate crowdfunding and the criteria they must fulfill.

Accredited Investors

Accredited investors are individuals meeting specific income or net worth criteria established by the Securities and Exchange Commission (SEC). They are permitted to engage in private offerings, including real estate crowdfunding.
To qualify as an accredited investor, an individual must boast an annual income of at least $200,000 or a net worth of at least $1 million, excluding their primary residence. Accredited investors enjoy a broader range of investment opportunities compared to non-accredited investors, gaining access to potentially higher-return, albeit riskier, projects.

Non-Accredited Investors

Non-accredited investors are individuals who fall short of the income or net worth thresholds defined by the SEC. The Jobs Act of 2012 expanded opportunities for non-accredited investors to participate in real estate crowdfunding.
They can invest up to 10% of their annual income or net worth, whichever is lower, within 12 months. While non-accredited investors have a more limited scope of investment options, they can still engage in projects with lower risk and potential returns.

Self-Directed IRA Investors

Self-directed IRA investors are individuals with a self-directed individual retirement account (IRA), enabling them to venture into alternative assets, including real estate crowdfunding. Adhering to specific rules and regulations set by the IRS is crucial for these investors to avoid penalties and taxes. For instance, a custodian must be in charge of holding the IRA, and all transactions must go through this custodian.

Institutional Investors

Institutional investors represent entities that invest on behalf of others, such as pension funds, endowments, and insurance companies. With substantial resources at their disposal, institutional investors can engage in large-scale real estate projects, including real estate crowdfunding. Their considerable financial leverage allows them to negotiate more favorable terms and fees compared to individual investors.

Real Estate Crowdfunding - FAQ

What Is REIT Crowdfunding?

A real estate crowdfunding platform gives its investors direct access to real estate investments. A REIT gives you broader exposure to real estate without directly owning the property. REITs do not provide defensive protection from stock market volatility.

Do You Get Money From Crowdfunding?

Crowdfunding can get you money to build a business, and the attention to build a customer base. Grants are a great funding option for some businesses. They can be a lot of work to get, but the reward is free money.

How Do Crowdfunding Investors Get Paid?

If you're going to become a crowdfunding investor, note that: You get returns from shares in case of business acquisitions and IPOs, and dividends from annual profits if a business succeeds; Debt-based investments are typically done through notes, bonds, and a portion of loans.

Bottom Line

Whether it's a hotel, apartment complex, or office building, real estate crowdfunding allows regular people to have a stake in big real estate projects. Investors face difficulty thoroughly researching crowdfunding companies and their track records due to the industry's early phases, despite the enticing opportunities.
Thoroughly researching the crowdfunding platform is crucial for individuals thinking about investing in real estate. Think long and hard about the investment's possible benefits and drawbacks before making any moves.
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